Cambodia at a critical juncture in its development journey

Cambodia is a development success story but one that is incomplete and now at a critical juncture. Politically, there is the ushering in of a new generation of leaders that aim to re-energise and sustain Cambodia’s impressive long term developmental progress. This agenda is manifest in the government’s ambition to reach upper middle-income country (UMIC) status by 2030. Yet, the economy has also been heavily damaged by the international economic shocks of recent years including the Covid-19 pandemic, Ukraine crisis, and economic problems in China. Cambodia’s economic and development progress has been substantially set back as a result. Meanwhile, climate change and rising geostrategic tensions in the region also pose significant challenges.

Cambodia reaching UMIC status would represent a truly enormous achievement, seeing the country transformed from a poor, post-conflict society to a reasonably prosperous one in just several decades. Whether, when, and how Cambodia can reach UMIC status is the subject of a detailed study being prepared by CDRI and expected to be published next year. For now, the prospect of reaching the UMIC ambition by 2030 is unclear, in part as Cambodia’s GDP numbers are undergoing rebasing and are yet to be released. But there can be no question that delivering on this ambition by 2030 is a very challenging task given the international shocks that Cambodia’s economy has endured and a global economic environment that remains difficult. Economic recovery will likely continue to proceed slower than desirable. The IMF for instance projects Cambodia’s economic growth at 5.3% this year and picking up towards 6% in future years – all well below the 7% pre-Covid pace. Notably, recent international shocks have imposed considerable costs on Cambodia’s economic trajectory, with its economy for instance likely to be around 14% smaller in 2023 than what was previously projected by the IMF just before the onset of the pandemic.

More fundamentally, Cambodia’s aspirations for national development should not solely be about narrowly reaching the gross national income target that is the basis for determining whether a country is classified as upper middle income. Two additional factors are equally relevant, if not more so as to whether Cambodia can truly lift its living standards in a comprehensive manner. First, Cambodia must go beyond merely generating fast growth and also ensure that this is inclusive, sustainable, and resilient. There is little point in pursuing rapid but low–quality growth for example involving inadequate job creation, rising inequality, damaging deforestation, or speculative real estate booms (and busts). The quality of growth matters. Second, despite the focus on the 2030 ambition, it is critical to also focus on building the foundations for continued progress towards the longer-term goal of becoming a high-income country by 2050. Again, there is little point in racing towards UMIC status only to find that the ability to sustain continued progress at a satisfactory rate is not possible. That will in turn require particular attention to strengthening the country’s resilience to climate change and improving the quality of its human capital and institutions. These take longer to deliver dividends but are necessary to ultimately underpin long term national development.

Ambitious goals such as reaching UMIC status provide useful guideposts and imperatives for more ambitious reform. Regardless of when exactly UMIC status can realistically be reached, what is clear is that the priority should be on well-designed policies and reforms that align with the desire for faster growth that is also more inclusive, sustainable, and resilient while simultaneously building the foundations for longer-term development. Crucially, although Cambodia has made much progress in many key policy domains, whether this is keeping up with the needs of a rapidly advancing economy and therefore sufficient to sustain one of the most rapid rates of economic progress in the world is more debatable.

In terms of driving future growth and job creation, manufacturing should continue to be prioritised as the central engine of Cambodia’s rapid growth and development, as it was during previous decades. Despite the trend towards increasingly premature deindustrialisation observed globally and concerns about automation and deglobalisation, manufacturing still offers the best opportunity for Cambodia to generate fast and progressively better–quality jobs for its people. Indeed, deepening Cambodia’s position in global manufacturing, diversifying its product and export markets, and upgrading into higher value-added activities would all help to protect and insulate Cambodia’s economy from these future threats. By comparison, other economic sectors generally either struggle to generate strong productivity gains or sufficient jobs, though international tourism is also an important growth sector.

Currently there is an important opportunity to take advantage of the reorientation of global supply chains as these are likely to increasingly move out of China given rising labour costs there and as countries and firms actively seek to diversify their supply chains. Doing so will require addressing a host of well-known issues affecting Cambodia’s manufacturing competitiveness, including improving the business regulatory environment, strengthening market access through more and higher-quality trade agreements, improving physical and logistic infrastructure, and strengthening the health, skills, and education of the workforce.

In the immediate term, to attract greater manufacturing FDI and relocating supply chains, Cambodia can prioritise quick wins, such as reducing trade and other regulatory barriers and cracking down on informal payments, while credibly signalling its commitment to pursuing ongoing reform. Success however will also require increasingly addressing new challenges. For instance, the US and European Union, which remain critical export markets, now put greater emphasis on their trading partners meeting higher environmental and labour standards. Although Cambodia remains a developing country, it will be key that it is able to signal and make credible progress towards meeting higher standards in this area over time. That would also be in line with the social aspirations that should accompany Cambodia’s 2030 and 2050 visions.

While manufacturing should continue to be seen as the main engine for driving fast and inclusive growth, this will need to be accompanied by broader progress on a range of other policy priorities that are key to ensuring that this also leads to higher quality development.

In terms of productive sectors, agriculture cannot be overlooked by policymakers as it plays an important role in determining whether growth is inclusive, sustainable, and resilient. First, as primary agricultural production provides an important basis for growth and diversification in the manufacturing industry through agro–processing. Second, most of the poor are still engaged in agriculture. Achieving agricultural growth therefore remains critical to ensuring progress towards UMIC status is inclusive of the poor and leads to continued strong poverty reduction. Agriculture, however, faces very significant headwinds, notably from environmental limits and degradation and the increasing impacts of climate change. Addressing these and ensuring equitable land governance will therefore be central to ensuring inclusive and sustainable growth.

Equitable progress towards UMIC status will in any case require going beyond inclusive growth alone and towards more active redistribution. This will require building on the solid progress the country has already made in developing its social protection system and greatly expanding its reach and generosity. Doing so will in turn necessitate mobilizing higher tax revenue, through both policy changes and better administration which can broaden the tax base and raise additional revenue. All of this is also in line with the broader institutional progress Cambodia must make to comprehensively move towards a higher standard of living for its people. Notably, as countries become richer, the demand for a modern welfare safety net tends to rise. In the immediate term, channelling more support to households through the social protection system is also key to reducing the economic and social scarring effects of the pandemic, which has pushed more Cambodians into poverty.

Digitalisation should be a key focus in assisting across the above priorities. Enhancing digitalization can support higher productivity and innovation across all productive sectors, from manufacturing to agriculture to services. There is much for the government to do around improving digital infrastructure, skills and literacy, and closing the digital divide between poorer and better off households to not only ensure an inclusive process but to maximise the economic benefits to the nation. Digitalisation can also provide the foundation for smarter and more effective government in numerous ways, through e-services, digitizing government-to-person programs (including social protection), enhancing transparency, and enabling faster policy learning through rapid data generation and analytics.

Responding to climate change is another cross-cutting policy issue. Cambodia is a minor emitter of greenhouse gases. Hence, rather than emissions reductions, the main priority is on increasing the country’s resilience to escalating climate change impacts. Cambodia is heavily exposed on this front including through flooding, drought, cyclones, landslides, and extreme heat. From a narrow economic perspective, these impacts will undermine key productive sectors, including agriculture, tourism, and manufacturing. With the poor and less wealthy regions more exposed and less able to cope, the impact of climate change also threatens to undermine inclusive development. Strong adaptation efforts will be critical, particularly to invest in climate-proof infrastructure, effective risk management, and better land-use planning along with programs to support climate vulnerable populations.

Turning to the foundations for longer term development, there is a well-recognised need to improve the quality of early and basic education as both a social objective and to support industrial upgrading and ensure that future Cambodian workers can compete in an age of increasing automation and digitalisation. Meeting Cambodia’s educational needs is a generational challenge. But policymakers must move urgently now. An especially urgent priority is reversing the learning losses induced by school closures during the pandemic that have imposed high social costs and will otherwise damage the country’s future economic potential and competitiveness. Specific strategies will be required to reverse this situation beginning for instance with assessments to fully understand the degree and forms of learning losses incurred and adjusting teaching approaches accordingly while instituting programs to encourage students that have may dropped out of schooling to return.

The other key long-term agenda should be strengthening the quality of the country’s institutions, which is perhaps the most important factor for sustaining high quality development over the long term. This is a challenging task for all countries, including Cambodia. For the purposes of thinking about Cambodia’s vision to reach upper middle income, and eventually high income, status, the basic reality is that Cambodia currently scores poorly in key measures of economic governance – including government effectiveness, regulatory quality, rule of law, and control of corruption – while the rate of improvement in these areas is not keeping pace with the continued advancement of its economy. A decade ago, Cambodia’s performance was low but about in line with its level of income. Today, while the quality of economic governance has improved, it now compares unfavourably to other countries at a similar level of income. In other words, Cambodia has been outgrowing the quality of its institutions which may now no longer be good enough to continue underpinning rapid economic growth into the future. Indeed, inadequate progress in improving governance is thought to be a key factor why many countries find themselves caught in the so-called ‘middle income trap’ and ultimately unable to break through to high income status. Cambodia needs to avoid that fate.