Structural Transformation for Inclusive Growth in Cambodia

Cambodia has a tragic history but has recovered remarkably since the 1991 Paris Peace Agreements and continues to harbour great aspirations. It aims to become an upper-middle-income country by 2030 and a high-income country by 2050. To realise these aspirations, Cambodia must address various constraints to achieve more inclusive growth that is also sustainable and resilient. This type of growth should be driven by, as well as generate, decent paying and sustainable jobs in the formal and informal sectors.

To do this, Cambodia needs a new phase of structural transformation. So far, the limited amount of diversification of its economy has not affected the rapid pace of growth but only its quality and inclusiveness. Cambodia’s average growth rate exceeded 7 per cent in the decade prior to the pandemic, driven by preferential trade access to developed country markets, tourism centred on Angkor Wat, and large capital and aid inflows into infrastructure and real estate.

With its graduation from the Least Developed Country status expected this decade, Cambodia will become a victim of its own success as trade preferences and aid flows diminish. It will need to pursue new drivers of growth, which will require a new type of diversification.

The initial phase of structural transformation involving rural-urban migration from agriculture into industry and services may be reaching its limit. The horizontal shift into sectors producing higher value products and services generated a one-off increase in productivity, which raised incomes and living standards, but this increase is not sustainable.

Future increases in Cambodia’s productivity will have to come from intra-sectoral diversification. This involves the vertical shift into higher value-added products and activities within sectors. This type of diversification is sometimes referred to as moving up the value-chain. In manufacturing, it involves greater participation in global supply chains.

Cambodia must address two sets of constraints to enable greater intra-sectoral diversification for more inclusive growth. These are its limited human capital and the high cost of doing business. To ensure that the new type of growth continues, another set of constraints that limit resilience and sustainability must be addressed. The Cambodians will require policy reforms, and public as well as private investment, to address all three types of constraints.

While the pandemic may have dashed Cambodia’s hopes of realising its vision of upper-middle-income status by 2030, addressing the constraints to inclusive, resilient, and sustainable growth in getting there is critical.

First, there is an urgent need to improve the quality of primary and secondary schooling. Technical and vocational education and training (TVET) and tertiary education can succeed only if students have a strong foundation. The World Economic Forum’s Executive Opinion Survey ranked Cambodia at 100 out of 130 countries for primary education quality in 2017. Improvements in educational quality need to be accompanied by measures to improve access and retention rates, which are currently low.

Cambodia needs to invest in skills development and training in close collaboration with the private sector to avoid skills mismatches. TVET and tertiary education institutions need to align their curricula more closely with the needs of the private sector.

For companies, the high cost of doing business in Cambodia stems from limited physical and logistics infrastructure, and expensive energy and finance.

With widespread infrastructure deficits, there is a need to prioritise investments within the transportation sector and economy wide.

The high cost of electricity limits vertical upgrading from labour-intensive assembly activities to higher value-added but energy intensive production of parts and components in electronics and automotive supply chains. Cambodia needs to invest in renewable energy and energy efficiency to reduce costs and the reliance on diesel and heavy fuel oil in electricity generation.

The high cost of finance, especially for small-scale farmers and micro-, small, and medium enterprises (MSMEs), perpetuates poverty. Their limited access to formal avenues of finance is closely related to cost. The potential for digital innovation, including for fintech and blockchain technology, however, presents significant opportunities for Cambodia’s financial sector to enhance financial inclusion.

Finally, there is a need to increase versatility in managing and responding to shocks, and to ensure the sustainability of growth and its drivers.

First, climate change threatens the livelihoods of millions, especially poor and vulnerable communities. The Asian Development Bank estimates that Cambodia’s GDP could be 10 per cent lower than it could be in 2050 due to lost labour productivity from climate change.

Economic growth and environmental protection are often considered trade-offs but there can be complementarity. The intersection between the two is green growth, which fosters ecologically sustainable economic growth with low carbon emissions and socially inclusive development.

Transitioning from heavy reliance on fossil fuels, reducing deforestation, and adopting more sustainable agricultural and fishing practices will be critical for Cambodia to protect its environment and to ensure the prospects of these industries. As sustainability aspects of production become increasingly important in business and investment decisions of international firms given rising global demand, reducing Cambodia’s carbon footprint would present it with new growth opportunities.

Second, Cambodia will need to strengthen its financial sector resilience by enhancing regulatory and supervisory frameworks, improving asset quality and risk management practices, and addressing other weaknesses in the banking system that threaten its stability. 

Third, government spending on healthcare needs to be significantly increased before the next pandemic. This was a major limitation for Cambodia in managing the COVID-19 pandemic, as it required more stringent mobility restrictions than countries with more robust healthcare systems.

Cambodia’s acceleration towards a digital economy will produce many benefits but will also create new challenges. Many low- and medium-skilled jobs may be initially lost and redeploying displaced workers will require substantive reskilling and retraining.

While the pandemic may have dashed Cambodia’s hopes of realising its vision of upper middle-income status by 2030, addressing the constraints to inclusive, resilient, and sustainable growth in getting there is critical. This will take more time but the journey is as important as the destination.

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