Leveraging Strategic Location and Natural Wealth for Inclusive and Sustained Growth
The limits of Lao PDR’s growth model have become apparent
1. Following substantial economic growth and development over the last two decades, some of the limits of Lao PDR’s growth model are now apparent. Since 2000, the country has been among the fastest growing economies in the world, recording average annual growth of around 7 percent, mostly driven by the capital-intensive resource sector (mining and hydropower) and supported by infrastructure development. However, the drivers of growth have not been sufficiently inclusive. Strong GDP growth did not create as many jobs as expected. Poverty decreased, but at a slower pace than in other fast-growing economies in the region. Moreover, this growth has not been sustainable from an environmental perspective. Stocks of natural capital have been depleting, albeit at a slower rate since 2015, and several of the country’s forests and water resources remain at risk.
2. Ongoing reliance on natural resources has also resulted in significant macroeconomic vulnerabilities. Public debt has increased to critical levels, rising by almost 20 percentage points of GDP since 2010, driven by low rates of revenue collection and debt-financed investments in the electricity sector. Up until 2017, resource exports and associated capital inflows also led to an appreciation in the value of the kip which, combined with rising wages, undermined the competitiveness of non-resource export sectors and slowed their growth. Public investments in mining and power have also reduced fiscal space and left less for investment in agriculture, education, healthcare, and other public services, which likely would have provided more long-term returns through increased labor productivity. COVID-19 has exacerbated many of these economic and fiscal pressures. The country recorded its lowest GDP growth in three decades in 2020, and faces the risk that progress achieved against poverty in the past will reverse, especially for women and poor rural households.
In contrast to other land-locked countries, Lao PDR’s natural assets and location offer significant potential for a more sustainable and inclusive growth model
3. While the country is landlocked with high transport costs, that may soon change given railway and road infrastructure projects. Laos has the enviable advantages of considerable natural wealth, a young population, and a strategic location. It is endowed with significant natural capital including a mosaic of forests, biodiversity, minerals and land types, as well as access to water. It has become increasingly clear that the present value of future benefits from environmental protection is significantly greater than that of uncontrolled resource extraction. If exploited sustainably and at a slower pace, natural resources can still be robust drivers of long-term inclusive growth. Lao PDR also has one of the youngest populations in the region, with potential for a substantial demographic dividend in coming decades.
4. Lao PDR’s geographic location, with some of the world’s fastest growing economies as neighbors, is a significant asset. Trade with and investment from these countries can drive overall growth in Lao PDR, while helping to diversify the economy away from mining and hydro or coal power generation. Lao PDR shares borders with five countries that account for over 17 percent of global GDP and over a fifth of the world’s population. Most are rich, have open trading systems, booming markets and demand for labor and goods, and are involved in global value chains (GVCs). This means there is demand for Lao exports, plus cheap sources of imports, along with GVCs and FDI opportunities right at the country’s doorstep. As such, Lao PDR can better partake in international value chains simply by letting location-driven market forces take place. Already there is some evidence of progress in this direction: for instance, recent investment in export-oriented manufacturing special economic zones (SEZs) has facilitated exports in the electronics, telecommunication, and electrical equipment sector and in the food industry.
But Lao PDR is more policy-locked than it is land-locked: this needs to change for the country to realize its potential.
5. The Government’s land-linked vision is sound, yet a lack of progress on reform implementation is limiting the country’s potential. The benefit of a strategic location is something that the Government of Lao PDR has rightly understood, focusing its economic and social development strategy around trade, investment and establishing Lao PDR as a bridge country within the region (the land-linked vision). Substantial investments are being made in railway and road infrastructure to realize this vision. However, regulatory reforms need to occur in tandem with infrastructure development. Corridor projects that provide secondary road networks along with adequate trade facilitation and logistics services can help economic activity spread into rural areas, bringing important poverty reduction benefits while smoothing spatial inequalities.
6. More than creating new policy reforms, the government needs to prioritize among existing reforms and follow through with implementation to see change accelerate. In 2019, Lao PDR was ranked in the bottom 20 percent on all dimensions of Worldwide Governance Indicators, except for political stability. The domestic business environment remains unpredictable and restrictive, adding to the already tough constraints of a small domestic market with bottlenecks in labor markets. Combined, these create formidable obstacles for Lao firms trying to compete regionally and internationally. The government needs to make significant strides in improving the business environment to allow productive companies to invest and expand, and to let efficient new firms enter the market and grow. Deeper forms of regional integration can also spur institutional and policy reform for improving the business and investment regime.
What can the Lao government do?
7. This Country Economic Memorandum (CEM) offers a set of policy directions that can help leverage Lao PDR’s strategic location and natural wealth to achieve more inclusive and sustainable growth (see Table 1 for a summary). The immediate priority is to correct the country’s macroeconomic instability, which, if not addressed, risks jeopardizing the impact of any future structural reforms. The report then offers ways in which the government can draw on its natural capital wealth in a more sustainable way. It shows that Lao PDR can continue to grow toward upper-middle income status by diversifying the economy into job creating, export-oriented sectors (including agri-food, light manufacturing, and services), ensuring that the benefits of growth are shared more broadly.