Speeches & Transcripts

Remarks by World Bank Managing Director and COO Sri Mulyani Indrawati at 20th International Nikkei Conference on the Future of Asia

May 23, 2014

World Bank Managing Director and Chief Operating Offier Sri Mulyani Indrawati 20th International Nikkei Conference on the Future of Asia Tokyo, Japan

As Prepared for Delivery

East Asia in the World Economy: Challenges for the Next 20 years

Distinguished guests, ladies and gentlemen,

It is my great pleasure to attend this conference for the third time. The rich agenda and excellent speakers always inspire me to think through some of the critical issues ahead of us.

The world economy has entered a new and very different phase since I was here last year.  The effects of the global financial crisis are starting to wane. Quantitative easing in the United States is coming to an end. And for the first time in over five years, developed economies are not a source of instability, but are in recovery mode and show growth, albeit slow.

This is encouraging news for developing countries because it will restore external demand. It also provides developing countries an opportunity to wind down some of their stimulus measures and also reduces risks in their economies. 

At the same time, it means that the days of easy money and easy growth are over.  So, in order to compete successfully and sustain growth, policymakers need to tackle the structural challenges they face today in order to overcome the challenges of tomorrow.   

So the theme of this conference is therefore entirely appropriate.

In Japan, the reform momentum of the Third Arrow has been building recently: measures such as the recent designation of special economic zones; the efforts to improve corporate governance; and the debate on a corporate tax cut are promising. And they are also vital to secure long-term growth.

Today I want to focus on this long view. I want to explore the following questions:

  • If current trends prevail, how will developing and emerging economies particularly in East Asia look 20 years from now?
  • How can they cross the hurdles ahead to stay on track?

So what is the outlook? Over the past 20 years, developing economies have been growing considerably faster than developed economies, particularly since the global financial crisis.

The World Bank Group released data last month confirming this trend. Measured in comparable prices, emerging and developing economies constitute half of the world economy, up from less than a third two decades ago.

This data – based on 2011 figures -  also shows that China now accounts for 15 percent of the world total economy compared to 17 percent for the U.S. Based on this, China is about to overtake the U.S. as the largest economy in the world much sooner than expected.  India is now in third place, surpassing Japan.

Globally, developing economies contributed more than two thirds of world growth in the past few years. More than half of world trade is taking place among developing and emerging economies.

Developing countries in East Asia and the Pacific now account for 28% of the world’s population, and some 40 % of world growth in 2012. 

It’s little wonder then East Asia is viewed economically as the most dynamic region in the world, today. And the neighborhood for growth and development.

If current trends prevail, we can expect the importance of emerging economies will only grow.  Looking at population, savings and catch up in productivity, emerging economies will dominate the world economy by the middle of this century.

On the other side, the relative economic importance of many of the advanced economies will decline.

But current trends are not destiny. 

Today’s emerging economies will need to manage a host of exceedingly complex economic, social and political challenges to secure success.  All related and intertwined.

Among the economic challenges two issues stand out: productivity and macroeconomic stability. 

Just consider the task ahead for countries to move from the ranks of middle income up the ladder to high income status. Over the last 50 years, only 13 of 101 middle income countries graduated to high income level.  Five of these, including Japan, are in East Asia. It’s a result that bodes well for other countries in the region, as they have good examples to follow among their neighbors. 

Avoiding the middle income trap means first and foremost changing their growth model. It won’t be enough to mobilize resources and move people from agriculture to industry and services. Instead productivity must increase within industries.

Most East Asian countries seem to have succeeded in this. People have moved into high productivity jobs, and productivity increased within industries, supporting continued growth. 

 But the challenge is sustaining this.

A successful transition to more productivity-driven growth requires investing in people – to upgrade their skills, so they can adapt to new technologies and innovate.  This requires research and development, an area where public and private sectors can both play a role.

And it needs infrastructure. Yesterday, in a speech at JETRO, I pointed out that developing and emerging countries need to double their investments in infrastructure every year until 2020 to meet the needs of their people and reach their potential.

In my view, several policy areas need to be managed to secure the continued reallocation of resources to the most productive sectors. First it means , developing labor market institutions that maintain flexibility in the labor force while protecting people; second, fostering financial institutions that can channel money to its most productive use; third, creating a positive business climate that allows new firms to emerge—and unproductive ones to exit.  

Finally, openness to trade and investment including well managed migration will provide the competitive pressures to allocate resources efficiently, as well as the links to markets and ideas that can foster innovation and productivity.

East Asian countries, with few exceptions, have been relatively open to trade and investment in the past. As a result those economies are now linked in supply chains that span the region.  This is a valuable basis for future growth and productivity increases.

Foreign direct investment has played a critical role in forging these ties. Japan took the lead in the early 1970s and 1980s, followed by Korea. China is likely to play a larger role in investment as production costs rise rapidly at home. 

A second challenge will be to maintain macroeconomic stability. 

The global financial crisis starkly reminded us that even advanced countries run the risk of severe macroeconomic imbalances which can create havoc for growth and prosperity. 

When Japan’s asset bubble burst in the early 1990s it led to decades of lost growth. It took Latin America more than a decade to recover from the debt crisis of the early 1980s. 

Of course, the immediate challenge for many East Asian countries is to weather the US federal reserve’s tapering of the quantitative easing. As you all know, much has been said about this, and I believe that, after some initial jitters last year, most countries in the region are well prepared to manage possible volatilities in capital flows.

In some countries in the region, credit growth has been rapid in recent years, and leverage has been building up. The effects on growth have been leveling off, and increasingly credit seems to be boosting asset prices. A decrease in capital inflows could reduce some of the risk.

Beyond tapering, in a post-financial-crisis-world, we can expect more volatility as the dynamics of capital flows in East Asia continue to be dominated by foreign direct investment. Bank intermediation is down, and will be for some time to come, as they repair their balance sheets and prepare for tougher standards. 

In recent years, countries in Asia and elsewhere have developed other ways to manage sharp capital inflows, broadly known as macro-prudential policies. In a more volatile world, these policies can be useful complements to traditional monetary instruments in maintaining macroeconomic stability.

Let me now come to social challenges – equally as important to deal with.

A prime obstacle for middle income countries is income inequality. 

With rapid growth in East Asia, the gap between the wealthy and the rest of the people has grown, most notably in China and Indonesia, both traditionally egalitarian societies. 

Rising inequality needs to be watched – not the least for the direct impact on people.

World Bank research shows if inequality starts to affect equity of opportunity, inequality can threaten growth. 

Inequality can also undermine the consensus needed to implement policies and reforms that keep growth high. Managing inequality requires first and foremost creating access to equal opportunities.  Recent research suggests that East Asia is still performing well in that respect: income mobility is still relatively high compared to other countries, and a child’s school performance is less dependent on its parents’ socio-economic position,  than in many other parts of the world. 

Another issue for middle income countries is to get urbanization right. 

We all know cities are magnets. Today, already more than half of the people in developing East Asia live in cities.  By the middle of this century it will be three quarters of the population.

If managed well, urbanization can create enormous opportunities, allowing innovation and new ideas to emerge. Almost 80 % of GDP is generated in cities, and it will be difficult for any country to reach middle-income status and beyond without getting urbanization right. And it matters for reducing poverty – for every ten people lifted out of poverty in the East Asia and Pacific region, two were helped solely because of urbanization.  But if not managed well, rapid urbanization can result in social tensions between newcomers and established citizens. It can overload public services and even lead to high urban unemployment, increased poverty and slums. And it can take a hefty toll on the environment. Cities consume around 70% of the world’s energy and account for nearly 80% of global greenhouse gas emissions.

In the past, Japan and Korea have managed rapid urbanization well, and can serve as an example for other East Asian Economies. Recently, China has published a plan to guide urbanization in the next decade.  We worked with our Chinese partners in the Development Research Center to develop a comprehensive program of reforms to make China’s future urbanization more efficient, more inclusive and more environmentally sustainable—goals that all urbanizing emerging economies can and should aspire to.

Lastly, East Asia’s societies are getting older. 

In the next two decades, some countries in East Asia, including Japan but also China, Korea, Hong Kong, Singapore and Malaysia, will have to manage a rapidly ageing society.

Japan’s population is already declining.  China’s labor force started to decline in 2012.

The negative effects on productivity and rising costs of pensions and health care for the elderly will have economic impacts. With Asian societies changing and family ties weakening, more of the burden of old age care is likely to fall on the state. 

This means societies will need to build up sufficiently robust pension and health systems to provide for the elderly in a cost effective manner. 

Other options should be considered including increasing the participation rate of women in the labor force. That can help reduce the effects on aging for some countries in the region, including Japan, but also in middle income countries such as Malaysia.

Economic and social challenges do not exist in a political vacuum.

The first political pressure is domestic. 

A rising middle class means greater demands. The expectations of the middle class on the political systems in East Asia are likely to rise further. But we know governments find themselves with limited resources. So maintaining the balancing act between the increased demand for services and good governance while addressing the challenges I mentioned before requires difficult trade-offs. All of them are inherently political. 

One of the toughest threats can come from state capture through elites who will seek to protect their privileges, by discouraging competition for resources. Countries will need encourage trade, competition, and promote political participation to balance the interests of the powerful with the need to share prosperity and provide inclusive growth.  The recent experiences in the Middle East provide useful lessons about the cost of state capture, rent seeking, and exclusive development.

Second, there are international political challenges as well. 

A rising East Asia—and for that matter the growing importance of all developing economies—will pose challenges for the international order.  This order, largely still based on the outcomes of World War II, will need to adapt to the newcomers, and provide the space for the emerging economies to have their say. 

As the most vibrant region with its rising economic weight, East Asia not only needs a strong voice on the international stage, it also has to be able to listen, and to act - as individual countries, as a region, and as a strong global partner.

This region has to determine the role it wants to play. I am hopeful that role will be driven by cooperation, mutual benefits, and positive leadership.

In closing let me stress that the World Bank Group stands ready to assist countries as they meet the challenges that lie ahead.   Indeed, our institutional goals s—eliminating extreme poverty and boosting shared prosperity—align fully with developing countries’ desire to succeed in the future. 

The internal reforms the World Bank Group is currently implementing are aimed at bringing the best possible expertise and knowledge to our client countries. And we strive to bring not just expertise, but also considerably more financial resources to help meet the challenges—resources from within and also those of the private sector. 

Japan has been very supportive of the WBG reforms.  It has been a great partner in development in the past, and I hope that we can continue to work closely together in the coming decades. The decades ahead will be crucial for Asia’s successful development and shared prosperity.  

Thank you.