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5 September 2006
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Feature Article
Integrating Southeast Asia's economies
go
The region is falling behind its rivals. Turning it into a true single market would boost its
competitiveness and help restore its economic luster.
Adam Schwarz and Roland Villinger
2004 Number 1
On the face of it, Southeast Asia should be an investor’s paradise. It offers a market of 560 million
people, rich natural resources, skilled labor, and an export industry concentrated in global highgrowth sectors—all tied together in a free-trade area created by the Association of Southeast Asian
Nations (Exhibit 1). In fact, ASEAN’s $330 billion consumer market equals that of China’s booming
coastal region in value and is bigger than any other market in Asia. The group’s ten member
countries (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore,
Thailand, and Vietnam) control 40 percent of the oil and gas resources in the Asia-Pacific region and
boast a strong industrial base benefiting from relatively low wages in attractive sectors such as
consumer electronics, PCs, and semiconductors.
Yet after achieving higher economic growth than virtually any other part of the world since ASEAN’s
inception, in 1967, the region has slipped dramatically in the wake of the Asian financial crisis that
began in 1997. Foreign direct investment shrank by two-thirds, and aggregate economic growth
dropped by 50 percent—in stark contrast to China’s surging investment, exports, and GDP growth
(Exhibit 2). Although the financial crisis hit investment and growth hard, the painfully slow
recovery—and the widening gap with China—signal more basic problems. In an increasingly
globalized economy, investors can pick and choose their markets according to the cost of labor,
capital, and materials as well as the productivity of companies using these factors. Southeast Asia is
losing its competitive edge.
Our yearlong study1 of the region has led us to conclude that ASEAN can no longer compete on low
labor costs alone. In 2002, a civil engineer in Thailand earned an average of $397 a month,
compared with $163 in China. A software developer made $927 a month in Thailand, compared with
$490 in India. To make the region competitive again, ASEAN’s leaders must raise workers’
productivity and cut costs across the production value chain, thereby boosting demand, foreign
direct investment, and exports. By extension, the rate of GDP growth will rise as well, since each
time a company increases its productivity, it generates an economic surplus, which becomes
available to consumers as lower prices, to employees as higher wages, or to shareholders as higher
profits.
ASEAN’s productivity challenge must be tackled through both national reforms and regional
integration. Member countries should remove homegrown barriers that raise costs, reduce
competition, and deter new investment (see sidebar, "The domestic agenda"). Equally important,
ASEAN must find the political will to reduce further the tariffs and nontariff barriers that raise the
cost of doing business across the region’s borders.
These reforms would in effect create a single production platform—as well as a large home market—
throughout Southeast Asia, thus enabling companies to realize economies of scale and to capitalize
on the region’s comparative advantages.2 They would also provide the incentive global companies
need to increase direct investment in Southeast Asia.
The price of fragmentation
Today the ASEAN countries are less a unified market for goods and services than a collection of
disparate markets. The consequences aren’t lost on investors, who shy away from the higher costs,
uncertainty, and subscale markets that fragmentation creates.
A lack of unity . . .
Intraregional trade as a percentage of the region’s total trade is perhaps the best measure of
ASEAN’s economic integration. From 1994 (when the group launched its free-trade area) to 2001,
intraregional trade as a proportion of total trade fell by 19 percent. By comparison, it rose by 41
percent in the first ten years of the European Union, by 17 percent in the first seven years after the
inception of the North American Free Trade Agreement (NAFTA), and by 67 percent in the first nine
years of Mercosur’s existence.3
A second sign of ASEAN’s economic fragmentation is the continuing high divergence of consumer
prices in the region’s countries, as we found when we analyzed the cost of 70 common household
products in most of them. The same packet of instant noodles, for example, costs nearly twice as
much in the Philippines as it does in Malaysia. On average, prices for the same goods varied by 31
percent across the region. In an integrated market, prices should converge—and fall—as the lowestcost suppliers export to the rest of the region and less efficient producers must improve their
productivity. In the European Union, price differences for the same goods fell to an average of 5
percent after the launch of the single European market, in 1992, compared with 17 percent in the
mid-1980s.
. . . puts off global investors
As our 100-plus interviews with investors and executives in the ASEAN countries and around the
world show, the higher costs of doing business in the region’s fragmented market stand in stark
contrast to the integrated Chinese market’s larger economic potential. Investors cited three main
concerns about ASEAN:
1.
2.
3.
Subscale markets. Since ASEAN isn’t integrated, companies can’t manufacture and market
goods for the whole region’s large and attractive consumer market. The challenge for
ASEAN’s companies is to reach production levels allowing them to operate at an
economically efficient and globally competitive scale. Every carmaker in the region, for
example, has production runs of fewer than 150,000 units a model—the low end of the
minimum efficient scale for auto manufacturing.
Unnecessary costs. Different product standards across member countries prevent
businesses from standardizing products—a problem that can add 10 to 15 percent to
operating costs. Until recently, for instance, a company that served both the Indonesian
and Thai soap markets needed different production runs to manufacture 100-gram (0.22pound) soap bars because in Indonesia weight is measured at the factory while in Thailand
it was measured on the shelf. Evaporation during transport meant that soap bars had to be
produced at 104 grams for the Thai market. Thailand ended this anomaly last year, but
countless similar cases remain across the ASEAN region. An executive at a processed-foods
company, for example, told us that different product standards for ice cream routinely add
three months to intraregional deliveries, thereby lengthening factory-to-shelf times, causing
stock-outs in shops, and ultimately raising consumer prices and the company’s cost of
working capital.
Unpredictable policy implementation. Investors expressed frustration over the way certain
policies are implemented and doubted ASEAN’s willingness and ability to integrate. An
executive at a consumer goods company, making a common complaint, explained that
ASEAN’s tariff rates were determined more by the whim of customs officials than by
government policy. Although the ASEAN Free Trade Area (AFTA) has a 0 to 5 percent tariff
band on raw materials, officials in some countries demand higher payments, adding millions
of dollars to the company’s charges. A representative of an electronics company noted that
identical parts can take from one day to more than five weeks to clear customs.
The benefits of integration
When markets integrate, increased economies of scale and scope, competi-tion, and productivity at
the company level all lead, at the regional level, to higher investment flows, more intraregional
trade, and the emergence of robust, globally competitive enterprises. Judging from the European
Union’s experience, the benefits of deeper integration across the ASEAN economy would be on the
order of 10 percent of the regional GDP, distributed over several years.
For a better understanding of how economic integration would benefit businesses in these countries,
we studied two sectors in detail: consumer goods and electronics. Consumer goods, the region’s
largest traded sector, account on average for 58 percent of household spending. Electronics, the
region’s most important export sector, represents some 50 percent of ASEAN exports. Jobs are at
risk in this sector unless rapid action is taken to boost the region’s competitiveness.
Our case study in the electronics sector reveals that market reforms to increase regional integration
could cut the costs of companies by 10 to 20 percent (Exhibit 3). Manufacturing costs will fall for
two reasons. First, a bigger consumer market reduces per-unit overhead and direct-labor charges.
Second, lower tariffs on components and the ability to buy the cheapest inputs regardless of country
of origin within the region lead to lower components costs. Thanks to improved efficiency in
collecting customs, logistics costs will fall—both directly (because of speedier deliveries and lower
warehousing and administrative costs) and indirectly (through improved inventory management).
The study of the consumer goods sector yielded similar results. In all, greater market integration
could cut the expenses of companies by up to 20 percent. Scale economies could eliminate about 10
to 12 percent of the cost of production by concentrating it in fewer, more specialized plants in the
region. Faster factory-to-shelf times—particularly important in the food business, where freshness is
critical and shelf life limited—could provide a further 5 or 6 percent worth of savings, since every
individual food shipment would no longer be subject to inspection and regulatory approval, which
now take up to three months. Faster factory-to-shelf times would also reduce working-capital
requirements, with a cost effect of around 2 percent.
Achieving a single market
Our study highlights a number of factors that have diluted ASEAN’s previous efforts to integrate its
ten economies. Foremost among these factors has been a lack of political will in most of the region
because of widespread uncertainty among policy makers and business executives about the end
goal of economic integration and its benefits for individual countries.
This lack of political will is also reflected in ASEAN’s past reluctance to create regional institutions to
expedite decision making and raise investor confidence in the integrity of the group’s commitments.
ASEAN remains primarily a government-led trade group. Members propose and consider policies
collectively, make decisions by consensus, and rely on mutual trust to implement policies. This
approach has helped preserve regional stability but is less suited to dealing with the myriad
technical policies that economic integration requires. The ASEAN Secretariat has neither the power
nor the resources to formulate and propose policies, coordinate their implementation, monitor
compliance, and settle disputes. Weak regional institutions have been a key reason for the relatively
low impact of ASEAN’s previous initiatives to reduce tariffs, eliminate nontariff barriers, and
enhance regional cooperation.
To set in motion the benefits that increased regional economic integration can bring—and to
overcome the factors now blocking it—ASEAN countries should implement a two-pronged
integration plan: a sector-based approach to focus the region’s integration efforts and a set of
reforms to create regional institutions and processes strong enough to manage the urgent and
complex tasks involved.
Fast-track sectors
Reforms across the entire economy are not only politically difficult but also risky. A well-targeted
approach focused on sectors, by contrast, would show more clearly the benefits of integration over
time and generate political support for extending the program.
We recommend that ASEAN begin an accelerated integration program in selected critical sectors—
mainly consumer goods and electronics—and then roll out the program more broadly.4 Four
initiatives should be pursued to achieve genuine economic integration:
1.
2.
3.
4.
Eliminate nontariff trade barriers. ASEAN’s most urgent priority is to remove nontariff trade
barriers. The group must increase the efficiency of customs, harmonize or mutually
recognize product and technical regulations, and remove duplication in testing and licensing
procedures. In the electronics sector, for example, most ASEAN countries don’t recognize
one another’s technical regulations, testing requirements, and certification procedures. The
result is a confusing welter of rules that indirectly raise costs for companies. ASEAN must
accelerate the work of harmonization and move toward regional performance directives—a
more flexible and cost-effective way of synchronizing regulations across countries. Instead
of indicating detailed product-specific technical requirements that may change, performance
directives identify the essential performance requirements for a given type of product.
Enhance tariff reform. Eliminating internal (intraregional) tariffs on trade as soon as
possible will diminish the amount of paperwork and speed up customs clearance. In
electronics, for instance, average internal tariffs are about 3 percent across ASEAN. These
low tariffs (the International Monetary Fund calls them "nuisance tariffs") can be eliminated
with little effect on government revenues. In addition, the closer alignment of each member
country’s external (interregional) tariffs, which today vary by up to 30 percent, would
discourage countries from using tariff policies as a competitive inducement to investors and
make it easier for ASEAN to negotiate trading arrangements with other countries and trade
groups. Starting with important inputs in priority sectors, ASEAN should institute bands
with maximum tariffs for each line of products.
Create a level playing field for capital. Eliminating restrictions on cross-border investments
within ASEAN will let more companies reach greater scale in the region. Introducing an
ASEAN-wide competition policy will discourage cartels and anticompetitive behavior and
ultimately lead to a more level playing field.
Improve regional collaboration. Greater and more targeted cooperation in several important
areas will reinforce the development of a single market. One important task is to promote
an easier flow of skilled labor across the region. Cooperation is also needed to streamline
the management of financial and technical support for less developed members, to
establish and share regional testing facilities to certify products, to automate and network
customs departments, and to create regionally enforceable protection for intellectualproperty rights (perhaps by establishing one patent bureau for the region).
Strengthening institutions
ASEAN’s current governance model, in which existing national structures (such as ministries of
trade) hammer out agreements, can work well for free-trade areas like NAFTA with few members.
But for a large regional grouping, such as the European Union, with its deeper aspiration of creating
a single market, strong regional institutions are needed to handle complex integration efforts
involving many countries, sectors, and issues. ASEAN will realize its ambition to create an economic
community only if it also develops effective regional institutions and efficient decision-making
processes. Without institutions representing the interests of the whole group, ASEAN in effect grants
a veto to any country that resists regional economic integration. It is important to stress that
stronger regional institutions need not diminish the sovereignty of any member country or take
away its rights over the political agenda of integration. Rather, stronger institutions are needed to
facilitate and implement the direction determined by the group’s political leaders.
ASEAN will need to develop an institutional framework, representing global best practice among
successful trade groups, in five critical areas:
1.
2.
3.
4.
5.
To set the direction, ASEAN should develop and formally approve a detailed economic
action plan explicitly stating the group’s economic goal as well as the time lines, resources,
and institutions required to achieve it.
To formulate policies more efficiently and professionally, ASEAN should entrust the
development of technical policies to a strengthened Secretariat responsible for outlining the
scope of the policies, assessing their potential impact, developing recommendations, and
syndicating draft policies with members. Responsibility for political decisions would remain
with each government. For technical policies, ASEAN should move from consensus to
qualified majority voting.
To support the effective implementation of policies, each member country should establish
one national coordinating unit that would communicate policies to domestic ministries and
coordinate domestic implementation and compliance.
To monitor the implementation of policies, ASEAN should move away from its current ad
hoc data collection and set up an objective monitoring bureau using regularly updated,
publicly disclosed "scoreboards" to publicize member countries’ compliance records.
To settle disputes, ASEAN ought to establish an independent, professionally administered
mechanism to handle any failure of member countries to implement their integration
commitments.5
Building momentum now
To build on the momentum generated by the October 2003 announcement of an ASEAN Economic
Community, the group should move quickly to provide a more robust vision and to lay out a clear
development plan for the region’s economic future. Such a plan—the foundation of any integration
effort—would be critical for driving the dramatic change involved in creating a single market.
ASEAN must also launch a comprehensive and well-endowed communications plan to explain the
objectives and expected benefits of greater economic integration to the region’s government
officials, the general public, and other key stakeholders—global investors, large local companies,
and small and midsize enterprises. Understandably, many stakeholders worry that regional
integration will hurt them. Some countries, especially the less developed ones, fear that the benefits
of deeper economic integration will pass them by, others that the region spans too broad a range of
economic-development levels for integration to work well.
Our analysis suggests that such concerns are largely unfounded; it is the diversity of these
economies that makes regional integration beneficial for the whole group, since the comparative
advantages of one country complement those of another. Consider the television value chain.
Semiconductor parts for TVs are made in Malaysia, the Philippines, and Singapore. Cathode ray
tubes, a core component, are produced in Malaysia, Singapore, and Thailand, which together
command 35 percent of the global market. Other components are sourced mainly from Indonesia
and Thailand. TV sets are assembled and tested in most ASEAN countries. ASEAN’s less developed
economies (Cambodia, Laos, Myanmar, and Vietnam) could leverage their cost advantage in this
chain—a role they now largely can’t play, because of the high transactional costs of moving goods
from one ASEAN country to another.
Experience from other trade groups suggests that these less developed countries have the most to
gain from integration. In the European Union, GDP growth has been far higher in Ireland, Portugal,
and Spain, which were largely agricultural when they joined, than for Britain, France, and Germany.
Similarly, in NAFTA, Mexico has grown faster since integration than the United States or Canada
(Exhibit 4). Studies indicate that regional economic integration significantly contributed to the
relatively high growth rates the less developed countries experienced after integration.
ASEAN’s less developed members will continue to need assistance, both technical and financial,
from the wealthier members and from bilateral and multilateral donors. This assistance is crucial not
only to ensure the timely implementation of integration initiatives but also to bridge the
development gaps between countries.
ASEAN has come a long way since its beginnings, but both the group and the world have undergone
dramatic changes over this period—changes that have presented new challenges and demands.
Closer and deeper integration of the ten ASEAN economies will play a critical role in rebuilding the
group’s competitiveness and paving the way for higher rates of growth and wealth creation.
The domestic agenda
ASEAN countries must make two broad reforms for the region’s businesses to reach their
productivity potential. The first is to remove regulatory barriers protecting companies from
competition, the second to stop keeping small, unproductive firms afloat by tolerating their evasion
of taxes, labor rules, and product regulations.
The McKinsey Global Institute’s study of Thailand’s productivity performance1 found that sectors
protected by entry barriers such as investment restrictions and licensing requirements are
characterized by low productivity, in contrast to competitive sectors, which rapidly improved their
productivity. The telecom sector is a case in point. State ownership and archaic regulations hold
back fixed-line telephony, whose productivity, as measured by the number of installed lines per
employee—a key indicator—is only 60 percent of the US level. Yet companies in the liberalized
mobile-telephony sector have roughly the same number of installed connections per employee as
their US counterparts. This difference demonstrates the powerful forces unleashed by sectoral
reforms that increase competitive intensity.
Unequal enforcement of regulations in many ASEAN countries encourages small, unproductive firms
(in residential construction and retailing, for example) to remain inefficient and go on evading
regulations. Enforcing tax and labor laws would compel these firms to raise their productivity or be
replaced by more productive companies. Illegal logging, for instance, is a problem in nearly all
ASEAN wood-producing nations and threatens the whole regional forestry industry. Improving
enforcement would cut the available supply and squeeze nonproductive operators (which can afford
only illegal wood) out of the market. Competitive players would have to use wood in the most
productive way by making higher-value-added products. And ensuring sustainable forestry would
secure the future of the raw material the industry needs to survive.
Notes
The study was undertaken in 2001 by McKinsey in collaboration with two leading Thai economicresearch institutes. See Pornchanok Tanskul and Roland Villinger, "Thailand’s chance for no-pain
gain," The McKinsey Quarterly, 2001 Number 4 special edition: Emerging markets, pp. 24–7.
1
Return to reference
About the Authors
Adam Schwarz is a consultant in McKinsey’s Singapore office, and Roland Villinger is a principal
in the Bangkok office.
Notes
McKinsey’s ASEAN Competitiveness Study, whose final report was completed in August 2003, was
commissioned by ASEAN’s economic ministers. The work was carried out by Jim Ayala, Eleanor
Chye, Ken Gibson, Tobias Hoschka, Tsun-yan Hsieh, Nicholas Kukrika, Vincent Palmade, David San
Pedro, Adam Schwarz, Roland Villinger, Soegeng Wibowo, and Angeline Yeap.
1
The leaders of ASEAN took an important step down that road at their annual summit in October
2003, when they endorsed an accord to create a single market—the ASEAN Economic Community
(AEC)—by 2020.
2
3
Mercosur is a free-trade zone comprising Argentina, Brazil, Paraguay, and Uruguay.
At the October 2003 leaders’ summit, ASEAN decided to accelerate the pace of integration in 11
priority sectors. Efforts are to be coordinated by different member countries: wood-based products
and automotive by Indonesia, rubber-based products and textiles and apparel by Malaysia,
agriculture-based products and fisheries by Myanmar, electronics by the Philippines, e-ASEAN (IT
linkages and development) and health care by Singapore, and air travel and tourism by Thailand.
While the ambitious effort to deepen integration across 11 sectors is praiseworthy, two key
problems should be highlighted: timetables with milestones for progress have not yet been
specified, and little progress has been made streamlining and clarifying ASEAN’s decision- making
processes.
4
ASEAN leaders agreed at their October 2003 summit to establish a monitoring function and to
revise the dispute-settlement process.
5
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