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"The Two Faces of Asia: Bridging the Gap Between High Growth Economies and the Poor"

Public Lecture by
Rajat M. Nag
Managing Director General
Asian Development Bank

At the London School of Economics

2 October 2008
London, United Kingdom

I.  Introduction

Good evening, ladies and gentlemen. I am delighted to be here in London for a brief few days, and particularly pleased to have this opportunity to visit my alma mater. I would of course like to thank Professor Hussain and the London School of Economics for providing an excellent venue for tonight's discussion. Most of all, I thank all of you for coming out to hear about what we at the Asian Development Bank broadly characterize as "the two faces of Asia."

Let me begin by clarifying that when I speak of Asia, I am referring to the entire Asia and Pacific region. As a multilateral development Bank, ADB supports economic and social growth across this region, which now encompasses an area extending from Georgia to Samoa to Sri Lanka and the Maldives. We serve countries as large as China, with a population of 1.4 billion, and as small as Nauru, home to fewer than 12,000 people.

Obviously such a vast swath of the world comes with a tremendous diversity - geographical, economic, social, political, cultural, and so on. Such diversity has had many positive effects. For instance, it has contributed to the creation of East Asia's value chains, driving economic growth and trade in the process. But as economic growth continues, we are witnessing a distressing increase in inequality - both among countries in the region, and within them. Thus is emerging the two faces of Asia - the glittering skylines of Beijing and Mumbai, against which exist some of the world's largest and most desperate slums. And then there is rural Asia and the millions of farmers, forest dwellers and fisher folk who barely subsist and now face the prospect of worsening poverty due to environmental degradation and climate change.

Today, I would like to focus your attention on this growing inequality - these two faces of Asia - and on the responses needed at national, regional and global levels to put Asia's growth on a more equitable and sustainable footing. Asia being home to half the world's population and two-thirds of the world's poor, nothing is more crucial to ensure a future of greater stability and opportunity for us all.

II.  Asia in 2020: the Vision

I would note at the outset that Asia is a region of huge potential. In preparation for designing our new Strategy 2020, ADB recently undertook an in-depth assessment of regional trends to determine how best to support future growth and poverty reduction. Overall, we believe that Asia will continue to exhibit high growth rates, even if somewhat moderated from recent high levels. By 2020, we expect Asia to account for more than a quarter of the global GDP in nominal terms and as much as 45% in PPP terms. At that time, we also expect Asia to be close to Latin American levels on a GDP per capita basis, whereas in 1980 it was less than a fourth. By 2020, we project that less than 10% of the population in Asia will live in absolute poverty (measured at $1 a day or less per capita) compared to about 19% now. And Asia will be much more urban, with a majority of its population living in mega or medium sized cities.

We expect Asia to remain a capital surplus region with huge accumulated reserves. Asia currently holds $3 trillion in foreign exchange reserves or 62% of the world's total. Asia will continue to increase intra regional trade and investment while becoming more globally integrated in goods, services and capital, and we expect that by 2020 Asia will account for about one third of the world's trade.

As a consequence, Asia will continue to attract significant private capital flows from within the region and from the rest of the world. A rather positive, rosy picture for Asia by 2020, but we think it's achievable.

However, none of this is preordained or guaranteed. Asia is not immune, for example, to the current turbulence in world financial markets and the accompanying global slowdown. While the effects of these events on Asia have thus far been limited, we are expecting growth in developing Asia as a whole to slow from last year's 9% to 7.5% in 2008 and 7.2% in 2009.

These are still healthy rates of growth. The region's financial systems also appear generally healthy and set to weather the storm, and the region's major powerhouses such as China and India continue to grow, providing support for regional demand and buffering against slowing external demand. However, the financial contagion might affect the region's financial markets more seriously if tightening credit conditions and financial instability weigh on broader economic activity. Should the cost of capital or the level of investment be severely affected, Asia's economic performance could suffer significantly.

III.  Unfinished Poverty Agenda: the Reality

Yet even assuming that the region pulls through this difficult time relatively unscathed, it has some very significant challenges ahead which have to be met to realize its potential. The over-arching challenge, of course, is the unfinished poverty agenda, together with rising inequality. Asians today are generally healthier, richer, better educated than they were a generation ago. And strong economic growth has benefited hundreds of millions of Asians and lifted many out of poverty. In 1970, 50% of Asians were poor, measured at a dollar a day per capita. By 1990, that number had come down to about a third. By 2003, it came down even further to 19%. In 1990, about one in every three Asians was poor; by 2003, less than one in five. That's a remarkable achievement.

Nevertheless, Asia still has 620 million people - about 10 times the population of the entire United Kingdom - living on less than a dollar a day. In fact, according to recent ADB research, the figure could be much higher if measured in purchasing power parity terms.

Access to basic services remains abysmal, particularly for the poor. About 700 million Asian people do not have access to improved drinking water, and about 1.9 billion do not have access to improved sanitation. A hundred million children in Asia are not enrolled in primary schools. And about 107 million Asian children under the age of five are underweight. This is a very serious statistic because this means that there are 107 million children who will be disadvantaged for life, principally due to stunted growth in their early childhood.

In terms of inequality, it is not that Asia's rich are getting richer and the poor are getting poorer. Rather, the rich are getting richer faster than the poor are getting richer and the gap between the two is therefore widening. From an economic point of view, increases in inequality dampen the effect of growth on poverty. This means that a given percentage of economic growth will have a lesser impact on reducing poverty, if the income distribution is more unequal.

Take, for example, Bangladesh, where the current poverty rate, again at dollar a day or less is about 35%. If the economic growth in Bangladesh from 1995 to 2003 had been what it was but the income distribution had remained unchanged during that period and did not become worse which it actually did, the poverty incidence would have come down to 27%.

Exacerbating the problems of poverty are the recent sharp increases in commodity prices, particularly fuel and food, which are stoking high inflation across the region. About one billion people in Asia spend at least 60% of their income on food. Should food become too expensive or scarce, millions more could be tipped over the line into poverty.

IV.  Responding to the Challenges

So what are the solutions? How can Asia ensure that poverty and inequality do not derail growth - and that growth itself remains adequate to continue reducing poverty? The solutions are many and varied, of course, but let me highlight this evening a few that we believe to be critical to achieving our vision for Asia in 2020.

Reigning in Inflation

In the short term, policy makers must deal with the pressing issue of inflation and the rising cost of fuel and food. Our recently released Asian Development Outlook Update explains that, in many countries, demand-pull factors rather than cost-push factors are what is driving high prices. This suggests that domestic monetary policy has an important role to play.

Specifically, governments need to tighten monetary policies to anchor inflation expectations and cool domestic demand. Alongside, they should allow exchange rates to appreciate in order to reduce the domestic cost of imports. This approach, however, is not without risks - if, for instance, external demand weakens simultaneously due to the slowing down of the G3 economies. However, without a tightening in monetary policy, the region faces an even more serious risk - that of forward looking inflation expectations reinforcing the already high backward looking inflation expectations.

At the same time, governments do need to alleviate the impact of inflation on the poor through the creation of safety nets. ADB is providing $500 million in immediate budgetary support to the hardest hit countries in Asia-Pacific for safety nets to protect the poor and vulnerable. But as we know, administrative solutions are not sustainable in the longer run. Agriculture sector reforms and measures to increase productivity must be put in place soon to avert a structural crisis. Countries should also make efforts to free up trade and avoid protectionist policies.

Infrastructure Deficits and Inclusive Growth

In the longer term, we believe the region must make growth more inclusive - ensuring that all citizens are able to participate in and benefit from the process of growth. A big part of this will be to correct what we call the "infrastructure deficit". Crumbling infrastructure or in many cases the lack of it, both in urban and rural areas is a major constraint to economic growth in Asia. Our estimate is that Asia needs about $300 billion a year or about $3 trillion over the next decade to bring infrastructure to an acceptable level. In India, for example, despite significant recent investments and improvements in the country's infrastructure, inadequate infrastructure is still a major choke for its growth. Moreover, lack of infrastructure prevents the poor from accessing the very services they need to rise out of poverty - be those health care, education, jobs, or basic utilities such as water and electricity.

Let me give you just one example of the difference infrastructure investment can make. In Cambodia, our Rural Infrastructure Improvement Project rehabilitated about 1,200 km of rural roads and other structures along these roads. The project, which completed in 2005, reduced vehicle operating costs by 25%-30%, passenger and freight charges by 38%, and travel time by 57%. As a result, the volume of goods transported doubled. Commercial activities blossomed along the roadsides. About half of the households saw their incomes rise by about 30% because they could transport their products to markets more easily and had more time to do other jobs.

One reason for the lack of investment in infrastructure is perceived risk. To encourage greater progress on these issues, ADB has established the Asian Infrastructure Financing Initiative, through which we aim to mobilize private investment and public-private partnerships. The key to this will be getting the dispute resolution mechanism right, as well as developing bankable projects that appeal to private investors.

Institutional Deficits

The region must address its institutional deficits, and here we include governance. Public sector institutions need to have adequate capacity to govern, manage and implement the development process broadly, as well as the development of specific sectors. Countries need adequate and predictable legal frameworks and dispute resolution mechanisms and appropriate and strong legal and judicial institutions to enforce them fairly and forcefully. In many countries in Asia, there are major inadequacies on this score which make it difficult for private sector investment to come in and possible public-private partnerships to flourish, and the public sector alone will not be able to close the infrastructure gaps. Corruption is similarly a major constraint to development but must be seen as a larger part of good governance.

Environmentally Sustainable Development

In addition to becoming more inclusive, growth in Asia must be put on a more environmentally sustainable course. The intense pace of economic development in the last few decades has come with significant environmental costs - not the least of which is the region's growing contribution to greenhouse gas emissions and climate change.

In the 1970s, the developing countries of Asia accounted for less than 10% of the world's energy-related greenhouse gas emissions. Today, that figure is around 27%. China has exceeded the US as the world's no. 1 greenhouse gas emitter. By 2030, the figure will go up yet further to a staggering 42% of the world's greenhouse gas emissions.

The region must find and adopt new patterns of urban development, energy production and consumption, land use and waste management, or else it will find itself increasingly a victim of its own success of very impressive growth and yet compromising the very growth it desperately needs to win its fight against poverty.

It will be a big challenge; it's a global challenge requiring collective global action. Global warming and the seriously detrimental effects of climate change pose a major risk for all of us and our future generations. We cannot ignore the environment anymore. And if we do so, it will at our peril not just economically but politically, socially and of course, the quality of our lives.

It is for this reason that we at ADB have featured the environment as a major component of our long term strategy for the region, called Strategy 2020. In line with our climate change program, we are expanding investment in clean energy projects. Last year we approved $668 million worth of such investment in 18 projects - 12 in the public sector and 6 in the private sector - that will contribute to mitigating greenhouse gas emissions, mainly carbon dioxide.

ADB is committed to taking a leadership role in helping our developing member countries respond to environmental degradation and climate change. But what we can contribute is just a drop in the bucket compared to the need. It will require the efforts of the entire international community to deal with these issues.

The Kyoto Protocol, through which 181 countries have committed to reduce global GHG emissions or engage in emissions trading, has proven to be an effective first step. Flexible mechanisms under the Kyoto Protocol such as clean development mechanism gave birth to the global carbon market, which has grown in scale year after year and continues to expand globally. Capital is effectively being transferred to developing countries for investment in projects that reduce carbon emissions. Last year the carbon market was estimated to have a global value of over $60 billion and the potential to generate up to 100 billion dollars in green investment flows. In fact, emissions trading is able to put a price tag on the environment and, through this, provide financing to clean energy and other GHG abatement projects.

However, this scale of investment and the positive change it will create in developing countries will only occur if there is certainty about the nature of the international climate change regime going forward. The question now is how carbon trading can create the necessary major shift to a low carbon economy especially where growth in greenhouse gas emissions is taking place and attract more private sector investment. According to the United Nations Framework Convention on Climate Change, more than 80 percent of the investment flows required for climate change mitigation and adaptation are expected to come from the private sector, and most of this investment must be directed to the large, fast growing developing countries.

Demographic Bulge: Dividend or Curse

Asia is passing through a demographic phase that has a high share of young adults in total population. More than a quarter (28.1%) of Asians are less than 15 years old. This "youth bulge" has the potential to stimulate economic growth through productive employment, asset creation, and investment. However, there is also the danger that Asian countries may fail to reap the "demographic dividend" if they do not invest in their education and training systems to make them more relevant to the demands of their rapidly modernizing economies, and indeed the demographic dividend can turn to a curse.

Youth unemployment and joblessness are on the rise. In developing Asia as a whole, only about 60% of young men and 40% of young women are employed. Poor quality education and training are increasingly pushing impoverished, young workers into lowly-paid jobs in the informal sector. To ensure that the dividends of the youth are reaped, it is critical that Asian economies create productive and sustainable jobs for the young.

Paradoxically, developing Asia, home to over two-fifths of the global population, is suffering from a serious shortage of skilled workers. The supply of highly skilled and professional workers has not been able to keep up with Asia's booming demand. Widening skills' gap not only raises costs for businesses but also hobbles productivity of industries and constrains growth of the economy.

To fix this problem, an overhaul of Asia's underperforming higher education systems is needed, but this will take time to yield results. Meanwhile, governments can implement short-term measures to help ease constraints. These include steps to stem the "brain drain"; encourage Asian emigrants to return home; making it easier for skilled non-Asians to live and work in the region; and raising retirement ages.

Regional Cooperation and Integration

The final response I will mention today is regional cooperation and integration. If Asia is to claim its place in the family of nations, it has to be more integrated. Asia's economies are increasingly vital to each other-and to the world. Asia's output today roughly equals that of Europe or North America, and may well become 50% larger than theirs will be by 2020, in terms of purchasing power parity. The challenge for a prosperous and interdependent Asia is to strengthen and spread the benefits of regional cooperation while playing a substantial, constructive role in global economic leadership. As Asia's economies have grown larger and more complex, they have also became more integrated-through trade, direct investments, financial flows, and other forms of economic and social exchange.

Asia's trade and investment ties are particularly advanced, and the regional integration of production networks has become central to Asia's leadership in global manufacturing. Today, Asia trades about as much within itself as Europe and North America do within themselves.

Asia is less integrated in finance than in trade. However, its financial markets are larger, deeper, and more sophisticated than they were a decade ago, and its legal and regulatory frameworks have improved. By several measures, Asia's financial integration has also progressed. However, most Asian funds are intermediated through distant global markets, despite the region's large savings and ample investment opportunities.

The battle for better lives begins with creating high-productivity jobs. Governments need to connect the poor to the thriving regional economy by eliminating labor market barriers, investing in workers' capabilities, and building infrastructure to connect disadvantaged regions with economic centers. Agricultural trade and aid focused on stimulating trade activities can play an especially important role, as the experience of the Greater Mekong Subregion shows. Rapid economic change also requires cost-effective and innovative social protection systems. And labor migration-within and among countries-can benefit both migrating workers and their hosts. Labor migration also needs to be managed carefully to ensure migrants' rights and to prevent human trafficking and forced labor.

Regional cooperation is equally essential for addressing a range of threats, including epidemics, natural disasters, and environmental degradation. Densely populated and closely integrated Asia needs world-class systems to monitor, prevent, and (if necessary) contain epidemics. It needs to cooperate to make responses to natural disasters faster, more effective, and less costly. And it needs to launch a common regional effort to control a wide range of cross-border environmental problems that are emerging as a consequence of rapid development.

Eventually, Asian economies may have a single market with common regulations, a common currency, and substantial freedom of movement for workers. But immediate policy requires both a long-term vision and pragmatic multi-track, multi-speed initiatives that will show early, step-by-step results.

We are witnessing the beginnings of a strong, prosperous, outward-looking Asian economic community, regionally integrated yet connected with global markets, and with responsibility and influence to match its economic weight. Emerging Asian regionalism is a powerful historic force-a partnership for regionally and globally shared prosperity.

V.  Conclusion

Ladies and gentlemen, let me close by saying that Asia does have a bright future, but there are major challenges to be overcome. These challenges are also opportunities - opportunities for Asia to exploit its natural advantage of dynamism and continue on its path of growth, and opportunities for the rest of the world, including those of you here today, to partner with Asia and be a part of the success story.

The broad areas I've touched upon are crucial to achieving Asia's potential. And they will be the focus for us at ABD as we work with our member countries and partners around the world to achieve our shared vision for Asia in 2020.

The challenges are by no means small. But if the performance of the past three decades is any indication, I strongly believe that Asia will be able to rise to those challenges. There are a number of policy choices which can only be made at the national level, true, but there is an equally pressing need to act in a cooperative and coordinated way to address these challenges to realize the dream we all have for the region: a region free of poverty.

Thank you very much.