RESILIENT DEVELOPMENT A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Cambodia Country Economic Memorandum RESILIENT DEVELOPMENT A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Cambodia Country Economic Memorandum December 2021 Contents Currency Equivalents iv Acronyms iv Acknowledgments v List of Boxes, Figures, and Tables vi Executive Summary ix Overview xi Enable productive firms and workers xv Diversify exports xviii Harness domestic investments xxi Cambodia’s Resilient Development Policy Matrix xxv Chapter 1: Improving Cambodia’s Productivity Performance 1 Labor productivity is constrained by weak human capital and low total factor productivity 2 Structural transformation has contributed to productivity growth but is incomplete 4 Within-sector productivity growth has been flat 5 Policy recommendations for productivity improvements 12 Chapter 2: Economic Transformation Through Exports 20 Economic upgrading through GVC participation in manufacturing 22 Value addition in Cambodian agriculture 32 Increasing competitiveness to export modern services 40 Chapter 3: Financing the Next Phase of Growth 66 Two options for obtaining finance 67 Analysis of Cambodia’s savings situation 74 Policy recommendations for raising finance 88 References 96 Annex 101 Empirical approach and data for firm-level productivity analysis 101 Currency Equivalents Exchange rate effective December 1, 2021 Currency Unit=Cambodian Riels (KHR) US$1=KHR4,069 Acronyms ASEAN Association of Southeast Asian Nations ASYCUDA Automated System for Customs Data CSES Cambodia Socio-Economic Survey DFS Digital financial services EAP East Asia and Pacific EU European Union FDI Foreign direct investment FTA Free trade agreement GATS General Agreement on Trade in Services GDP Gross domestic product GNI Gross national income GVC Global value chain HCI Human Capital Index ICT Information and communication technologies IMF International Monetary Fund IPR Intellectual property rights KHR Cambodian riel Lao PDR Lao People’s Democratic Republic LDC Least developed country MDI Microfinance deposit taking institution MFI Microfinance institution NTM Non-tariff measure OECD Organisation for Economic Co-operation and Development PIM Public investment management PTA Preferential trade agreement RGC Royal Government of Cambodia SME Small and medium enterprise SPS Sanitary and phytosanitary standards TFP Total factor productivity UN United Nations US United States US$ US dollar VAT Value-added tax WTO World Trade Organization Regional Vice Presidents Victoria Kwakwa, Manuela Ferro Regional Director Hassan Zaman Country Director Mariam Sherman Practice Managers Deepak Mishra, Sebastian Eckardt Team Task Leader Claire H. Hollweg RESILIENT DEVELOPMENT: iv A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Acknowledgements The report was written by a World Bank team led by Claire H. Hollweg. The team included Bradley Larson, Mikel Tenllado, Laura Gomez-Mera (Chapter 1); Roberto Echandi, Luis Rubalcaba, Martha Soprana (Chapter 2); Rishabh Sinha, Kimsun Tong, Wendy Karamba, Clarence Tsimpo Nkengne, Nikola Kojucharov, Ratchada Anantavrasilpa, and Sodeth Ly (Chapter 3). The team worked under the close supervision of Deepak Mishra and Sebastian Eckardt. The World Bank’s Cambodia Economic Diversification Study (World Bank 2019a) led by Miguel Eduardo Sánchez Martín was written as Part I of the Cambodia Country Economic Memorandum. This earlier study was subsequently extended in the areas of (i) firm-level productivity, (ii) services export diversification, and (iii) financing the next phase of growth as Part II of the Cambodia Country Economic Memorandum. This report summarizes the findings and recommendations of Part I and Part II of the Cambodia Country Economic Memorandum. The report was prepared in 2020 and reflects the most up to date data available at the time. The report was prepared under the guidance of Victoria Kwakwa and Manuela Ferro, Vice Presidents for East Asia and Pacific; Hassan Zaman, Regional Director for East Asia and Pacific; Mariam Sherman, Country Director for Cambodia, Myanmar, and Lao People’s Democratic Republic; and Inguna Dobraja and Maryam Salim, Country Managers for Cambodia. The report benefitted from peer review guidance provided by Nora Dihel, Miguel E. Sánchez Martín, Chan Sophal, and many colleagues in the World Bank who provided insights and suggestions to the report, including Hans Beck, Rinku Murgai, Zafer Mustafaoglu, and Antonio Nucifora. The team is grateful for editorial support from Jessica Wholey and financial support from the Umbrella Facility for Trade Trust Fund. The team thanks H.E. Vongsey Vissoth (Minister Attached to the Cambodian Prime Minister and Permanent Secretary of State, Ministry of Economy and Finance, H.E. Dr. Phan Phalla (Secretary of State, General Secretariat of the Committee on Economic and Financial Policy, Ministry of Economy and Finance), H.E. Tep Phyorin (Under Secretary of State, General Department of Economic Policy, Ministry of Economy and Finance), and H.E. Vanarith Chheang (Director General, General Department of Economic Policy, Ministry of Economy and Finance) for their guidance. The team is also grateful to participants in consultation meetings with the Ministries of Economy and Finance, Commerce, Culture and Fine Arts, and Agriculture, Forestry, and Fisheries, as well as representatives from the private sector, non-governmental organization community, and the development partners. RESILIENT DEVELOPMENT: v A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL List of Boxes, Figures, and Tables BOXES Box 0.1: Main findings and recommendations of the Cambodia Economic Diversification Study xiii Box 2.1: Ecotourism can promote upgrading in tourism 41 Box 2.2: Diversifying through creative services in Cambodia 51 Box 3.1: Required savings for meeting upper middle income 2030 and high income 2050 targets 73 Box 3.2: Econometric analysis of saving behavior in Cambodia 75 Box 3.3: Why do households save and what factors explain the variation in saving behavior across households? 80 Box 3.4: Exploring the inclusion-savings link 84 FIGURES Figure 0.1: The pandemic-induced economic slowdown has been more severe in Cambodia than in other EAP countries xi Figure 0.2: Cambodia’s growth generating process suffers from high concentration of products, markets, and factor inputs xii Figure 0.3: Physical capital accumulation accounts for two thirds of growth xiv Figure 0.4: Cambodia’s exports have a narrow base xiv Figure 0.5: Cambodia’s labor productivity is low for its level of economic development xv Figure 0.6: Low labor productivity reflects low TFP xvi Figure 0.7: Labor productivity of Cambodian firms is lower than firms in comparator countries xvii Figure 0.8: Cambodia’s exports are concentrated in garments with little diversification xix Figure 0.9 : Business environment constraints inhibit backward linkages from FDI to domestic firms xx Figure 0.10: Cambodia’s savings rates are low xxii Figure 0.11: Cambodia’s private savings have been declining in recent years xxii Figure 0.12: Cambodia’s savings rate is slightly below other countries at a similar income level xxiii Figure 0.13: Most households save through informal mechanisms xxiii Figure 0.14: A low share of households in Cambodia have a financial account xxiii Figure 1.1: Cambodia’s labor productivity is low for its level of economic development 1 Figure 1.2: Cambodia's aggregate TFP is low and has grown slowly in recent years 3 Figure 1.3: Workers have moved from agriculture to industry and services, alongside large productivity increases in agriculture 4 Figure 1.4: Workers are moving to more productive industries, boosting overall productivity growth 5 Figure 1.5: Labor productivity has been stagnant in Cambodia’s key sectors 6 Figure 1.6: Average firm-level labor productivity is low in Cambodia 7 Figure 1.7: Firm-level labor productivity declined in 2013-15 8 RESILIENT DEVELOPMENT: vi A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Figure 1.8: Informality was identified as the biggest obstacle by a plurality of non-agricultural firms 9 Figure 2.1: Cambodia’s exports outperform globally 20 Figure 2.2: Cambodia’s exports have a narrow base 21 Figure 2.3: Cambodia specializes in limited manufacturing GVC tasks 23 Figure 2.4: In Cambodia there has been little diversification into other GVC sectors, unlike in Vietnam 23 Figure 2.5: Cambodia’s top GVC exports have fallen on the global quality ladder 24 Figure 2.6: There has been little discovery of new garment products… 24 Figure 2.7: …with some signs of diversification outside of garments 24 Figure 2.8: Non-garment manufacturing export growth has slowed 25 Figure 2.9: FDI inflows to manufacturing have tapered 25 Figure 2.10: Most manufacturing inputs are imported 26 Figure 2.11: Cambodia has relatively low shares of foreign firms with quality certificates… 26 Figure 2.12: …or technologies licensed from foreign companies 26 Figure 2.13: Business environment constraints inhibit backward linkages from FDI to domestic firms 27 Figure 2.14: Rice and cassava have driven Cambodia’s agricultural export growth 32 Figure 2.15: Foodstuffs exports underperform against comparator countries 33 Figure 2.16: Survival rates of vegetables in export markets are lower than in Vietnam and Thailand 33 Figure 2.17: Cambodia’s key agricultural exports are positioned low on the quality ladder 34 Figure 2.18: Cambodian rice yields have improved but net returns and labor productivity are low 36 Figure 2.19: Mechanization has been increasing in Cambodia 36 Figure 2.20: NTMs increase the cost of agricultural inputs 36 Figure 2.21: The business environment constrains agro-processing firms and input importers 37 Figure 2.22: Cambodia relies heavily on tourism and has not diversified into modern services 42 Figure 2.23: Cambodia outperforms in tourism-related services 42 Figure 2.24: Compared to the Philippines and Thailand, services are used less as inputs 43 Figure 2.25: Sectors rely most heavily on traditional domestic services inputs, rather than domestic modern services 43 Figure 2.26: Cambodia has significantly liberalized its services trade regime 44 Figure 2.27: Cambodia scores low on rule of law… 45 Figure 2.28: …and property rights protection 45 Figure 2.29: Broadband access is limited 45 Figure 2.30: Improvements are needed in trade infrastructure 45 Figure 2.31: Cambodia has a low-educated workforce 46 Figure 2.32: Restrictions remain in professional services 46 Figure 2.33: Trade agreements are increasingly covering services 47 Figure 2.34: Cambodia participants in relatively few regional trade agreements with services provisions 47 Figure 3.1: Capital formation remains low relative to high-growth countries at Cambodia’s stage of development 67 Figure 3.2: Investment has largely been financed by FDI 67 RESILIENT DEVELOPMENT: vii A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Figure 3.3: Cambodia’s reliance on FDI for capital formation is much higher than comparator countries 68 Figure 3.4: FDI has increased faster in non-tradable sectors 69 Figure 3.5: Cambodia’s large current account deficit… 70 Figure 3.6: …has been largely financed by FDI 70 Figure 3.7: Covid-19 threatens foreign investment in developing economies 70 Figure 3.8: Cambodia’s savings rate is lowest among comparator countries... 70 Figure 3.9: …and is low given income level 71 Figure 3.10: Cambodia’s savings trajectory falls below that of high-growth countries 71 Figure 3.11: Growth declines without an increase in the savings rate 72 Figure 3.12: Cambodia’s private savings is lowest among comparator countries 77 Figure 3.13: Government savings have been growing while private savings have been declining 77 Figure 3.14: Dollarization in Cambodia is among the highest globally 78 Figure 3.15: The share of adults saving is high given Cambodia’s income level… 79 Figure 3.16: …but below most comparators 79 Figure 3.17: Formal savings is far less prevalent in Cambodia than in comparator countries 82 Figure 3.18: Financial inclusion has grown… 83 Figure 3.19: …but lags behind most countries 83 Figure 3.20: Financial sector issues are among the top reasons cited for not banking... 85 Figure 3.21: …posing a larger constraint in Cambodia than in other countries 85 Figure 3.22: A large share of Cambodia’s population does not have a national ID 86 Figure 3.23: DFS remain nascent 87 Figure 3.24: FDI outflows have been growing 88 Figure B2.1: Creative services are a subset of creative industries 52 Figure B3.1: Cambodia falls short of its growth targets without significant increases in savings 76 Figure B3.2: Household needs, health care, asset purchase, and agricultural expense are the most important reasons for households to save in Cambodia 80 Figure B3.3: The dependency ratio is negatively correlated with savings 81 Figure B3.4: Saving patterns follow the life cycle 81 Figure B3.5: Savings rate increases with household income decile 81 TABLES Table 1.1: Cambodia scores poorly on the World Bank HCI 2 Table 1.2: Firm employment and firm productivity are weakly correlated within sectors 6 Table B2.1: Smaller services subsectors have experienced fast export growth in Cambodia 51 Table B3.1: Demographics and other household characteristics correlate with higher savings 76 Table A.1: Objective constraints faced by firms 103 RESILIENT DEVELOPMENT: viii A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Executive Summary Cambodia’s growth slowdown in 2020 due to the Covid-19 • Low quality and weak export linkages. Low pandemic was among the most pronounced in the East Asia competitiveness and limited integration within global value region. The devastating impact on Cambodia’s economy lies chains (GVCs) have led to concentrated markets and trade. A in the country’s growth generating process. Cambodia’s primary cause of low diversification and inability to upgrade growth has been remarkable, but insufficiently diversified is the quality of FDI, where FDI firms do not create backward in products, markets, and factor inputs. Five products— linkages or share knowledge, limiting opportunities for garments, footwear, rice, cassava, and tourism—accounted technology transfer and productivity spillovers. Barriers in for 80 percent of total exports; two markets—the European the business environment and the current investment and Union (EU) and the United States—accounted for 69 percent tax incentives regime influence the quality of FDI. Other of merchandise exports; and foreign capital—through constraints to diversifying and upgrading Cambodia’s trade foreign direct investment (FDI) and official development are low firm and worker capability, costly trade-related assistance—accounted for 72 percent of gross fixed capital regulatory barriers (particularly affecting agricultural formation in 2018. Not surprisingly, when the pandemic products), insufficient trade-related infrastructure, and disrupted cross-border flow of goods, services, and capital, nascent use of regional trade agreements to support Cambodia was ill-positioned to absorb the shock. greater market access for exporters. Cambodia’s inability to diversify its development through • High FDI but low domestic investment. The country’s alternate products, markets, and financing sources predates low private savings rate, and as a result low domestic the pandemic, and has its roots in low and declining investment, has led to reliance on external financing productivity, low quality and weak export linkages, and sources. Rather than how many households save, high FDI but low domestic investment. The Covid-19 crisis how much households save and more important how exacerbates these challenges. households save appear to be key factors impeding greater domestic investment. While 51 percent of adults • Low and declining productivity. Cambodia’s inability reportedly saved some money in the past year, only 22 to grow the product basket is explained by low labor percent had any savings at a point in time, and only 5 productivity, or output per worker, which lags behind percent participated in formal savings, significantly most countries globally when at Cambodia’s development below other countries. There is a relatively lower share of level. Low labor productivity, at least in part, reflects low adults with a savings account in Cambodia. Low formal human capital. But the largest contributor, and largest savings by households stems from inefficiencies in the cause for concern, is low and declining total factor formal financial sector that pose high barriers including productivity (TFP). This report’s analysis suggests two financial sector regulatory gaps, low financial literacy, primary causes. First, resource misallocation within low technology adoption and therefore limited access sectors, likely caused by shortcomings of market to financial services, and underdeveloped financial institutions where market signals governing resource instruments beyond banks and microfinance institutions allocation need to be generated in more competitive (MFIs) that would otherwise support savings. and well-regulated markets, and an incipient public investment management (PIM) system where value for Urgent action is needed to support Cambodia’s economic money in domestic public investment remains limited. recovery from Covid-19 in a way that addresses the Second, and more important, low within-firm productivity diversification problem to build back even stronger. growth, explained by a disabling business environment Cambodia’s policymakers have the opportunity to forge a that imposes significant obstacles to firms’ operations. new growth path—by enabling productivity of firms and Poor access to finance, inefficient business regulations, workers, diversifying exports, and harnessing domestic prevalent informality, and inadequate electricity are investment. An ambitious reform agenda is needed—one found to be the main constraints to firm productivity that focuses on improving capabilities, strengthening performance in Cambodia. regulations, and investing in infrastructure. RESILIENT DEVELOPMENT: ix A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL • Enable productivity of firms and workers. Investing app to offer basic matchmaking services and overcome in human capital, supporting more efficient resource information asymmetry between foreign investors and allocation through improved market institutions and domestic producers; intensifying market surveillance and PIM, reducing the cost of operating a business for traceability for food quality and safety; and introducing a firms, and improving the performance of key services risk-management system at the border to lower costs and inputs to strengthen domestic linkages are key reform increase timeliness of agricultural inputs. areas to promote more productive firms and workers. The Covid-19 crisis threatens to further erode labor • Harness domestic investment. Promoting higher productivity, requiring an immediate focus on improving savings to support domestically financed private, the business environment. Short-term policy priorities productive investment will be critical to sustain the are: making the recently promulgated competition law rapid expansion of fixed capital formation required to and regulator effective and implementable through meet Cambodia’s growth targets. To harness domestic sub-regulations; improving PIM capacity at all ministries investment, key reform areas include promoting FDI and agencies and preparing PIM appraisal and into productive and export sectors, promoting higher implementation manuals; implementing the insolvency domestic savings rates, improving access to savings legal framework; and simplifying tax-audit compliance. institutions, supporting access through digital financial services (DFS), addressing financial and administrative • Diversify exports. A cross-cutting and medium-term costs of savings accounts and products, and supporting policy agenda to diversify Cambodia’s trade is structured financial sector stability and development more broadly. on upgrading in manufacturing GVCs, creating value This is even more critical today, where the massive addition in agriculture, and increasing competitiveness disruption in the international credit market brought on to export modern services. Key short-term reforms to by Covid-19 will likely further threaten investment activity support post-Covid-19 recovery of Cambodia’s exports for years to come. Ensuring financial sector stability is include: building capacity of trade negotiators to negotiate a priority to promote long-term savings and resilience deeper trade agreements; moving away from a blanket tax to shocks like Covid-19. Reforms that target stability holiday scheme to an investment incentives system that include: establishing a national deposit protection fund introduces reinvested dividends, investment tax credits, and strengthening the crisis preparedness regime; and investment depreciation on the value of acquired promoting greater financial literacy; implementing the machinery and equipment, quality certificates, or new legal framework for government bonds and finalizing the technologies; reviewing the effectiveness of all licenses, legal framework for micro-insurance and sub-regulations quotas, and fees on imported agricultural inputs; supporting of the new Social Security Law; and developing the backward linkages by developing an online portal and digital infrastructure backbone for digital banking. RESILIENT DEVELOPMENT: x A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Overview The devastating impact of the Covid-19 pandemic on the Cambodian economy—where the growth slowdown was among the most pronounced in the East Asia and Pacific (EAP) region—lies in the country’s growth generating process. Recent growth has been remarkable, but insufficiently diversified in products, markets, and factor inputs. The diversification problem is rooted in low and declining productivity; low quality and weak export linkages; and high foreign direct investment (FDI) but low domestic investment. Just when past success was fueling high ambitions for future growth—to become upper middle income by 2030 and high income by 2050—the pandemic threatens to put those targets out of reach. Cambodia’s policymakers have the opportunity to build a new and stronger growth path—by enabling productivity of firms and workers, diversifying exports, and harnessing domestic investment. But an ambitious reform agenda is needed—one that focuses on improving capabilities, strengthening regulations, and investing in infrastructure. Cambodia’s economy has been devastated by growth record, Cambodia was expected to withstand the Covid-19—experiencing one of the starkest growth Covid-19 shock better than most of its comparators.1 Instead, slowdowns in the region. Prior to the pandemic, Cambodia the economic impact has been more severe in Cambodia was a world leader in economic growth and poverty reduction. than in other EAP countries; growth fell by an estimated 10.1 It sustained an average growth rate of 7.7 percent between percentage points from its pre-pandemic average growth rate,2 1995 and 2019, raising its per capita income from US$323 in compared to 3.5 and 6.3 percentage points in Vietnam and 1995 to US$1,621 in 2019, and graduated to a lower-middle- Myanmar, respectively (figure 0.1). In fact, the pandemic poses income economy in 2015. The poverty rate fell from 47.8 the biggest risk to Cambodia’s development in the 25 years of percent in 2007 to 13.5 percent in 2014. Given its resilient its modern history. FIGURE 0.1 The pandemic-induced economic slowdown has been more severe in Cambodia than in other EAP countries Difference in the average real growth between 2010-19 and 2020 0 -2 -4 -6 Percent -8 -10 -12 -14 Cambodia China Vietnam Lao PDR Indonesia Thailand Malaysia Mongolia Source: World Bank staff calculations using data from World Bank World Development Indicators. RESILIENT DEVELOPMENT: xi A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Why did the pandemic lead to such a dramatic growth investment levels.3 Covid-19 has poured cold water on slowdown in Cambodia? The answer, as this report these aspirations. It effectively curbed the construction and demonstrates, lies in the country’s growth generating real estate boom that relies heavily on foreign investment, process that suffers from high concentration of products, indicated by sharp contractions in steel and cement imports markets, and factor inputs (mostly capital). In short, in the first nine months of 2020. Due to travel restrictions Cambodia’s growth generating process has been insufficiently and lockdowns, Cambodia’s tourism and hospitality sector diversified. In 2018, five products—garments, footwear, rice, has collapsed. Global supply and demand shocks have led to cassava, and tourism—accounted for 80 percent of its total contractions in Cambodia’s key merchandise export sectors. exports (figure 0.2, panel a). Together the European Union (EU) Additionally, the Covid-19 pandemic will likely accelerate and the United States accounted for 69 percent of merchandise global megatrends that were already reshaping Cambodia’s exports (figure 0.2, panel b). And foreign capital, through FDI future growth opportunities like automation, protectionism, and official development assistance, accounted for 72 percent and the reconfiguration of global value chains (GVCs). of gross fixed capital formation (figure 0.2, panel c). Not surprisingly, when the pandemic disrupted cross-border flow Cambodia’s inability to diversify its development predates of goods, services, and capital, Cambodia was ill-positioned the pandemic. The Cambodia Economic Diversification Study4 to absorb the shock without alternate products, markets, and shows the country’s insufficiently diversified growth model is financing sources. Compared to Cambodia, countries like a crucial impediment to achieve rapid and sustained growth. Indonesia, Malaysia, and Vietnam faced equally or more severe It identifies critical bottlenecks to economic transformation external shocks, however they have shown greater economic but also opportunities for growth acceleration through further resilience due to their diversified export baskets, varied trade diversification, upgrading, and domestic linkages (see box 0.1 for destinations, or deeper domestic financial markets. a summary of the study’s main findings and recommendations). Focusing on exports, the report applied both trade outcomes Just when past success was fueling high ambitions analysis and GVC participation assessment methodologies for future growth, the pandemic has pushed those to draw a series of empirical findings about Cambodia’s growth targets further out of reach. Cambodia set a performance relative to comparator countries. This report target to become an upper-middle-income economy by integrates the findings of the previous study (undertaken as Part 2030 and a high-income economy by 2050—lofty goals I of the Cambodia Country Economic Memorandum) with new that require substantial strategic effort. Under the World analytical work (undertaken as Part II of the Cambodia Country Bank’s Long-Term Growth Model, meeting these targets Economic Memorandum) to show that, in addition to low quality would entail growth rates achieved only by China and the and weak export linkages, the diversification problem is also Republic of Korea, and require significant growth in total rooted in low and declining productivity (using firm-level data) factor productivity (TFP), improved labor quality, and higher and high FDI but low domestic investment.5 FIGURE 0.2 Cambodia’s growth generating process suffers from high concentration of products, markets, and factor inputs Share of export products, import and export markets, and capital formation, 2018 a. Products b. Markets c.  Capital formation Other FDI+ODA Tourism EU Other CSV Garments Footwear Rice US Other Note: CSV=Cassava; FDI=Foreign direct investment; ODA=Official development assistance. Source: World Bank staff calculations using data from World Bank World Development Indicators, UN Comtrade, and UN Conference on Trade and Development. RESILIENT DEVELOPMENT: xii A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL BOX 0.1: Main findings and recommendations of the Cambodia Economic Diversification Study The Cambodia Economic Diversification Study (World Bank 2019a) highlights how Cambodia’s growth has remained highly concentrated in exports of garments and footwear, rice, and tourism to Angkor Wat, with limited success in diversifying its export basket, upgrading its activities, or linking its export-oriented sector to domestic firms. The limited success of diversifying, upgrading, and linking is a reality across all manufacturing, agriculture, and services sectors, and hinders economic complexity and, ultimately, Cambodia’s potential growth. The study identified a series of root causes that limit value addition and further GVC integration in Cambodia. Weaknesses in investor protection (including property rights) and lack of cost-effective incentives for acquiring machinery likely discourage investors in higher-value-added industries. Cumbersome and non-transparent regulation affects both service provision (for example, information and communication technologies (ICT) services) and uptake of agriculture inputs (for example, irrigation). In addition, deficient provision of public goods and infrastructure (for example, information portals and electricity access) affect the scope for product upgrading and the introduction of agro-processing or more complex forms of manufacturing. Finally, lack of local capacity results in missed opportunities to foster domestic value addition across sectors. The study recommends that to sustain or even accelerate economic growth and to achieve its long-term goals, Cambodia would need to move up the value chain through diversification, upgrading, and domestic value addition. First, attract a new wave of FDI into electronics, auto assembly, and other emerging light-manufacturing clusters; reduce restrictions for manufacturing firms to use more modern services; and introduce a more varied set of crops for diversification. Second, pursue production process upgrading by upskilling the workforce; adopting international standards; and ensuring sanitary and phytosanitary standards (SPS) compliance (to go organic in agriculture). Third, facilitate domestic value addition by building capacity in domestic firms; promoting digitalization and connectivity; and facilitating the uptake of agricultural inputs. Source: World Bank (2019a). Cambodia’s growth model has been built largely Cambodia’s stellar export performance has been on physical capital accumulation with low driven by few products shipped to a handful of contributions of human capital accumulation and countries—namely, garments in manufacturing, rice and declining contributions of productivity. Physical capital cassava in agriculture, and tourism in services.7 In 2018, accumulation—aided largely by FDI—has been responsible textiles, wearing apparel, and leather products represented for nearly two thirds of Cambodia’s real gross domestic 81 percent of manufacturing exports, rice and cassava product (GDP) growth since 1995 and nearly three quarters represented 79 percent of agricultural exports, and tourism of real GDP growth since 2011 (figure 0.3). Another 20 represented 89 percent of services exports (figure 0.4). percent can be attributed to increases in the average Moreover, about 70 percent of goods and services exports number of employed workers since 1995. The quality of go to North America and Europe.8 But Cambodia’s export the labor force—a measure of human capital—has made model is increasingly under pressure. In recent years, only modest contributions to GDP growth, with just 8 garment sector competitiveness has weakened due to percent of growth during the past three decades attributed rapid escalation in legislated minimum wages, which tripled to improvements in labor quality. Labor quality has also between 2012 and 2019. This, coupled with stagnant contributed less to GDP growth in Cambodia than in other productivity, threatens the sustainability of Cambodia’s key comparator countries, like Vietnam.6 More worrying, despite garment export sector. Moreover, the partial suspension of Cambodia’s high inflows of foreign capital that traditionally the country’s preferential access to the EU market under supports technology transfer, the contribution of TFP has the “Everything But Arms” agreement took effect in August declined. TFP explained 28 percent of Cambodia’s real 2020, affecting approximately 20 percent of Cambodia’s GDP growth between 2004 and 2011—aided largely by exports to the EU. In addition, global megatrends like increased productivity and structural transformation out of automation, protectionism, and the reconfiguration of agriculture—but just 5 percent since 2011. GVCs have added uncertainty to Cambodia’s prospects for continued export success in its current activities. RESILIENT DEVELOPMENT: xiii A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL FIGURE 0.3 Physical capital accumulation accounts for two thirds of growth GDP growth decomposition, share in total, 1995-2017 100 80 Contribution to growth (percent) 60 Capital Labor quality 40 Average hours 20 Employment 0 TFP -20 -40 1995-2017 1995-1999 1999-2004 2004-2007 2007-2011 2011-2017 Source: World Bank staff calculations using data from Penn World Tables 9.1, World Bank Cambodia Socio-Economic Survey (CSES), World Bank World Development Indicators, and Asian Productivity Organization and Cambodia Future Jobs (World Bank 2019b). FIGURE 0.4 Cambodia’s exports have a narrow base Products’ share of sector exports, 2018 a. Manufacturing b.  Formal agriculture c. Services Textiles, wearing apparel, leather products Rest Rice and cassava Rest Tourism Rest Source: World Bank staff calculations using data from UN Comtrade and UN Conference on Trade and Development and Cambodia Economic Diversification Study (World Bank 2019a). Cambodia’s physical capital accumulation is owed rates in the range of those seen in the Republic of Korea. largely to external capital—private as well as official Moreover, sustaining the current rate of FDI will be harder in development assistance—with modest and declining the future.9 First, as incomes rise, Cambodia will continue reliance on domestic investment. As a share of GDP— to lose preferential access to markets that motivate much averaging 18 percent from 1995-2019—gross fixed capital of the inbound FDI in the garment sector (wages will also formation remains low relative to what was achieved by rise with development). Second, as GDP increases over other high-growth countries when at Cambodia’s stage of the long term, capital inflows will also have to increase development. Growth simulations using the World Bank’s significantly to maintain the share of GDP, which will be Long-Term Growth Model show that Cambodia falls short harder and harder to attract without substantial reform in of its high income growth target without higher investment the investment climate.10 RESILIENT DEVELOPMENT: xiv A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL What will it take for Cambodia to recover economic could lead to less efficient resource allocation across growth in the aftermath of Covid-19 and achieve its sectors and firms, and dampen the diffusion of technology.12 growth aspirations? This study revisits Cambodia’s growth Improvements in labor productivity should be forefront to model to identify constraints and opportunities for sustained Cambodia’s recovery and long-term economic growth. economic growth and proposes policy options to address them. In the recovery from Covid-19, Cambodia’s policymakers have Low labor productivity in Cambodia reflects, at least the opportunity today to build a new and stronger growth path in part, low human capital.13 According to the World Bank for tomorrow. This report identifies three key transformations Human Capital Index (HCI), which measures how much human that are needed to upgrade the country’s development model: capital a child born today can expect to achieve in adulthood, • Enable productive firms and workers. Future growth Cambodia ranks 118th of 174 countries for which data are will need to become more balanced with respect to the available—on par with India and Myanmar but far behind most contributions of physical capital, labor quality, and TFP. A focus other comparators.14 Cambodia’s low World Bank HCI score on firms and their workers is key to unleashing productivity. demonstrates deficiencies in early childhood nutrition and education—reflected by high rates of stunting particularly in • Diversify exports. Cambodia’s export success can poor households, and by high incidence of late school entry, continue driving growth if the country can upgrade grade repetition, and dropping-out. Income shocks due to the growth contribution of exports. This means moving Covid-19 further threaten educational outcomes and nutrition beyond the country’s labor-intensive, low-value-added in poor and newly poor households. Key challenges facing export model by achieving greater diversification and the health and education systems are: lack of administrative upgrading of exports. and financial autonomy, outdated services, low professional • Harness domestic investment. Even higher investment qualification standards, and incipient social protection programs. levels are needed to achieve Cambodia’s growth targets. These systemic problems ultimately result in low labor quality, A greater reliance on domestic investment is needed to which drags down labor productivity and inhibits future growth. finance the next phase of Cambodia’s growth, which In short, weak health and education systems result in weak entails increasing domestic savings with a focus on human capital. Cambodia’s labor force is growing rapidly, but removing inefficiencies in the financial system. the growth dividends of an expanding labor force will be lower without improvements in human capital.15 The Royal Government of Cambodia (RGC) has a central role to play in forging a new growth path. To recover and sustain long-term economic growth, an ambitious reform agenda is needed that focuses on FIGURE 0.5 improving capabilities of Cambodia’s firms, workers, and Cambodia’s labor productivity is low for its level of households; strengthening regulations to address market economic development distortions and improve the enabling environment; and Labor productivity vs. gross national income (GNI) per capita, investing in infrastructure that supports higher-quality 2000-18 growth. To stimulate the public and policy debate, this report makes specific short- and medium-term policy proposals Output per worker (2016 US$ thousand, PPP) in each of these three areas. These recommendations are 125 aligned to an economic recovery strategy that supports Malaysia Cambodia to come back stronger after the Covid-19 crisis. Thailand 25 Enable productive firms and workers India Philippines Vietnam Cambodia’s inability to grow the product basket is Myanmar Bangladesh explained by low productivity.11 Despite high and sustained Cambodia GDP and GDP per capita growth rates, Cambodia has not been 5 able to increase its output per worker at similar levels. Globally, Cambodia’s labor productivity lags behind most other countries when at Cambodia’s level of development (figure 0.5). 1,035 4,045 12,535 The Covid-19 crisis threatens to further erode labor GNI per capita, Atlas method (current US$) productivity gains. Human capital and earning losses are Cambodia (2000-2018) Comparators (2000-2018) likely to result from sickness, food insecurity, job losses, Other countries (2018) and school closures. Firm closures and disruption in firm- Note:  Output per person employed. PPP = Purchasing power parity. worker relationships could hurt productivity through a loss Source: World Bank staff calculations using data from Total Economy of intangible assets, while disruptions to trade and GVCs Database. RESILIENT DEVELOPMENT: xv A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL The largest contributor to Cambodia’s low labor manufacturing and services sectors has been suboptimal. productivity, and largest cause for concern, is low Between 2007 and 2017, within-sector productivity TFP.16 First, Cambodia’s TFP level is low for its income level growth has been flat across most services, industrial, and (figure 0.6). High-growth countries like China, Malaysia, and manufacturing subsectors including construction, garments, Thailand had achieved much higher levels of TFP when at and food and beverages. Cambodia’s level of economic development. Second, TFP growth has declined since the 2008 global financial crisis. Misallocation of resources is contributing to poor Since 2011, TFP growth has fallen to just 0.2 percent per productivity outcomes. Resource misallocation refers to year, compared to 2.1 percent annual growth between inefficient enterprises commanding more resources (land, 2000 and 2007. Although this trend is consistent around labor, and capital) than warranted by their productivity the world, the decline is more pronounced in Cambodia, levels. In a sector with zero misallocation, firms’ rank by widening the TFP gap with other countries and putting it productivity level would be perfectly correlated with firms’ further behind the labor productivity frontier. Third and rank by input use. In Cambodia, there is a very weak finally, the contribution of TFP to GDP growth has been correlation between the most productive firms within a lower than physical and human capital. sector and their use of production factors, particularly labor inputs. Resource misallocation is likely caused by Analysis of Cambodia’s firm-level data suggests that shortcomings in market institutions—where resource low labor productivity stems from two causes: resource allocation through market signals is efficient only to the misallocation within sectors and, more important, low extent that the signals are generated in competitive and within-firm productivity growth.17 Despite resources moving well-regulated markets—and an incipient public investment broadly from agriculture to manufacturing and services management (PIM) system where value for money in public with higher labor productivity,18 productivity growth within investment remains limited. FIGURE 0.6 Low labor productivity reflects low TFP TFP trend relative to the United States vs. GDP per capita, 1980-2018 2.0 Relative TFP (United States=1) 1.5 1.0 All Thailand 0.5 China Cambodia Malaysia 0.0 4 6 8 10 12 Ln GDP per capita (2011 US$, PPP) Note: Cambodia from 1995. PPP = Purchasing power parity. Source: World Bank staff calculations using data from Penn World Tables 9.1. RESILIENT DEVELOPMENT: xvi A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Firm-level labor productivity appears to be the biggest Empirical evidence confirms business environment challenge to overall productivity performance. constraints are associated with the lower productivity Global evidence shows that within-sector productivity performance of Cambodian firms. Overall, the results improvements—particularly through the expansion of suggest that poor access to finance, inefficient business highly productive firms and the entry of new firms—is regulations, informality, and inadequate electricity are much more important than inter-industry reallocation the main constraints to firm productivity performance in of production factors in driving aggregate productivity Cambodia. Burdensome insolvency procedures remain a growth.19 In Cambodia, however, labor productivity in firms key issue for firms and are one of the reported reasons that underperforms comparator countries (figure 0.7). Moreover, micro and small and medium enterprises (SMEs) choose to data on labor productivity growth rates over 2013-15 stay informal, coupled with burdensome tax procedures and suggests sales per worker has declined over this period in continued high costs of business registration.22 Moreover, Cambodia, and this deterioration has been more pronounced the cost of bank finance is high, with interest rates for small than for the average EAP firm. business loans ranging 15-18 percent or more per year. Weak firm-level productivity is explained by a weak A business environment where investment business environment that imposes severe obstacles opportunities can depend on knowing the right to firms’ operations. Firms report a variety of constraints people breeds mistrust in rules-based transactions to their operations, notably informal sector practices and makes the transition from informality to formality (having to compete against unregistered or informal firms), harder. Fair competition and a level playing field have been political instability, an inadequately educated workforce, shown to matter in other countries. Efficient and fair markets and business regulations.20 Moreover, firms also report are essential for catalyzing private sector development, and availability and quality of services inputs used in production competition is central to the operation of markets. Crucially, as obstacles to their operations, notably electricity and competition facilitates greater equality of opportunity by finance as well as transport and telecommunications.21 On breaking down the barriers that otherwise protect incumbent most of these issues, the perceptions of Cambodian firms elites, thereby fostering innovation, productivity, and growth. are bleaker than firms in other countries. Ultimately, lack of trust in rules-based business transactions could impede Cambodia’s economic recovery in the short term and its diversification in the medium and long term. FIGURE 0.7 Labor productivity of Cambodian firms is lower than Improving productivity is central to Cambodia’s long- firms in comparator countries term growth agenda. Government action can encourage a more productive and competitive private sector. This Median labor productivity, 2012-18 analysis suggests the primary focus should be reducing the 40,000 cost of operating a business for firms, including by improving services inputs, followed by addressing misallocation, and finally by improving human capital. The RGC has committed Value added per worker 30,000 to improving the business environment in Cambodia and US$, 2009 prices has taken a number of recent initiatives in this regard. An 20,000 inter-ministerial working group was established in April 2020 with members from around 20 relevant ministries and institutions. The Government has made a number of recent 10,000 reforms, such as online business registration, with others ongoing. Nevertheless, it is an ongoing and medium-term agenda underpinned by a range of policy recommendations 0 described below. The Covid-19 crisis adds urgency to this agenda and warrants a streamlined set of crucial policy 3) ) ) Ma ia (2 ) Ph ysia 14) es 5) ag am 5) 12 5) 8) ma 016 16 Ind 016 01 pin 01 av ietn (201 20 01 01 mb r (20 0 options for the next three years to adapt to the new normal. (2 (2 (2 (2 (2 -2 h d ia es an od Some of these areas are presented in Cambodia’s Resilient lad ail an la e( ilip Th My ng V Ca Development Policy Matrix at the end of this Overview. Ba er al ob Gl Note: Similar results when using sales per worker (2009 US$). Source: World Bank staff calculations using data from World Bank Enterprise Surveys. RESILIENT DEVELOPMENT: xvii A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL • Improving capabilities by investing in people. Human overall efficiency of the courts to expedite bankruptcy capital matters for the quality and productivity of the labor proceedings (even more important during Covid-19); force and ultimately long-term growth. Improvements and review the corporate governance framework for are needed in education and health services early in life. investors in the Companies Law, particularly around The RGC could consider giving more administrative and corporate transparency, ownership and control, and financial autonomy to health and education institutions, shareholder rights. modernizing health and education services using technology, upgrading professional qualifications, and • Investing in infrastructure to improve critical services investing in teacher training. Expanding the maternal inputs. Investments in services inputs—notably, and child nutrition cash transfer program would improve electricity and finance—will strengthen domestic early childhood nutrition and reduce stunting. This linkages. Continued efforts are needed to ensure reliable could be done by (i) expanding the eligibility criteria of electricity and timely connections. To this end, the households, (ii) improving targeting, and (ii) extending RGC should introduce time limits for issuing electricity the program beyond two years old, for example through contracts, consider setting up online processes for entry into primary school. requesting new connections, improve the reliability of power supply, and establish an automated system to • Strengthening regulations to promote competition, monitor power outages thereby reducing their frequency improve PIM practices, and reduce the cost of operating and duration. To reduce the cost of finance particularly a business for firms. A key step to improving market for SMEs, Cambodia should scale up the recently enacted institutions is to make the recently promulgated Credit Guarantee Scheme to ensure it is functioning competition law and competition regulator effective well and to monitor access for SMEs. The RGC should and implementable through sub-regulations including develop incentives to attract early- and growth-stage guidelines on merger control and ensure strong venture capital to crowd in private capital. Operational coordination of the competition regulator with the efficiency of creditors can be improved by adopting private sector. Dispute resolution can also be improved measures that increase staff productivity or reduce the by creating a specialized commercial court for solving costs of decentralized delivery to expand outreach. commercial disputes,23 creating a small claims court, and developing an electronic case management system of judges and lawyers. Lawyers could also benefit from continual training. To improve PIM, the government should Diversify exports prepare PIM appraisal and implementation manuals that Despite Cambodia’s export success, low follow from the recently enacted PIM Sub-decree, and competitiveness and limited integration into GVCs centrally monitor public investment project delays and have led to concentrated markets and trade. cost overruns to strengthen in-year project monitoring by Manufacturing exports remain concentrated in garments line ministries. The government should also build capacity for PIM at all relevant ministries and agencies including unlike in some comparator countries that have been able to for project preparation and review to ensure quality. diversify into other GVC sectors (figure 0.8). But even within garments there has been limited upgrading to higher value- Improved business regulations are needed. While the added products or more sophisticated tasks over the past two report does not identify policies to target informality decades. Formal agriculture exports have increased twenty- explicitly, tackling relatively high business registration fold over a decade, driven by a comparative advantage costs and burdensome tax and insolvency procedures in exporting rice and cassava,24 but Cambodia has yet to will have the added benefit of creating incentives develop a similar advantage in vegetables or processed that reduce informality and its impact on the broader foodstuffs. In addition to low diversification, Cambodia’s economy. Cambodia can review and further reduce the key manufacturing and agricultural exports have fallen fees for business registration and continue integrating even lower on the quality ladder. Cambodia outperforms remaining agencies into the online business registration counties in its services exports, but this is fully explained by platform; simplify tax-audit compliance for businesses the growing role of tourism, where Cambodia is among the and streamline the current audit procedures; implement most reliant in the world on travel and transport services. the insolvency legal framework by establishing an Cambodia’s highly concentrated export basket made it insolvency administration profession; improve the particularly vulnerable to the Covid-19 shock. RESILIENT DEVELOPMENT: xviii A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL FIGURE 0.8 Cambodia’s exports are concentrated in garments with little diversification Sectoral export share, 1990-2019 a. Cambodia b. Vietnam 100 100 80 80 60 60 Percent Percent 40 40 20 20 0 0 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 Agriculture Fishing Mining and quarrying Food and beverages Textiles and wearing apparel Paper and wood Petroleum, chemical, and non-metallic mineral products Metal products Electrical and machinery Transport equipment Other manufacturing Source: World Bank staff calculations using mirror data from UN Comtrade and Cambodia Economic Update (World Bank 2019a). A primary cause of low diversification and inability Cambodia’s current investment and tax incentives regime to upgrade is the quality of FDI. Literature shows strong also influences the quality of FDI. Tax incentives currently rely productivity spillovers from upstream linkages with FDI firms, entirely on tax holidays for qualified investment projects, rather but these linkages have not yet formed in Cambodia. When than cost-effective incentives like tax credits used to promote FDI firms do not create backward linkages and do not share innovation, backward linkages, workforce training, or focusing knowledge, there are limited opportunities for technology on high-value-added sectors. Firms with Qualified Investment transfer and productivity spillovers through GVC participation. Project status reportedly prefer to source from abroad because Foreign manufacturing firms in Cambodia rely heavily on they are exempt from paying value-added tax (VAT) on imports imported inputs, and Cambodia has relatively low shares of and claiming a VAT refund when dealing with local suppliers foreign firms with quality certificates or technologies licensed would be too cumbersome and time-consuming.26 from foreign companies. This helps explain Cambodia’s low within-firm productivity growth as discussed above.25 Low capability of firms and workers also constrains upgrading. More than 95 percent of Cambodia’s apparel Barriers in the business environment likely discourage exporters are branch manufacturing plants of foreign-owned FDI firms and block a key channel for productivity firms whose overseas headquarters undertakes all activities spillovers for those that do come. A World Bank survey associated with functional upgrading, leaving little or no room found significant capacity and business-climate constraints for branch sites to take on more activities. The abundance of for foreign manufacturing firms in Cambodia to source locally, low-cost labor in low-income countries is often an entry point due to unavailability of inputs, difficulty identifying domestic for participation in the labor-intensive manufacturing segments suppliers, or suppliers unable to meet the quality, cost, and of GVCs. Upgrading knowledge and skills becomes necessary delivery standards required (figure 0.9). Rapidly rising wages, to transition into advanced manufacturing, services, and together with electricity and logistics costs that are higher than innovative activities that require a more educated workforce in neighboring countries, also allegedly discourage the arrival of with appropriate technical skills and sophisticated managerial new investors. Instead, investment is increasingly concentrated practices. Modern services in particular require a high-skilled in the construction and real estate sector alongside sharp workforce, absence of which poses a major constraint for increases in real estate prices, with a slowdown in the tradable diversification. The most recent World Bank Enterprise Survey sector. Domestic institutions play a complementary role in revealed that a significant percent of firms said an inadequately creating well-functioning and competitive services markets, trained workforce was among their top three constraints, with but in terms of the broader business environment, Cambodia exporters twice as likely to report this constraint as non- ranks lowest among comparators in rule of law as well as exporters (42 percent compared to 21 percent).27 Cambodia property rights protection. has not yet developed an effective system to upskill its existing workforce and this contributes to its skills deficit,28 as do regulatory restrictions towards foreign professionals. RESILIENT DEVELOPMENT: xix A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL FIGURE 0.9 Business environment constraints inhibit backward linkages from FDI to domestic firms Factors considered a barrier to source locally, as reported by surveyed firms in Cambodia, 2017 The inputs are simply not available from Cambodian firms 65 It is too time consuming to identify potential Cambodian suppliers 50 Potential Cambodian suppliers don’t meet our quality, cost, delivery standards 46 Dealing with Cambodian suppliers is cumbersome due to VAT issues 43 Cambodian suppliers lack basic certifications 35 Potential Cambodian suppliers are informal 33 Cambodian suppliers don’t have the right management capabilities 33 Fiscal incentives make importing a more competitive option than engaging with local suppliers 32 Cambodian suppliers don’t have the production volume to meet our minimum requirements 30 Percent of interviewed firms Source: World Bank staff calculations using data from World Bank Group 2017 FDI Survey and Economic Diversification Study (World Bank 2019a). A third key constraint to export diversification and Finally, Cambodia has not leveraged regional trade upgrading is trade-related regulatory barriers that agreements to support greater market access for its increase input costs and undermine productivity exports to other countries. Market access through trade and competitiveness, particularly for agricultural preferences has driven Cambodia’s GVC participation, but exporters. Mechanization can modernize agriculture and the existing unilateral preferences will eventually expire. improve labor productivity through labor reallocation, but Cambodia participates in few deep trade agreements, tariffs applied to some tools, implements, and spare parts which can facilitate higher participation, and it has not increase modernization costs for smallholder farmers. While used regional trade agreements with services provisions to non-tariff measures (NTMs) are less pervasive in Cambodia support market access for services exporters. compared to other countries, their associated cost, measured as the percentage increase in the price of imports, is steep Policy can help transform the country’s international and affects agricultural inputs like fertilizers, pesticides, trade to a more diverse, higher quality, and better and seeds. Tariffs also increase the cost of imported inputs integrated export sector. This agenda is paramount as for manufacturing production, where the average weighted trade offers vital channels for productivity improvements. tariff rate of manufacturing products is higher in Cambodia Priority areas include upgrading skills, incentivizing domestic than most comparator countries. linkages, revising the tax incentive scheme, pursuing a “go-green” differentiation strategy in agriculture, and Gaps in trade-related infrastructure also help explain reducing regulatory hurdles for modern services providers. Cambodia’s lack of export diversification, particularly Cambodia’s Resilient Development Policy Matrix at the end for modern services. New technologies are having a large of this Overview presents policy actions for diversifying impact on how services are delivered, and although internet exports in the era of Covid-19. prices are competitive, broadband access in Cambodia remains limited. The Covid-19 pandemic is further quickening • Improving capabilities by retraining workers and trade the pace of technological change, as producers are looking negotiators. The enterprise sector should be incentivized for techniques that avoid face-to-face interaction. Investing in to play a larger and more structured role in providing, digital infrastructure now (and preparing the workforce for non- guiding, and advocating for a demand-driven skills routine, knowledge-intensive jobs) will strengthen Cambodia’s development system—ideally involving internship adaptability to embrace technological change, thereby programs. Cambodia can also introduce results-based increasing competitiveness. Additionally, quality national financing for technical and vocational education and infrastructure needed for exports of fruits and vegetables— training institutions, explore individual learning accounts, like certification systems, border risk management, pest and expand short course offerings to serve the working surveillance, and laboratory testing—is missing. adult population. RESILIENT DEVELOPMENT: xx A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Given the importance of the apparel and footwear sector, • Investing in trade and digital infrastructure. Foreign another opportunity for building capacity is to continue firms’ high dependence on imported inputs suggests supporting vertical integration through joint ventures opportunities may exist for establishing and expanding between the Garment Manufacturers Association in local sourcing linkages—particularly with foreign Cambodia and international brands and investors. investors—if local inputs are competitive in quality and price. In the short run, developing an online portal Cambodia’s trade negotiators should be upskilled and digital app to offer basic matchmaking services to negotiate deeper trade agreements with services can overcome information asymmetry between foreign provisions and maximize the potential benefits of firms and domestic producers. Over time, more international agreements for Cambodia. This can be established supplier development programs can be done through modules covering recent developments in developed. With training, SMEs could become vendors rulemaking in the field. Cambodia could also implement in global e-commerce platforms. Simplifying VAT refund mutual recognition agreements and participate in procedures could incentivize exporting firms to source Association of Southeast Asian Nations (ASEAN) Trade from local SMEs. To facilitate the uptake of agriculture in Services Agreement that can also support market inputs, Cambodia can intensify market surveillance and access. traceability, and introduce a risk-management system at the border to lower cost and increase timeliness of • Strengthening investment and tax regulations and agricultural inputs. reducing trade barriers. Cambodia needs to attract a new wave of high-value-added FDI. Resolving challenges in investor protection and conflict resolution Harness domestic investments in sub-regulations to the new Investment Law is a first step. Subsequently, the tax incentives regime should Cambodia’s low domestic investment reflects the be revised to move away from a blanket tax holiday country’s low savings rate. Cambodia’s gross national scheme toward an investment incentives system that savings rate was 11.5 percent of GDP in 2018, the lowest introduces reinvested dividends, investment tax credits, among comparator countries (figure 0.10). Moreover, the and investment depreciation on the value of acquired savings rate has declined since a peak in 2012 of 22.9 machinery and equipment, quality certificates, or new percent. Even more concerning is Cambodia’s low and technologies. Raising and enforcing taxes on property declining gross private savings rate in recent years, in place and land can abate speculative investments, lowering of large and growing government savings (figure 0.11). In business operation costs, and attracting investors to 2018, government savings accounted for more than half of new projects. Cambodia’s total savings, compared to 2010 when it made up less than 4 percent. Promoting higher savings to support Policies can pursue a “go green” agricultural domestically-financed private, productive investment will differentiation strategy. Cambodia should introduce be critical to sustain the rapid expansion of fixed capital safety and quality standards for agricultural products formation required to meet Cambodia’s growth targets. and a national system for certification and labeling. Higher savings would also support greater macroeconomic Adapting institutional models supportive of agribusiness stability for long-term growth. This is even more critical like incubators, farmer-enterprise productive alliances, today, where the massive disruption in the international and contract farming systems can promote a local credit market brought on by the Covid-19 pandemic will agribusiness industry. In the short term Cambodia should likely threaten investment activity for years to come. review the effectiveness of its non-tariff barriers including licenses, quotas, and fees on imported agricultural inputs Concern about low private savings is not necessarily while also lowering tariffs and reducing costs related to how many households save but rather how much they transportation and trade facilitation. are saving. While data do not exist to disaggregate private savings into enterprise savings and household savings, evidence To support modern services, Cambodia should reduce suggests that the level of household savings is low. More than regulatory hurdles for services firms and entry half (55 percent) of adults reported having some type of savings restrictions to professional services sectors, particularly in 2017, higher than expected given Cambodia’s income per for accountants and lawyers. Enforcing intellectual capita. However, other surveys report a much lower share of property rights (IPR) legislation, implementing the households with savings at a given point in time. For example, e-Commerce Law, and improving digital infrastructure only 22 percent of households in the 2019 Living Standards like broadband/4G would further improve the enabling Measurement Study reported having savings. Differences in environment for modern services. these survey results could be capturing seasonality trends in RESILIENT DEVELOPMENT: xxi A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL FIGURE 0.10 FIGURE 0.11 Cambodia’s savings rates are low Cambodia’s private savings have been declining in recent years Gross national savings rate, 1995-2018 Private and public savings rate, 2010-18 40 16 Gross national savings rate (percent of GDP) 30 14 1.9 0.5 1.0 4.8 12 Percent of GDP 3.4 4.8 20 5.2 10 2.2 10 6.3 8 12.9 12.9 13.4 0 6 10.0 10.1 9.2 4 8.4 8.4 -10 5.2 1995 1998 2001 2004 2007 2010 2013 2016 2 Bangladesh Indonesia Phillippines 0 Cambodia Malaysia Thailand 2010 2011 2012 2013 2014 2015 2016 2017 2018 India Myanmar Vietnam Gross government saving Gross private saving Source: World Bank staff calculations using data from International Source: World Bank staff calculations using data from IMF Article IV for Monetary Fund (IMF) World Economic Outlook. Cambodia. income (for example, agriculture) but is more likely explained gross national savings rate is slightly below the average of by their different measures of savings. Whereas one survey other countries at a similar level of economic development counts discreet contributions, the other looks for sustained (figure 0.12). Other demographics and the enabling balances. Thus, some households would not be considered environment also explain Cambodia’s saving behavior, in savers if they saved some part of their income but ran it down line with literature.29 A long-term growth strategy should over the year. This suggest that savings are often modest and consider promoting higher savings levels, including targeting elude long-term accumulation. households that do not currently save. The large and persistent negative shock to livelihood Cambodia’s high dollarization offers another potential unleashed by the Covid-19 pandemic has exposed explanation for low savings. Together with rising FDI Cambodian households to dire consequences, and inflows, dollarization causes exchange rates to appreciate, they are unable to cope given their deficient savings. boosting imports that are mostly for consumption, which Cambodia has been one of the leading countries in poverty undermines domestic savings. Dollarization could also affect reduction and shared prosperity. But beyond extreme savings by (i) increasing output volatility, in turn inhibiting poverty, socioeconomic mobility has been limited with growth and depressing savings; (ii) creating barriers to many households escaping poverty only by a small margin. monetary policies that promote savings; and (iii) creating Most Cambodians are economically vulnerable even if currency imbalances that can lead to a crisis.30 they are not below the poverty line. Recent developments have weakened the labor markets considerably, and with How households save, however, appears to be a inadequate savings, households have limited means to key factor impeding greater domestic investment, absorb job loss shocks. Not surprisingly, low-income reflecting an inefficient formal financial sector. households are more adversely affected by the crisis. Formal savings in financial institutions is not as prevalent in Cambodia as in comparator countries. Only 5 percent Income dynamics are key to explaining Cambodia’s of adults participated in formal savings, significantly savings rate. The share of adults with savings is strongly below other countries (figure 0.13). Instead, 69 percent of correlated with income level in Cambodia, where only 3 households that save choose to do so informally (usually percent of households in the poorest income quintile in the at home in the form of cash or jewelry), and 22 percent 2019 Living Standards Measurement Study reported having through rotating savings and credit associations (ROSCAs), savings, compared to 45 percent in the richest quintile. savings groups, or other semi-formal mechanisms. A bias There is a similarly strong correlation between savings and towards informal savings impedes efficient allocation of income per capita across countries, where Cambodia’s credit, which drags down productivity growth.31 RESILIENT DEVELOPMENT: xxii A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL FIGURE 0.12 Cambodia’s savings rate is slightly below other countries at a similar income level Gross national savings vs. GDP per capita, 2018 60 Gross national savings (percent of GDP) 50 40 30 All countries 20 Comparators 10 Cambodia Linear (All countries) 0 5 6 7 8 9 10 11 12 Ln GDP per capita (current US$) Source: World Bank staff calculations using data from IMF World Economic Outlook and World Bank World Development Indicators. FIGURE 0.13 FIGURE 0.14 Most households save through informal mechanisms A low share of households in Cambodia have a financial account Percent of adults with savings by saving method, 2017 70 Share of adults with an account vs. GDP per capita, 2017 10 60 50 8 40 Percent Share of adults with an account 30 6 20 10 4 0 sia d ia DR es am My ia r ng ia h ma an es es od d pin lay oP n tn lad ail an on mb I 2 Vie ilip Ma Th La Cambodia Ind Ca Ph Ba Informal and other Semi-formal (e.g. savings association) 0 400 3,000 22,000 160,000 With financial institution GDP per capita (current US$) Source: World Bank staff calculations using data from World Bank Findex Source: World Bank staff calculations using data from World Bank Findex Database. Database. Access to savings vehicles has increased, but the share Regulatory issues in the financial sector pose more of adults with an account is much lower than other significant barriers to formal savings in Cambodia countries at a similar level of economic development than in other countries. Only 2 percent of Cambodian (figure 0.14). While more adults are getting accounts, the share adults reported not needing financial services in 2017. of adults saving formally has not increased at the same pace. Insufficient funds was the top reason for not owning a Instead, most accounts were treated as mailboxes to receive financial account in 2017, but many of the other reasons funds and withdraw them almost entirely and immediately. cited relate directly to financial sector issues. These include RESILIENT DEVELOPMENT: xxiii A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL lack of documentation, distance to a financial institution, the era of Covid-19 are presented in Cambodia’s Resilient cost of owning an account, and mistrust in financial Development Policy Matrix at the end of this Overview. institutions.32 Around 11.5 percent of the population does not have a national ID, often an essential document for • Improving capabilities by investing in financial literacy. account ownership. According to FinScope data, for over International experience shows that improved financial half of the nation’s population, the time to reach the nearest literacy, financial education, and financial planning can formal financial services provider exceeds 30 minutes. incentivize higher savings given a household’s income. Residents that do save in financial institutions are subject Key measures include: incorporating financial literary to a 4 percent tax on interest income earned via savings education into the school curricula and textbooks accounts, and income from fixed deposits is liable to a 6 under the purview of the Ministry of Education, Youth, percent tax. For non-residents, a tax rate of 14 percent is and Sports; developing financial literacy materials levied on interest income, regardless of the savings vehicle. on leasing, mobile banking, and new technologies to Key regulations that ensure financial sector stability are access finance; and supporting the efforts of National missing in Cambodia, which may impact households’ trust Bank of Cambodia, Association of Bankers Cambodia, in financial markets and institutions. and Cambodia Microfinance Association for financial literacy to clients, particularly low-income clients and Low financial literacy is the second reason for low those in rural areas. formal savings. A survey conducted in 2016 showed that Cambodia’s population has among the lowest financial • Strengthening regulations for deposit insurance and literacy scores relative to a global comparator set of 30 the domestic bond and insurance market. Several countries, including other ASEAN countries like Vietnam policy measures could boost savings in the formal with high informal savings rates. financial system where it can earn higher returns, be better protected, and, from an efficiency perspective, be A third challenge is limited technology adoption that intermediated to the most productive uses. Cambodia would increase access to financial services. DFS are should ensure financial sector stability by establishing untapped in Cambodia. Currently they are mostly limited a national deposit protection fund and strengthening a to payments services rather than for borrowing, saving, crisis preparedness regime for the whole financial sector. or lending, and lack an adequate consumer payments and Some small changes could also address financial and protection framework. administrative costs of savings accounts and products, like accepting other forms of ID to open an account in Finally, beyond banks and microfinance institutions/ the short term until a national ID is ubiquitous. microfinance deposit taking institutions (MFIs/MDIs), other financial instruments that can support savings Addressing regulatory gaps can support financial sector have yet to develop. Currently, neither the corporate nor development more broadly. These include implementing government bond market in Cambodia is very active, so the legal framework for government bonds; promulgating there is no facility to raise long-term funds or opportunity for the Micro-insurance Sub-decree to strengthen the the public to invest their long-term savings. The insurance regulatory and supervisory regime, broaden insurance market, which can substitute traditional savings in other products, expand distribution channels, and protect assets, remains small though growing. The recently enacted policyholders; and establishing sub-regulations of the social security law that establishes the principles and new Social Security Law to support its implementation. mechanisms to implement a system of pensions beyond public sector employees is not yet implemented. • Investing in digital payment infrastructure. Digital savings products can improve access for those who Even higher investment levels—through greater cannot easily or cost-effectively access physical bank savings—will be needed to achieve Cambodia’s branches. Cambodia should support the development of long-term growth targets. Policies can incentivize nonbank e-money issuer-to-bank interoperability—the higher domestic savings rates and encourage savings in technological backbone for digital savings partnerships the formal financial sector through improved access to and distribution strategies. The country should also savings institutions, including DFS, lower financial and develop legal and regulatory frameworks that: ensure administrative costs of financial accounts and products, and customer funds protection standards are robust for bank greater support for financial sector stability and development deposits and e-money accounts; and allow deposit- more broadly. While a broader list of short- and medium- taking institutions to pursue digital savings partnerships term policy areas is listed below, a set of policy actions for with nonbank entities and conduct limited purpose harnessing domestic investment over the coming years in banking services through retail agent networks. RESILIENT DEVELOPMENT: xxiv A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Cambodia’s Resilient Development Policy Matrix Objective Improving capabilities Strengthening regulations Investing in infrastructure Enable Build capacity for PIM at all Make the Competition Law effective Scale up the Credit Guarantee productive relevant ministries and agencies and implementable through sub- Scheme; develop incentives to attract firms and including project preparation and regulations including guidelines early- and growth-stage venture workers review to ensure quality; prepare on merger control; ensure strong capital [MEF] PIM appraisal and implementation coordination of the competition Initiate a media campaign and a manuals that follow from the regulator with the private sector ‘Regulatory Reform’ website to recently enacted PIM Sub-decree; [MOC] continuously update the private centrally monitor public investment Simplify tax-audit compliance sector on recent reforms, and engage project delays and cost overruns; requirements; streamline the them in public-private dialogue strengthen in-year monitoring of current tax-audit procedures [MEF] throughout the reforms process [MEF] projects by line ministries [MEF] Diversify Build capacity of Cambodia’s trade Move away from a blanket tax Develop an online portal and digital exports negotiators to negotiate deeper holiday scheme to an investment app to offer basic matchmaking trade agreements that cover incentives system that introduces services and overcome information services and implement mutual reinvested dividends, investment tax asymmetry of foreign firms and recognition agreements [MOC] credits, and investment depreciation domestic producers; establish a on the value of acquired machinery, supplier development program [CDC] equipment, quality certificates, or Intensify market surveillance and new technologies [CDC & MEF] traceability and introduce a risk- Review the effectiveness of all management system at the border to licenses, quotas, and fees on lower cost and increase timeliness of imported agricultural inputs [MOC] agricultural inputs [MAFF] Develop and strengthen intermediation mechanisms (job matching platforms and the National Employment Agency) to collect data on job vacancies and create outreach programs [MLVT] Harness Incorporate financial literacy Establish a national deposit Support the development of domestic education into school curricula and protection fund; strengthen the nonbank e-money issuer-to- investment textbooks; develop financial literacy crisis preparedness regime [MEF & bank interoperability, which is the materials on leasing, mobile NBC] technological backbone for digital banking, and new technologies to savings partnerships and distribution Implement the legal frameworks access finance; support efforts of strategies [NBC] for government bonds; promulgate the National Bank of Cambodia, the Micro-insurance Sub-decree; Develop legal and regulatory Association of Bankers Cambodia, finalize sub-regulations of the new frameworks that allow deposit-taking and Cambodia Microfinance Social Security Law to support its institutions to pursue digital savings Association for financial literacy implementation [MEF, MLVT, & NBC] partnerships with nonbank entities to low-income and rural clients [NBC] [MOEYS & NBC] Note: CDC=Council for the Development of Cambodia; MAFF=Ministry of Agriculture, Forestry, and Fisheries; MEF=Ministry of Economy and Finance; MLVT=Ministry of Labour and Vocational Training; MOC=Ministry of Commerce; MOEYS=Ministry of Education, Youth, and Sports; NBC=National Bank of Cambodia. RESILIENT DEVELOPMENT: xxv A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Endnotes 1 A group of nine countries were selected as comparators used throughout the report to benchmark Cambodia’s performance, including Bangladesh, India, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Thailand, and Vietnam. These countries were selected based on similar income level, size, and/or region. 2 In addition to Covid-19, economic activity has also been impacted by the partial suspension of the country’s preferential access to the EU market under the “Everything But Arms” agreement that came into effect in August 2020 and the ban on online gambling on January 1, 2020 that triggered large outflows of Chinese nationals. The Country Economic Memorandum focuses on Cambodia’s long-term growth. The short-term impact of the Covid-19 pandemic on Cambodia’s economy is analyzed in depth in the bi-annual Cambodia Economic Updates. 3 This entails sustaining GNI per capita growth at 9.3 percent until 2030 to achieve Cambodia’s upper middle income target—which has only been achieved by China—or 7.2 percent until 2050 to achieve Cambodia’s high income target— only achieved by the Republic of Korea. World Bank (2018a). 4 World Bank (2019a). 5 The World Bank’s Cambodia Economic Diversification Study (World Bank 2019a) led by Miguel Eduardo Sánchez Martín was written as Part I of the Cambodia Country Economic Memorandum. This earlier study was subsequently extended in the areas of (i) firm-level productivity, (ii) services export diversification, and (iii) financing the next phase of growth as Part II of the Cambodia Country Economic Memorandum. This report summarizes the findings and recommendations of Part I and Part II. 6 World Bank (2019b). 7 Since 1995, goods exports have increased more than 17-fold, from US$855 million to US$150 billion in 2019. The increase in services exports has been even more dramatic, expanding 53-fold from US$144 million in 1995 to US$6.1 billion in 2019. Current US$, Balance of Payments, from World Bank World Development Indicators. 8 Atlas of Economic Complexity. 9 World Bank (2018a). 10 World Bank (2018a). 11 Productivity improvement has long been recognized as a central driver of long-term economic growth and poverty reduction. A country’s ability to improve its income per capita over time depends largely on its ability to raise its output per worker in the long run. 12 World Bank (2020b). 13 Three factors can explain low labor productivity at the macro level: insufficient physical capital, low human capital, and low levels of TFP. Usually, these factors work together. High and rising endowments of human capital combined with high rates of physical capital investment explain most of the growth success of the East Asian miracle countries, including the Republic of Korea, Malaysia, and Thailand. World Bank (2018a). 14 World Bank HCI. 15 Cambodia is in the early phases of a ‘demographic dividend’ with the pool of potential workers expected to expand by 135,000 per year on average for the next 35 years. World Bank (2019a). 16 Output that cannot be attributed to inputs of labor and capital is known as TFP. It captures innovation, managerial skill, technology adoption, and other aspects that cannot be directly modeled. 17 Improvements in TFP can come from various sources. First, greater allocative efficiency of resources, from the reallocation/ structural transformation of economic activity to more productive sectors or to more productive firms within sectors, is a key source of aggregate productivity growth. Second, the exit of less productive firms and the entry of more productive firms can generate within-firm productivity improvements and aggregate productivity growth. Data do not exist to explore the contribution of firms exit and entry to aggregate productivity performance. RESILIENT DEVELOPMENT: xxvi A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL 18 These sectoral productivity differences also allowed substantial wage differences across sectors—for example about 50 percent higher in manufacturing than agriculture. This transition from lower-wage and less productive jobs in agriculture to higher-wage and more productive jobs in services and industry helps explain the significant poverty declines achieved in Cambodia (in addition to the higher productivity growth within agriculture). 19 Lewrick, Mohler, and Weder (2014). 20 World Bank (2017c). 21 Professional services, ICT, transport, finance, and electricity are key inputs for other sectors including manufacturing. In Cambodia, firms rely much less on business services, finance, and ICT than firms in the Philippines or Thailand. World Bank (2019a). 22 While having been reduced recently from US$420 to US$252.5 (at the time of writing this report), there is still scope for further reductions. In many countries, for example, business registration is free. 23 The RGC is currently in the process of establishing a commercial court. 24 Total agricultural export growth is likely even higher. Agricultural trade statistics are limited to formal agricultural trade, which underrepresents trade in products that are informally traded (such as, crossing borders without passing through customs agencies). This is particularly relevant for exports of raw products such as mangoes, cashew nuts, pepper, rubber, and other crops. 25 International trade supports productivity improvements through various channels. Yet in Cambodia, counterintuitive to global experience, the median firm is more productive in terms of value added per worker than the median firm that exports goods, is large (70 or more full-time employees, which are also more likely to be exporters), is integrated into a GVC (imports and exports), or that is foreign-owned (more likely to be exporters). 26 Under the Cambodian Investment Law, projects that meet a minimum capital investment requirement may qualify for tax exemptions on both inputs and profits. 27 World Bank (2019b). 28 Cambodia’s public and private skills development system is fragmented and small, and reform efforts so far have focused on setting standards rather than developing feedback mechanisms from the ultimate clients (the employers) or creating results-based incentives for training institutions. World Bank (2019b). 29 Land ownership, agricultural employment, formal employment, education, remittances, distance to financial institutions, and dependency ratio correlate with household savings in Cambodia. There is also a positive relationship between the coverage of MFIs and savings in Cambodia, suggesting the presence of MFIs has supported savings domestically. The deposit rate does not empirically explain the savings rate in Cambodia, consistent with global empirical evidence and the ambiguous theoretical prediction, based on offsetting substitution, income, and human-wealth effects (Grigoli, Herman, and Schmidt-Hebbel 2018). 30 Yeyati (2006), Ramey and Ramey (1999), Loayza, Schmidt-Hebbel, and Servén (2000), Grigoli, Herman, and Schmidt- Hebbel (2018), Balino, Bennett, and Borensztein (1999), Krugman (1999), Organisation for Economic Co-operation and Development (2001), and Hausamm and Velasco (2005). 31 A well-functioning financial system contributes to economic growth by allocating capital efficiently across the economy. This high reliance on informal savings implies less opportunity for these savings to be intermediated through financial markets and used for productive investment projects. 32 World Bank Findex Database. RESILIENT DEVELOPMENT: xxvii A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL CHAPTER 1: xxviii IMPROVING CAMBODIA’S PRODUCTIVITY PERFORMANCE Chapter 1 Improving Cambodia’s Productivity Performance Productivity has long been recognized as a central FIGURE 1.1 driver of long-term economic growth and poverty Cambodia’s labor productivity is low for its level of reduction.33 Across countries, productivity is correlated economic development with income per capita; and within countries, reducing Labor productivity vs. GNI per capita, 2000-18 poverty and raising incomes largely depends on raising output per worker.34 More productive firms have higher earnings, which they can use to invest in new technologies, create jobs, and pay higher wages. Enhanced productivity Output per worker (2016 US$ thousand, PPP) 125 also enables cost reductions that result in lower prices of consumer goods, therefore improving the purchasing power Malaysia and living standards of the poor.35 In Paul Krugman’s words, “productivity isn’t everything, but in the long run, it is almost Thailand everything.”36 25 Philippines India Cambodia needs to balance its accumulation- Myanmar Vietnam Bangladesh led growth model with a greater reliance on Cambodia productivity-led growth if it is to achieve its long- term development goals. To date, Cambodia has relied 5 largely on factor accumulation—ever increasing amounts of labor and physical capital to produce goods and services in the economy. But there are limits to factor accumulation, and all economies must eventually improve productivity to 1,035 4,045 12,535 continue to grow. Despite high and sustained gross national GNI per capita, atlas method (current US$) income (GNI) per capita growth rates, Cambodia has not Cambodia (2000-2018) been able to increase its labor productivity at similar levels, as measured by output per worker. Over the period 2000- Comparators (2000-2018) 18, GNI per capita increased 4.6 times to reach US$1,380 Other countries (2018) (current US$), elevating the country to lower-middle-income Note:  O utput per person employed. PPP = Purchasing power parity. status. But over the same period, output per worker only Source: World Bank staff calculations using data from Total Economy increased 2.2 times, and remains low compared to most Database. other countries at a similar development level (figure 1.1). In this context, productivity growth will be a key priority for promoting long-term economic growth. allocation across sectors and firms and dampen technology The Covid-19 pandemic and its impact on the global diffusion.37 And extended periods of unemployment could economy threaten to erode Cambodia’s productivity erode skills and discourage workers from returning to or improvements. Covid-19 is projected to cause a short- staying in the workforce.38 term economic contraction in every geographic region and in most countries, and the medium- to long-term prospects Productivity growth should therefore be a major are uncertain. Sickness, food insecurity, and job losses determinant of Cambodia’s economic recovery and threaten to reverse recent improvements in Cambodia’s future growth model. This chapter analyzes productivity human-capital growth, while school shutdowns could reduce performance in Cambodia. It attempts to explain Cambodia’s the number of learning-adjusted years of education for the weak productivity performance by exploring aggregate, future workforce. Firm closures and disruption in firm-worker sectoral, and firm-level productivity trends and factors relationships could hurt firm productivity through a loss driving those trends. It concludes with recommended of intangible assets, and disruptions to trade and global reforms to alleviate obstacles, improve allocative efficiency, value chains (GVCs) could lead to less efficient resource and boost firm-level productivity growth. RESILIENT DEVELOPMENT: 1 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Labor productivity is constrained by Human capital weak human capital and low total Cambodia’s human capital on the other hand is low factor productivity relative to its comparators and the rest of the world. According to the World Bank Human Capital Index (HCI), Three factors can explain low labor productivity at the which measures the impact of investments in children today macro level: insufficient physical capital, low human on future productivity and long-term economic growth, capital, and low levels of total factor productivity Cambodia ranks 118th of 174 countries for which data are (TFP). Usually, these factors work together. For example, available—on par with India and Myanmar, but far behind high and rising endowments of human capital, combined most comparators (table 1.1). Based on health and education with high rates of physical capital investment, explain most outcomes, its overall index score of 0.49 indicates that a of the growth successes of the East Asian miracle countries, child born today is expected to be 49 percent as productive including the Republic of Korea, Malaysia, and Thailand. in adulthood as he or she would have been with complete In Cambodia, availability of physical capital has not been education, good health, and a well-nourished childhood.39 a major constraint to growth, but its human capital is low relative to its comparators, and low TFP is a significant Education is Cambodia’s biggest obstacle to concern. improving human capital. Cambodia ranks 138th on the World Bank HCI in expected years of schooling.40 This Physical capital reflects shortcomings in Cambodia’s educational system, including late entry, high grade repetition, and high drop- The availability of physical capital has not been a out rates. As of 2017, only about 60 percent of 15-year- major constraint to growth in Cambodia. Over the last old students were on track, meaning they had reached two decades, the average gross fixed capital formation grade 10. In contrast, 73 percent of 15-year-old students averaged 18 percent of gross domestic product (GDP). in Thailand and 86 percent in Vietnam were on track. Capital formation was by far the biggest driver of GDP Grade repetition was the main reason, with 30 percent of growth in the country, and in recent years, capital was Cambodian students repeating a grade at least once in more important to Cambodia’s GDP growth than any of its primary or secondary school. The problem was especially comparators. However, Cambodia still needs to attract more pronounced for boys, who were 1.4 times more likely to capital if it is to meet its development goals, as discussed repeat than girls.41 School enrollment has increased over in Chapter 3. past decades, but overall educational attainment remains TABLE 1.1: Cambodia scores poorly on the World Bank HCI HCI score, rank, and sub-index scores, 2020 Fraction Learning- of children Expected years adjusted years Adult survival under five not Country HCI score HCI rank of schooling of schooling rate stunted Vietnam 0.69 38 12.9 10.7 0.87 0.76 Malaysia 0.61 62 12.5 8.9 0.88 0.79 Thailand 0.61 63 12.7 8.7 0.87 0.89 Philippines 0.52 103 12.9 7.5 0.82 0.70 India 0.49 116 11.1 7.1 0.83 0.65 Cambodia 0.49 118 9.5 6.8 0.84 0.68 Myanmar 0.48 120 10.0 6.8 0.80 0.71 Bangladesh 0.46 123 10.2 6.0 0.87 0.69 Source: World Bank HCI. CHAPTER 1: 2 IMPROVING CAMBODIA’S PRODUCTIVITY PERFORMANCE low. Only 8.5 percent of the working age population beneficiary would need to be increased to have a substantial (ages 15-64) is projected to have completed secondary effect on consumption and poverty.45 Moreover, stopping education, and only 1.5 percent to have completed tertiary the program at age two leaves a gap in nutritional support education by 2020. These educational attainment rates are until the age of five when children in poor households can lower than most countries with comparable income levels. participate in school nutrition programs. Inadequate nutrition Within the region, only Papua New Guinea and Lao People’s in children can lead to deficiency and poor health outcomes, Democratic Republic (Lao PDR) have similar or lower levels eroding child development and future productivity later in life. of secondary school completion rates, and only Papua New Guinea has lower tertiary completion rates.42 Total factor productivity A key challenge in the education system is low quality The largest contributor to Cambodia’s low labor of education services. Public educational institutions productivity, and largest cause for concern, however, lack the requisite administrative and financial autonomy is low TFP.46 Cambodia’s TFP is low for its income level to modernize their services. Low professional qualification and, in contrast to many of its comparators, Cambodia is not standards for educators also lowers the quality of education converging with the global productivity frontier. High-growth services, alongside low teacher capacity. countries like China, Malaysia, and Thailand had much higher Cambodia also faces challenges related to health, TFP at similar income levels. TFP growth is also low. Between particularly child nutrition, which further weaken 2000 and 2017, Cambodia’s TFP barely improved relative human capital and learning outcomes. The fraction of to the United States.47 And although TFP growth slowed for children under five who are stunted (low height for age) is most countries in the wake of the 2008 global financial crisis, higher in Cambodia than in any of its comparators except the decline for Cambodia was more severe. Since 2011, TFP India (table 1.1).43 Stunted children are more susceptible growth has fallen to just 0.2 percent per year, compared to to disease and infection. Stunting is also associated with 2.1 percent annual growth over the period 2000-07. TFP late school enrollment, lower cognition, poorer executive growth was also stagnant for Vietnam and Bangladesh, but function, and lower levels of educational attainment. At a other comparators saw more improvement (figure 1.2). The societal level, stunting lowers human capital and undermines widening TFP gap means Cambodia is not converging with its the economy. The problem is most severe for vulnerable comparators, let alone the global productivity frontier. populations. Health systems are in place, but many poorer families do not have the resources to access healthcare, FIGURE 1.2 and health emergencies threaten to push the near-poor into Cambodia’s aggregate TFP is low and has grown poverty. Covid-19 could compound these problems, first slowly in recent years with the direct health impact on individuals, and second by placing extra strain on health systems. Indirectly, income TFP trend relative to the United States vs. GNI per capita, 2000-17 losses due to Covid-19 could result in lower nutritional 1.5 outcomes for children in poor households. Addressing the high degree of malnutrition and Relative TFP (United States=1) stunting will be critical for building human capital. 1.0 Evidence demonstrates that malnutrition, lack of stimulation and learning, and/or exposure to toxic stress when young has an irreversible impact on brain development. Children Malaysia in the poorest quintile are more than twice as likely to be stunted as those in the richest quintile (42 percent and 19 0.5 Myanmar India Philippines Thailand percent, respectively). In July 2019, the Royal Government of Cambodia (RGC) introduced the maternal and child cash Vietnam Cambodia Bangladesh transfer program for pregnant women and children under two. This program targets poor women, with IDPoor cards 0.0 given to households in the bottom 15 percent of the income 1,035 4,045 12,535 distribution, conditional upon regular visits to a health facility GNI per capita, atlas method (current US$) from pregnancy through the first two years of their child’s life, Cambodia (2000-2017) making it the first nationwide social assistance program.44 Comparators (2000-2017) By targeting children’s health, the program seeks to improve Cambodia’s human capital, particularly among families that Other countries (2017) otherwise may not be able to afford regular health visits or Source: World Bank staff calculations using data from Total Economy a nutritious diet for their children. However, a recent World Database. Bank assessment shows that the amount received by each RESILIENT DEVELOPMENT: 3 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL There are various ways to improve TFP. First, improve manufacturing and services sectors. A Shapley Decomposition allocative efficiency of resources. This entails redressing confirms the large intersectoral reallocation of labor market distortions so that resources—including labor, contributed to Cambodia’s aggregate productivity. Workers capital, and land—are allocated to more productive sectors were incentivized by substantial wage differences, for example and more productive firms within sectors. At the broadest wages in manufacturing were about 50 percent higher than in level, reallocation of resources constitutes whole-scale agriculture. The result of individuals’ market-driven decisions structural transformation whereby a country moves from was an increase in allocative efficiency, as resources moved to a predominantly low-productivity agricultural economy to industries where they could achieve a higher return. one dominated by higher-productivity manufacturing and services. Second, aggregate productivity growth can come The impact on agriculture was huge. The sector’s share from within-firm productivity improvements, the exit of less of the workforce declined by more than half (figure 1.3, productive firms, or the entry of more productive firms. This panel a). As a result, the sector’s share of total value added entails redressing constraints in the business environment in the economy declined as the share of other sectors grew and improving the availability and quality of production (figure 1.3, panel b). Value added per worker increased in inputs. This chapter explores each of these in detail to all sectors (figure 1.3, panel c). But it increased the most in diagnose Cambodia’s low TFP performance. agriculture, where declining numbers of workers—coupled with smallholder land-use expansion, gains in crop yields, and diversification into higher value-added crops—resulted Structural transformation has in a near tripling of productivity from 2000 to 2019. The transition from lower-wage and less productive jobs in contributed to productivity growth agriculture to higher-wage and more productive jobs in but is incomplete services and industry helps explain Cambodia’s significant poverty reduction. However, at the same time, Cambodia’s Structural transformation is well underway in Cambodia. sectors are converging at a low level of productivity relative Between 2000 and 2019, workers moved from the lower- to its comparators, which could limit future gains in poverty productivity agricultural sector to the higher-productivity reduction.48 FIGURE 1.3 Workers have moved from agriculture to industry and services, alongside large productivity increases in agriculture Employment, value added, and value added per worker by sector, 2000-19 a. Employment b.  Value added c.  Value added per worker 100 100 2,500 Percent of total employment 80 80 2,000 Constant 2010 US$ Percent of GDP 60 60 1,500 40 40 1,000 20 20 0 0 500 2000 2009 2019 2000 2009 2019 2000 2009 2019 Agriculture Industry Services Note: Value added by sector does not add to 100 because of statistical discrepancies. When necessary the remainder is typically assigned to the services sector. Source: World Bank staff calculations using data from International Labour Organization and World Bank World Development Indicators. CHAPTER 1: 4 IMPROVING CAMBODIA’S PRODUCTIVITY PERFORMANCE FIGURE 1.4 growth. Third, much of Cambodia’s labor force have Workers are moving to more productive industries, emigrated, with potential for Cambodia to re-attract these boosting overall productivity growth workers if job opportunities existed back home. As of 2015, an estimated 1.19 million Cambodians (7.6 percent of the Employment growth vs. labor productivity, 2009-17 population) lived abroad, mostly in Thailand and the United States. More than 90 percent emigrated through irregular 20 Real estale and business Finance or illegal means, and most were young and low-skilled. And fourth, workers should theoretically move between sectors Construction until the marginal product of labor is equal across all three. (average annual change) Employment growth 10 Textiles and apparel Even after major gains in the agricultural sector, the value added per agricultural worker is still less than two-thirds of the value added per services sector worker. 0 Fisheries Mining Crops Within-sector productivity growth has been flat -10 0 5 10 15 20 Despite resources moving broadly to sectors with Value added per worker higher labor productivity, productivity growth within (average million riels in 2000 prices) manufacturing and services sectors has been suboptimal. Between 2007 and 2017, within-sector Agriculture Services productivity growth has been flat across most services, Industry Overall economy industrial, and manufacturing subsectors including Note: The rubber manufacturing sector is excluded because of incomplete construction, garments, and food and beverages. Major data. Mining is excluded from the calculation of the fitted line because industries that saw slow productivity growth include it is an outlier. construction and real estate and business (figure 1.5). Source: World Bank staff calculations using data from Cambodia National In many subsectors productivity growth was negative, Accounts and World Bank Cambodia Socio-Economic Survey (CSES). particularly those in the services sector. In fact, no single industry in the services sector grew faster than the overall economy for the period 2009-17. Within manufacturing and services, workers moved to more productive industries. Excluding mining, Flat productivity growth stems from two causes at there is a strong positive correlation between average the micro level: misallocation of resources within annual employment growth and average productivity from sectors and low within-firm productivity growth.53 2009 to 2017 (figure 1.4).49 The biggest relative gains in Two factors contribute to low productivity growth at the employment were seen in finance, real estate and business, sector level and ultimately the aggregate level in Cambodia. construction, and textiles and apparel.50 Meanwhile, all First, misallocation of resources—including labor, capital, agricultural subsectors saw employment shrink. and land—between firms within sectors prevents those resources from being efficiently utilized. Second, both lower At the same time, Cambodia’s labor force is growing, firm-level productivity and low within-firm productivity and the process of structural transformation is growth contribute to lower aggregate TFP, output, and incomplete, with further productivity gains still economic growth for Cambodia’s economy as a whole. to be had. First, Cambodia is in the early phases of its Each of these factors is discussed in detail in the following ‘demographic dividend’, with the pool of potential workers sections. expected to expand by 135,000 yearly on average for the next 35 years.51 Cambodia’s working age to total population ratio expanded from 54 percent in 1995 to 69 percent in Resource misallocation within sectors 2019 and is projected to continue increasing to 78 percent contributes to low sector-level productivity by 2050. Second, a large share of workers is still employed in agriculture. Among Cambodia’s comparators, Myanmar, In Cambodia, more productive firms have fewer India, Bangladesh, and Vietnam have a greater share workers than warranted given their productivity working in agriculture; Thailand is on par; and Malaysia and levels, which decreases aggregate TFP and output. the Philippines have far less. According to recent household Resource misallocation exists when inefficient enterprises surveys, workers laid off in response to the Covid-19 crisis command more resources (land, labor, and capital) than are returning to agriculture.52 This could reverse some of the warranted by their productivity levels. According to rankings apparent gains in reallocation and disrupt future productivity of firms in the 2014 Cambodia Inter-censal Economic RESILIENT DEVELOPMENT: 5 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL FIGURE 1.5 Labor productivity has been stagnant in Cambodia’s key sectors Value added per worker, 2009-17 a. Services b. Manufacturing 30 30 (million riels in 2000 prices) (million riels in 2000 prices) Value added per worker Value added per worker 20 20 10 10 0 0 2009 2010 2011 2012 2013 2014 2015 2016 2013 2009 2010 2011 2012 2013 2014 2015 2016 2013 Trade Finance Hotel and restaurants Food, beverages, and tobacco Textile and wearing apparel Transport and communications Other services Wood, paper, and publishing Non-metallic manufacturing Public administration Real estate and business Basic metal and metal products Other manufacturing Source: World Bank staff calculations using data from Cambodia National Accounts and World Bank CSES. TABLE 1.2: Firm employment and firm productivity are weakly correlated within sectors Correlation between within-sector firm ranking by employment and labor productivity, 2014 Industry / Sector Correlation Food and beverages -0.44 Textiles and apparel 0.24 Wood and paper printing -0.32 Non-metallic minerals -0.16 Metals 0.07 Wholesale and retail trade 0.04 Hotels and restaurants -0.19 Information and communication technologies -0.02 Finance and insurance 0.12 Administrative services -0.44 Education, health, and social 0.00 Note: Labor productivity is measured as sales per worker. The lower the correlation between firms’ labor productivity and firms’ labor usage (as reported in the 2014 Cambodia Inter-censal Economic Survey), the greater the extent of misallocation. Source: World Bank staff calculations using data from the 2014 Cambodia Inter- censal Economic Survey. CHAPTER 1: 6 IMPROVING CAMBODIA’S PRODUCTIVITY PERFORMANCE Survey, there is very low or negative correlation between investment management (PIM) institutions excel at planning labor productivity and the number of workers employed but underperform in the allocation and implementation at a given firm, most present in food and beverages and phase. Cambodia has not fully implemented its medium- admin services (table 1.2). A similar result is found when term fiscal framework; appropriations are made as a lump looking at capital.54 If resources were allocated with perfect sum, not for individual projects; and budget documents efficiency, the correlation would equal 1 for all industries. do not cover all public investment projects. Moreover, The mismatch in Cambodia shows that less productive Cambodia continues to rely heavily on external development firms tend to employ more factors of production, including partners, and coordination between government agencies workers, than are warranted by their productivity level.55 If could be strengthened.59 labor was more efficiently allocated, total productivity—and output—would increase. Although misallocation is high for all industries, it is less extreme for more productive (and Productivity and productivity growth are low larger) industries, like textiles and apparel. at the firm level When competitive and well-regulated, markets provide Low within-firm productivity also appears to be the right signals to bring about efficient resource challenging aggregate productivity. At the firm level, allocation. Underdeveloped or poorly functioning market Cambodia performs poorly on labor productivity relative institutions can instead contribute to resource misallocation to its comparators. According to World Bank Enterprise across firms within sectors. For example, rigid labor-market Surveys conducted from 2013 to 2016, median productivity regulations coupled with a high degree of informality has firms in Cambodia had lower labor productivity (measured been shown to increase relative labor costs for formal by value added per worker) than median productivity firms firms and result in lower overall productivity.56 In addition, in most comparator countries (except Bangladesh, Thailand, preferential treatment for state-owned enterprises could and Myanmar). Additionally, from 2012 to 2018 Cambodia’s increase the relative costs of finance for privately owned labor productivity was below the world average (figure 1.6). firms, putting them at a competitive disadvantage and again More productive Cambodian firms above the 75th percentile lowering overall productivity.57 Where markets fail—or where of labor productivity exhibit labor productivity on par with public goods are involved—the RGC needs to invest its fiscal more productive firms in Vietnam, but behind Malaysia and resources. However, inefficient public investment can also the world average.60 contribute to resource misallocation within an economy. Improving allocative efficiency requires strengthening FIGURE 1.6 market institutions to better allocate resources to Average firm-level labor productivity is low in Cambodia more productive firms within sectors. In Cambodia, Firm-level labor productivity, 2012-18 competition and contract enforcement within the court system are weak. Despite major gains in the past two 40,000 decades, Cambodia’s competition framework is still in the early stages of development. A regulatory framework Value added per worker has only recently been enacted and a regulatory body 30,000 US$, 2009 prices only recently established. Contract enforcement through courts is another key market institution where significant 20,000 improvements are needed, reflected by high costs and slow processing time. On average, it takes 483 days and costs over 100 percent of the claim value, in part because 10,000 Cambodia lacks a specialized commercial court for resolving commercial disputes.58 Lastly, low judicial quality reduces 0 the overall performance of courts. 3) 6) ia 6) Ma ia (2 ) Ph ysia 14) es 5) ag am 5) 12 5) 8) Ind 016 01 01 1 pin 201 av ietn (201 20 01 01 mb r (20 0 The RGC can also improve the allocation of resources (2 (2 (2 (2 -2 ( h d ma es an od for public goods through greater efficiency of lad ail an la e( ilip Th My ng V Ca government investment. Public investment has ramped up Ba er since the 1990s, improving access to electricity, education, al ob and clean water. But value for money in public spending Gl remains among the lowest in the region, and Cambodia Note: Using data from most recent available year. The dots represent the could double the impact of its public investment through 25th, 50th, and 75th percentile of labor productivity. enhanced efficiency, improving the effectiveness of fiscal Source: World Bank staff calculations using data from World Bank policy. Compared to the rest of the region, Cambodia’s public Enterprise Surveys and World Bank (2018c). RESILIENT DEVELOPMENT: 7 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL There is also larger dispersion in productivity or are integrated into GVCs are exposed to international performance across Cambodia’s firms. According to competition, and theoretically should be more productive. World Bank Enterprise Surveys, firms in Cambodia exhibit Likewise, large firms and foreign-owned firms theoretically greater labor productivity dispersion than other comparator have more access to technology, financial resources, and countries except Malaysia.61 The high productivity expertise than average firms, and should therefore be more differentials at the firm level in Cambodia are confirmed productive. This pattern generally holds within sectors in by the 2014 Cambodia Inter-censal Economic Survey. Cambodia. The exception is firms that only export, which The largest labor productivity dispersions (measured as on average are less productive than firms that do not sales per worker) are found in transportation, finance and trade, though the difference is not statistically significant. insurance, wholesale and retail trade, and construction. But Established firms—those that have been in business for ten despite large productivity differences, there is also high years or more—as well as registered firms are also more market concentration of firms within many of Cambodia’s productive on average, according to the 2014 Cambodia productive sectors. For example, the top four firms Inter-censal Economic Survey, when measuring productivity accounted for 92 percent of sales in transportation, 99 as sales per worker.63 percent in construction, and 82 percent in wholesale and retail trade in 2014. More concerning is the decline in firm-level labor productivity between 2013 and 2015. According to the Exploring productivity differences across firms World Bank Enterprise Surveys, firms in the services sector shows the distribution of labor productivity varies fared worse than those in manufacturing, but only slightly by firm type. In particular, the general population of (figure 1.7, panel a). This pattern was repeated across most firms in Cambodia perform worse than subsets that of Cambodia’s comparator group during the periods for should theoretically be more productive. According to the which data are available, in 2011-15. Among Cambodia’s 2016 World Bank Enterprise Survey, median firms in the comparators, only the Philippines saw positive productivity- overall sample are less productive in terms of value added growth in the period covered by the World Bank Enterprise per worker than median firms that are large (70 or more Surveys (figure 1.7, panel b). The regional drop was largely full-time employees), are integrated into a GVC (imports driven by a decline in sales, as median firms in all but one and exports), or are foreign-owned.62 Firms that export country showed no change in employment. FIGURE 1.7 Firm-level labor productivity declined in 2013-15 Distribution of labor-productivity growth in Cambodia and median annual growth, 2010-15 a.  By sector b.  Versus comparators 0.0 Median annual growth (percent) -2.5 Kernel density -5.0 -7.5 -10.0 -50 -25 0 25 50 ) ) ) 5) ) ) ) ) 13 15 12 14 15 14 14 01 Percent change in labor productivity 20 20 20 20 20 20 20 -2 1- 3- 0- 2- 3- 2- 2- 13 01 01 01 01 01 01 01 20 (2 (2 (2 (2 (2 (2 (2 r( Manufacturing Services ia d h sia ia am es ma an es Ind od pin lay tn lad ail an mb Vie ilip Ma Th My ng Ca Ph Ba Note: The kernel density plot estimates the underlying probability density function. Firms with greater than 50 percent productivity growth or less than -50 percent are not shown in the density plot. Labor productivity is measured here as sales per worker, not value added per worker as above, because historical data on the cost of materials and intermediate goods are not available. Data for Cambodia in panel a are for 2016. The median firm had positive sales growth but 0 employment growth in most countries, resulting in negative labor-productivity growth. Source: World Bank staff calculations using data from World Bank Enterprise Surveys. CHAPTER 1: 8 IMPROVING CAMBODIA’S PRODUCTIVITY PERFORMANCE A challenging operating environment useful information on otherwise difficult to measure aspects of constrains firm-level productivity the business environment though they have shortcomings. For example, managers may not be honest, they may be unaware of A growing body of literature has focused on the or misinterpret the actual constraints faced by the firm, or they role of institutional and regulatory frameworks and may not answer questions reliably for other reasons. That said, the business regulatory environment to explain managers are assumed to know more about the immediate differences in firm-level productivity outcomes. A problems confronted by their firms than outside analysts and the challenging operating environment—including burdensome constraints they identify provide the basis for further analysis. regulations; low quality, expensive, and unreliable inputs; and low human capital—prevents firms from making the An empirical study conducted for this report echoes best use of resources they do acquire.64 There are significant firm managers’ perceptions about obstacles and challenges in the Cambodian business environment. The helps quantify the impact of those alongside objective RGC has committed to improving the operating environment constraints, finding that poor access to finance, for firms in Cambodia and has taken a number of recent inefficient business regulations, informality, and initiatives in this regard. An inter-ministerial working group inadequate electricity services are the most significant was established in April 2020 with members from around constraints to firm performance in Cambodia. The study 20 relevant ministries and institutions. The Government has used regression analysis to determine the relationship between made a number of recent reforms, such as online business five measures of firm performance—labor productivity, TFP, registration, with others ongoing. Nevertheless, it is an labor-productivity growth, employment growth, and sales ongoing and medium-term agenda. Determining specific growth—and dozens of controls and explanatory variables, constraints—as identified by firm managers or through including firm managers’ perceptions and objective measures firm-level analysis—helps understand the cause of low like access to finance, backbone services and infrastructure, within-firm productivity performance in Cambodia. labor skills and regulations, business regulatory environment, and crime and corruption. The data comprise a cross-section According to firm managers the biggest obstacles to of pooled data from firms in 139 countries collected by World operating a business in Cambodia are practices in the Bank Enterprises Surveys from 2006 to 2019, including data informal sector, political instability, and an inadequately for 842 Cambodian firms—472 surveyed in 2013 and 370 educated workforce. These were identified by more than in 2016. To mitigate endogeneity of firm-level responses, 10 percent of firms in the most recent World Bank Enterprise subjective constraints are measured as the peer average for Survey—higher than the rates in all but a few of Cambodia’s clusters defined by size-industry, excluding the firm’s own comparators (figure 1.8).65 Perceptions-based data provide observation (see Annex 1 for the methodology). FIGURE 1.8 Informality was identified as the biggest obstacle by a plurality of non-agricultural firms Percent of firms identifying an obstacle as the biggest faced, 2013-16 Pratices of informal sector Political instability Inadequately educated workforce Access to finance Transportation Corruption Tax rates Access to Land Business licensing and permits Electricity Crime, theft, and disorder Labor regulations Tax administration Cambodia Courts Comparator Customs and trade regulations countries 0 5 10 15 20 25 30 35 Percent of firms identifying obstacle as biggest faced Note: Showing data from the most recent available years between 2013 and 2016. Source: World Bank staff calculations using data from World Bank Enterprise Surveys. RESILIENT DEVELOPMENT: 9 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Taken together, firm managers’ perceptions and in Cambodia were particularly onerous compared to its the empirical study suggest four categories of regional comparators and getting worse. Between 2013 and constraints that need to be addressed if Cambodia 2016, the average time Cambodian firms spent addressing is to successfully improve firm-level performance: government regulations increased from 1.3 percent to 16.4 burdensome regulations; informality; low quality, expensive, percent—more than six times longer than the East Asia and and unreliable services inputs; and low labor quality. Pacific (EAP) average. On average, firms were required to meet with tax officials 5.8 times in a fiscal year, well above Burdensome regulations the regional average, and up from 2.3 times a year in 2013. It also takes longer than the EAP average for Cambodian In general, countries with simpler business regulatory firms to obtain an operating license, construction permits, environments grow faster.66 But those regulatory and import licenses.72 environments also need to create the right incentives. A supportive regulatory environment that protects property High wage growth has similarly eroded productivity rights, facilitates skill acquisition and technology transfer, gains. Between 2009 and 2015, average wages in the and discourages corruption and expropriation is essential apparel sector increased by 81 percent, reflecting big for generating high output per worker.67 Other aspects of the increases in Cambodia’s minimum wage. Other sectors business environment, like delays in obtaining construction similarly saw high wage growth, like other manufacturing (61 permits, complex customs procedures, inefficient tax percent) and services (47 percent). Yet evidence suggests administration, and rigid labor markets, have also been that labor productivity in garment firms has not kept pace linked to lower levels of innovation, investment, and with increased labor costs, and in 2016 Cambodia had the productivity.68 These ideas are supported in the literature highest unit labor costs as a percentage of value added where studies have found a positive association between the in that sector.73 Policymakers should therefore focus on quality of governance and institutions—including the rule of efforts to improve labor productivity alongside any legislated law, political stability, and the absence of corruption—and wage increases. Focus areas could include, for example, economic growth.69 incentivizing skills improvements through workforce training with cost-effective tax incentives and lowering the costs in Cambodia lags behind its comparators in the quality the business environment such as transport costs. of its regulatory environment. Burdensome insolvency procedures are a key issue for Cambodian firms.70 Current Informality legislation provides a solid base for insolvency practices in Cambodia, but steps can be taken to speed up insolvency Informality is both a cause and a consequence of the proceedings and recovery rates for secured creditors. It high regulatory burden. In Cambodia, only 6 percent of takes about six years for creditors to recover credit through small firms are registered. Sixty-four percent of medium- judicial reorganization, liquidation, or debt enforcement sized firms and 97 percent of large firms are registered proceedings and they can only recover on average 14.2 while hardly any micro firms are.74 A qualitative assessment cents on the dollar. Additionally, improvements could be in neighboring Lao PDR, where informality appears made to regulate the insolvency administrators’ profession to create the same level of constraint on businesses, and address early voluntary filings by debtors, post- revealed that inadequate registration, tax evasion, complex commencement financing, the complicated set of priorities and inconsistently enforced regulations, and a culture for creditors, overly stringent requirements for compromise of noncompliance were among the main reasons why plan approval, and the inability to transfer a business. companies remained informal.75 The challenge similarly lies in lack of a specialized court, judges, lawyers and professionals. Finally, investors also One reason for such high informality in Cambodia need simpler, but stronger protections around corporate is the level, quality, and enforcement of regulations transparency, ownership and control, and shareholder governing state-business transactions. Anecdotal rights.71 evidence suggests burdensome insolvency procedures are one of the main reasons micro and small and medium According to the empirical study conducted for this enterprises (SMEs) choose to stay informal. The difficulty and report, tax administration and import regulations cost in obtaining operating licenses also directly encourage were the two most significant regulatory constraints firms to stay informal. More broadly, informal firms may to firm productivity and expansion. Decreasing the be able to avoid costly taxes and burdensome procedures average time (number of days) firms in Cambodia must related to tax, labor law, public health, environment, safety, wait to obtain an import permit by one standard deviation and more. There is ample evidence that countries with would increase sales and employment growth rates in excessively burdensome tax systems (including in many parts 0.03 and 0.04 standard deviations respectively. According of the world with prohibitively high tax rates) create perverse to the World Bank Enterprise Surveys, regulatory burdens incentives, including widespread tax evasion, informality, and, CHAPTER 1: 10 IMPROVING CAMBODIA’S PRODUCTIVITY PERFORMANCE not surprisingly, low levels of revenue collection. Additionally, for example, improved quality, variety, and cost of services medium to large formal firms attract a lot of inspections, which inputs resulted in improved performance for firms in may increase the opportunities for corruption. According to downstream sectors.78 Analysis of Cambodia’s broader the World Bank Enterprise Surveys, an informal payment or services sector is presented in Section 2.3. gift was expected in nearly 60 percent of public transactions in Cambodia in 2016, and nearly 65 percent of Cambodian In Cambodia, there exist weak linkages with firms reported experiencing at least one bribe payment services inputs used in manufacturing production. request. On these two corruption measures, Cambodia For example, manufacturing firms in Cambodia rely much performed significantly worse than its comparators. less on domestic business services, finance, and ICT than firms in the Philippines or Thailand79 and report that the Informality appears to be more pervasive and availability and quality of electricity, finance, transport, and problematic in Cambodia than in its comparator telecommunications challenge their operations. countries. In 2016, the latest year for which data are available, more than 28 percent of non-agricultural firms Firm managers cited access to finance, in particular, identified practices of the informal sector as their biggest as a major constraint to their business operations. obstacle. Nearly 78 percent of firms reported having to Cambodia’s financial sector is at a nascent stage. Fewer than compete against unregistered or informal firms, far higher 40 percent of firms have bank accounts, which is half the than the regional average of 50 percent and the global EAP average and well below all comparator countries. Only 20 average of 53 percent.76 percent had obtained a bank loan or line of credit in the fiscal year before the survey.80 The cost of bank finance is high, with Informality puts formal firms—which pay taxes interest rates for small business loans ranging 15-18 percent and follow regulations—at a relative disadvantage, or more per year, according to recent information published on and the high degree of informality itself signals a bank websites. This is in part due to limited competition and problem with the economy. In general, informal firms an imbalance of power between creditor and debtor. are less productive, with lower shares of skilled workers and weaker TFP. Informal workers often do not have access Poor access to finance constrains productivity and to social protection programs, leaving them vulnerable to growth. According to the empirical study conducted for shocks including Covid-19. And a large informal economy this report, limited and costly bank financing is associated erodes the tax base, depriving the government of revenue with the highest productivity losses for Cambodian firms. and making it more difficult to provide public services.77 The On average, firms that have a credit line or loan from a empirical study conducted for this report confirms these bank are more productive than those that do not. Many patterns in Cambodia. All else equal, firms that were not firms, particularly SMEs, face challenges in access finance registered when starting operations were less productive; due to for example collator requirements by banks. Firms being registered at the start of operations is associated with whose applications for bank loans were rejected in the higher TFP and labor-productivity levels; and the longer a previous year have lower labor-productivity levels and business remained informal, the weaker its performance. report lower average sales growth rates. The higher the An increase in the informality time (number of days) by one collateral requirement firms face, the lower their TFP and standard deviation is associated with a decrease in sales labor-productivity levels, and the weaker their average of 0.02 standard deviation, and a decrease in employment employment growth rates. And heavy reliance on internal growth rates of 0.01 standard deviation. funds—for financing investments in fixed assets or working capital—is associated with lower productivity levels and Low quality, expensive, and unreliable services inputs weaker sales growth. The quality, cost, and reliability of inputs becomes Although not identified by firm managers as a more important as an economy develops and top concern, poor electricity and water services becomes more complex because of the proliferation nevertheless appear to have a substantial impact on of value-chain linkages between sectors. Professional labor productivity and constrain the ability of firms services, information and communication technologies to grow. Results from the empirical study show that the (ICT), transport, finance, and electricity are key inputs for more power cuts and water insufficiencies a firm confronts, other sectors, like manufacturing and agriculture. Cross- and the longer the duration of these events, the lower the country evidence suggests that productivity performance is average labor productivity of the firm. In addition, the longer affected by poor service provision—if an upstream services a firm must wait to have electricity installed or reconnected sector is not competitive, it will lower the competitiveness of after power cuts, the lower its average sales growth rates. downstream sectors to which it provides inputs. Productivity This exacerbates the high cost of operating a business in growth in services has been a key driver of GDP growth Cambodia and erodes the international competitiveness of in both advanced and developing countries. In Indonesia, its businesses. RESILIENT DEVELOPMENT: 11 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Low labor quality this reform is now even more critical as part of the effort to facilitate a robust recovery after the crisis. The Covid-19 Low labor quality—reflecting Cambodia’s low human income shock to poor and vulnerable households severely capital—is a major problem in the current workforce. risks reducing educational attainment and increasing According to the World Bank Enterprise Surveys, an malnutrition and associated poor health outcomes due to inadequately educated workforce was the third-biggest inadequate dietary intake, lowering Cambodia’s human obstacle faced by firms, behind informal sector practices capital for years to come. To improve human capital and political instability.81 Insufficiently skilled labor hinders in the future workforce, the RGC needs to make major production, reduces current profits, and slows business investments, focusing on education and health services development. The problem is especially bad for SMEs, early in life. A strong social protection system can also exporters, and foreign firms.82 Low skills also make it enhance Cambodia’s resilience to future income shocks. harder for workers to transition to more productive (and higher paying) jobs, exacerbating the misallocation problem First, in the short term, invest in early childhood discussed earlier in this chapter.83 Social factors like soft nutrition, parental education, and childcare. skills and attitude towards employment also affect labor Addressing the high degree of malnutrition and stunting productivity. Finally, firms’ top management experience will be critical for building human capital. Disadvantages in Cambodia lags. On average, the top manager of a in early life are more significant for the poor, and prevent Cambodian firm has worked 12 years in the firm’s sector— realization of their full potential, which dims their labor half as long as top managers in Thailand and barely one market prospects and future income-generating potential. year more than top managers in the worst performing Cambodia could consider scaling up the maternal and child comparator country, India.84 Cambodia’s policy agenda to nutrition cash transfer program by (i) expanding and better improve skills is discussed in Chapter 2. targeting households that can participate in the program, (ii) increasing the transfer amount for households, and (iii) continuing the program beyond age two (ideally until age five Policy recommendations for when children get support through school programs). Ideally, productivity improvements the maternal and child nutrition cash transfer program should only be one part of a wholistic and comprehensive Cambodia needs to boost productivity growth to approach to tackling stunting and malnutrition in Cambodia. achieve its long-term growth agenda. Productivity The Ministry of Labour and Vocational Training, currently growth is associated with higher income per capita, lower overseeing the maternal and child nutrition cash transfer poverty, and higher standards of living for the poor. But there program, could continue as the key implementing agency. has been a global slowdown in productivity growth over the last decade, with the Covid-19 pandemic further threatening Second, in the medium term, invest in public services productivity improvements. And despite positive trends like in education and health. Giving more administrative and Cambodia’s deepening structural transformation, problems financial autonomy to health and education institutions to remain. Policy reform in target areas can help the country modernize their services with technology will be critical. meet its potential, including: investing in human capital The RGC can capitalize on its decentralization efforts, by through health and education; supporting more efficient setting pro-growth, sustainable, and adequately resourced resource allocation through improved market institutions policies at the ministerial level and empowering provincial and PIM; easing the regulatory burden for firms thereby governments to implement them effectively. Upgrading reducing informality and its negative impact; and improving health and education professional qualifications will also be the performance of key services inputs to strengthen important to improving the quality of services and capacity domestic linkages. In each of these areas, policy reforms of health and education professionals. The Ministry of support improving capabilities, strengthening regulations, Education, Youth, and Sports and the Ministry of Health have and investment in infrastructure. leading roles in implementation. Invest in human capital Third, in the medium term, improve education curricula to align with the needs of a modern workforce and There is already a clear commitment from government address skills gaps in the future workforce. (Improving to improve human capital. Phase four of the government’s the skills of the current workforce is discussed in Chapter “Rectangular Strategy” puts human development first. Still, 2.) A modern workforce increasingly requires a mix of secondary school enrollment rates remain low, too many higher-level skills like cognitive, socio-emotional, and digital students repeat grades, and too many children are stunted literacy. Updating training methods and equipment will also due to inadequate nutrition. Even before the economic be important for better learning outcomes. Consulting with shock resulting from the Covid-19 pandemic, it was clear private sector on the skill mismatches they face should that Cambodia needed to improve its human capital. But also be undertaken during this process, which would help CHAPTER 1: 12 IMPROVING CAMBODIA’S PRODUCTIVITY PERFORMANCE alleviate the demand-supply skills mismatch reported by coordination with the private sector. As a short-term firms. Attracting Cambodians who study abroad to return priority, the government should ensure the competition back home can also help alleviate skills mismatches. In regulatory is truly independent based on international many countries, government-funded scholarships to study best practices, with the ability to issue decisions, orders, abroad are conditional on returning and working in the and interim measures; impose fines; and draft rules and home country for a minimum number of years, for example. guidelines. This entails eliminating the bifurcated Cambodia The Ministry of Education, Youth, and Sports would lead Competition Commission and Directorate functions, these improvements. consolidating all competition functions within the Cambodia Competition Commission. Strengthen market institutions and PIM The Ministry of Justice should reform the way Cambodia needs to support more efficient resource commercial disputes are handled by the courts. allocation through improved market institutions Performance of Cambodia’s courts, illustrated by weak and PIM. Structural transformation is well underway, but contract enforcement, is another key market institution with misallocation is evident at the sectoral level, especially in scope for improvement. In the short-term, Cambodia can the services sector. This prevents resources from being publish reports about the performance of courts (time to utilized by the most productive firms, lowering aggregate disposition, clearance rate, age of pending cases) as well TFP and labor productivity. As businesses close and workers as judgements for commercial decisions at all levels (first are laid off due to Covid-19, better allocative efficiency will instance, appellate, supreme court). In the medium term, be key to strengthening Cambodia’s economic recovery and Cambodia should review the existing case management rebuilding its economy. To improve allocative efficiency, the system for commercial disputes and proceed with creation RGC needs to strengthen market institutions to send clear of a specialized commercial court for solving commercial signals and facilitate efficient allocation between firms and disputes, creating a small claims court, and developing an improve PIM.85 electronic case management system of judges and lawyers. Additionally, lawyers should be provided continual training, To improve outcomes for the private sector, the and the courts would benefit from a widespread campaign RGC needs to issue sub-regulations to bolster the to improve dispute resolution processes and draw attention Competition Law in the short term (next one to two to the importance of alternative dispute resolutions. years). The RGC needs to promote competition in key sectors of the economy and implement the competitive The RGC also needs to reform its PIM to provide neutrality principle. A new Competition Law provides the sufficient public goods in an equitable and efficient foundation for market reforms. To promote competition, way, by prioritizing reforms and building capacity to the RGC should make the Competition Law effective implement public investment project and program. and implementable through sub-regulations including The government’s new PIM strategy (2019-25) and budget guidelines on merger control that could continue to be led system reform strategy (2018-25) provide the basis for by the Ministry of Commerce. Currently, the law lacks sub- reforming PIM. To further strengthen PIM, in the short term regulations and guidance on key aspects of merger-control the RGC should prepare PIM appraisal and implementation policy, including notification thresholds, elements of the manuals that follow from the recently enacted PIM Sub- administrative process, and substantive assessment and decree, and centrally monitor public investment project available remedies. These gaps increase the potential for delays and cost overruns to strengthen in-year project discretionary decision-making and hinder legal certainty. monitoring by line ministries. In the medium term, a full- At present, the law also provides inadequate protections fledged medium-term fiscal framework must be implemented for legitimate business practices. For example, the strict to provide multi-year guidance on budget preparation and prohibition of vertical agreements risks affecting efficiency- identify individual public investment projects during budget enhancing business practices absent a consideration of preparation. The government should also build capacity whether the parties have some concerning degree of market for PIM at all relevant ministries and agencies including power. Conduct should be permitted where objectively for project preparation and review to ensure quality necessary and proportionate, or where the activities produce assurance. The Ministry of Economy and Finance could be significant efficiencies to outweigh any anticompetitive the main implementing agency. In addition, improvement of effects on consumers. institutional coordination among government institutions as well as between government and private sector will also For the Competition Law to be effective, the RGC promote more efficient resource allocation and improve needs to ensure independence of the recently competitiveness of the economy as a whole. This is a cross- established competition regulator and ensure key government agenda. RESILIENT DEVELOPMENT: 13 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Reduce regulatory burdens and informality Finance with involvement of other ministries and agencies across government. The empirical analysis confirms that to achieve greater productivity outcomes Cambodia needs Second, authorities should consider making it easier to reduce the regulatory burden faced by firms. In for firms to file for insolvency and bankruptcy. recent years, the RGC has undertaken reforms to address Burdensome and costly insolvency procedures are a key corruption, trade facilitation, and smuggling. The Anti- reason firms reported staying informal. Revisiting bankruptcy Corruption Unit under the Prime Minister is working with and insolvency procedures may become a priority during the private sector to build a culture of transparency and Covid-19. Asset deterioration will increase the risk of create an environment where corruption can be reported insolvency for many firms, with negative implications on and disciplined. And the General Department of Customs credit markets, supply chains, and worker productivity, and Excises has successfully rolled out the Automated which will dissipate only gradually. The RGC can prepare for System for Customs Data (ASYCUDA) and enhanced anti- recovery by creating enabling environments to restructure smuggling measures.86 But many obstacles remain. To debt in firms, including through strengthening insolvency ease the regulatory burden on the formal sector, Cambodia resolution and legal frameworks for corporate and consumer needs to reduce the time and cost of operating in a formal debt restructuring. To this end, the RGC led by the Ministry manner and ensure that regulations are applied fairly.87 of Justice should implement the insolvency legal framework Linkages between domestic firms and foreign direct by establishing an insolvency administration profession investment (FDI) firms can also improve firm-level and improve the overall efficiency of the courts to expedite productivity through learning and technology spillovers, as bankruptcy proceedings. While this is a medium-term discussed in Section 2.1. While the report does not identify agenda, implementation should be a short-term priority. policies to target informality explicitly, by tackling high costs Out-of-court conciliation and resolution measures will be of business registration and burdensome tax and insolvency particularly important to prevent a surge in insolvency, procedures this agenda will have the additional benefit of value-destroying liquidations, and asset fire-sales, helping creating incentives that reduce informality and its impact on to preserve employment. The RGC can review the corporate the broader economy. governance framework for investors in the Companies Law, particularly around corporate transparency, ownership and First, as a short-term priority, Cambodia should review control, and shareholder rights. and further reduce the fees for starting a business and integrate remaining agencies into the online Third, simplify tax administration procedures. The business registration platform. Quick, efficient, and General Department of Taxation has made some progress cost-effective business registration processes are critical in the last few years to modernize tax filing and payment for fostering greater entrepreneurship in Cambodia as well procedures.88 The likelihood of corporate income tax audits as supporting firm formalization. Reforms that support firm for a minor error in a corporate income tax return or an creation and formalization are important now more than ever underpayment of a tax liability was high in Cambodia.89 to help the economy recover from the Covid-19 crisis and The time burden associated with audits is high; complying provide access to government relief programs. Cambodia with a corporate income tax audit takes 31 hours, and it has recently set up online business registration, which has takes 35.1 weeks to complete the audit.90 Similarly, after substantially reduced the time to register a business. Key a large capital purchase, the audit for the value-added ministries and agencies involved in the process of business tax (VAT) cash refund takes about 50 weeks to process. registration (the Ministry of Commerce, the Ministry of Though it is important to protect the tax system against Economy and Finance’s General Department of Taxation, improper influences from the business community, it is also and the Ministry of Labour and Vocational Training including important for businesses to be unburdened by unnecessary the National Social Security Fund) are now connected requirements and procedures. In this regard, Cambodia through the single online portal and coordinated back office. should simplify tax-audit compliance for businesses and However, other agencies involved in the company licensing streamline the current audit procedures. This initiative could process are still being brought online, which would further be led by the General Department of Taxation. Although reduce the time for businesses to start operations. The this is a medium-term agenda, implementation should be government should also review and reduce the registration a short-term priority. More broadly, in the immediate term, and licensing costs of starting a business. While having the Ministry of Economy and Finance can initiate a media been reduced from US$420 to US$252.5 (at the time of campaign on improving the business environment, create writing this report), there is still scope for further reductions. a dedicated website to continuously update the private In many countries, for example, business registration is free. sector on recent reforms, and engage them in public-private This initiative could be led by the Ministry of Economy and dialogue throughout the reforms process. CHAPTER 1: 14 IMPROVING CAMBODIA’S PRODUCTIVITY PERFORMANCE Improve quality, cost and reliability of services inputs Operational efficiency of creditors can further be improved by adopting measures that increase Cambodia should improve the performance of key the productivity of staff or reduce the costs of services inputs to strengthen domestic linkages. decentralized delivery and expand outreach. Such Cambodia has substantially improved electricity services measures would include supporting business processes access in recent years, but continued efforts are needed to optimization (including through leveraging technology) and ensure the reliability of electricity and reduce the number adopting innovative delivery models to reduce distribution and duration of power outages. Similarly, Cambodia has costs and increase outreach. Chapter 3 will discuss how improved finance but could still expand access particularly authorities, including the National Bank of Cambodia, for SMEs. Digital infrastructure is discussed in Section 2.3. can also introduce a framework and clarify regulations for electronic banking, mobile banking, and agent-based New regulations and investments can improve the banking as a cost-effective mechanism for banks and reliability and accessibility of electricity connections. microfinance institutions (MFIs) to reach new customers The RGC has increased electricity supplies through large and lower costs. Authorities should also enhance capacity investments in generation capacity and accelerated by strengthening financial literacy so consumers can better electricity connections for households and businesses. choose among lending options—from discerning the most Electric Du Cambodge has recently set up an automated attractive terms across lenders to selecting the appropriate system to monitor power outages, which should help financial products for their needs. improve the reliability of the power supply. Nevertheless, access remains a concern for businesses. To continue To improve access to finance, it will be important to improving access, the RGC can introduce time limits for target support for SMEs. While the financial sector has issuing an electricity contract and finalize online processes grown significantly over the past decade in terms of the for requesting new electricity connections in the short term. number of banks, access to finance remains a significant Electric Du Cambodge has a leading role in implementation. challenge for SMEs. The Covid-19 crisis amplifies the Investing in renewables such as solar power can also help importance of providing SMEs immediate financing and cash improve reliability and accessibility of electricity in Cambodia flow at reasonable and affordable rates to help operators over the medium term. in key economic sectors weather the storm and maintain employment levels. Cambodia should scale-up the recently To lower the cost of finance, it will be important to enacted Credit Guarantee Scheme to ensure it is functioning enhance regulation and sector supervision.91 This is well, and monitor access for SMEs. Strengthening the a short-term priority that could be led by the National Bank Khmer Enterprise to provide both beyond-credit financial of Cambodia. Managing risks and containing nonperforming support (for example, start-up grants, equity financing) and loans are a key part of reducing the cost of credit. Sector non-financial support to firms and to develop incentives to supervision should be enhanced, including by fully attract early- and growth-stage venture capital to crowd-in implementing and closely monitoring the new Prakas on private capital can also help provide financial support to Credit Risk Grading and Impairment Provisioning. Regulatory micro firms and SMEs. Each of these could be implemented and licensing requirements are also needed for the diversity in the next one to two years, with the Ministry of Economy of actors providing credit, including pawn shops, which and Finance in the lead. currently fall outside the regulatory supervision of the National Bank of Cambodia. RESILIENT DEVELOPMENT: 15 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Improving productivity to drive growth Objective Improving capabilities Strengthening regulations Investing in infrastructure Invest in Upgrade health and education Improve quality of public services Invest in early childhood nutrition, human capital professional qualifications [MT; by giving more administrative and parental education, and childcare MOEYS & MOH] financial autonomy to health and for improved quality of life by education institutions; modernize scaling up the maternal and child Support teacher upskilling through health and education services using nutrition cash transfer program [ST; greater teacher training [MT; technology [ST; MOEYS & MOH] MLVT] MOEYS] Align curricula with the needs of a modern workforce, which increasingly requires a mix of higher-level skills like cognitive, socio-emotional, and digital literacy, while updating training methods and equipment [MT; MOEYS] Support more Provide continual training Make the Competition Law effective Create a special court for solving efficient for lawyers; conduct a more and implementable through sub- commercial disputes; create a resource widespread campaign to draw regulations including guidelines on small claims court; develop an allocation attention to the importance of merger control [ST; MOC] electronic case management through alternative dispute resolutions; system for judges and lawyers [MT; Ensure strong coordination of the improved improve dispute resolution DOJ] competition regulator with the market processes [MT; DOJ] private sector [ST; MOC] Review the existing case institutions Build capacity for PIM at all management system for and PIM Publish reports about the courts’ relevant ministries and agencies commercial disputes [MT; DOJ] performance (time to disposition, including project preparation and clearance rate, age of pending review to ensure quality [MT; MEF] cases) as well as judgements on commercial decisions at all levels (first instance, appellate, supreme court) [ST; DOJ] Prepare PIM appraisal and implementation manuals that follow from the recently enacted PIM Sub- decree [ST; MEF] Centrally monitor public investment project delays and cost overruns; strengthen in-year project monitoring by line ministries [ST; MEF] Implement the full-fledged medium- term fiscal framework to provide multi-year guidance for budget preparation; identify individual public investment projects during budget preparation [MT; MEF] CHAPTER 1: 16 IMPROVING CAMBODIA’S PRODUCTIVITY PERFORMANCE Objective Improving capabilities Strengthening regulations Investing in infrastructure Reduce Review and reduce the fees for Initiate a media campaign and a the cost of starting a business; integrate ‘Regulatory Reform’ website to operating a remaining agencies into the online continuously update the private business for business registration platform [ST; sector on recent reforms, and firms MEF] engage them in public-private dialogue throughout the reforms Review the corporate governance process [ST; MEF] framework for investors in the Companies Law, particularly around corporate transparency, ownership and control, and shareholder rights [MT; MOC] Implement the insolvency legal framework by establishing an insolvency administration profession; improve the overall efficiency of the courts to expedite bankruptcy proceedings [MT; DOJ] Simplify tax-audit compliance requirements for businesses; streamline the current tax-audit procedures [MT; MEF] Improve the Strengthen Khmer Enterprise Introduce time limits for issuing Set up an automated system performance to provide both beyond-credit electricity contracts; finalize the to monitor power outages and of key financial support (for example, online processes for requesting new improve the reliability of the power services start-up grants, equity financing) electricity connections [ST; EDC] supply to reduce the number and inputs to and non-financial support to firms duration of outages [MT; EDC & Enhance financial sector strengthen [ST; MEF] MME] regulation and supervision by domestic fully implementing and closely Scale up the recently enacted linkages monitoring the new Prakas on Credit Guarantee Scheme to ensure Credit Risk Grading and Impairment it is functioning well, and monitor Provisioning [ST; NBC] access for SMEs [ST; MEF] Impose regulatory and licensing requirements for the diversity of actors providing credit, including pawn shops [ST; NBC] Develop incentives to attract early- and growth-stage venture capital to crowd-in private capital [ST; MEF] Note: ST=short term; MT=medium term. DOJ=Department of Justice; EDC=Electric Du Cambodge; MEF=Ministry of Economy and Finance; MLVT=Ministry of Labour and Vocational Training; MME=Ministry of Mines and Energy; MOC=Ministry of Commerce; MOH=Ministry of Health; MOEYS=Ministry of Education, Youth, and Sports; NBC=National Bank of Cambodia. RESILIENT DEVELOPMENT: 17 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Endnotes 33 Productivity measures output per unit of input. Improving productivity means increasing that ratio by more efficiently combining inputs, applying technological innovations, or implementing new ideas. At the aggregate level, productivity can be calculated as GDP or GNI per employed person or hours worked. At the firm level, productivity can be measured as sales or profits per unit of labor, capital, or other factor of production. 34 Caselli (2005), Hall and Jones (1999), and Krugman (1994). 35 Cusolito and Maloney (2018). 36 Krugman (1994). See also Hall and Jones (1999), Easterly and Levine (2001), and Caselli (2005). On productivity growth and the prospects for economic development, see Lewis (1954) and Chenery (1960). 37 World Bank (2020b). 38 World Bank (2020d) and World Bank (2020e). 39 World Bank HCI. 40 World Bank HCI. 41 Ministry of Education, Youth, and Sports (2018). 42 Projected educational attainment for total population based on historical school enrollment and completion statistics. Barro and Lee (2021). 43 World Bank HCI. 44 Women receive US$50 at childbirth plus US$140 total for fourteen health visits spread over the course of pregnancy through the first two years of the child’s life (or US$10 per visit). 45 World Bank (2020f). 46 Output that cannot be attributed to labor and capital inputs—the “residual” in growth decompositions—is known as TFP. It captures innovation, managerial skill, technology adoption, and other aspects that cannot be directly modeled. By nature, TFP is high for countries that experience rapid growth without similarly rapid increases in labor or capital inputs. TFP can be negative if growth in labor and capital outpaces overall economic growth. This signals an inefficient use of inputs and has been a regular occurrence in Cambodia over the last decade and a half. 47 TFP is calculated as the residual of real GDP growth from real-capital accumulation, human-capital accumulation, and employment assuming a Cobb-Douglas production function with a return to capital of 1/3 and a return to labor of 2/3. 48 World Bank (2017a). 49 There is also a statistically significant positive relationship between employment growth and lagged productivity, using linear regression, with or without mining excluded. Similarly, there is a statistically significant negative relationship between productivity growth and lagged productivity, but only when mining is excluded. 50 Mining was an outlier on both measures. A small and capital-intensive part of the economy, it saw large productivity gains but little employment growth. 51 World Bank (2019a). 52 High-Frequency Phone Survey of households in Cambodia undertaken in May and August 2020. 53 Data do not exist to explore the contribution of firms’ exit and entry to aggregate productivity performance. 54 World Bank staff calculations using data from the 2014 Cambodia Inter-censal Economic Survey. 55 However, there are substantially fewer observations for firms, so results are not reported. 56 Kim and Loayza (2017). 57 Hsieh and Klenow (2009). 58 The RGC is currently in the process of establishing a commercial court. World Bank (2020g). 59 International Monetary Fund (2020a) and World Bank (2019e). 60 Cambodian firms fare better in terms of TFP, where there is less variation. World Bank Enterprise Surveys, various years, and World Bank (2018c). CHAPTER 1: 18 IMPROVING CAMBODIA’S PRODUCTIVITY PERFORMANCE 61 Several caveats exist to measuring firm-level productivity. Unlike aggregate productivity, firm-level productivity measures use estimated factor shares, which face potential estimation biases. Moreover, the 2016 World Bank Enterprise Survey for Cambodia only covers non-agricultural sectors from select provinces and has a sample of 373 firms. 62 Results are obtained by regressing labor productivity on a dummy to control for sector fixed effects. For example, if a firm only exports, only imports, both exports and imports, or is foreign owned. 63 That registered firms and more established (older) firms are more productive is confirmed with the 2014 Cambodia Inter- censal Economic Survey when measuring productivity as sales per worker. 64 A third factor, barriers to entry and exit, is beyond the scope of this chapter because the necessary panel data to measure firm entry and exit are not available. Aggregate productivity is lower when there are barriers to the exit of less productive firms, and the entry of more productive firms. This conclusion is well grounded in empirical research. Divanbeigi and Ramallo (2015), for example, find that an overall sound business environment is associated with higher levels of new business entry, and indirectly, with higher income per capita. Similar research by Barseghyan (2008) shows that an increase in entry costs reduces both TFP and labor productivity. 65 World Bank Enterprise Surveys, various years. 66 Djankov, McLiesh, and Ramalho (2006). 67 Hall and Jones (1999) and Easterly and Levine (2003). 68 Dall’Olio et al. (2013), Dutz et al. (2011), and Chang, Kaltani, and Loayze (2009). 69 Barro (1991), Rodrik, Subramanian, and Trebbi (2004), and Acemoglu, Johnson, and Robinson (2004). 70 World Bank (2020g). 71 World Bank (2017b). 72 World Bank Enterprise Surveys, various years. 73 World Bank (2019b). 74 World Bank (2019b). 75 World Bank (2018b). 76 World Bank Enterprise Surveys, various years. 77 World Bank (2019f). 78 Duggan, Rahardja, and Varela (2016). 79 World Bank (2019a). 80 World Bank Enterprise Surveys, various years. 81 2016 World Bank Enterprise Surveys for Cambodia. 82 World Bank (2019b). 83 Organisation of Economic Co-operation and Development (2017). 84 2016 World Bank Enterprise Survey for Cambodia. 85 Data constraints prevent linking the empirical findings of resource misallocation directly to its causes, and instead the policy areas are based on economic literature of key causes of misallocation matched with Cambodia’s own context. For example, the importance of a competitive environment as well as public investment decisions for resource allocation correspond with Cambodia’s nascent competition framework and PIM regulation. 86 World Bank (2018b). 87 The key policy areas have been informed by the econometric analysis that links productivity differences across firms with barriers in the business environment, with the recommendations informed by Cambodia’s own country context and existing analytical work. 88 To simplify the process of tax audits, the General Department of Taxation has divided the audits into three types: desk review, limited scope, and comprehensive audits. Corporate income tax correction involves desk review, while VAT refund involves limited scope audits. In addition, the General Department of Taxation has also tried to improve its process of tax audits by training auditors and providing gold status to companies with good record of tax compliance. 89 World Bank (2020g). 90 World Bank (2020g). 91 World Bank (2019g). RESILIENT DEVELOPMENT: 19 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Chapter 2 Economic Transformation Through Exports Over the past two decades, Cambodia has achieved manufacturing accounted for 941,000 jobs or 21 percent of stellar export performance, expanding dramatically paid employment, while tourism accounted for 620,000 jobs both goods and services exports. Since 1995, goods or 13.9 percent of paid employment.94 Cambodia’s labor- exports increased more than 17-fold, from US$855 million intensive manufacturing and agricultural exports played a to US$15 billion in 2019. The increase in services exports crucial role in poverty reduction, which declined fell from 47.8 has been even more dramatic, expanding 53-fold from percent in 2007 to 13.5 percent in 2014. US$144 million in 1995 to US$6.1 billion in 2019 (current US$).92 Today, services exports represent about 28 percent Cambodia’s export success has been driven by a few of Cambodia’s total export basket. products and markets in which it has been able to specialize. Cambodia has been extremely successful in Thanks to this rapid growth, Cambodia’s exports what it does well, but it seems to only do a few things well. outperform globally in both goods and services. Its success has been built around three products, one in Merchandise export values amounted to 55 percent each sector—namely, garments in manufacturing, rice and relative to gross domestic product (GDP) in 2019, and cassava in agriculture, and tourism in services. In 2018, services export values amounted to 22 percent.93 Cambodia textiles, wearing apparel, and leather products represented outperforms countries at its level of economic development, 81 percent of manufacturing exports, rice and cassava as well as most comparators (figure 2.1). represented 79 percent of agricultural exports, and tourism represented 89 percent of services exports (figure 2.2). Exports have supported non-agricultural job creation, Cambodia´s endowments have favored the current pattern driving structural transformation and poverty reduction. of economic specialization: a young but low-skilled labor Cambodia’s key export sectors contribute more than a third force; rainfall and topography that favor rice production; of all paid employment. In 2019, garment and footwear and the magnificent landmark of Angkor Wat.95 FIGURE 2.1 Cambodia’s exports outperform globally Exports to GDP vs. GDP per capita, 2016-18 a.  Goods exports b.  Commercial services exports 100 Service exports to GDP (percent) Goods exports to GDP (percent) Vietnam 80 80 60 60 Malaysia Cambodia 40 Thailand 40 Lao PDR 20 Cambodia Philippines Thailand Bangladesh Indonesia Myanmar India Malaysia 20 Vietnam Philippines Myanmar India 0 Bangladesh Lao PDR Indonesia 0 6 8 10 12 6 7 8 9 10 11 Ln GDP per capita (current US$) Ln GDP per capita (current US$) Note: Commercial services are total services excluding government services. Source: World Bank staff calculations using data from World Bank World Development Indicators and Cambodia Economic Diversification Study (World Bank 2019a). CHAPTER 2: 20 ECONOMIC TRANSFORMATION THROUGH EXPORTS FIGURE 2.2 Cambodia’s exports have a narrow base Products’ share of sector exports, 2018 a. Manufacturing b.  Formal agriculture c. Services Textiles, wearing apparel, leather products Rest Rice and cassava Rest Tourism Rest Source: World Bank staff calculations using data from UN Comtrade and UN Conference on Trade and Development and Cambodia Economic Diversification Study (World Bank 2019a). But global megatrends and an uncertain global reflects the significant concentration of export products and environment are putting Cambodia’s labor-intensive, markets, which have been affected by the global supply and low-value-added export model increasingly under demand shocks. Due to travel restrictions and lockdowns, pressure. Export diversification is a top priority, featuring Cambodia’s tourism and hospitality sector has collapsed, prominently in many of Cambodia’s national policies such as with international arrivals falling by 71.9 percent during the the Rectangular Strategy Phase IV, Industrial Development first eight months of 2020 (year-on-year). Global supply and Policy, Cambodia Trade Integration Strategy, e-Commerce demand shocks have shrunk Cambodia’s key merchandise strategy, among others. Cambodia now faces a series of export sectors, where garment, footwear and travel goods headwinds that require strengthening its existing growth exports had fallen 11.5 percent by August 2020 (year-on- drivers, which are weakening, while building new drivers.96 year). The Covid-19 shock has been worsened by the partial In recent years, garment sector competitiveness has suspension of the country’s preferential access to the EU weakened due to rapid escalation in legislated minimum market under the “Everything But Arms” agreement that wages, which tripled between 2012 and 2019. This, coupled came into effect in August 2020, affecting approximately with stagnant productivity (see Chapter 1), threatens the 20 percent of Cambodia’s exports to the EU. While the sustainability of Cambodia’s key garment export sector. In duration of the suspension is still undecided, it affects addition, global megatrends like automation of routine jobs, select garments and footwear products, travel goods, and protectionism, and the reconfiguration of global value chains sugar amounting to $1.1 billion in exports to the EU and (GVCs) have added uncertainty to Cambodia’s prospects the United Kingdom. The potential negative impact of this for continued export success in its current activities. The suspension, coupled with Covid-19 and global megatrends, sources of foreign direct investment (FDI) are also changing, adds to the urgency to act on Cambodia’s trade integration where outward FDI by Asian countries, particularly China, and diversification agenda. into other developing countries will continue to become a much more important share of global FDI, but Cambodia has Cambodia’s labor-intensive, low-value-added export not yet been successful as a key supplier in regional value model also helps explain Cambodia’s productivity chains. The escalation of trade tensions in recent years challenge. International trade supports productivity between global mega-powers adds additional uncertainty in improvements through various channels. One key channel is the global trade environment. through firm-to-firm relationships with international suppliers or buyers—particularly characteristic of trade in GVCs— The Covid-19 pandemic and the partial loss of which supports the international diffusion of technology. preferential access to the European Union (EU) market There is strong evidence that firms that either export or import further risk Cambodia’s export-oriented growth model. are more productive than non-traders, while firms that both The severe impact of Covid-19 on Cambodia’s economy import and export are more productive than one-way traders.97 RESILIENT DEVELOPMENT: 21 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Although FDI has supported exports and FDI firms tend to be on reducing poverty and enhancing productivity and more productive than non-FDI firms, FDI firms in Cambodia job growth. Empirical evidence strongly suggests GVCs do not create backward linkages or share knowledge, greatly boost productivity and income and support poverty preventing productivity spillovers, as discussed later in this reduction beyond what countries can achieve through one- chapter. Moreover, Cambodia’s export specialization is in low way trade in anonymous markets.102 The “relational” nature complexity and low technological content.98 of GVCs makes them a particularly powerful engine for growth, as they represent a natural vehicle for technology Transformation of Cambodia’s international trade is transfer. As discussed in Chapter 1, Cambodian firms that needed to ensure better jobs, create domestic value both import and export tend to be more productive than addition, and support productivity improvements. non-trading firms. Considering the limited diversification and the emerging challenges, this chapter aims to renew a sense of urgency for reforms targeting Cambodia’s exports. The purpose is Cambodia successfully integrated into to identify policy options to help Cambodia pursue further GVCs… diversification, upgrading, and domestic linkages— ultimately to promote economic recovery from Covid-19 Cambodia’s participation in GVCs has grown and strengthen their export performance to drive long-term steadily since the 1990s with the arrival of garment growth. The discussion focuses separately on manufacturing manufacturing and footwear. Cambodia integrated into exports through GVC participation, followed by agricultural GVCs much faster than countries like Malaysia, Thailand, exports and services exports.99 and Vietnam as well as other developing countries like Bangladesh and Sri Lanka, both as a buyer (importing inputs to produce exports, or ‘backward’ GVC participation) and a Economic upgrading through GVC 2.1  seller (exporting intermediate inputs used in the production of a third countries’ exports, or ‘forward’ GVC participation). participation in manufacturing100 Between 1990 and 2018, backward GVC participation grew Integrating into the global economy through GVCs is faster than these comparator countries, at an average annual appealing to governments in developing countries growth rate of 12.5 percent. Forward GVC participation, at for a variety of reasons. GVCs—or the fragmentation of 13.6 percent annual growth, also surpassed other countries’ production across countries—grew swiftly after 1990 as performance.103 Cambodia’s position in GVCs—primarily in technological advances—in transportation, information, garment assembly—increased the share of manufacturing and communication—and reductions in trade barriers in total domestic value added in exports. Thirty years later, caused manufacturers to extend production processes Cambodia continues to specialize in limited manufacturing beyond national borders.101 Two features distinguish GVC tasks within GVCs (figure 2.3). trade from traditional trade. …but with little diversification or upgrading First, countries import not only for domestic consumption, but also to export. As such, GVCs involve hyper-specialization. since Countries do not need to produce a whole good, they can Cambodia’s participation has been concentrated in focus on one part of that good. This makes participation garments, but with little diversification into other in trade easier and allows countries to better exploit GVC sectors since then, unlike some comparator comparative advantage and reach economies of scale. countries. The garment and footwear sector remains Second, in contrast to “standard” trade carried out in the largest exporting sector of Cambodia’s economy, anonymous markets, GVC transactions typically involve longer- representing about 78 percent of total merchandise term firm-to-firm relationships. Firms have a shared interest exports in 2018. Transitioning to advanced manufacturing in specializing in specific tasks, exchanging technology, and and services GVCs presents a much bigger challenge learning from each other. GVCs thus deliver easier access for countries, an experience not unique to Cambodia. Yet than ever before to capital, technology, skills, and expertise. other countries in the region have seen more progression than Cambodia. Thailand and Malaysia, for example, have Because of these two key features of GVCs—hyper- transitioned into advanced manufacturing GVCs, while specialization and strong firm-to-firm relationships— Vietnam has diversified into other manufacturing GVCs, GVC trade has a greater effect than standard trade most notably electronics (figure 2.4). CHAPTER 2: 22 ECONOMIC TRANSFORMATION THROUGH EXPORTS FIGURE 2.3 Cambodia specializes in limited manufacturing GVC tasks Taxonomy of GVC participation, 2015 GVC linkages, 2015 Low participation Limited commodities High commodities Limited manufacturing Advanced manufacturing and services Innovation activities Data gaps IBRD 44640 | August 2019 Source: World Development Report 2020 (World Bank 2019c). FIGURE 2.4 In Cambodia there has been little diversification into other GVC sectors, unlike in Vietnam Sectoral export share, 1990-2019 a. Cambodia b. Vietnam 100 100 80 80 60 60 Percent Percent 40 40 20 20 0 0 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 Agriculture Fishing Mining and quarrying Food and beverages Textiles and wearing apparel Paper and wood Petroleum, chemical, and non-metallic mineral products Metal products Electrical and machinery Transport equipment Other manufacturing Source: World Bank staff calculations using data from UN Comtrade and Cambodia Economic Update (World Bank 2019d). Cambodia’s top garment exports compete at the values between 2000 and 2018, moving up the quality low end of price and value addition and have fallen ladder, while Cambodia has fallen behind globally. For on the global quality ladder. Within garments, there example, for knit or crocheted sweaters, pullovers, and has been little upgrading within products between 2000 vests (harmonized system 6-digit product 611030) to and 2016/17. Cambodia’s top export garment products the United States market, Vietnam improved in relative (harmonized system 6-digit products 611020 and 611030) unit-value rank from 3rd to 24th between 2000 and 2018, are on the lower end of the quality ladder globally. More while Cambodia fell from 51st to 15th of 104 countries striking is that comparator countries including Vietnam exporting that product to the United States in the same experienced a significant increase in their relative unit period (figure 2.5). RESILIENT DEVELOPMENT: 23 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL There has also been little discovery of new garment Cambodia’s merchandise export growth is on the extensive products, despite some signs of diversification margin by selling existing products in established markets, outside of garments. This already mature sector is no but with slight signs of new products in established markets longer incorporating new product groups into the export (figure 2.7). In 2015, new products were discovered in basket, with almost no new apparel products exported since precision instruments, machinery, and chemical and allied 2003 (figure 2.6). Moreover, the composition of top garment industries. Cambodia achieved some diversification into products in Cambodia has also not changed significantly; other manufacturing exports like auto part assembly (Denso four of the top five garment products in 2017 were also Group, Sumi), electrical devices and motors, smart phone the top five garment products in 2000. Overall, most of parts (Minibea), and optical parts (Tanaka Foresight). FIGURE 2.5 Cambodia’s top GVC exports have fallen on the global quality ladder Relative unit value of knit or crocheted sweaters, pullovers, or vests exports to the United States vs. unit value rank a. 2000 b. 2018 2.5 2.5 2.0 2.0 Relative unit value 1.5 Relative unit value 1.5 1.0 1.0 Thailand 0.5 Vietnam Sri Lanka Malaysia 0.5 Sri Lanka Malaysia Bangladesh Vietnam 0.0 Bangladesh Cambodia 0.0 Thailand Cambodia 0 20 40 60 80 100 120 0 20 40 60 80 100 120 Rank Rank Note: For each product (HS6=611030 in this case), year (2000 and 2018 here), and importing country (the United States in this case), the relative unit value is calculated as a country’s unit value exported to the importing country, relative to that unit’s value at the 90th percentile of the unit-value distribution across countries that export that product. Source: World Bank staff calculations using data from Centre d’Etudes Prospectives et d’Informations Internationales and Cambodia Economic Update (World Bank 2019d). FIGURE 2.6 FIGURE 2.7 There has been little discovery of new garment …with some signs of diversification outside of products… garments Apparel and non-apparel discoveries, 1997-2019 Export growth decomposition, 2010-13 vs. 2016-19 250 160 Growth contribution (percent) New product exports (HS6) 200 120 150 80 100 40 50 0 0 -40 uc uc ark ucts rk ing tab ion ket s uc tro ark cts tab f n rket w 97 99 01 03 05 07 09 11 13 15 17 19 es ex ark cts ar ct e 19 19 20 20 20 20 20 20 20 20 20 20 ma f n in in d m odu in xtin d m odu od In d m odu ets ets lis ew s lis ing ts lis of s in ct ts ma ist m d e e w ex pr Intr ed pro w o r r e r ne ion he p ea lish ing p he p ne of in n ts tio Int ts du b t tab ist De sta exis Non-apparel Apparel h es o es ct in tion od od in of se e E c as du e re ro cr pr Inc 2010-13 2016-19 Note: Apparel includes harmonized system chapters 61-64. Source: World Bank staff calculations using data from UN Comtrade and Source: World Bank staff calculations using data from UN Comtrade and Cambodia Economic Diversification Study (World Bank 2019a). Cambodia Economic Diversification Study (World Bank 2019a). CHAPTER 2: 24 ECONOMIC TRANSFORMATION THROUGH EXPORTS FIGURE 2.8 FIGURE 2.9 Non-garment manufacturing export growth has slowed FDI inflows to manufacturing have tapered Non-garment manufacturing exports, 2004-19 FDI inflows by sector, 2014-19 1,500,000 1,400 1,200 1,000,000 Million US$ 1,000 Billion KHR 500,000 800 600 0 400 20 4 20 5 20 6 20 7 20 8 20 9 20 0 20 1 20 2 20 3 20 4 20 5 20 6 20 7 20 8 19 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 20 200 0 Bicycles and other cycles Telephone sets ga t m u re t m fac g Fin ufac ing Ac cial ing od or Te on ns om dr on al er e r he tat en anu rr yin Insulated wire Lamps and lighting fixtures n- en d q ltu mm ct Re ow ati Hy ucti an tur an tur Co ec Ot Es co se No rm an cu op l a tr Liquid crystal devices Microphones and stands thereof Ga ing Agri Electrical transformers TV and radio apparatus Electric motors and generators TV and radio parts n rm Mi 2014 2015 2016 2017 2018 2019 Source: World Bank staff calculations using data from UN Comtrade and Source: World Bank staff calculations using official data and Cambodia Cambodia Economic Diversification Study (World Bank 2019a). Economic Diversification Study (World Bank 2019a). Despite a promising start, there are signs that non- the disruptions caused by global megatrends, and support garment manufacturing exports may not live up to diversification of export products and markets. expectations. While Cambodia has attracted a few pioneer producers of bicycles, electrical appliances, and auto parts, Exploring possible explanations for Cambodia’s low it has yet to form industrial clusters in these value chains, quality and inability to upgrade in the apparel value and export diversification remains limited. The boom in non- chain and its limited diversification into other value garment manufacturing exports seems to have plateaued chains can inform policy recommendations to support except for lamps and lighting fixtures (figure 2.8). In fact, economic upgrading through GVC participation. This some export products, like television and radio parts, agenda is even more imperative today, given the significant experienced a drop since 2015-16, and other emerging impact Covid-19 has had on Cambodia’s GVC exports in exports like bicycles and other cycles have not taken off garments and footwear. as expected, where export growth to the EU market has slowed due to difficulty meeting rules of origin. The wave of supplying firms that would be expected to follow the Low diversification and inability to upgrade pioneer firms has not materialized yet. In fact, FDI inflows to reflect in part the quality of FDI non-garment manufacturing has barely grown since 2014, while FDI into non-tradable sectors like construction, real Although FDI has supported exports, quality of FDI estate, and finance is booming (figure 2.9). Discussions appears to be a problem, where FDI firms in Cambodia with stakeholders confirm this trend. In particular, do not create backward linkages. Cambodia is among Japanese FDI into manufacturing seems to be drying up, the top countries in the world in attracting FDI, and most with no investments in special economic zones in 2018. manufacturing export firms in Cambodia are foreign owned. Regional trade agreements that grant preferential access Literature shows strong productivity spillovers can occur from to new markets and promote investment targeting these upstream linkages with FDI firms, but these linkages have burgeoning sectors would support diversification. Deeper not yet formed in Cambodia. Instead, foreign manufacturing trade agreements that cover both goods and services, along firms rely largely on foreign inputs, with limited domestic with a broader set of regulatory areas like e-commerce or linkages (figure 2.10). In Cambodian manufacturing firms, intellectual property rights (IPR) would further help address 91.8 percent of total production inputs are of foreign origin, RESILIENT DEVELOPMENT: 25 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL FIGURE 2.10 compared to 10.4 percent in Thailand, 54.2 percent in Most manufacturing inputs are imported Vietnam, and 75.3 percent in Bangladesh. This is because Cambodia remains a small market whose manufacturing Percent of foreign inputs in total production inputs, sector receives mostly export-oriented FDI. The high manufacturing firms, 2013-16 dependence of foreign firms on imported inputs suggests 91.8 91.8 opportunities may exist for establishing and expanding local sourcing linkages—particularly with foreign investors—if 75.3 local inputs are competitive in quality and price. 54.2 The potential for technology spillovers from foreign investors in Cambodia also seems limited. 41.6 Cambodia has relatively low shares of foreign firms with 27.8 27.5 quality certificates (figure 2.11) or technologies licensed 23.6 22.2 from foreign companies (figure 2.12), providing limited 16.4 10.4 opportunities for technology transfer. In Cambodia, just 6.1 percent of foreign firms have an internationally recognized 1.3 quality certification and only 13.6 percent use technology Bangladesh Cambodia Myanmar Philippines Thailand Vietnam (2013) (2016) (2016) (2015) (2016) (2015) licensed from foreign companies. In Vietnam, the shares with quality certification and technology licenses are 49.9 Domestic Foreign percent and 35.0 percent, respectively. This limited potential Note: Foreign ownership is 10 percent or more foreign ownership share. for spillovers is further diminished by the weak linkages to Source: World Bank staff calculations using data from World Bank domestic input firms described above. Enterprise Surveys and Cambodia Economic Diversification Study (World Bank 2019a). FIGURE 2.11 FIGURE 2.12 Cambodia has relatively low shares of foreign firms …or technologies licensed from foreign companies with quality certificates… Percent of manufacturing firms using technology licensed from Percent of firms with an internationally recognized quality foreign companies, 2013-16 certification, 2013-16 65.7 49.9 42.6 41.1 35.0 23.0 21.1 19.4 18.4 18.0 15.5 14.6 13.6 13.8 10.1 8.6 7.6 7.4 7.2 6.1 5.2 4.6 3.2 3.3 Bangladesh Cambodia Myanmar Philippines Thailand Vietnam Bangladesh Cambodia Myanmar Philippines Thailand Vietnam (2013) (2016) (2016) (2015) (2016) (2015) (2013) (2016) (2016) (2015) (2016) (2015) Domestic Foreign Domestic Foreign Source: World Bank staff calculations using data from World Bank Source: World Bank staff calculations using data from World Bank Enterprise Surveys and Cambodia Economic Diversification Study (World Enterprise Surveys and Cambodia Economic Diversification Study (World Bank 2019a). Bank 2019a). CHAPTER 2: 26 ECONOMIC TRANSFORMATION THROUGH EXPORTS A poor business environment blocks linkages access to finance for domestic firms, more advanced logistics, between FDI and domestic firms competitive energy costs, access to more sophisticated services inputs, and enhanced contract enforcement.106 Barriers in the business environment likely create Policy predictability, in addition to macroeconomic stability, negative selection of FDI firms, and also block a key becomes an increasingly important dimension of good channel for productivity spillovers for those that governance for GVCs. An agenda for improving the business do come. A recent World Bank survey found significant environment is discussed in Chapter 1. capacity and business-climate constraints for foreign- owned manufacturing firms to source locally (figure The slowdown in investment in Cambodia is also 2.13).104 Two-thirds of the surveyed foreign-owned attributed to rapidly rising wages, not matched with companies said the production inputs they require are not improvement in the business environment. Conversations available in Cambodia. Even when inputs are available, with stakeholders in the manufacturing sector reveal that a foreign firms report that identifying domestic suppliers is large and young workforce, coupled with preferential access too time-consuming (50 percent), and when they do find to key markets, investment incentives, and relative stability potential suppliers, the suppliers often do not meet the made Cambodia their preferred choice when deciding to quality, cost, and delivery standards required (46 percent). invest. Currently, manufacturers are facing the challenges of A particularly concerning issue is that firms with Qualified quickly rising real wages and high turnover rates. The minimum Investment Project status prefer to source from abroad wage in the garment sector was around US$80 a month in because they are exempt from paying value-added tax 2013.107 In recent years, the minimum wage in garments has (VAT) on imports and claiming a VAT refund when dealing been increasing rapidly, which has led to an overall increase with local suppliers would be too cumbersome and time- in garment firms’ wages.108 By 2019, the minimum wage consuming (43 percent).105 in Cambodia had increased to US$182 a month,109 while in Vietnam it ranged between equivalent of US$126 to US$180 The business environment also influences the per month,110 and approximately the equivalent of US$95 a transition to and upgrading in more advanced month in Bangladesh.111 Together with electricity and logistics manufacturing GVCs. Global evidence shows more costs that are higher than in neighboring countries, these rising advanced manufacturing and services tasks require better wage costs allegedly discourage the arrival of new investors. FIGURE 2.13 Business environment constraints inhibit backward linkages from FDI to domestic firms Factors considered a barrier to source locally, as reported by surveyed firms in Cambodia, 2017 The inputs are simply not available from Cambodian firms 65 It is too time consuming to identify potential Cambodian suppliers 50 Potential Cambodian suppliers don’t meet our quality, cost, delivery standards 46 Dealing with Cambodian suppliers is cumbersome due to VAT issues 43 Cambodian suppliers lack basic certifications 35 Potential Cambodian suppliers are informal 33 Cambodian suppliers don’t have the right management capabilities 33 Fiscal incentives make importing a more competitive option than engaging with local suppliers 32 Cambodian suppliers don’t have the production volume to meet our minimum requirements 30 Percent of interviewed firms Source: World Bank staff calculations using data from World Bank Group 2017 FDI Survey and Cambodia Economic Diversification Study (World Bank 2019a). RESILIENT DEVELOPMENT: 27 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Trade policy also determines GVC participation Skills and firm capabilities are vital for upgrading International trade agreements enable GVC-related trade growth, especially when they go beyond issues Moving beyond assembly-type processes and into of market access and national treatment, to include higher value-added goods requires a more skilled agreements to protect certain types of intellectual property, to workforce. While the abundance of low-cost labor in low- adopt common approaches to regulate services sectors, or to income countries is often an entry point for participation implement a competition law that embodies criteria mirroring in the labor-intensive manufacturing segments of GVCs, those of trading partners. In fact, GVC trade is greater between upgrading knowledge and skills becomes necessary for countries sharing deep trade agreements.112 For example, in transitioning into advanced manufacturing and services Vietnam’s case, the United States-Vietnam Bilateral Trade and innovation activities that require a more educated Agreement of 2001 resulted in a boom in garments exports workforce, and better managerial practices and technical (and other products) to the United States.113 skills. For example, evidence from countries across the world shows a positive correlation between higher skills Market access through trade preferences has been a and integration in innovative GVCs: countries with a key determinant of Cambodia’s GVC participation, but Cambodia should look to deeper trade agreements relatively low endowment of low-skilled labor in the 2000s to promote future participation. One key question were more likely to be specialized in innovative activities confronting Cambodia is how loss of preferences and by 2011.115 increased trade protectionism in major markets globally As expected with weak human capital, an will impact future GVC trade. Most of Cambodia’s trade ‘inadequately skilled labor force’ appears to be a preferences are granted on a unilateral basis as a least binding constraint for firms. The most recent World developed country (LDC) under Generalized System of Bank Enterprise Survey revealed a majority of firms said an Preferences schemes operated by developed countries (without negotiation/agreement of reciprocal trade inadequately trained workforce was among their top three concessions by Cambodia). Cambodia’s preferential access constraints, but exporters were twice as likely to report this to the EU market under the “Everything But Arms” agreement constraint as non-exporters (42 percent compared to 21 was recently partially suspended, and preferential access to percent).116 According to a National Employment Agency other markets is expected to erode as the country graduates survey, insufficient skills led to lower worker productivity from LDC-status in the coming years. Cambodia’s only and hurt business in many ways like: delays in developing existing trade agreements in force are through the new products and services, increased workload for skilled Association of Southeast Asian Nations (ASEAN) Free Trade workers, difficulties in meeting customer service objectives Area including those negotiated with the Republic of Korea, and quality standards, and business lost to competitors.117 Japan, India, China, and Australia-New Zealand. Cambodia recently signed a bilateral free trade agreement (FTA) with Low skills reflect low educational outcomes. Only 8.5 the Republic of Korea and ratified its recently-signed FTA percent of the working age population were projected to with China. A stronger focus on regional trade agreements have completed secondary education, and only 1.5 percent that grant preferential access to new markets, promote to have completed tertiary education by 2020—lower than e-commerce, and promote investment targeting burgeoning most countries with comparable income levels.118 Moreover, sectors would support diversification of products and the returns on education are low: workers with only one markets. Stronger regional trade agreements would also year of education earn similar wages to those with 11 years address the trade disruptions caused by recent global of education. This suggests that the education system is megatrends and the greater uncertainty in the global trade not a solution for the current workforce, and instead an environment. Instead, Cambodia participates in few deep effective skills development system is needed to address trade agreements—an agenda discussed in Section 2.3. current skills gaps.119 In a world of GVCs, where firms import to export, Cambodia has not yet developed an effective system higher costs of importing intermediate inputs can to upskill the existing workforce, contributing to be another barrier to participation. Trade liberalization Cambodia’s skills deficit. Cambodia’s public and private has a more positive effect on GVC trade than on traditional skills development system is fragmented and small, and exports.114 Though tariffs declined following Cambodia’s reform efforts so far have focused on setting standards World Trade Organization (WTO) membership, the average rather than developing feedback mechanisms to identify weighted tariff rate of manufacturing products is higher in what skills employers need or creating results-based Cambodia than comparator countries except Bangladesh. incentives for training institutions.120 Moreover, there is In Cambodia, the average weighted tariff is 9.7 percent, little participation from the private sector to ensure skills relative to, for example, Vietnam, where it is 2.6 percent. development matches skills demand. CHAPTER 2: 28 ECONOMIC TRANSFORMATION THROUGH EXPORTS Cambodian firms’ absence in the garment and footwear firms’ slow uptake of these new technologies risks their value chain limits upgrading opportunities. Over 95 global competitiveness and ultimately the sustainability of percent of Cambodian apparel exporters are branch plants their GVC exports. For example, while the garment sector is of foreign-owned firms. It is difficult for countries dominated currently less automated than other GVC-intensive sectors by foreign firms to upgrade in this industry because of like automotive, there is evidence Cambodian garment firms’ relationships between global lead firms, multinational apparel technology adoption—like the use of Enterprise Resource manufacturers, and their foreign branch plant locations. All Planning or automated cutting systems—is lower than in the activities associated with functional upgrading take place other countries. Consequently, a key policy recommendation at the headquarters location of foreign firms, leaving little is to ensure an adequate tax incentive framework that is or no room for branch manufacturing sites to take on more conducive to technology uptake, while also providing the activities like textile sourcing, sales/buyer acquisition, and requisite training and/or re-skilling. technical product development. Opportunities for functional upgrading of these multinational corporations is further limited Technological change means 21st century workers because the apparel industry is buyer driven. The company or require a more complex skill set than in the past, brand responsible for setting the final price and selling the making human capital and skills development more product is not the same company that owns manufacturing important for GVC participation going forward. The facilities. Apparel manufacturers (whether at the headquarters Covid-19 pandemic is accelerating the pace of technological or branch locations) do not control retail, marketing, branding, change, as producers are looking for techniques that avoid or creative new product development, which are the most face-to-face interaction. Preparing the workforce today for lucrative and knowledge-intensive activities in the sector. non-routine, knowledge-intensive jobs will make Cambodia Thus, branch plants of foreign operations—like those more competitive when these changes come—an agenda operating in Cambodia—have little opportunity for functional related to skills discussed below. upgrading. Incentives are also needed to promote increased technology Many upgrading opportunities require private domestic adoption in garments. Anecdotal evidence suggests firms to develop in the industry. Upgrading opportunities automation in Cambodia’s garment sector has fallen behind can come from domestic firms assuming the preproduction regionally. For example, there is relatively low use of the and production stages. This would also allow them to management reporting systems within management control undertake full package or original equipment manufacturer systems that can provide important business information or production—currently done abroad at the headquarters automated processes along the production line like fabric of foreign multinational corporations with manufacturing cutting. These technologies can help firms move into higher locations in Cambodia—including sourcing, logistics, and value-added products. Slow adoption is in part linked to low client management. Once skills are developed, eventually skills (including in management functions), the type and firms can upgrade to creative design, branding, and top quality of Cambodia’s FDI, and lack of incentives promoting management.121 more sophisticated production techniques—an agenda related to quality of FDI discussed below. Technological change will reshape the skills needed in GVCs Policies to support diversification and upgrading in GVCs One important question confronting the region is what changing production technology means Cambodia is at a critical juncture where to sustain for developing countries’ future participation in economic growth it needs to ensure diversification GVCs. Machines are taking over routine tasks or parts and value addition do not falter. Participation and of the production process, and there has been a global upgrading in GVCs can help achieve these goals. Cambodia shift away from manual, routine jobs into non-routine, has already successfully integrated into the apparel GVC, knowledge-intensive jobs. These labor-saving technologies, and currently has a comparative advantage in assembly-type especially automation and 3D printing, will likely pose labor-intensive processes. However, to remain competitive as both opportunities and challenges for countries’ future production costs rise, Cambodia would need to increase value participation in GVCs, including Cambodia’s. For example, addition in mature industries like garment manufacturing, there is a risk that these technologies could bring production while establishing new clusters around pioneer non-garment closer to consumers and reduce labor-intensive imported manufacturing exporters, strengthening the capacity of local inputs from developing countries, but evidence shows these firms, and fostering domestic value addition. Policy measures technologies also contributed to higher productivity and a in each of these areas that focus on improving capabilities, larger scale of production, which has increased the demand strengthening regulations, and investing in infrastructure can for imported inputs from developing countries. Cambodian transform Cambodia’s participation in GVCs. RESILIENT DEVELOPMENT: 29 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Attracting a new wave of high-value-added FDI Cambodia has currently revised the Investment Law, which creates an opportunity to introduce these suggested policy To support Cambodia’s diversification into light changes through sub-regulations. In the medium term, it will manufacturing exports like electronics and auto be important to collect data on firms that use tax incentives parts, Cambodia needs to appeal to a new generation to monitor and evaluate while developing a strategy to of FDI by ensuring investor protection. With the right minimize tax risks from the scheme. This could be led by incentives in place, this could also help the country tap into General Department of Taxation. foreign knowledge and facilitate productivity spillovers and incentivize adoption of new digital or automation technologies Building the skills of the workforce that will likely take-off in a post-Covid-19 world. This is an immediate priority, which could be led jointly by the Ministry Among the most pressing issues the Royal of Economy and Finance and the Council for the Development Government of Cambodia (RGC) needs to tackle is of Cambodia. It will be important to simultaneously support addressing skills gaps in the current workforce. developing skills in new digital technologies during the So far, reform efforts have focused on setting standards upgrading process. Removing remaining import tariffs and rather than developing feedback mechanisms to identify participating in deep trade agreements could further improve the appropriate mix of skills in demand by employers. All Cambodia’s attractiveness to FDI firms in new GVC sectors, told, only 22 percent of Cambodian employers offer formal as discussed in Section 2.2 and Section 2.3, respectively. training courses, far less than the regional average of The importance of the business environment for attracting 57 percent.122 Improving labor mobility and job matching FDI is discussed in Chapter 1 and Section 2.2. can help firms find the right worker. This cross-cutting policy agenda could be led by the Ministry of Labour and First, legislation should resolve challenges in investor Vocational Training, while sector-specific measures can protection and conflict resolution, including by also be taken to strengthen manufacturing skills. This is increasing shareholders’ rights and role in decision- also an opportunity to build a system that is geared toward making, and strengthening courts. Despite some 21st century jobs, especially as Covid-19 speeds the pace improvements in business registration and electricity access of digital technology adoption and automation, and would in recent years, Cambodia continues to struggle in several simultaneously support upgrading in the garment sector aspects of its business environment, including the protection as well as enhanced competitiveness and diversification in for minority investors and contract enforcement, which other GVC-intensive sectors. affect potential joint ventures and FDI firms in particular. The recent passage of a new Investment Law could be an To improve skills in the current workforce, Cambodia opportunity to resolve some of the remaining challenges needs to make its technical and vocational in investor protection and conflict resolution through sub- education and training system more agile, flexible, regulations. It will be important for the Investment Law to and responsive to the market so that workers cover all investors, beyond those given qualified investment can regularly upgrade their skills.123 The RGC could project status. introduce results-based financing technical and vocational education and training institutions and expand the provision Second, investment tax credits can be introduced of short courses to serve the working adult population in on the value of acquired machinery and equipment, the short term. In the medium term, the government can quality certificates, or new technologies. Cambodia also support establishing vocational and digital education could shift to cost-effective tax incentives to promote centers aligned with industry needs, in cooperation with machinery acquisition and human-capital formation. private sector and development partners, and expand the Currently, tax incentives in Cambodia are not being used certification system to ensure that skills acquired through to encourage the provision of public goods like technology vocational training can be formally certified. Tailoring adult acquisition, human-capital building, or innovation. In this learning by expanding technical short courses and offering context, Cambodia could rethink its investment incentives individual learning accounts can further facilitate access to mix, limiting tax holidays and moving toward more cost- skills development. effective incentives. For example, it could introduce investment tax credits on 80 percent of the value of acquired The enterprise sector should be incentivized to machinery and equipment, as well as super deductions for play a larger and more structured role in providing, firms that acquire quality certificates or new technologies, guiding, and advocating for a demand-driven skills or that train their workers. This would help attract FDI that development system including facilitating the use of aims for higher value added and could boost learning and internship programs. These should ideally be complemented upgrading in the Cambodian economy. Cambodia should with foreign investors’ efforts to identify and support talent consider developing a new tax incentive regime with specific currently enrolled in tertiary education, for example through guidelines that detail eligibility criteria for each incentive. scholarships like those provided by Samsung Vietnam. The CHAPTER 2: 30 ECONOMIC TRANSFORMATION THROUGH EXPORTS RGC can also encourage collaborations between domestic manufacturers or suppliers; (iv) subcontractors that perform and international technical training institutions and attract finishing activities (for example, sewing, embroidering, trainers with industry experience. Both are short-term policy screen printing); and (v) broad services applicable to a priorities. range of industries like transportation, logistics, catering, information technology, construction, cleaning, security, In the short term, Cambodia can leverage professional human resources, and training.126 associations and other intermediaries like special economic zone management or recruitment agencies Fostering joint ventures between the Garment to implement training programs and provide Manufacturers Association in Cambodia and professional certification to trainees at different international brands and investors can facilitate skill levels, if a governing framework is provided.124 sector upgrading (including by integrating design The professional associations and other intermediaries functions into the offering). To access the expertise could help aggregate knowledge and implement training and technology needed to produce certain apparel-making programs and professional certification for trainees at fabrics, the Garment Manufacturers Association in Cambodia different skill levels, based on the needs and requirements and other public and private stakeholders could engage of the employer at the sector, industry, and firm level. In with suitable foreign partners to foster value addition cases where intermediaries are weak, incentivizing in-house and learning, which could be overseen by the Ministry of training for mid- to high-skilled workers could be another Commerce. As an example, Sri Lanka has benefited from this potential avenue to explore. The government could partner type of partnering. However, this would require having more with foreign investors (for example, from Japan, the Republic internationally-competitive domestic apparel producers to of Korea, and China) and development partners to establish act as potential joint venture partners which necessarily industry-specific training centers. For example, drawing means building capacity of indigenous firms. from lessons from the Republic of Korea’s experience, Cambodia could establish vocational high schools.125 Strengthening domestic firm linkages More attention should also be given to promoting Building the capacity of domestic firms may take efficient labor mobility and job matching. In the several years, but policy options could be implemented short term, authorities can collect and disseminate user- in the short term to strengthen backward linkages. friendly information to students, jobseekers, employers, The Industrial Development Policy already outlines a and education and training institutions to enable them series of measures to build the capacity of domestic to make skills development choices that are aligned with firms, including support to small and medium enterprise market demand. In the medium term, authorities can invest (SME) parks, machinery and inputs acquisition, and skills in hardware and software for the labor-market information development. Additional policies are needed to address the system and establish and strengthen intermediation specific problems highlighted in the above-mentioned FDI mechanisms (job matching platforms and the National linkages survey. Employment Agency) like developing outreach programs and collecting increasingly timely data on job vacancies. First, establish an online portal and digital app (in collaboration between relevant ministries, chambers Supporting domestic firms’ integration in the apparel of commerce, and private industry associations) to and footwear sector offer basic matchmaking services and overcome information asymmetries. In some cases, specific A possible strategy for the Cambodian garments government programs can assist foreign investors’ industry would be to offer higher value-added goods, research efforts to identify local suppliers and provide them by developing or linking to supporting industries. with more detailed capabilities evaluations in the medium A few firms have already started to move away from the term.127 Since reinvestment plays a large role, aftercare cut-make-trim segment of the apparel value chain toward services are also important as a short-term policy objective, offering free-on-board type products with higher value and include collecting feedback from existing investors to added, which helps them increase margins and cope with ensure investor satisfaction. Such an agenda would best be the significant increase in labor costs in recent years. One implemented by Council for the Development of Cambodia. possibility for Cambodia to achieve higher value-added garment manufacturing would be by attracting or linking Second, authorities would need to simplify VAT to supporting industries such as (i) apparel trims (that is, procedures and reduce the time needed to claim materials to differentiate garments) and accessories (for refunds, since domestic suppliers are currently example, zippers, thread, elastic, labels, hangers); (ii) disadvantaged when competing with tax-exempt imported nonessential inputs such as packaging (for example, cartons inputs. This is a short-term priority that could be overseen and poly bags); (iii) capital equipment and machinery-parts by the General Department of Taxation. RESILIENT DEVELOPMENT: 31 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Third, in the medium and long term, establish Value addition in Cambodian 2.2  a supplier development program, linked to the Entrepreneurship Development Fund, to build local agriculture131 firms’ capacity to serve FDI exporters. This could be Formal agriculture exports have increased 20-fold jointly implemented by the Ministry of Commerce and the over a decade, driven by a comparative advantage Ministry of Economy and Finance. Country case studies in exporting rice and cassava. The value of Cambodia’s show policies fostering linkages as part of systematic agriculture, forestry, and fishing exports has increased from supplier development programs, industrial upgrading just US$55 million in 2007 to US$1.1 billion in 2018.132 programs, and spatial development programs, which Agricultural export growth has been driven by rice and integrate investors and their requirements and emphasize cassava (figure 2.14), in which Cambodia has maintained local capacity building have been most successful. Such a comparative advantage since 2010.133 Together these two policies can be found in countries like Singapore, Malaysia, products represented 79 percent of total formal agricultural Chile, Costa Rica, and South Africa. The RGC’s recently exports in 2018.134 established Entrepreneurship Development Fund and Khmer Enterprise could help address some of the constraints local Total agricultural export growth is likely even higher. SMEs face, like lack of managerial and planning capacity Agricultural trade statistics in Cambodia are limited to formal needed to grow and produce more efficiently.128 Training agricultural trade, which fail to capture informally traded and marginal incentives for SMEs to become vendors in products (that is, those crossing borders without passing global e-commerce platforms should also be considered. through customs agencies). This is particularly relevant for raw products exports like mangoes, cashew nuts, pepper, Fourth, enact policy to ensure domestic firms comply rubber, and other crops that have experienced recent export with international standards required in GVCs. The growth to neighboring countries. This chapter therefore complexity and heterogeneity of international standards analyzes formal agricultural trade, and underestimates in GVCs increases costs for firms.129 SMEs face greater trends in key products that tend to be traded informally. challenges in complying with product standards and certification requirements, which are very important when entering, for example, the food processing segment of FIGURE 2.14 the agribusiness GVC. This applies to quality and safety Rice and cassava have driven Cambodia’s agricultural standards and environmental and social sustainability export growth standards. Adopting standards requires the necessary incentive schemes and a long-term commitment by the Evolution of the 2016 top five agriculture exports in Cambodia, RGC. The Industrial Development Policy 2015-25 formulates 2006-19 ambitious goals for special economic zone development 600 to meet international standards, not only in terms of the Value (US$ millions) necessary physical infrastructure and management systems 400 but also environmental and safety standards for investment projects located in these zones. The initiatives to improve industrial standards outlined in the Industrial Development 400 Policy are headed in the right direction, but they focus mainly on building capacity of standard-setting national institutions. These efforts could be complemented by 0 sequencing the introduction of standards. Some SMEs may 06 07 08 09 10 11 12 13 14 15 16 17 18 19 need to participate in regional value chains first to benefit 20 20 20 20 20 20 20 20 20 20 20 20 20 20 from learning and economies of scale, before adopting HS071410 – Manioc (cassava) stricter international standards.130 This is a medium-term HS080130 – Cashew nuts agenda that could be led by the Ministry of Commerce with other relevant ministries and agencies involved (for example, HS100630 – Semi-milled/wholly milled rice the Ministry of Agriculture, Forestry, and Fisheries). HS120100 – Soya beans HS151110 – Palm oil, crude Source: World Bank staff calculations using data from UN Comtrade and Cambodia Economic Diversification Study (World Bank 2019a). CHAPTER 2: 32 ECONOMIC TRANSFORMATION THROUGH EXPORTS FIGURE 2.15 Foodstuffs exports underperform against comparator countries a.  Vegetables, 1995-2019 b.  Foodstuffs, 1995-2019 7 5.0 6 4.5 4.0 Exports-to-GDP (percent) Exports-to-GDP (percent) 5 3.5 4 3.0 2.5 3 2.0 2 1.5 1.0 1 0.5 0 0.0 95 97 99 01 03 05 07 09 11 13 15 17 19 95 97 99 01 03 05 07 09 11 13 15 17 19 19 19 19 20 20 20 20 20 20 20 20 20 20 19 19 19 20 20 20 20 20 20 20 20 20 20 Bangladesh Cambodia Myanmar Bangladesh Cambodia Myanmar Philippines Thailand Vietnam Philippines Thailand Vietnam Note: Cambodia excludes cassava, rice, and cashew. Source: World Bank staff calculations using data from UN Comtrade and Cambodia Economic Diversification Study (World Bank 2019a). Low diversification, limited survival, and poor FIGURE 2.16 quality characterize Cambodia’s agricultural Survival rates of vegetables in export markets are exports lower than in Vietnam and Thailand Survival rates of vegetables, 2007-17 Diversification is a key challenge, as Cambodia has 1.00 yet to develop a similar advantage in vegetables or Survival rates, vegetables processed foodstuffs. Cambodia’s agriculture remains 0.75 highly concentrated in unprocessed rice and cassava, with (hs2 = 06-14) little diversification over time into other crops like fruits, 0.50 vegetables, animal products, or processed foodstuffs. As a share of GDP, Cambodia’s agriculture products exports have exceeded most comparators, in contrast to foodstuffs 0.25 exports that are below most comparators (figure 2.15). One exception is bananas, which have reported strong export 0.00 0 2 4 6 8 10 12 growth since 2018, from US$18.8 million to $132 million in Year 2020. In terms of destination markets, exports of cassava, Thailand Vietnam Cambodia soya beans, cashew nuts, and palm oil reach only two to Note: Vegetables include harmonized system chapters 06-14. three markets, whereas exports of rice (milled, broken, and Source: World Bank staff calculations using data from UN Comtrade and paddy) are more diversified. Moreover, the concentration of Cambodia Economic Diversification Study (World Bank 2019a). the export basket in these two products has made agriculture performance highly exposed to swings in commodity prices countries. Cambodian vegetable exports have much lower and weather events. survival rates than those of Vietnam and Thailand (figure 2.16), suggesting challenges confronting agricultural goods Cambodia’s vegetable products also face difficulty are more severe for Cambodia than comparator countries. surviving in export markets. Most export relationships The survival rate for Cambodian vegetable products in five (at the product-country level) forged by developing countries years is 36 percent, compared to 66 percent in Vietnam do not survive more than a few years. In Cambodia, the and 70 percent in Thailand. The survival of Cambodia’s rice probability of export survival is higher for manufacturing exports is also lower than in Thailand and Vietnam, despite goods than for agricultural goods. The survival of Cambodian having relatively more destinations and relatively longer agriculture export relationships is shorter than in comparator export relationships as recorded in the data. RESILIENT DEVELOPMENT: 33 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL FIGURE 2.17 Cambodia’s key agricultural exports are positioned low on the quality ladder Relative unit value of cassava exports to ASEAN vs. unit value rank a. 2010 b. 2016 1.5 2.0 Relative unit value Relative unit value 1.5 1.0 1.0 0.5 0.5 Cambodia Cambodia 0.0 0.0 0 5 10 15 0 5 10 15 Rank Rank Relative unit value of milled rice exports to the EU vs. unit value rank c. 2008 d. 2016 1.5 2.0 1.5 Relative unit value Relative unit value 1.0 1.0 0.5 Cambodia 0.5 Cambodia 0.0 0.0 0 10 20 30 40 50 0 20 40 60 Rank Rank Note: The figure shows the relative unit value for cassava (top panel) or milled rice (bottom panel) exported by Cambodia and other countries to ASEAN (top) or EU (bottom) countries in 2010 and 2016 (top) or 2008 and 2016 (bottom), ranked by ascending relative unit values. Source: World Bank staff calculations using data from UN Comtrade and Cambodia Economic Diversification Study (World Bank 2019a). Quality also appears to be a challenge, where Cambodian In addition, agriculture growth has decelerated agriculture exports remain positioned relatively low on significantly in recent years and is no longer the main the unit value/quality ladder.135 Cambodia’s relative unit driver of poverty reduction. Agriculture has played an value of cassava exports to ASEAN has not increased relative important role in growth and poverty reduction in Cambodia to other exporters, and the relative unit value of Cambodia’s and remains a major source of jobs. Recently, however, milled rice exports to the EU has fallen (figure 2.17). agricultural GDP growth has slowed dramatically, stagnating in 2014 and 2015 and averaging just 1 percent from 2013 Agriculture linkages with other sectors are still to 2019. Deceleration is explained by the fact that previous emerging. The agriculture sector relies mainly on domestic drivers of agriculture growth—like high international inputs from the same sector, with low sourcing from other commodity prices, land expansion, and cheap labor—have domestic sectors that could help increase product value. not persisted. Moreover, the use of domestic agriculture products in hospitality is limited, and the agro-processing industry is nascent. CHAPTER 2: 34 ECONOMIC TRANSFORMATION THROUGH EXPORTS There are opportunities to diversify productivity of key agricultural products. The business Cambodia’s agricultural exports environment appears to be further inhibiting diversification and upgrading into agro-processing. There are new opportunities for Cambodia to grow its agriculture exports, particularly within the East Asia High inputs costs lower value addition in and Pacific (EAP) region. First, recent evidence suggests that Covid-19 has further boosted the trend toward EAP trade agriculture regionalization. Faster recovery in the EAP region meant that While rice yields—Cambodia’s main agricultural intra-regional trade suffered less than trade in and with other product—improved over the past decade, labor parts of the world. In the first six months of 2019, China’s import productivity and returns remain low due to high input growth from ASEAN+5 was negative, but it had positive growth costs. A 2013 survey shows Cambodian rice yields per of 8 percent in the first six months of 2020. This is despite hectare have caught up to those of other producing countries, China’s total import growth being negative, including from but net returns remain below comparator countries, and both the United States and the EU.136 This finding is consistent labor productivity is relatively low (figure 2.18). Cambodia’s with Cambodia’s agricultural exports, where agriculture has labor use per season was between labor-intensive producers been the sector least affected by the Covid-19 crisis. During (Indonesia and the Philippines) and more capital-intensive the first seven months of 2020, Cambodia’s milled rice export producers (Thailand and Vietnam), but low labor productivity (of which fragrant rice accounts for about 80 percent) surged, played a role in keeping net returns below competitor rising 45.3 percent year-on-year, reaching 0.4 million metric countries. The survey further identified increases in input tons. China is the largest market for Cambodia’s milled rice costs affected net returns, with the cost of seeds and labor exports, capturing 35.5 percent of total milled rice exports or tripling and fertilizer prices doubling.138 Moreover, many 160 thousand metric tons. Cambodian farmers cannot grow dry season rice or other Second, the recently signed China-Cambodia FTA aims to multi-cropping alternatives due to lack of water and irrigation improve market access for Cambodia’s agricultural products for dry season cultivation. In contrast, Vietnamese farmers to China. An additional 340 tariff lines currently not offered generally cultivate three rice crops per year, increasing annual under the ASEAN-China FTA have been agreed (4 percent of labor demand and farmer income.139 the total), covering most of chapters 1 to 10 of Cambodia’s Mechanization of agriculture can improve labor ASEAN Harmonized Tariff Nomenclature, ranging from live animals/animal products to meat, fish, and cereals. Immediate productivity and output growth through labor benefits of the China-Cambodia FTA—when it becomes reallocation and modernization of production. effective—may come from exporting non-rice, high-value Increased use of modern technologies has a clear positive (raw and processed) agricultural products like cassava, effect on productivity and profitability in both per hectare rubber, and soybean since China has already provided quotas and per labor terms. In absolute terms, mechanization has for Cambodia’s milled rice and mango exports. The Cambodia- been increasing in Cambodia (figure 2.19). A comprehensive Republic of Korea FTA as well as the Regional Comprehensive survey of Cambodian agriculture showed all crops, except Economic Partnership (if signed) could further enhance for dry season rice, had significantly higher economic market access for Cambodia’s exporters. returns per hectare when using “modern” technologies, with average gross margins (revenue less cost) per hectare Third, other global megatrends are changing consumption between 1.6 to 3.4 times higher than those of “traditional” patterns and demand for what will be produced. Incomes producers.140 The effect was especially pronounced for are rising in Cambodia and Asia, and consumption is small farm vegetable producers: gross margin per hectare both increasing and diversifying into higher value-added was 3.6 times higher when using modern technology than goods and services. Non-poor households purchase more traditional technology. The survey further showed that expensive food baskets than poor households do—including for all crops, the return on labor increased by factors of non-rice cereals, fruits, and meat—and they expect these 1.15 to 10.3 when using modern technology, showing the goods to meet solid hygiene and food safety standards.137 impact of modern input use on productivity performance.141 Evidence also indicates technology adoption explains To reap these opportunities Cambodia needs to address nearly all scale advantages in rice and maize cultivation, constraints that currently inhibit diversification and as larger farms in these crops seem to benefit from upgrading of its agricultural exports. Cambodia’s low labor savings in management and monitoring, and better value added in agriculture can be explained by high inputs access to capital and therefore labor-saving equipment. cost and low adoption and high cost of mechanization Beyond mechanization, use of irrigation, contract farming, due in part to tariffs and non-tariff barriers, which lower marketing, and processing can also support diversification. RESILIENT DEVELOPMENT: 35 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL FIGURE 2.18 Cambodian rice yields have improved but net returns and labor productivity are low a.  Yields, 2013 b.  Net return, 2013 c.  Labor productivity, 2013 9 1,200 0.6 8 1,000 0.5 7 6 800 0.4 Ton/person/day US$/ha 5 Ton/ha 600 0.3 4 3 400 0.2 2 200 0.1 1 0 0 0.0 Dry season rice Wet season rice Dry season rice Wet season rice Dry season rice Wet season rice Cambodia Indonesia Philippines Thailand Vietnam Source: World Bank (2015), Bordey et al. (2016), and Cambodia Economic Diversification Study (World Bank 2019a). FIGURE 2.19 Yet production costs increase with modern input use, Mechanization has been increasing in Cambodia and farmers said high cost was the main constraint Use of agricultural machinery, 2004-15 to adopting or expanding use, due in part to high 800 tariffs on equipment. Machinery can be prohibitively expensive for smallholders, and various factors increase their cost. Although Cambodia does exempt tractors and 600 some agriculture machinery from import duties, tariffs are Thousand units still applied to some tools and implements. Moreover, spare 400 parts are expensive and considerably increase costs to farmers. Tariffs ranging between 15-25 percent are paid on 200 imported implements, and tractors’ spare parts face 15-35 percent tariffs. Maintenance for some agricultural equipment 0 (including spare parts as well as skilled professionals) can equal the initial purchasing cost over the life of a machine, 04 05 06 07 08 09 10 11 12 13 14 15 20 20 20 20 20 20 20 20 20 20 20 20 Harvester Rice milling Power tiller increasing farming costs considerably. Tractor Thresher Irrigation pumps Source: Department of Agricultural Engineering of the Ministry While non-tariff measures (NTMs) are less pervasive of Agriculture, Forestry, and Fisheries and Cambodia Economic in Cambodia than in other countries, their associated Diversification Study (World Bank 2019a). cost is steep and affects agricultural inputs like fertilizers, pesticides, and seeds. Only about one in FIGURE 2.20 three tariff lines in Cambodia are affected by NTMs. This NTMs increase the cost of agricultural inputs coverage ratio is much smaller than what is observed in Ad-valorem equivalent of NTMs and average tariff rates, 2015 other countries around the world, and is lowest among 100 ASEAN countries with available data except the Philippines. In China, for example, NTMs cover about 90 percent of 80 tariff lines. In Cambodia, however, those that do exist are highly taxing. The ad-valorem equivalent of Cambodia’s 60 Percent NTMs, which measures the percentage increase in the 40 price of imports, are the highest in the region (figure 2.20). Cambodia’s NTMs increase the cost of imported products by 20 96 percent, compared to around 75 percent in China. The average ad-valorem equivalent is almost 10 times higher 0 than the average tariff, which are equal to 9 percent of the Cambodia China Malaysia Philippines Thailand Vietnam AVE of NTMs Simple average applied tariff import value. Tariff and non-tariff barriers are increasing Trade-weighted average applied tariff the cost of key agriculture inputs like tractor implements, Note: AVE = Ad-valorem equivalent. fertilizers, irrigation equipment, and greenhouse materials, Source: Niu et al. (2018) and Cambodia Economic Diversification Study thus limiting the potential for productivity improvements. (World Bank 2019a). CHAPTER 2: 36 ECONOMIC TRANSFORMATION THROUGH EXPORTS Addressing infrastructure gaps to support areas have been zoned, and therefore many lack a map of upgrading where productive activities can be undertaken (for example community and sustainable land-use areas) and where they Supporting infrastructure can improve productivity cannot (for example conservation and core areas). As a result, for farmers by greater connectivity to markets, most protected areas are under high pressure from logging, improved production techniques, and reduced inputs poaching, and land clearing, with a significant share having costs. In Cambodia there are some gaps in the key already been heavily degraded or converted to agriculture infrastructure that supports agricultural production. Low production. Strengthening the capacity for protected area survival reflects challenges related to quality, conservation, landscape planning and management, preparing Protected and transportation of agricultural products, as well as Area and Community Protected Area management plans, associated sanitary and phytosanitary standards (SPS) risks. implementing an effective natural resource management Cambodia has insufficient quality assurance standards system (including financial management and procurement, and SPS compliance mechanisms, which inhibit quality environmental and social management, and revenue and upgrading of agricultural exports. fee management), and providing technical assistance on a protected area enforcement framework would help ensure Investments in and policy towards land management environmental, social, and economic sustainability. and natural resource preservation are also vitally important for the future growth potential of Cambodia’s agriculture exports. With low population Business environment constraints inhibit density, land availability is not a constraining factor for upgrading into processing and establishing investment in larger plantations and agribusinesses, which domestic linkages mainly produce and process for export. But the management of public land and the on-going reallocation of concessional There are substantial opportunities to establish land continues to result in ownership grievances. A key processing plants to add value to basic products for issue is lack of transparency in the land management export and domestic consumption and create jobs system. To address this, it will be important for the RGC to in Cambodia, but business environment constraints finalize agricultural land policy. This policy needs greater put Cambodian processing firms at a disadvantage. A transparency around the rules, regulations, and fees so they 2016 survey of existing processing firms and input importers are implemented according to a clear system. This could in Cambodia identified numerous business-environment support greater FDI for agriculture in the long term and challenges that constraint agro-processing firms and input more sustainable agriculture export systems. importers in Cambodia. Insufficient market information, informal payments, lack of supportive public policies, and Exploitation of protected areas however is a broader high energy costs were the most binding constraints for concern for natural resource preservation in agro-processing (figure 2.21). To illustrate, high fuel and Cambodia. According to the World Database on Protected electricity costs caused average rice milling costs to be 30 Areas, Cambodia has one of the highest ratios of protected percent higher for Cambodian millers than for Vietnamese land areas in the world at 41 percent. Yet few protected and Thai millers in 2013.142 FIGURE 2.21 The business environment constrains agro-processing firms and input importers Key constraints in the agro-processing sector identified by existing enterprises in Cambodia, 2016 Market information and information systems Informal payments/corruption Top five constraints Absence of reliable market Lack of government policies and encouragement for the agro-processing sector High energy and electricity cost Irregular and insufficient supply of raw materials High cost of transportation Lack of skilled labor/workers for maintenance and operation of agricultural machinery Other constraints Poor road connections from farm to factory Marketing and branding of Cambodian products (perception of Cambodian products as inferior) Access to technology and modern machinery Costly exporting procedures which require significant paperwork Source: Bdlink (2017) and Cambodia Economic Diversification Study (World Bank 2019a). RESILIENT DEVELOPMENT: 37 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Policies can support value addition in Cambodian an essential precondition for all crops. Planned irrigation agriculture investments should consider how they can support farmers in cultivating a diversified range of crops. For example, flood A multidimensional strategy is needed to increase control irrigation is insufficient to grow tree crops, which value addition in Cambodia’s agriculture export require year-round water access as well as flood prevention. sector. Given opportunities provided by vegetables as This is a short-term agenda that could be led by the Ministry well as agro-processing and foodstuffs, Cambodia could of Agriculture, Forestry, and Fisheries. pursue new drivers of agriculture growth that would boost value addition and job creation in the sector. These are In the medium and long term, Cambodia should crop diversification, differentiation, agro-processing, and foster public-private partnerships that envisage improved use of agriculture inputs. Within each of these contract farming and extension services to support objectives, a range of policies are identified that focus investments in selected crops. This could be led by the on improving capabilities, strengthening regulations, and Ministry of Agriculture, Forestry, and Fisheries. Some crops, investment in infrastructure. particularly tree crops, may require financial interventions or arrangements (for example contract farming) to support Promoting diversification toward higher-value fruits smallholder entry, as these crops typically require significant and vegetables up-front investment and three to five years of growth before significant yields can be harvested and returns realized. Supporting diversification toward crops like fruits To support smallholders in cultivating higher-value, high- and horticulture products may be a first avenue quality crops, extension services and irrigation systems must toward high-value-added agriculture in Cambodia. be adapted accordingly. Farmer extension services would Horticulture crops show high gross margins and, given the need to support relevant crop types and related practices, labor-intensive production involved, would contribute to empowering farmers to engage in higher-value crop maintaining employment, while also being compatible with production. One way for the government to achieve this is to smallholder farming due to limited scale advantages.143 provide extension services in collaboration with local private Domestically grown fruits and horticulture products have sector actors through public-private partnerships. Support to potential both as substitutes to imports in the domestic bring agricultural products to markets can also be provided to hospitality industry and local markets, and as differentiated smallholders through these institutional arrangements. Cambodian export products. Diversification would also help reduce monocrop dependency and associated risks. Focus on upgrading through quality assurance and branding In the short term, Cambodia should support the private sector in assessing market potential for new Introducing and marketing food safety and quality crops (fruits and vegetables) that are suitable for standards to pursue a ‘go green’ differentiation Cambodia’s climate, with the Ministry of Commerce strategy for high-quality food products presents an in the lead. Identifying market potential through market opportunity for Cambodian producers and exporters. assessments is integral to crop investment decisions and Fruit and horticulture products are especially well-suited to important for ensuring success. For instance, the increasing target niche markets, as they make up the largest component demand for plant-based protein may make protein-rich of the United States’ organic market demand at 43 percent beans preferable to other legumes that would otherwise be of the total.145 Targeting part of fruit and horticulture goods equally suitable for cultivation in the same plot. Although no production to organic markets could generate higher document or person can provide all the answers up front, farmer incomes and employment in processing, sales, and some indication can be given based on general climatic distribution services. Forecasts expect world demand for conditions.144 Alongside support to the private sector, the organic products to increase from US$110.25 billion in government should also strengthen its own institutional 2016 to US$323.09 billion by 2024.146 Growth is forecast capacity to provide support services such implementation primarily in the traditional European and American markets, of standards around food safety and SPS (discussed below). but demand is also expected to more than double in the Asia-Pacific region.147 Success will depend on area-by-area assessments and irrigation investment. Agriculture is inherently First, improve implementation of pest and disease uncertain and carries risk. Which crops to grow and how they surveillance, quarantine services, and laboratory should be used is never completely certain until attempted, testing for contaminants and residues, among other and the specific characteristics of each location require trial food safety functions. Producing fruits and horticulture and error and experimentation. The suitability of crops is products that meet food-safety and/or organic requirements also heavily influenced by the irrigation systems available, in advanced economies would require capacity building and as varying degrees of water control and availability are appropriate institutional arrangements to ensure better CHAPTER 2: 38 ECONOMIC TRANSFORMATION THROUGH EXPORTS traceability and quality assurance mechanisms, as well as Fourth, in the medium and long term, establish successful communication of safety and quality to buyers. geographical indicator arrangements and blockchain At the production level, improved capacity will be needed technology to improve traceability through the in relation to a broad array of SPS service functions, both agriculture supply chains. Another possible avenue for for the domestic market and for supporting exports. The branding and differentiation is geographical indication. A Ministry of Agriculture, Forestry, and Fisheries could lead geographical indication signals certain quality and production- this medium-term agenda. related qualities to consumers, with the possibility of obtaining better market access, increased sales, or increased Second, introduce a national system to certify unit value/price, as well as possibilities for tourism in both SPS compliance and organic labeling. This is producing areas. The minimum requirements for establishing particularly important for exports, because trading partners, a geographical indication is a product with certain existing modern food retail distributors, and tourist facility operators market recognition, producers (or government entities) who need assurance that purchased commodities conform to want to protect the product, and a legal framework enabling the expected standards of food safety, quality, and desirable protection.151 Once these are established, further efforts characteristics (for example, organic production, adapted are required to delineate the coverage, characteristics, varieties).148 A trusted certification is a convenient assurance. and responsibilities of the geographical indication and its In the long term, certification should be provided by national enforcement.152 Blockchain technologies could be introduced institutions, which would require laboratories, systems, and to manage the geographical indication brand by improving procedures to be approved by target market authorities.149 traceability through the agriculture supply chain. Such an In the short term, a simpler procedure for obtaining third- agenda would best be led by the Ministry of Agriculture, party certification could be considered.150 Capacity building Forestry, and Fisheries. will also be needed to implement certification and higher standards, for example training of lab technician. Targeted Improve conditions for agro-processing and the outreach to farmers on organic agricultural practices, promotion of higher value-added products fertilizer use, or other technologies will be required for compliance with new standard, which would also improve The food processing sector has strong potential for food safety, productivity due to more efficient use of inputs, domestic upstream linkages and export growth, and better environmental outcomes. Here, the Ministry of increased value addition, and job creation. Despite Agriculture, Forestry, and Fisheries could lead this medium- some positive developments in recent years, agro- term agenda. processing activity in Cambodia remains incipient. Most processed food products are imported from neighboring Third, develop a national branding strategy and countries like Thailand or Vietnam, who acquire raw communication campaign for other fresh fruits and materials from Cambodia. horticulture products (beyond rice and pepper). Cambodia already has an internationally established In the short term, Cambodia can establish a local reputation in premium fragrant rice (declared the World’s agribusiness industry by continuing to lower energy Best Rice for several years) and Kampot pepper, and it costs (led by the Ministry of Mines and Energy) and could build on this momentum to enhance and implement a improving trade infrastructure for better market strategy to establish an internationally-recognized national access (led by the Ministry of Commerce). Cambodia brand in fruits and horticulture products. For a credible has substantially improved trade facilitation and logistics in national brand based on quality, some fundamental steps recent years, but continued efforts are needed to streamline must be taken. For example, a list of safety and quality processes to boost competitiveness and reduce cost for requirements must be established for all products intended agricultural importers and exporters. Here, Cambodia should for inclusion, and third-party entities must be accredited to fully implement the national single window by: i) integrating certify producers, processors, and packing operators against remaining agencies; ii) building capacity and training for those requirements. Subsequently, efforts are needed to customs officials on the new national single window or promote the brand both for expansion among producers Automated System for Customs Data (ASYCUDA) system; iii) and for market acceptance by communicating the value to automating and integrating the remaining border processes consumers. Beyond these fundamentals, brand credibility like SPS certification into the system iv) and reviewing must be strengthened and the certification process simplified customs requirements for export and import permits while (without compromising on safety and quality standards), in also linking the Certificates of Origin systems (to automate collaboration with private sector actors. This medium-term their issuance) and the customs ASYCUDA system. agenda could be led by the Ministry of Commerce. Authorities should also focus on reducing constraints in the business environment discussed in other parts of this report, rather than providing sector-specific support. RESILIENT DEVELOPMENT: 39 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL In the medium and long term, authorities should and non-transparent licensing system for importing consider adapting institutional models supportive fertilizers and pesticides, which is meant to support food of agribusiness. To further support SME agribusiness safety and product quality, results in smuggling and the development and ensure inclusive agricultural growth, presence of potentially hazardous products in domestic Cambodia can adapt institutional models that have worked markets. The RGC, led by the Ministry of Agriculture, elsewhere, including agribusiness incubation, farmer- Forestry, and Fisheries, could streamline fertilizer import enterprise productive alliances, and contract farming requirements. These reforms would decrease smuggling, systems, which could be spearheaded by the Ministry improve competition, lower fertilizer prices, and improve of Agriculture, Forestry, and Fisheries.153 Strengthening fertilizer quality available in the market, while increasing capacity of agricultural cooperatives will also help ensure fertilizer consumption by farmers and enhancing the stable and adequate supply of local agricultural inputs for competitiveness of Cambodian agricultural exports. The agro-processing firms and encourage FDI into the agro- reform of the fertilizer licensing and permit requirements processing sector. The RGC should also investigate the can be embedded in the RGC’s overall effort to improve its availability of financing mechanisms and facilitate contact trade facilitation regime. The reforms could be introduced between local entrepreneurs, national development finance with a modular approach, prioritizing organic fertilizers that institutions, and active, developmental, and temporary can be used in organic farming. shareholders to promote access to long-term financing.154 A business model that integrates primary, secondary, Third, in the medium and long term, authorities could and tertiary activities (medium-scale processing, on- introduce a risk management system at the border site primary production, smallholder cooperation, and profiling importers, exporters, and products. This sales and distribution) could be a viable alternative for would ensure food safety and sufficient quality standards Cambodia. One example of such an integrated value chain in products like fertilizers or pesticides, without comprising is Malawi’s “Nyama World,” which secured investment from the timeliness of import procedures. Key to implementation Development Finance Institutions to achieve necessary will be building capacity of inspectors and border staff. Risk expansion. management could potentially be introduced as a module in phase II of the national single window and led by the Ministry Improve the availability and affordability of of Agriculture, Forestry, and Fisheries in coordination with agricultural inputs the Ministry of Commerce. Facilitating the uptake and appropriate use of agriculture inputs to improve productivity involves ensuring competitive cost of agricultural inputs to Increasing competitiveness to 2.3  farmers. Agricultural inputs include high-quality seeds, export modern services fertilizers, and tractor implements and facilitating uptake should include education to ensuring appropriate use. The increasing tradability of modern services is Output prices of agricultural products have declined, making recognized as one of the major changes in global the cost of inputs an even greater barrier to adoption. trade patterns during the last quarter of the 20th century.155, 156 The explosion of services trade—and First, in the short term, the RGC could review the services more generally—in the global economy resulted effectiveness of all licenses, quotas, and fees on from falling trade and investment barriers and new digital imported agriculture inputs. Authorities could extend the technologies that have reduced the costs of delivering current policy applying to tractors and remove import duties services across borders.157 For developing countries in on implements and tractor parts to facilitate improved particular, services offer an increasingly important avenue access to agricultural tools and equipment. This could be for integrating into global markets. accompanied by a certificate issued by a business chamber to confirm their intended use for agricultural machinery. Services support a country’s trade through a dual role. Import duties on other agriculture machinery implements First, services are key inputs enabling export competitiveness could be phased out as well. These policies could be led by of agriculture and manufacturing sectors. Indeed, the the Ministry of Commerce. higher the costs of services like transportation, electricity, utilities, financial, distribution, accounting, engineering, Second, in the short term, Cambodia could intensify consulting, and legal services, the higher the final cost of market surveillance and traceability of fertilizers, those agricultural and manufacturing products using them. including by using mobile testing facilities. Pesticide As the Cambodian manufacturing and agriculture sectors use has increased substantially and must be managed face increasing competition from abroad, both in domestic efficiently in the future to avoid raising food safety and and external markets, the greater the need for these sectors environmental concerns. Unfortunately, the cumbersome to rely on efficient services inputs. CHAPTER 2: 40 ECONOMIC TRANSFORMATION THROUGH EXPORTS Second, supporting firms’ competitiveness to export a Angkor Wat temple complex facilitated the revival of tourism diverse set of modern services provides a direct avenue in the aftermath of three decades of war and instability. for export growth. Countries like India, the Philippines, and Cambodia’s tourism continues to draw heavily on visitors Vietnam have benefitted from the expanding opportunities to Angkor Wat, the main destination for tourists; arrivals to offered by new technologies, to be exporters of modern Siem Reap province where the temple is located account for services activities. Literature has demonstrated the positive 60 percent of total international arrivals by air. effect of services trade on economic growth, productivity, jobs, and knowledge transfer.158 There are some worrying trends that could threaten tourism development as a central pillar of an Cambodia has similarly witnessed an explosion of inclusive economy. Cambodia has globally significant services trade over the past decades. Services exports tourism resources that are diverse and well placed to be in Cambodia have grown at an impressive rate of 17 percent a pillar for socioeconomic development as identified by the annually on average between 1995 and 2019, compared to government. Yet Cambodia is ranked 98th on the global goods export growth of 12 percent. As a result, the share of tourism competitiveness index, lowest in South-East Asia.159 cross-border services trade in total trade has grown steadily Value captured per tourist has not changed much in the during the last decades. Services exports now account for last decade (from US$585 in 2005 to US$655 in 2016), about 28 percent of Cambodia’s total trade. low-end businesses have mushroomed, stays remain short with limited repeat visits, and there are signs of Services exports are concentrated in tourism overcrowding and degradation of the key assets at the Angkor temples.160 The average expenditure per visitor Cambodia’s services export performance is dominated in 2016 in Cambodia (US$655) was much lower than it by the growing role of tourism (travel and transport). was in Thailand (US$1,489) or Vietnam (US$925). While Since 2005, Cambodia has outperformed EAP comparator some progress has been made in diversifying destinations, countries in services export growth. Most of this growth has especially to the coastal region, the potential for ecotourism been driven by the expansion of the tourism sector, which as a more sustainable growth model remains untapped (box accounts for nearly all of Cambodia’s services exports. In 2.1). Covid-19 and the collapse of international arrivals 2018, travel services represented 83 percent of Cambodia’s has illustrated the fragility of the concentrated reliance on services exports, and transport services constituted another tourism, with a sluggish recovery expected in the coming 13 percent (figure 2.23). The magnificent landmark of years.161 BOX 2.1: Ecotourism can promote upgrading in tourism Cambodia’s spectacular and pristine natural assets provide a potential comparative advantage in ecotourism. Ecotourism includes tourism activities related to nature-based tourism in natural areas like birdwatching, fishing, camping in natural areas, hiking, kayaking, ziplining, and adventure tourism. There are already examples of successful mid- to high-end ecotourism operations in Cambodia, yet there are enormous opportunities to expand the ecotourism industry. For example, the Cardamom Mountains have natural assets to enable development of high-end tourism experiences for both younger and wealthier North American, European, ASEAN, Chinese, and Khmer tourists. Given the current situation—with the sharp slowdown in Cambodia’s international arrivals—investing in the development of sustainable ecotourism now would be strategic for diversifying Cambodia’s tourism product. Marketing Cambodia as a place to visit, with a unique biodiversity, nature-based experiences, and remoteness will help attract tourists in a post-Covid-19 world. Ecotourism also has the potential to bring in higher tourism revenues, create better jobs, and provide stimulus for rural communities. Key policy priorities are to i) improve the enabling environment for private sector investing in ecotourism with new policies and clear guidelines for ecotourism development in protected areas; ii) develop the Cardamom Mountains as an ecotourism destination and support the private sector in destination marketing and branding, developing new ecotourism products, and investing to enable connectivity to ecotourism sites within the Cardamoms; and iii) integrate protection of forest resources into ecotourism development including strengthening protected area management and promoting inclusive growth of rural communities. Source: World Bank (2020c). RESILIENT DEVELOPMENT: 41 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL In contrast, development of modern services has been Cambodia has substantial room for further growth limited. Cambodia has seen little diversification over the past in services trade beyond tourism, mainly in other decade in its services exports, particularly in modern services commercial services. Cambodia is among the most where Cambodia underperforms against comparators. In reliant in the world on travel and transport services (figure 2018, other commercial services (other than travel and 2.23). While other commercial services exports are on par transport services) represented less than 4 percent of total with Cambodia’s current level of development, their growth services exports. Examples of modern services include is significantly lagging in relation to similar countries. For information and communication technologies (ICT), banking, example, according to WTO data, ASEAN growth rates in insurance, business services, business process outsourcing, other commercial services averaged 23.1 percent from knowledge process outsourcing, and education. Other 2005 to 2018, compared to 9.7 percent in Cambodia over business services, like lawyers and accountants, were more this period. Consequently, ASEAN’s world market share important in Bangladesh (28 percent of total commercial of other commercial services increased from 3.3 percent services exports), the Philippines (43 percent), and Thailand to 5.3 percent from 2005 to 2018—almost a 60 percent (14 percent) than Cambodia (2 percent) (figure 2.22). increase. Meanwhile Cambodia’s world market share fell from 0.007 percent to 0.006 percent in that period—almost Covid-19 is reshaping services trade, which may a 10 percent decrease. offer new opportunities for countries like Cambodia. Covid-19 is likely to shift the pattern of services globalization from trade in face-to-face services like Services sector linkages are minimal tourism and transport to trade in digitally delivered services like telecommunications, business processes, and software. In Cambodia, the services sector has relatively few The ICT revolution has already led to a rapid growth in linkages with other sectors. Professional services, ICT, business services exports from countries like Vietnam and transport, finance, and electricity are key inputs for other the Philippines. Since Covid-19 is making face-to-face sectors like manufacturing and agriculture. Literature has transactions difficult, firms and people are investing heavily established the importance of services inputs for firms’ in digital equipment and literacy.162 The results may mean outcomes in downstream sectors. Productivity growth in new opportunities for developing countries to advance into services has been a key driver of GDP growth for Organisation more sophisticated services exports. for Economic Co-operation and Development (OECD) FIGURE 2.22 FIGURE 2.23 Cambodia relies heavily on tourism and has not diver- Cambodia outperforms in tourism-related services sified into modern services Travel and transport services exports to GDP, 2016-18 Services export composition, 2018 100 20 Cambodia 80 16 Exports to GDP (percent) Thailand 60 12 Percent Malaysia 40 8 20 4 Lao PDR Myanmar Philippines Bangladesh India Indonesia 0 0 ia h ia ia DR sia r es d am ma 6 8 10 12 es an od Ind es pin lay oP tn lad ail an on mb Vie ilip Ma Th La My Ind ng Ca Ln GDP per capita (current US$) Ph Ba Other business Travel Financial ICT Transport Insurance IP charges Goods-related Construction Source: World Bank staff calculations using data from UN Conference on Source: World Bank staff calculations using data from World Bank World Trade and Development. Development Indicators. CHAPTER 2: 42 ECONOMIC TRANSFORMATION THROUGH EXPORTS countries as well as developing countries. In Indonesia, Second, international trade policies can help modernize and improved services input quality, variety, and cost resulted internationalize services sectors through preferential trade in improved performance for firms in downstream sectors. agreements (PTA) and other trade agreements. This section However, Cambodia lags behind comparator countries in the explores these options to understand Cambodia’s inability to use of domestically sourced services in the production of diversify into modern services exports. its manufactured exports (figure 2.24), particularly financial, insurance, and utility services. Instead, wholesale and retail National regulatory environment services account for approximately half of all domestic services inputs to manufacturing, and transportation and Reforms to improve regulatory policies and remove storage services represent approximately 18 percent, the barriers to entry facilitate well-functioning and second-largest share (figure 2.25). competitive services markets, inflows of foreign services, and ultimately modern services trade. This happens through various channels. Services liberalization Key enablers in the domestic policy policies increase foreign investment in services sectors, environment are missing which increases international competition and can spur exports. Services liberalization can also affect a country’s Targeted policies and enabling factors could facilitate comparative advantage and thus the composition of trade. a competitive modern services sector and increase For example, better business services can help countries domestic firms’ potential to export a diverse set of move up the value chain towards more complex goods.163 modern services. There are two main complementary ways Services reforms can also lead to knowledge spillovers and of diversifying economic growth through services-related network effects, increasing the productivity of capital and policies. First, services sector diversification can be achieved labor inputs and affecting total factor productivity (TFP). through national policies that strengthen the domestic There are a growing number of studies using firm-level data enabling environment. Competitive, modern services exports demonstrating that liberalization of services through FDI require a variety of fundamental enabling factors like a increased the productivity of firms by 7 percent in Chile, 3.8 strong domestic regulatory environment, market access, percent in the Czech Republic, 2.4 percent in Romania, and infrastructure, high skills and human capital, and institutions. 9.1 percent in India.164 FIGURE 2.24 FIGURE 2.25 Compared to the Philippines and Thailand, services Sectors rely most heavily on traditional domestic are used less as inputs services inputs, rather than domestic modern services Domestic services value added in exports by export sector, 2015 Composition of domestic services value added in manufacturing exports, 2015 79.0 Cambodia 67.5 60.9 58.4 Philippines 39.9 Thailand Percent 29.4 27.5 20.0 Vietnam 16.8 16.1 16.0 14.2 12.9 12.9 11.4 11.4 0 10 20 30 40 50 60 70 80 90 100 9.8 9.9 9.6 8.6 7.3 7.0 5.5 3.8 Percent Electricity, gas, water supply, sewerage, waste, and remediation services Cambodia Philippines Thailand Vietnam Construction Wholesale and retail trader; repair of motor vehicles Total Transportation and storage Accomodation and food services Agriculture, forestry, and fishing Information and communication Financial and insurance activities Manufacturing Real estate activities Other business sector services Food products, beverages, and tobacco Public administration and defence; compulsory social security Textiles, wearing apparel, leather, and related products Education Human health and social work Total business sector services Arts, entertainment, recreation, and other services activities Source: World Bank staff calculations using data from OECD Trade in Source: World Bank staff calculations using data from OECD Trade in Value Added Database and Cambodia Economic Diversification Study Value Added Database and Cambodia Economic Diversification Study (World Bank 2019a). (World Bank 2019a). RESILIENT DEVELOPMENT: 43 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Cambodia has significantly liberalized its services FIGURE 2.26 trade regime compared to other ASEAN countries. Cambodia has significantly liberalized its services Cambodia undertook an ambitious program of liberalization trade regime when it joined the WTO in 2004, including in the services Services trade restrictiveness index, 2008 vs. 2012 sector. Cambodia is one of the most open countries in 46.9 the EAP region with low levels of restrictiveness against Indonesia 54.4 foreign services providers, as measured by the World 51.9 Bank’s Services Trade Restrictiveness Index (figure 2.26).165 Philippines 50.7 Cambodia has left the provision of cross-border services 48.4 (mode 1) unrestricted in most sectors and there are almost Thailand 46.8 no limitations on foreign ownership (mode 3).166, 167 Lao PDR 45.7 So how can Cambodia’s high services liberalization 46.2 yet low diversification of services exports be Malaysia 42.7 reconciled? Notably, many of the other key enabling 40.7 factors of modern services exports in the domestic policy Vietnam 37.5 environment are underdeveloped, suggesting additional Myanmar steps are needed. These are cross-cutting, but also affect 27.9 growth of specific sectors like Cambodia’s bourgeoning 21.6 Cambodia creative services industry, as discussed in box 2.2. 12.1 2008 Singapore Institutions 9.0 2012 Restrictiveness of services trade policy Domestic institutions play a complementary role in Note: Lao PDR, Singapore, and Myanmar not covered in 2008. creating well-functioning and competitive services Source: Gootiiz and Mattoo (2015). markets. Cambodia ranks lowest among comparators in rule of law (figure 2.27) and property rights protection and the relatively low price of mobile-broadband internet (figure 2.28). Though Cambodia adopted laws on copyrights, compared to fixed-broadband internet.169 trademarks, and patents in 2002-03, enforcement is reported to be weak, and initiating procedures in Other trade-related infrastructure associated with Cambodian civil court can be cumbersome and costly (as better services export performance is also lagging. discussed in Chapter 1). The RGC also reserves the right Modern services also depend on the quality of transport to revoke patents, utility model certificates, and industrial infrastructure like port or airport facilities and reliable and design certificates, shorten the time of protection, or use cost-effective electricity supply. Cambodia has substantially intellectual property to promote public interests, and there improved trade facilitation and logistics in recent years, but is no approved legislation on trade secrets.168 As a result, continued efforts are needed to streamline processes at the according to the World Economic Forum, Cambodia scores border, as discussed in Section 2.1 (figure 2.30). Efforts just 3 out of 7 on the IPR protection index, compared to a are also needed to ensure the reliability of electricity and regional average of 4.7. address the high costs discussed in Chapter 1. At 17.5 cents per kilowatt hour, Cambodia has the highest commercial Infrastructure electricity rates in the region.170 New technologies are having a large impact on how Human capital services are delivered, and access to high-bandwidth telecommunications infrastructure is key to Appropriate educational standards and ICT countries’ participation in modern services exports. competency of graduates are essential for developing Although internet prices are competitive, broadband access and sustaining modern services exports in developing remains limited in Cambodia (figure 2.29). Fixed-broadband countries. A workforce trained in a common global language subscriptions, at 0.6 per 100 inhabitants in 2016, were like English also supports bilateral services exports between well below regional and global averages, and most mobile countries. Cambodia ranks lowest among comparators in broadband subscriptions operate in 2G and 3G services foundational human capital as measured by the World Bank since 4G coverage remains limited. Low fixed-broadband Human Capital Index (HCI), discussed in Chapter 1, and adoption in Cambodia may be due to a combination of lowest in educated workforce as measured by the share factors, including limited availability of optical fiber in rural of the population aged 15 and over with tertiary education areas, the low number of households with a computer, (figure 2.31). CHAPTER 2: 44 ECONOMIC TRANSFORMATION THROUGH EXPORTS Restrictions on professional services as well as transportation and telecommunications where some restrictions remain in mode 1 as well as mode 3 Restrictions remain in some key sectors, particularly (figure 2.32). In accounting services, only Cambodian professional services. Firm performance correlates with accountants can sign off audited reports. In legal services, objective measures of professional services in addition to foreign lawyers cannot register with the Bar. Restrictions access to transport and telecommunications, discussed also remain in mode 1 in audiovisual services, maritime above.171 Despite services reforms, in Cambodia there is transport, land transport, and internal waterways transport, still room for improvement in the regulatory environment and in mode 3 in telecommunications, travel agencies, and for professional services including legal and accounting tour operators. FIGURE 2.27 FIGURE 2.28 Cambodia scores low on rule of law… …and property rights protection Rule of law rank, 2020 Property rights score, 2020 87 69 63 Property rights score 60 60 56 Rule of law rank 55 55 54 53 43 43 41 41 37 28 19 17 13 ia sia am d ia ia es h DR r ia sia ia ia d es am DR h ma an es an es od Ind es od Ind es pin pin lay oP tn lay oP tn lad ail lad an ail on mb on mb Vie ilip Vie Ma ilip Ma Th La Th My La Ind ng Ind ng Ca Ca Ph Ph Ba Ba Source: World Bank staff calculations using data from World Bank Source: World Bank staff calculations using data from Heritage Governance Indicators. Foundation. FIGURE 2.29 FIGURE 2.30 Broadband access is limited Improvements are needed in trade infrastructure Fixed broadband subscriptions per 100 inhabitants, 2018 World Bank Logistics Performance Index score, 2018 15.4 14.5 3.4 3.4 Logistics Performance Index score Subscriptions per 100 inhabitants 3.2 3.1 3.1 2.9 2.7 2.6 2.4 9.3 2.3 5.0 3.9 3.5 1.5 1.1 1.1 0.2 ia sia d ia am ia es h DR r ia am d sia h es ia ia DR r ma ma an es an es od Ind es od es Ind pin pin lay oP lay oP tn tn lad lad ail ail an an on on mb mb Vie Vie ilip ilip Ma Ma Th Th La La My My Ind ng Ind ng Ca Ca Ph Ph Ba Ba Source: World Bank staff calculations using data from World Bank World Source: World Bank staff calculations using data from World Bank Development Indicators. Logistics Performance Index. RESILIENT DEVELOPMENT: 45 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL FIGURE 2.31 FIGURE 2.32 Cambodia has a low-educated workforce Restrictions remain in professional services Tertiary education, 2020 Services Trade Restrictiveness Index for professional services, 2012 23 100 Services Trade Restrictiveness Index Percent of population aged 15+ 19 80 60 13 10 40 9 6 6 20 6 4 2 0 ia ina ia sia a es d am oli an od es pin lay Ch tn ng ail on mb Vie ilip Ma ia es sia d r ia ia DR am h Mo Th ma Ind an es Ca od Ind es pin Ph lay oP tn lad ail an on mb Vie ilip Ma Th La My Ind ng Mode 1 (imports) Mode 3 (FDI) Ca Ph Ba Source: World Bank staff calculations using data from Barro-Lee Source: World Bank staff calculations using data from World Bank Educational Attainment Dataset. Services Trade Restrictions Database. Market access through PTAs could attract export-oriented FDI and offer greater export opportunities for domestic service providers as they develop Modern services exports require good access to global in the medium term. markets, and PTAs can be instrumental for boosting that. There are two main channels through which PTAs can There is evidence that PTAs can be essential help boost services exports. First, there is an “external” for boosting international services trade (GATS dimension, which refers to the greater export opportunities supply mode 1).173 Regulation of services is not derived from FTAs for domestic exporters and new investors homogeneous, but heterogeneous between countries, and who may be lured into the host country as a result. Second, heterogeneity in regulation negatively impacts bilateral there is a domestic or “internal” dimension, by which modern services trade.174 Services trade negotiation should FTAs—by including certain in-built mechanisms—facilitate therefore create mechanisms to promote pro-competitive a political-economic dynamic fostering gradual domestic domestic regulatory reform and international regulatory reforms towards services trade liberalization. However, cooperation.175 For this reason, “optimum regulatory areas” whether a particular FTA achieves such goals depends on emerge as an important element to facilitate integration.176 the quality of the commitments included therein. More important, by signing a PTA, countries ensure that: i) their services exports cannot be hampered from measures The benefits of PTAs stem largely from limited taken by their trade partners, as the most advanced PTAs multilateral liberalization achieved under the General “bind” the status quo on discriminatory barriers and non- Agreement on Trade in Services (GATS). The GATS172 discriminatory market access restrictions and ii) certainty was the first general international trade agreement on enables FDI, which entails high sunk costs and requires services ever negotiated. Because of its novelty, the long-term predictability for business planning. GATS’s architecture provided significant leeway to WTO members as to whether or not to undertake commitments While services are increasingly integrated in the on services liberalization. It was not only based on a design and implementation of FTAs, Cambodia’s few positive list, but also did not commit members to bind nor trade agreements that cover services are through to list—for transparency—their existing regulatory barriers ASEAN. In 1995, only five PTAs included a services provision affecting services trade. Further, GATS did not include any globally.177 By 2019, 154 PTAs had been negotiated with mechanism to capture any unilateral liberalization by WTO some type of services provision, and nearly 70 percent of members after its entry into force. Consequently, a quarter these took effect between 2005 and 2015 (figure 2.33). of a century later, GATS-led liberalization and transparency In 2019, Cambodia participated in six PTAs, four of which of restrictions to services trade has been quite limited. contained services provisions (figure 2.34). All of these were negotiated through Cambodia’s participation in ASEAN. Because of Cambodia’s already relatively high level The China-Cambodia FTA is Cambodia’s first bilateral FTA of openness, the benefits of PTAs are largely in the and contains provisions to liberalize services trade. It was “external” dimension. Although Cambodia’s modern signed in October 2020 and is expected to take effect services sector is nascent, better market access for services in 2021. CHAPTER 2: 46 ECONOMIC TRANSFORMATION THROUGH EXPORTS FIGURE 2.33 FIGURE 2.34 Trade agreements are increasingly covering services Cambodia participants in relatively few regional trade Evolution of regional trade agreements, 1948-2019 agreements with services provisions 40 Number of regional trade agreements that cover services and goods provisions, 2019 35 16 Number of agreements per year 30 14 Number of agreements 25 12 10 20 8 15 6 10 4 5 2 0 0 48 53 58 63 68 73 78 83 88 93 98 03 08 13 18 ia Vie ia Th m d ia Ind nes La ia My R Ba mar h an es D od s Ind es a 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 lay oP tn pi lad ail an on mb ilip Ma ng Accessions to an RTA Services notifications Ca Ph Goods notifications Goods Services Source: World Bank staff calculations using data from WTO Regional Source: World Bank staff calculations using data from WTO Regional Trade Agreements Database. Trade Agreements Database. The shortcomings of GATS were reproduced in many First, modern FTAs are based on a negative list approach. earlier regional trade agreements that used it as That is, as a matter of principle, all services sectors a model for their own services trade frameworks, are bound and subject to the disciplines of the services including ASEAN. Cambodia has participated in ASEAN for agreement, except those measures explicitly reserved many years, and it is a signatory of the ASEAN Framework in an annex of “non-conforming measures”. Any other Agreement on Services. The ASEAN Framework Agreement on restriction to services trade not included in the annex Services has been used to promote services liberalization in is considered subject to roll-back. This technique forces the region since 1995, by expanding the scope and coverage countries to list absolutely all measures they may deem of its commitments in successive rounds. However, the ASEAN to be inconsistent with the agreement, leading to a great Framework Agreement on Services suffers from limitations that outcome: total transparency of all restrictions to services prevent it from fostering effective services trade liberalization trade, which remain standing after the enactment of the in the region. Liberalization is important, given that ASEAN agreement. has, on average, more restrictive policies in the services sector compared to other regions of the world. The World Second, the non-conforming measures included in the Bank’s Services Trade Restrictiveness Index, which measures annex will be subject to a standstill commitment regarding the extent of policy restrictiveness in services, indicates that their level of dissidence with obligations of the agreement, the average Services Trade Restrictiveness Index for ASEAN preventing countries from introducing new restrictions to was 60 percent higher than the global average in 2012. services trade. This approach provides total transparency Modern FTAs (or deep trade agreements) are more regarding each discriminatory barrier. effective at fostering liberalization policies that boost services trade than earlier traditional FTAs. Modern FTAs Third, modern FTAs also include a ratchet clause, by like those followed by the EU-Canada, United States Treaties, the which any unilateral liberalization of an existing restriction Comprehensive and Progressive Agreement for Trans-Pacific to services trade will become the new standstill bound Partnership agreement or even the recently negotiated ASEAN under the agreement, ensuring gradual services trade Trade in Services Agreement tackle a wider variety of topics like liberalization, even if no successive rounds of negotiations digital trade, regulatory coherence, labor and environmental are undertaken. The ratchet provision locks in the existing standards, and investment. They provide greater opportunities level of restrictions and ensures that any autonomous for services trade liberalization due to the inclusion of a horizontal liberalizing measure enacted after a PTA's entry into standstill obligation, coupled with a list-or-lose negative list, and force becomes the new reference level. This ensures complemented by a ratchet mechanism. There are three main easy adoption and flexible implementation in a one-way ways modern FTAs are more effective. direction towards gradual liberalization of services trade. RESILIENT DEVELOPMENT: 47 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL On the external dimension, modern FTAs include high- and effective enforcement. The development goal level regulatory standards that signatories adhere to, of establishing a modern services-based economy will and compliance is ensured by efficient enforcement require an open, investment-friendly, and sound regulatory mechanisms included in the agreements. Regulation environment for the services sector with fewer regulatory greatly opens access for Cambodia’s exports to foreign hurdles for services firms. markets, which can further induce FDI into the country to benefit from enhanced market access. The experience of First, streamline licensing requirements (including in many developing countries like Costa Rica, Chile, Morocco, services) through effective implementation of the one- Turkey, and Colombia (among others) shows how effective stop shop. Licensing requirements are currently carried implementation of a modern FTA with a major trade partner out across various ministries and departments depending (like the United States, China, Japan, or the EU) has led to on the sector/type of firm. Cambodia could consider setting increased FDI in services sectors. up a one-stop shop for licensing requirements, including in services, led by the Ministry of Economy and Finance Recognizing its limitations and based on their as a short-term policy priority. Consolidated management experience negotiating deep trade agreements with has helped reduce business start-up time and costs in major trade partners, ASEAN countries opted to countries like the Philippines.179 To reduce face-to-face negotiate the new ASEAN Trade in Services Agreement interaction in a post-Covid-19 world and reduce the time in 2019 to advance services liberalization—and that is for businesses, licensing could further be integrated into a promising step. The ASEAN Trade in Services Agreement the online business registration system by incorporating has been completed and is expected to be signed following other agencies into the portal (for example, the Council for domestic approval by member states. In addition to the Development of Cambodia, the Ministry of Industry, etc.). ASEAN Trade in Services Agreement, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership is Second, make all laws and regulations on trade and investment in services publicly available through a a modern FTA that comprises most of the important trade Cambodia services trade portal. This is a short-term partners and sources of investment for Cambodia in the EAP agenda that could be led by the Ministry of Commerce. region. The Comprehensive and Progressive Agreement for Using a single website, the portal would contain legislation, Trans-Pacific Partnership may provide powerful engagement measures, procedures, forms, services trade commitments, for Cambodia to facilitate services modernization by signaling news and other information. Information would be published to international investors a strong commitment to free trade in both English and Khmer to improve search functionality. It in services and new investment opportunities in this sector. should also allow viewers to submit comments or questions to the relevant authorities via a services portal focal point, who Policies to export modern services178 can provide answers through the portal management and maintenance team. The main objective is easier electronic Given Cambodia’s relatively open regulatory access to necessary information for business operations environment for services, policies should focus related to services trade and investment for business, on strengthening other aspects of the enabling domestic and foreign investors, and the Cambodian public. environment to support competitiveness to export This process would also allow the RGC to review and reject modern services. This can be done by improving capabilities procedures that do not facilitate domestic business and and investing in infrastructure while strengthening domestic and foreign investors to access services more regulations by removing remaining restrictions in some key easily. Lao People’s Democratic Republic (Lao PDR), for subsectors. As Covid-19 shifts the pattern of trade from example, has successfully implemented a services trade face-to-face services to trade in digitally delivered services, portal that parallels its goods trade portal. improving the enabling environment for modern services could support Cambodia’s diversification and its economic Third, in the medium term, ensure that regulations recovery. establish a clear authority among different regulatory agencies for business licensing in the services sector Facilitate the emergence of modern services by and prevent overlaps. Regulation and administrative reducing regulatory hurdles procedures could also be streamlined by a one-stop shop, led by the Ministry of Economy and Finance. This could The services trade openness that has been achieved be undertaken in the context of ASEAN commitments, to should be complemented with clear and transparent ensure that domestic regulation is done in a way that does application of regulations governing the sector not invalidate the common regulatory objectives.180 CHAPTER 2: 48 ECONOMIC TRANSFORMATION THROUGH EXPORTS Remove remaining entry restrictions in professional of Justice could lead this agenda. One model that could services be explored is that used by Singapore. After passing the Foreigner Practice Examinations conducted by the Cambodia needs to build up its human capital to meet Singapore Institute of Legal Education, a foreign-qualified the demands of the services sector. As discussed in lawyer can be registered with the Legal Services Regulatory Chapter 1 and Section 2.1, Cambodia needs to ramp up Authority as a foreign supplier and practice permitted areas the skill level of its current and future workforce by making of Singapore law: banking law, corporate law, intellectual deep and broad educational investments in its youth— property law, and maritime law. which will yield long-term returns—as well as practical, applied, and short-term skill upgrades for its existing Improve the enabling environment for services firms workers. In the interim, Cambodia should also take steps to encourage the entry of foreign labor to temporarily alleviate Cambodia should improve the enabling environment any skills constraints in its services sectors, particularly in for modern services including IPR, property professional services. rights, and trade-related infrastructure. Domestic enabling factors—like human capital, natural resources, First, in the short term, drop the proposal allowing infrastructure (including digital infrastructure), and only Cambodian accountants to sign off audited institutions—are an important complement to good trade reports. Reliable financial services are critical for attracting policies and regulations to support modern services foreign investment and administering domestic finances. exports. In Cambodia, targeted policy can improve these Cambodia’s open and dynamic regulation of the sector has key enablers. As mentioned above, this will be particularly helped enhance capacity in the accounting sector and has important for reaping new opportunities for exports of non- resulted in a strong foreign presence in the country. Specific face-to-face services that are likely to become increasingly to professional services, Cambodia would benefit from important post-Covid-19. Improving human capital and maintaining the open regulatory environment for accounting skills is also integral to improving the enabling environment services providers. The proposal allowing only Cambodian for modern services, an agenda discussed in Chapter 1 and accountants to sign off audited reports should be dropped Section 2.1. as it could restrict foreign expertise from operating in Cambodia and deter foreign investment. The National First, improve the implementation and enforcement Accounting Council could take the lead on this topic. of existing Cambodian IPR legislation. The Ministry of Commerce could lead this short-term agenda. Cambodian Second, in the short term, amend the 1995 law to allow civil court can be cumbersome and costly. To address some foreign lawyers to register with the Bar Association. of the existing weaknesses, Cambodia could revisit its To provide legal services in Cambodia, lawyers must be regulation of IPR protection, including the ability of the RGC registered with the Bar Association of the Kingdom of to revoke patents, utility model certificates, and industrial Cambodia. Legal services in Cambodia are governed by the design certificates. 1995 Law on the Bar, which created the Bar Association of the Kingdom of Cambodia and charged it with oversight Second, in the medium and long term, the RGC with and registration of the legal profession. Foreign firms the Department of Justice could establish a special are allowed to operate with less than 51 percent foreign court or judicial channel to deal with IPR protection- ownership. However, only lawyers who are registered related cases. While Cambodia adopted laws on copyrights, with the Bar Association of the Kingdom of Cambodia trademarks, and patents in 2002-03, enforcement is can practice in Cambodia, as specified in Articles 5 and reported to be weak, and initiating civil procedures is costly 6 of the Law on the Bar. A priority for the legal services and time consuming. subsector is to establish a formal process for registration for foreign legal services providers. The 1995 Law on the Third, in the short term, the Ministry of Commerce Bar should be amended to allow foreign lawyers to register should implement the new Law on Electronic with the Bar Association of the Kingdom of Cambodia, with Commerce and introduce legislation on data clear registration requirements. This could be led by the protection, cybersecurity, and e-payments with the Department of Justice. Ministry of Posts and Telecommunications. Cambodia passed the Law on Electronic Commerce in October 2019 Third, in the medium term, establish a formal process that establishes legal provisions for regulating domestic of registration for foreign legal services providers. and cross-border commercial and civil transactions Lack of a clear framework for the provision of legal services via electronic systems. The law fills many important by foreign practitioners in Cambodia reduces transparency legislative gaps governing e-commerce in Cambodia. and brings into question Cambodia’s compliance with its It outlines the legitimacy and processes of electronic GATS commitments on services trade. The Department communications, legalizes electronic records and electronic RESILIENT DEVELOPMENT: 49 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL sigantures (including contracts), sets the responsibiliites A short-term step could be to upskill Cambodian officials of intermediaries and e-commerce services providers, in charge of negotiating and implementing international sets protections for consumers for data protection and services trade agreements. Officials could benefit from unrequested, fake, or malicious communications, and modules covering recent developments in rulemaking in establishes licensing requirments and responsibilities of the field to maximize the potential benefits of international electronic payments providers and/or electronic funds agreements for Cambodia. transfers. Authorities should implement the law, and continue to fill in missing legislation including a National To foster a fundamental level of transparency on restrictions Payment Systems roadmap and cyberseucrity and data affecting services trade, another key step would be for protection that are not yet passed. Cambodia to undertake a regulatory audit of the services sector. Regulatory audits examine all laws and regulations Fourth, in the medium to long term, improve access of a country applicable to a sector’s trade and aim to to digital infrastructure including broadband and measure the country’s openness by identifying restrictions 4G/5G. The RGC has accumulated substantial resources in (and eventual non-conforming measures under PTAs). As its Universal Services Obligation Fund, started in 2017 as a part of the capacity building activities discussed above, levy on gross revenue for the country’s telecom operators, government officials could learn about the audit, how to to help fund growth of telecom networks in rural Cambodia. keep the audit updated, and how to use it for policymaking. However, so far there has been little use of these funds. The RGC should leverage the Universal Services Obligation Fund From a policy dimension, four key recommendations may be to improve digital infrastructure and close the digital divide, worth considering for Cambodia. particularly in rural areas currently without 4G access where the private sector is unlikely to invest in the short term. First, in the short term, use the LDC’s services waiver Other regulatory reforms can be implemented to support that offers preferential treatment on market access the private sector to continue investing in broadband for services to WTO members. Cambodia currently does and 4G/5G access in the short term. This includes the not leverage trade agreements for services and underutilizes RGC releasing bandwidth for the 4G and 5G spectrum in the LDC’s services waiver. This legal instrument, adopted some areas, allowing private investment in the spectrum by WTO members in 2011, allows members to grant (including through updating licensing arrangements). This preferential treatment to services and service suppliers from would ensure the private sector can invest and compete LDC members to facilitate the increasing participation of in new key infrastructure and promote tower and other developing countries in services trade. However, so far, few investment sharing among private firms. The Ministry of developed and developing country members have used the Posts and Telecommunications with the Telecommunication LDC’s services waiver and offers for preferential treatment Regulator of Cambodia are well-suited to lead this policy and on market access, particularly in creative services, has been investment reform agenda. More broadly, the government very limited. should work across ministries and agencies to implement the new Digital Government Masterplan and Digital Economy Second, in the short term, Cambodia should and Society Policy Framework. participate in the ASEAN Trade in Services Agreement to advocate for services liberalization in other ASEAN Leverage international trade agreements to foster member countries. Although the agreement has not services exports entered into force yet, it is not yet clear whether Cambodia has made the political decision to leverage the ASEAN Trade Cambodia should strengthen its capacity to in Services Agreement, as the agreement allows only those participate in deep trade agreements with provisions ASEAN Member who consider themselves ready to fully on services to support market access and attract engage. export-oriented FDI. A stronger focus on regional trade agreements that grant preferential access to new markets Third, in the medium to long term, implement mutual would support diversification of products and markets while recognition agreements for services professionals also addressing the trade disruptions caused by recent within ASEAN and with other trading partners. ASEAN global megatrends and greater uncertainty in the global have made progress in developing mutual recognition trade environment. FTA strategies cannot be one-size- agreements, including Engineering Services (2005), fits-all: each country follows different strategies and each Nursing Services (2006), Architectural Services (2007), one must find their own best option. The strategies must Surveying Qualifications (2007), Accountancy Services be adapted to the geographical context, the development (February 2009 and 2014), Dental Practitioners (2009), stage, and the particular assets of the country. This is an Medical Practitioners (2009), and Tourism Professionals agenda that could be led by the Ministry of Commerce. (2012). Cambodia should actively implement these mutual CHAPTER 2: 50 ECONOMIC TRANSFORMATION THROUGH EXPORTS recognition agreements, which are now in various stages Fourth, in the medium to long term, Cambodia of progress in ASEAN member states. Other measures should seriously consider whether to participate in to address short-term shortages of skilled workers could other deep trade agreements that include services include exploring guest worker programs, loosening entry provisions, like the Comprehensive and Progressive requirements in sectors with skills shortages, adopting Agreement for Trans-Pacific Partnership. The quota systems for foreign workers on the basis of economic preceding three recommendations would also be a good needs tests, and allowing services growth sectors to enter way for Cambodian authorities to prepare and better assess into direct agreements with the government to fill labor the importance of diversifying the potential sources of FDI in shortages. services, which could be critical for diversifying Cambodia’s services exports into new markets. BOX 2.2: Diversifying through creative services in Cambodia Trade data show some commercial services subsectors are growing rapidly in Cambodia from a low base. Available statistical data show a noticeable growth in ‘other business’ and telecommunications services in the past decade (table 2.1). This growth signals a near-term opportunity for Cambodia to diversify its economy away from tourism through other services export avenues. The vast majority of these high-growth sectors comprise creative services sub-categories. TABLE B2.1: Smaller services subsectors have experienced fast export growth in Cambodia Commercial services exports, US$ millions, 2005 vs. 2018 Industry / Sector 2005 2018 Transport 136 688 Travel 840 4,362 Construction 2 14 Insurance and pension services 1 3 Financial services 11 15 Charges for use of IPR 0 2 Telecommunication, computer, and information services 34 65 Other business services 39 98 Personal, cultural, and recreational services 1 2 Source: World Bank staff calculations using data from UN Conference on Trade and Development. Though no universally agreed definition exists, ‘creative industries’ are all the activities that use people’s creativity, skills, and talent to create jobs and grow wealth through generating and exploiting intellectual property. A vast and heterogeneous field, creative industries cover both goods and services. Creative services—a subset of creative industries—covers a variety of subsectors including advertising, architecture, photography, printing and publishing, audiovisual services, online content, and entertainment services (figure B2.1). RESILIENT DEVELOPMENT: 51 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL FIGURE B2.1 Creative services are a subset of creative industries Creative industries sub-sectors Creative industries Artisanal Visual Performing Cinema and Literature, books Multimedia products arts arts audiovisual and publishing Clothing and Artistic Film and Digital Dance Novels assessories crafts video art Live Recorded Decoration Painting Advertising Magazines music music Household Sculpture Theater Radio Communication Newspapers items Internet Gifts Photography Circus Education Comics broadcasting Street Toys Design Entertainment Podcasts performance Stationary Fashion Ebooks Source: International Trade Center (2004). Anecdotal evidence confirms this ‘other services’ export growth is mainly related to Cambodia’s emerging creative services industry. Cambodia is slowly but steadily exporting film production and animation services in response to the surge in international demand. 2D and 3D animation studios in Cambodia are already exporting high-value-added niche services, like digital animation. In 2014, 64 film projects were shot in Cambodia, with the majority originating from Japan (15), France and Europe (12 each), followed by the United States, Thailand, Canada, and Australia. Local film production is showing timid but encouraging signs of growth. And some firms are now outsourcing knowledge-intensive business services like content creation, website design, and video production to overseas customers. Other creative services are emerging in the domestic economy but could have potential for export in the future. The rapid growth of the construction industry in Cambodia has been accompanied by a dramatic increase in architectural services, both local and international. Cambodia is experiencing growth in its digital advertising, media, and services market, as evidenced by the increase in advertising spending, for example. In 2017, two Cambodian companies deployed a video streaming platform and a subscription-based video-on-demand service for online content into the local market, providing movies, television shows, and original content to Cambodian audiences with an internet connection, for an affordable price. Creative services are becoming increasingly traded in the digital economic era. Access to internet and technological development have enabled creative industries—and creative services in particular—including their tradability. Recent estimates suggest that creative services account for a significant and growing portion of total services trade in developed countries. Between 2011 and 2015 the annual growth rate of creative services trade for developed countries was 4.3 percent, with creative services contributing almost 20 percent of total services trade. CHAPTER 2: 52 ECONOMIC TRANSFORMATION THROUGH EXPORTS Four key developments that characterize the digital economic era facilitate creative services: i. The Fourth Industrial Revolution has led to a shift from goods to services production, a trend that is poised to accelerate. Cases in point are e-books, digital news, and online streaming services for movies and music (for example, Netflix, Spotify), which are replacing physical goods like printed books and newspapers, DVDs, and CDs. ii. Ubiquitous mobile connectivity can also be considered an essential feature of the digital economy. This translates to increased demand for quality content, whether for information or entertainment, opening up new opportunities for developing countries to focus on the creation of audio-visual content to access foreign markets. iii. In the digital era entry barriers for creating content have drastically reduced, thus providing opportunities for small services operators in developing countries to actively participate in the creative services industry. For example, photographers, bloggers, musicians, videographers, dancers, and cross-cutting multi-media specialists can now use social media and a wide range of new internet-based tools to create and distribute their work and profit from it. iv. Services are undergoing a transformation whereby digital services show greater potential for growth than traditional services. In 2018, for example, 73 percent of information technology-services exports, which account for the largest share of total export services (59 percent), was attributable to other business services, including animation and game and software development. Developing countries are increasingly becoming key players in a number of creative services subsectors, especially in Asia. India, China, and Malaysia are emerging centers in the visual effects industry and Thailand’s animation industry grows at an annual rate of 10 percent. Also, LDC’s share in exports of personal, cultural, and recreational services has been growing at 17.1 percent a year since 2012. Limited data and anecdotal evidence suggest that the most dynamic segments in the creative services industry with the highest potential for growth are film, television and video, music, publishing, animation and video games. Animation, which has expanded from cartoons to live films and animated movies, as well as advertising and video games, boasts a worldwide annual growth rate of 2 percent, recording a global output value of approximately US$259 billion in 2018. The Republic of Korea and India are among the main exporters in animation services in Asia. Information technology-enabled creative services, like animation and videogame design, can have profound implications for development. Making use of their rich supply of creativity and cultural assets, many developing countries can seize this opportunity to establish new economic and trading relations, foster income generation, encourage job creation, and create synergies with other sectors (for example, crafts, textiles, and tourism) from which they can draw business development.181 Moreover countries can promote social cohesion, preserve cultural heritage and cultural diversity, and celebrate human development. For example, in Jamaica, a decrease in youth unemployment can be partly attributed to a government-backed animation certificate program and the KingstOOn Fest initiative, both supported by the World Bank.182 Ancillary services, creative and otherwise, used during film production—such as set preparation, photography, props, costumes, extras, drivers, food and beverage services, etc.—also offer local job opportunities. A few developing economies have started to design specific economic road maps targeting creative services to become a primary source of growth in the next decade. The RGC views creative services as a promising new source of growth that could be instrumental in achieving economic transformation. The National Strategic Development Plan 2014-18 signals film production as a key priority area, indicating plans to further encourage the production of foreign films in Cambodia. The Rectangular Strategy-Phase IV promotes development of the entertainment and audiovisual services sector (for example, literature, arts, animation, and movies) as a key priority, due to their high potential for creating value added and jobs while encouraging domestic production and consumption. The Cambodia Trade Integration Strategy lists animation services as a priority services export sector, highlighting its impact for economic growth, youth employment, and inclusiveness. The National Policy for Culture also refers to the strategic importance of the creative services industry. In early March 2020, on Culture Day, the Prime Minister of Cambodia reiterated the importance RESILIENT DEVELOPMENT: 53 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL of the creative services sector, and film production in particular, by highlighting the need to continue creating new mechanisms to support Cambodians to produce quality, original, local content that honors Cambodian culture and to do this through training programs in schools, universities, or art associations. Cambodia has many strengths that support creative services sector growth. Cambodia in particular could capitalize on the combination of three key assets: a young labor force, reliable urban information-technology infrastructure, and a supportive regulatory environment. First, Cambodia has a young population, with a median age of 26 years. Young Cambodians are digital natives in smartphone technologies and eager to profit from their expertise, though anecdotal evidence suggests they are not as proficient in computer skills. In Cambodia there are over 12 million internet users, and 8.4 million active social media users, with the vast majority being active mobile social media users. Cambodian artists, animators, and designers use social network platforms like Facebook to self-promote, showcasing their art to local and worldwide audiences. For example, Rounh Creative Studio, a wholly- owned Cambodian company specialized in motion graphics, graphic design, and digital marketing, whose Kolab Pailin 2D animation trailer, based on one of Cambodia’s most famous novels, proved a hit when it was posted to Facebook.183 Second, for the vast majority of suppliers of creative services like animation, advertising, and entertainment services, digital technologies are crucial to accessing foreign markets, reducing geographical distances, and allowing direct contact with a larger share of potential final users. With satisfactory internet access (especially in urban areas), Cambodia is at an advantage. Third, Cambodia’s regulatory environment can also play a central role in supporting the country to become an outsourcing hub for creative services and attracting foreign investment in the sector. For example, in its GATS and ASEAN schedules, Cambodia inscribed full commitments in architectural services and cinema theater services including cinema projection services across all supply modes except movement of natural persons. Recent reforms, including the adoption of the new Law on Electronic Commerce, legalizing digital contracts and prohibiting data localization requirements, are expected to have a positive impact on the growth and internationalization of Cambodia’s creative services industry. Cambodia’s geographic location and fast-growing economy are other assets that make Cambodia an attractive market for creative services suppliers interested in setting a commercial presence abroad to serve the Asian region. However, the creative services industry requires key elements with a strong enabling environment to flourish. Participation in the creative services industry and export capabilities depend on a variety of enabling factors, whose relevance may vary from subsector to subsector. For Cambodia to develop the creative services sector, foster its internationalization, and wield it as a tool to diversify the economy, it must overcome a few significant hurdles. Governmental action should be directed, in particular, at addressing: human resource constraints, national branding, taxation, access to finance, regulatory implementation and enforcement, and good governance. Other factors that policymakers should target to stimulate the creative services economy include access to digital technologies, enabling creative ventures to be launched from any location at scale, and adequate regulation and incentives to create the right conditions for creative economies to flourish. i. Human resources constraints stem from a variety of challenges related to education and skills development. There is a marked disconnection between the skills and competences the young Cambodian population acquires in the school system and the technical and visual expertise required by public and private entities operating in the creative services industry. Cambodia’s educational curriculum falls short of adequately preparing students in using and managing new digital technologies. Low proficiency in English may also affect Cambodia’s ability to participate more actively in the creative services industry, especially in sectors like film production and online content creation where English is the lingua franca. Additionally, there is no adequate framework for recognizing industry qualifications through accreditation. CHAPTER 2: 54 ECONOMIC TRANSFORMATION THROUGH EXPORTS ii. Cambodia’s reputation affects the country’s ability to diversify its economy through creative services trade. Currently, Cambodia is not perceived as major player in the sector, nor does it have an established national reputation as a reliable and high-quality outsourcing hub for creative services, though examples exist at the firm level (for example, Ink Animation, Mango Tango Asia). iii. Among the main challenges that Cambodian companies operating in the creative services industry face when attempting to grown and internationalize is the tax system, both at the domestic and international level. Lack of transparency on how the tax system actually applies to film production companies makes it difficult for these service suppliers to embark on long-term projects with potential foreign business partners. Additional taxes imposed on foreign funds to finance film production disincentivize international trade in film production. The absence of international tax treaties further disincentivizes foreign companies from establishing export-oriented operations in Cambodia. Moreover, there are few tax/investment incentives targeting the industry, particularly for smaller enterprises. iv. Access to finance is paramount for companies, especially SMEs, to grow and internationalize; creative services suppliers need the scale to transform Cambodia into an outsourcing hub. Firms in the creative services industries cite limited and inadequate access to finance as a key barrier. Collateral is a key issue, where services firms rarely have tangible assets they can use as collateral to obtain credit, with Cambodian banks unable to grant loans on the basis of purchase orders or letters of intent alone. Cambodia also does not participate in any international co-production agreements that could help offset this lack of access to finance in film production. v. Notwithstanding the remarkable reforms of the last two decades, the country’s regulatory system requires further fine tuning to properly support the growth and internationalization of the local creative services industry. Particularly relevant for the creative services industry that relies on intellectual property and knowledge creation, Cambodia’s IPR framework is still early in its development, is yet to achieve WTO compliance, and has poor implementation and enforcement. Data protection has not yet been aligned with international standards, and there are no privacy nor data protection laws in Cambodia. Moreover, companies struggle to access information on services trade and investment regulations without an online central repository. vi. Attention should also focus on addressing governance and policy-making hurdles that constrain capacity for creative services suppliers. There is currently a limited role of public institutions like sectoral associations and trade promotion agencies, which also means there is inadequate statistical data to develop appropriate evidence- based policies. Cambodia also has not leveraged trade agreements like the LDC’s services waiver. Developed and developing countries implement a variety of measures to support the development and internationalization of their creative industry, and its services segment in particular. Below are more detailed policy recommendations to help Cambodia take advantage of the opportunities offered by emerging digital technologies and the abundant creative and cultural knowledge within its national borders. Institutional intervention should aim primarily at: enhancing, supporting, and strengthening skills and competences of individuals; creating a supportive business environment; boosting Cambodia’s reputation and international standing; and improving data collection and management. Enhancing, supporting, and strengthening skills and competencies of individuals Individual talent and imagination are the core of the creative services industry. To nurture those, Cambodia must confront human resources constraints like low-quality education and inadequate technical training as well as misconceptions and unawareness of job opportunities in the creative services industry. Addressing them requires a multilayered approach that would involve implementing a variety of policy actions. First, encourage collaborations between domestic and international technical training institutions like film schools and art schools including faculty and staff exchanges to promote the transfer of knowledge and best practices. Additional in-kind and/or financial support could be provided to existing training programs and schools specialized in creative services fields. RESILIENT DEVELOPMENT: 55 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Second, encourage collaborations between educational institutions and the private sector. This includes encouraging and facilitating internship programs and providing tax incentives for creative services firms to partner with vocational training institutions. Ensuring that the private sector participates in designing and implementing learning programs helps bridge the gap between skills development and the demands of the job market. Third, expand the certification system to ensure vocational skills can be formally certified. Cambodia could introduce certified courses on business management open to young entrepreneurs who are not eligible to enroll in tertiary education, in collaboration with the Cambodian Chamber of Commerce, sector-specific trade associations, vocational training centers and/or the private sector. Fourth, organize job fairs for secondary and tertiary education students specifically dedicated to the creative services industry. These types of programs can help match job seekers with prospective employers, while also raising broader awareness of job opportunities in the industry. Fifth, in the medium term, revise the national curriculum to include visual and applied arts like, painting, drawing, printmaking, sculpture, ceramics, photography, video, filmmaking, design, crafts, and architecture, industrial design, graphic design, fashion design, interior design, and decorative art. Sixth, introduce formal training in specific sectors for the creative services industry. For example, in the form of government-certified animation and film schools or summer/winter academies (organized by universities) on filmmaking, architecture, design, digital creation, online content creation, and the like. Creating a supportive business environment Creating a supportive business environment encourages and promotes the development of a creative services industry that matches international standards of quality and reliability. The RGC should focus policy intervention on tackling access to finance, IPR protection, investment attraction, and other constraints to the business environment. First, in the short term Cambodia should consider providing tax breaks, tax holidays, or tax exemptions to attract FDI and internationalize creative services. Government financial support should ensure compliance with Cambodia’s GATS and ASEAN scheduled commitments on services subsidies. Second, Cambodia should improve the implementation and enforcement of existing Cambodian IPR legislation. Intellectual property consists of both industrial property (patents, designs, and trademarks) and copyrighted property (in sectors like music, art, and literature), and comes from applying imagination, talent, and creativity to the production of creative services. Owning or licensing local creative assets is a key feature of this particular industry. Ensuring IPR protection, therefore, is paramount for the Cambodian creative services sector to grow sustainably and expand beyond the national borders. In the short term, Cambodia should focus especially on addressing issues that hinder the (under-resourced and overburdened) judicial system. A national campaign with practical guides on IPR would increase public awareness and help end-users and suppliers learn how to respect and use IPR in creative services. In the medium term, establishing a collective management organization would help copyright holders better administer their rights and deal with IPR infringements. Third, implement the new Law on Electronic Commerce and introduce legislation on data protection and cybersecurity. The Law on Electronic Commerce contains disciplines on digital contracts that would make it easier for creative services companies to operate digitally. This needs to be implemented through the formulation of relevant Prakas. Fourth, establish a business forum specifically dedicated to creative services. This will improve communication between the public and private sector, whereby parties can discuss challenges in developing and internationalizing the industry, and agree on potential solutions. CHAPTER 2: 56 ECONOMIC TRANSFORMATION THROUGH EXPORTS Fifth, in the medium and long term, set up an online portal specifically dedicated to advertising the Cambodian creative services industry abroad. It could include information on companies operating in the field, regulations affecting in creative services trade, and investment opportunities in the sector. Sixth, in the medium and long term, liberalize the audiovisual services sector, especially in digital media. This needs to happen through the removal or reduction of market access restrictions, possibly by negotiating new commitments under the GATS and ASEAN frameworks, or at least in the short term, through unilateral (uncommitted) action. Improving Cambodia’s reputation and international standing For Cambodia to participate more actively in the creative services industry, it will be crucial to build a stronger national brand and move beyond the ‘cheap workforce’ label. While the country has the potential to increase the competitiveness of its creative services sector, efforts may not yield the expected results unless the government also intervenes to promote Cambodia as a reliable supplier of high-quality creative services. In the short term, design a national branding strategy focused on promoting Cambodia as a creative services outsourcing hub. Cambodia could follow the strategy adopted by the Republic of Korea, which established a Presidential Council on Nation Branding to promote the country’s global image through the support, control, and integration of effective national branding projects with public participation and cooperation.184 The RGC could also collaborate with regional partners to present South East Asia (including Cambodia) as a viable and reliable supplier of high-quality creative services. Supporting creative services suppliers to participate in trade fairs and international film festivals abroad through financial assistance, and by sponsoring booths at these events, the RGC would help raise Cambodia’s international profile in the industry. The government could organize a creative services trade fair in Cambodia and offer financial and logistical support to the private sector so they can hold B2B / B2C meetings in Cambodia to provide potential foreign business partners and clients with first-hand experience of the creative services industry to attract their business. Improving data production, quality, and use Data can help advance the understanding of the size, composition, and main characteristics of the creative services industry in Cambodia. The lack of disaggregated services trade data and statistics to measure the economic importance of the creative services sector in Cambodia likely hinders attempts to design evidence- based policies to support diversification through creative services trade. In the short term, improve overall data collection and statistical reporting on size and composition of the creative services industry and value and characteristics of creative services trade. This primarily will involve training new and current staff of the National Institute of Statistics—especially those based in the statistical units in the provinces and districts—on international standards and methods for data collection and statistical reporting. Surveys should include information on number of companies operating in the creative services industry (overall and in each subsector), size of the companies (for example, annual revenue, number of employees), main services exported abroad, main services imported in Cambodia, ownership composition (for example, joint-venture, wholly foreign owned, wholly local owned), and type of firm (for example, headquarters, branch, representative office). In the medium term, revise the national data collecting and reporting system to better capture the realities of the creative services industry. For example, by adopting a classification system based on international best practices that better identifies the wide array of sub-segments of the creative services industry. RESILIENT DEVELOPMENT: 57 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Economic upgrading through GVC participation in manufacturing Objective Improving capabilities Strengthening regulations Investing in infrastructure Attracting a Resolve challenges in investor Collect data on firms that use tax new wave of protection and conflict resolution, incentives to conduct monitoring high-value- including by increasing shareholder and evaluation while developing added FDI rights and their role in decision-making a strategy to minimize tax risks through sub-regulations to the new from the scheme [MT; MEF] Investment Law and strengthening the courts [ST; CDC & MEF] Broaden the Investment Law to cover all investors, beyond those given qualified investment project status [ST; CDC & MEF] Move away from blanket tax holiday schemes to an investment incentives system that introduces reinvested dividends, investment tax credits, and investment depreciation on the value of acquired machinery, equipment, quality certificates, or new technologies [ST; CDC & MEF] Develop specific guidelines that detail eligibility criteria for each incentive [ST; CDC & MEF] Building the Professional associations and Introduce results-based financing for Support establishing vocational skills of the other intermediaries like special technical and vocational education and and digital education centers workforce economic zone management training institutions and expand the aligned with industry needs, in or recruitment agencies can provision of short courses to serve the cooperation with private sector implement training programs and working adult population [ST; MLVT] and development partners [MT; provide professional certification MLVT] Provide incentives for in-house training to trainees at different skill levels, of mid- to high-skilled workers [ST; Invest in hardware and software if a governing framework is CDC & MEF] for a labor market information provided [ST; MLVT] system [MT; MLVT] Develop and strengthen intermediation Encourage collaborations between mechanisms (job matching platforms Collect and disseminate domestic and international and the National Employment Agency) user-friendly information to technical training institutions to collect increasingly timely data on students, jobseekers, employers, and attract trainers with industry job vacancies and create outreach and education and training experience [ST; MLVT] programs [MT; MLVT] institutions to enable them to make skills development choices Expand the certification system to that are aligned with market ensure vocational skills can be formally demand [ST; MLVT] certified [MT; MLVT] Facilitate access to skills development by exploring individual learning accounts; tailor adult learning by expanding technical short courses [MT; MLVT] Incentivize the enterprise sector to play a larger and more structured role in providing, guiding, and advocating for a demand-driven skills development system including internship programs [ST; MLVT] CHAPTER 2: 58 ECONOMIC TRANSFORMATION THROUGH EXPORTS Objective Improving capabilities Strengthening regulations Investing in infrastructure Supporting Foster joint ventures between vertical the Garment Manufacturers integration in Association in Cambodia and the apparel international brands and investors and footwear to facilitate sector upgrading [MT; sector MOC] Strengthening Assist foreign investors’ research Simplify VAT procedures and reduce the Develop an online portal and domestic firm efforts to identify local suppliers time needed to claim refunds to level digital app to offer basic linkages and provide them with more the playing field of domestic suppliers matchmaking services and detailed capabilities evaluations competing with tax-exempt imported overcome information asymmetry and aftercare services [ST; CDC] inputs [ST; MEF] of foreign firms and domestic producers (in collaboration with Establish a supplier development Enact policy to ensure domestic firms’ relevant ministries, chambers of program linked to the compliance with international standards commerce, and private industry Entrepreneurship Development [MT; MOC] associations) [MT; CDC] Fund to build local firms’ capacity to serve FDI exporters [MT; MEF & MOC] Provide training and marginal incentives (from Entrepreneurship Development Fund) for SMEs to become vendors in global e-commerce platforms [MT; MEF & MOC] RESILIENT DEVELOPMENT: 59 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Value addition in Cambodian agriculture Objective Improving capabilities Strengthening regulations Investing in infrastructure Promote Support the private sector in Undertake area-by-area diversification assessing market potential for assessments and irrigation toward new crops (fruits and vegetables) investment based on crop higher-value that are suitable for the suitability [ST; MAFF] fruits and Cambodian climate [ST; MOC] Foster public-private partnerships vegetables that envisage contract farming and extension services to support investments in the selected crops [MT; MAFF] Focus on Build capacity and appropriate Introduce a national system to certify Improve pest and disease upgrading institutional arrangements to both SPS compliance and organic surveillance, quarantine services, through ensure better traceability and labeling [MT; MAFF] and laboratory testing for quality quality assurance mechanisms as contaminants and residues, Develop a national brand strategy and assurance well as SPS service functions [MT; among other food safety communication campaign for other and branding MAFF] functions [MT; MAFF] fresh fruits and horticulture products to pursue a Invest in building capacity to (beyond rice and pepper) [MT; MOC] Establish geographical indication “go green” meet regional and international arrangements and blockchain differentiation standards [MT; MOC] technology to improve traceability strategy through the agriculture supply chains [MT; MAFF] Improve Build capacity and train customs Fully implement the national single Continue lowering energy costs conditions officials on the new national window by integrating remaining and improving infrastructure for for agro- single window or ASYCUDA agencies; automate and integrate the better market access [ST; MME processing system [ST; MOC] remaining border processes into the & MOC] and the national single window system like SPS promotion of certification [ST; MOC] higher value Review customs requirements for added export and import permits while also linking the origin certification system (to automate their issuance) and the customs ASYCUDA system [ST; MOC] Consider adapting institutional models supportive of agribusiness, including incubators, farmer-enterprise productive alliances, and contract farming systems [MT; MAFF] Improve the Review the effectiveness of all Intensify market surveillance and availability licenses, quotas, and fees on imported traceability of fertilizers, including and agriculture inputs [ST; MOC] by using mobile testing facilities affordability [ST; MAFF] of agricultural Introduce a risk-management inputs system (profiling importers, exporters, and products) at the border to ensure food safety and sufficient quality standards in products like fertilizers or pesticides, without comprising timeliness of import procedures, potentially as a module in phase II of the national single window [MT; MAFF & MOC] CHAPTER 2: 60 ECONOMIC TRANSFORMATION THROUGH EXPORTS Increasing competitiveness to export modern services Objective Improving capabilities Strengthening regulations Investing in infrastructure Facilitating Streamline licensing requirements Make all laws and regulations on the (including in services) through effective trade and investment in services emergence implementation of a one-stop shop publicly available online through of modern [ST; MEF] a Cambodia services trade portal services by [ST; MOC] Ensure that regulations establish a clear reducing authority among different regulatory regulatory agencies for business licensing in the hurdles services sector and prevent overlaps [MT; MEF] Removing Drop the proposal allowing only remaining Cambodian accountants to sign off entry audited reports [ST; NAC] restrictions in Amend the 1995 Law on the Bar to professional allow foreign lawyers to register with services the Bar Association [ST; DOJ] Establish a formal process of registration for foreign legal services providers [MT; DOJ] Improve the Improve the implementation and Improve access to digital enabling enforcement of existing Cambodian IPR infrastructure including environment legislation [ST; MOC & MPTC] broadband and 4G by leveraging for services the Universal Services Obligation Establish a special court or judicial firms Fund to improve infrastructure channel to deal with IPR protection- in lagging regions [MT; MPTC & related cases [MT; DOJ] TRC] Implement the new Law on Electronic Commerce; introduce legislation on data protection, cybersecurity, and the National Payment Systems roadmap [ST; MOC & MPTC] Release bandwidth for 4G and 5G spectrum in some areas, allowing private investment in the spectrum (including through updating licensing arrangements); ensure the private sector can invest and compete in new key infrastructure; promote tower and other investment sharing within the private sector [ST; MPTC & TRC] Leverage Build capacity of Cambodia’s Implement mutual recognition international trade negotiators to negotiate agreements for services professionals trade deeper trade agreements that within ASEAN and with other trading agreements cover services [ST; MOC] partners [MT; MOC] to foster Use the LDC’s services waiver Participate in the ASEAN Trade in services that offers preferential treatment Services Agreement to advocate for exports on market access for services to services liberalization in other ASEAN WTO members [ST; MOC] member countries [ST; MOC] Note: ST=short term; MT=medium term. CDC=Council for the Development of Cambodia; DOJ=Department of Justice; MAFF=Ministry of Agriculture, Forestry, and Fisheries; MEF=Ministry of Economy and Finance; MLVT=Ministry of Labour and Vocational Training; MOC=Ministry of Commerce; MPTC=Ministry of Posts and Telecommunications; NAC=National Accounting Council; TRC=Telecommunication Regulator of Cambodia. RESILIENT DEVELOPMENT: 61 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Endnotes 92 World Bank World Development Indicators. 93 World Bank World Development Indicators. 94 World Bank (2020a) and official estimates. 95 World Bank (2019a). 96 World Bank (2019a). 97 World Bank (2019c). 98 Economic complexity is a proxy measure of all the productive capabilities (infrastructure, land, laws, machines, people, ideas, etc.) of a society that, in combination, determine the frontiers of what it can produce, and has been identified as a determinant of growth (Hidalgo and Hausmann 2009). World Bank (2019a). 99 The recently signed China-Cambodia FTA and Cambodia-Republic of Korea FTA offer potential for Cambodia to leverage new export opportunities to transform its economy. These FTAs were signed after this report’s analysis was undertaken, and, as such, an analysis of potential market access opportunities is left to follow-up work. 100 This section draws on Chapter 2 of the Economic Diversification Study (World Bank 2019a) prepared as Part I of the Cambodia Country Economic Memorandum as well as the Special Focus of the November 2019 Cambodia Economic Update (World Bank 2019d). 101 World Bank (2019c). 102 World Bank (2019c). 103 OECD Trade in Value Added Database. 104 The World Bank Group conducted a survey to assess the scope of FDI linkages, identify demand for local sourcing, and highlight concrete barriers to building FDI linkages in Cambodia. World Bank (2018b). 105 Under the Cambodian Investment Law, projects that meet a minimum capital investment requirement may qualify for tax exemptions on both inputs and profits. More detail on Qualified Investment Project status is provided by the Council for the Development of Cambodia at http://www.cambodiainvestment.gov.kh/investment-scheme/investment-incentives.html/. 106 World Bank (2019c) and World Bank (2019d). 107 The country’s minimum wage legislation has been in effect since 1997, when the regular minimum wage was set at US$40, and has been revised multiple times since then. 108 World Bank (2019b). 109 Unlike many countries in the region, the Cambodian economy is highly dollarized, and employees are paid in US dollars. 110 https://www.vietnam-briefing.com/news/vietnam-hikes-minimum-wages-by-5-3-percent-in-2019.html/. 111 https://fashionunited.uk/news/business/bangladesh-raises-minimum-wage-for-garment-workers/2018091438912/. 112 World Bank (2019a). 113 World Bank (2019a). 114 World Bank (2019c). 115 World Bank (2019c). 116 World Bank (2019b). 117 World Bank staff calculations using data from National Employment Agency (2014 and 2015) and World Bank (2019b). 118 Projected educational attainment for total population based on historical school enrollment and completion statistics. Barro and Lee (2021). CHAPTER 2: 62 ECONOMIC TRANSFORMATION THROUGH EXPORTS 119 World Bank (2019b). 120 World Bank (2019b). 121 World Bank (2019c) based on Frederick (2018). 122 World Bank (2019b). 123 World Bank (2019b). 124 World Bank (2019a). 125 Lee, Vanndy, and Peou (2017). 126 Staritz and Frederick (2014). 127 World Bank (2018b). 128 World Bank (2019i). 129 Cusolito, Safadi, and Taglioni (2016). 130 Cadot and Malouche (2012). 131 This section is a summary of Chapter 3 of the Economic Diversification Study (World Bank 2019a) prepared as Part I of the Cambodia Country Economic Memorandum. 132 UN Comtrade reported data. 133 The revealed comparative advantage index is the ratio of a country’s export share in a specific sector to the world share in that sector in total world exports. A revealed comparative advantage index above 1 indicates that the country’s share of exports in a sector exceeds the global export share of that product and is thus a measure of its competitiveness. 134 Cambodia’s exports of milled rice to the EU have been affected by safeguards imposed following an investigation that concluded a significant increase in imports of rice from Cambodia and Myanmar has caused economic damage to EU farmers. 135 To assess the quality of Cambodia’s exports, the unit value of an exported Cambodian product to a given destination was calculated, which is the ratio of trade value to physical volume and provides a proxy for perceived quality. This unit value was compared with the unit values of the same product exported by other countries to the same destination. Since similar products with heterogeneous quality may be included in the calculation of unit values and will bias this statistic, the calculations were done at the most disaggregated level—that is, at the harmonized system 6-digit level—to reduce this risk. 136 World Bank (2020b). 137 World Bank (2019b). 138 World Bank (2015). 139 Bordey et al. (2016). 140 The categorization was made through a principal component factor analysis, used to reduce the optimal combination of several independent variables into one score index that ranked farmers along one dimension. Farmers were characterized as modern or traditional based on their level of use of modern inputs, labor, and services. These variables were used to compute the rank of each farm into one latent variable, the projection of each farm from a multi-dimensional to a one- dimensional space. The analysis was conducted per crop. World Bank (2015). 141 World Bank (2015). 142 World Bank (2015). 143 World Bank (2015). 144 Meitzner, Price, and Sobel (1996). 145 United States Department of Agriculture (2019). 146 TechSci (2017) and Zion Market Research (2018). RESILIENT DEVELOPMENT: 63 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL 147 TechSci (2017). 148 A report on the relationship between third-party certification and exports to target markets found significant benefits to increased numbers of certified exporting firms. Zheng, Muth, and Brophy (2013). 149 An example of a setup process for a national certification system can be found in Thailand’s shrimp aquaculture sector. Diaz-Ros and Jaffee (2013). 150 For an introduction to the GLOBAL Good Agricultural Practice certification, see https://www.globalgap.org/uk_en/what- we-do/globalg.a.p.-certification/. 151 Diaz-Ros and Jaffee (2013). 152 Steps include: i) define the name of the region and the product to be protected; ii) characterize the product in terms of its essential characteristics/features (physical, chemical, microbiological, and organoleptic) or cultural aspects, etc.; iii) define the geographic boundaries of the geographical indication; iv) establish the rules/standards of production for the product; v) define the factor(s) that link the product with the specific origin; vi) define the institutions responsible for the control; vii) establish the labelling elements; and viii) meet other requirements according to different national rules. Diaz- Ros and Jaffee (2013). 153 World Bank (2017a). 154 The evolving sector of national developmental venture capital provides potential partners and financiers for ambitious entrepreneurs in developing countries. Examples include Sweden’s Swedfund, Britain’s CDC Group, and the Entrepreneurial Development Bank (FMO) from the Netherlands. 155 Sáez and Taglioni (2016). 156 ‘Modern services’ are those delivered through Mode 1, that is, they can be traded without the buyer and seller being in the same place but with some knowledge content such as ICT, banking, insurance, business services, business process outsourcing, knowledge process outsourcing, and education. Modern services are associated with higher productivity and better-quality jobs. Hollweg and Sáez (2019). 157 Hollweg and Sáez (2019), Van der Marel (2016), Baldwin and Forslid (2019), and World Trade Organization (2019). 158 Hoekman and Mattoo (2008), Mattoo, Subramanian, and Rathindran (1999), Javorcik (2004), and Echandi, Krajcovicova, and Qiang (2015). 159 World Economic Forum (2019). 160 World Bank (2017a). 161 Similar to countries around the world, Cambodia’s tourism exports have collapsed, with international arrivals falling by 72 percent (year-on-year) during the first eight months of 2020. 162 World Bank (2020b). 163 Sáez and Villant (2010) and Sauvé and Roy (2016). 164 Fernandes and Paunov (2012), Javorcik and Li (2013), and Arnold et al. (2016). 165 EAP is one of the regions with higher Services Trade Restrictiveness Index (43.9), more than 15 points above the world average (28.3). 166 The GATS classifies services trade in four different modes of supply: direct cross-border trade (mode 1, services are delivered from one country into another); consumption abroad (mode 2, foreign consumers move to the provider country); commercial presence (mode 3, services are supplied through presence in another country) and, presence of natural persons (mode 4, a country moves persons to another country to provide services). 167 World Bank (2014). 168 Information provided by the EU´s South-East Asia IPR SME Helpdesk, accessed on June 21, 2019 at https://ebn.eu/index. php?lnk=K2tiZmlkaWp5MVZzVWF6SzFUWkpHNHEyaEdLR0g5NlpKeElLNWczQmEzdz0=/. 169 World Bank (2019h). 170 World Bank (2018b). CHAPTER 2: 64 ECONOMIC TRANSFORMATION THROUGH EXPORTS 171 World Bank (2019a). 172 Negotiated as part of the Marrakesh Agreement establishing the WTO in 1995. 173 Several studies have shown the complementarity between FDI (mode 3) and trade (mode 1), including Fontagné (1999), Markusen (2005), and Van der Marel and Sheperd (2013). 174 Shingal, Roy, and Sauvé (2018). 175 Hoekman and Mattoo (2013). 176 Hoekman and Mattoo (2011) and Shingal, Roy, and Sauvé (2018). 177 WTO Regional Trade Agreements Database. 178 This section draws on policy recommendations in Chapter 4 of the Economic Diversification Study (World Bank 2019a) prepared as Part I of the Cambodia Country Economic Memorandum. 179 ASEAN Secretariat and World Bank (2015). 180 ASEAN Secretariat and World Bank (2015). 181 International Trade Centre (2004), ProTrade Consult and International Economics (2015), and Simatupang, Rustiadi, and Situmorang (2012). 182 Crane (2016). 183 Tourism of Cambodia (2019). 184 For more information on its functioning and strategy, see Presidential Council on National Branding of the Republic of Korea, available at http://17koreabrand.pa.go.kr/gokr/en/cms/selectKbrdCmsPageTbl.do?cd=0116&m1=1&m2=1/. RESILIENT DEVELOPMENT: 65 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Chapter 3 Financing the Next Phase of Growth Capital accumulation has been the primary driver of The rapid expansion of fixed capital formation is long-term economic growth in Cambodia. It accounts needed alongside increases in other growth engines, for nearly two-thirds of real gross domestic product (GDP) notably human-capital accumulation and TFP. The growth since 1995 and almost three-quarters of real GDP abovementioned growth projections assume human capital growth since 2011. Other growth drivers have played only and TFP will grow by an average of 1.5 and 2.0 percent a secondary role. For instance, changes in employment each year. This growth rate of human capital matches the together with changes in hours worked explain about a Republic of Korea's long-term average rate during 1960- quarter of the growth since 1995. An increase in labor 2014. On the other hand, the assumed TFP growth rate quality over the years has also yielded only marginal impact. outpaces that of the Republic of Korea's in each decade The contribution of total factor productivity (TFP) has been except the 1980s and is significantly above Cambodia’s volatile but has remained low in general. Since 1995, TFP recent performance.186 Since 2009, TFP has grown annually has accounted for just 7 percent of the growth, with its on average by 1.0 percent, but only 0.2 percent since share being even lower in the past decade. 2011. As such, the projections use a best-case scenario for the other growth drivers, and the possibility of a positive Yet Cambodia needs to sustain—and even surprise to reduce the burden on capital accumulation accelerate—the rapid expansion of fixed capital remains unlikely. formation in the next phase to meet its growth targets. Growth projections from the World Bank’s Long- Given the low base, global experience suggests Term Growth Model show that Cambodia will surpass the a sizable increase in the investment rate over a high income gross national income (GNI) per capita target medium- to long-term horizon is achievable. Until threshold by 2050 only if the country manages to expand now, this below 20 percent rate of investment has proved its investment rate to 33 percent, compared to the average sufficient in delivering robust economic expansion. The gross fixed capital formation over the last two decades growth efficiency of investment has been supported by standing at 18 percent.185 Simulations further show that Cambodia’s relatively lower capital-to-output ratio (figure the high income status remains distant in 2050 under an 3.1). However, the marginal productivity of capital is investment paralysis in which the capital formation rate declining as it is becoming less scarce, which reduces the remains stuck at the current level. The Republic of Korea’s effectiveness of investment in boosting growth. To keep the growth experience provides a blueprint for Cambodia. The growth engine running, Cambodia can aim to follow in the Republic of Korea’s investment rate was not different from footsteps of economies that managed considerably higher Cambodia when it was at its level of development. However, rates during their period of rapid economic growth. For the country managed to grow it steadily over 15 years and instance, China and the Republic of Korea averaged around maintained an average investment rate of 33 percent for 35 percent during 1978-2017 and 1977-2000, respectively. almost two decades. Not far behind, the average gross fixed capital formation in Thailand and Vietnam came at 33 and 31 percent during their boom years. Thus, Cambodia has ample room to grow its investment before it reaches such levels. CHAPTER 3: 66 FINANCING THE NEXT PHASE OF GROWTH FIGURE 3.1 Two options for obtaining finance Capital formation remains low relative to high-growth countries at Cambodia’s stage of development To boost capital formation, Cambodia will need to Gross fixed capital formation, period average find ways to finance the underlying investments. There are two broad alternatives for raising finance. First, 40 the country can look to grow its domestic savings, which 35 can then translate into domestic investment. Domestic savings can come from either the private (both households 30 and enterprises) or the public sector. Second, the country can source the required incremental finance externally via 25 foreign investments in firms operating domestically. Percent of GDP 20 External capital has been a critical source of 15 finance 10 External capital inflows in the form of FDI have been 5 a critical source of finance in recent years (figure 3.2). FDI inflows have averaged 11.8 percent of GDP from 2015- 0 19, accounting for more than 70 percent of Cambodia’s capital and financial account on average. In 2019, FDI inflows 20 ina 20 rea 19 nd 20 am 20 dia accounted for nearly 60 percent of aggregate investment 7- aila ) ) ) ) ) 8- Ch 0- bo 4- tn 7- Ko 17 00 98 11 17 99 Vie 00 m 97 Th (2 Ca (figure 3.3). In contrast, FDI constitutes a much smaller 97 97 share of aggregate fixed capital formation in other countries: (1 (1 (1 (1 Source: World Bank staff calculations using data from World Bank 25 percent in Vietnam, with Myanmar, India, and Bangladesh World Development Indicators and Cambodia Economic Update (World reporting considerably lower figures. Though certainly active, Bank 2018a). domestic investment remains a more limited source of finance in Cambodia relative to many other countries. A substantial expansion in capital formation requires finance, and sourcing it successfully is a critical FIGURE 3.2 component of the growth strategy. Cambodia faces two Investment has largely been financed by FDI options that are not necessarily exclusive: external capital Sources of capital formation, 1993-2019 inflows through foreign savings and domestic investment 25 through domestic savings. The former has been instrumental in financing capital formation to date. But can the country 20 continue to rely on foreign direct investment (FDI) to finance its investment in the next phase? If so, how can it attract 15 FDI to reap the maximum benefits? Or should Cambodia 10 also look inwards by trying to boost the anemic rate of Percent of GDP domestic investment? This chapter aims to answer these 5 questions by exploring the challenges and opportunities in attracting FDI as well as boosting domestic investment 0 through domestic savings that would be needed to deliver growth going forward. Deciding whether to continue relying -5 on external sources to finance its next growth phase, or to -10 start looking for ways to build domestic financial sources through domestic savings, requires careful evaluation of -15 the challenges and opportunities of the two alternatives. Covid-19 further increases the importance of this question -20 today, as human capital, TFP, and foreign investment are all 93 95 97 99 01 03 05 07 09 11 13 15 17 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 likely to be negatively impacted in the coming years. The chapter concludes with vital policy recommendations based Investment Savings Current account balance on the analysis. Foreign direct investment Source: World Bank staff calculations using data from International Monetary Fund (IMF) World Economic Outlook and World Bank World Development Indicators and Cambodia Economic Update (2018a). RESILIENT DEVELOPMENT: 67 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL FIGURE 3.3 free access for up to 5,000 products. Though partially Cambodia’s reliance on FDI for capital formation is and temporarily suspended, the “Everything But Arms” much higher than comparator countries agreement exempts all exports to the European Union (EU) Net FDI inflows as percent of gross fixed capital formation, 2019 from import duty and quota. Such preferential arrangements have spurred FDI inflows into export sectors. A considerable share of the investment in the garment sector—the 60 dominant export sector—flows through such channels. However, Cambodia's preferential standing is temporary. FDI to total investment (percent) 50 Strong economic growth will lead to the country’s graduation 40 from LDC status sometime in the future. A resulting decline in the competitive edge of its exports will make export- 30 oriented FDI relatively less attractive. Moreover, economic growth threatens export competitiveness through channels 20 exogenous to loss of preferential treatment. Wages are likely 10 to grow as a result of the overall development (in addition to rapidly rising minimum wages over the past years), which 0 will increase production costs and make Cambodian exports less competitive without equally improving productivity. ia am sia es ia ia r d h ma an es od es Ind pin lay tn lad ail an on mb Vie ilip Ma Th My Ind ng Ca The preferential agreements are subject to regulatory Ph Ba requirements, and the recent suspension of the Note: Data not available for Lao PDR. “Everything But Arms” agreement further jeopardizes Source: World Bank staff calculations using data from World Bank FDI inflows. The European Commission temporarily World Development Indicators. suspended Cambodia's preferential privileges in August 2020, which is likely to have a significant impact on trade, at least in the short term. However, FDI flows will also feel the heat should the suspension (or the threat of suspension) continue for long.187 Attracting greater FDI might prove challenging Cambodia’s high GDP growth puts further pressure in the coming years on the needed FDI levels. Even if FDI inflows continue to grow in nominal value, they will shrink as a share of An increase in FDI inflows can help meet investment GDP if they are unable to keep up with GDP growth. The targets, but a weak investment climate creates current account balance increased from around 8.5 percent headwinds (discussed in more detail in Chapter 1). of GDP in the early-to-mid 2010s to 16 percent by 2019. Moreover, the current investment and tax regime contribute Underlying the expansion is the impressive surge in external to the low quality of FDI (discussed in more detail in Chapter capital flows that have outpaced the high rate of output 2). Cambodia not only misses out on additional FDI but growth. However, the IMF projects a considerable revision also fails to attract high-quality FDI because of its current investment environment. In recent years Cambodia has in the current account balance ratio in the long term and made efforts to improve the investment climate including anticipates it to reach 7.5 percent by 2025.188 In part, the prioritizing reforms to improve the business environment, expected decline reflects the waning short-term demand passing the new Investment Law, and signing new free forces. But the projections do not imply that FDI flows will trade agreements (FTAs) with key trade partners. deteriorate in nominal terms. Instead, inbound FDI in dollar terms appears large as a share of GDP because GDP is Aside from a weak business environment, other still relatively low. As GDP increases over the long term, the factors make attracting FDI at required levels real dollar value of capital inflows will also have to increase increasingly more difficult. Owing to its status as a significantly simply to maintain the share of GDP. As it least developed country (LDC), Cambodia's exports receive becomes harder to attract these additional flows each year preferential treatment by many countries. The United States’ to help sustain FDI as a share of GDP, the growth rate of FDI Generalized System of Preferences program provides duty- will likely fall below the GDP growth rate. CHAPTER 3: 68 FINANCING THE NEXT PHASE OF GROWTH The likelihood of raising the investment rate through Moreover, FDIs are volatile and create risks FDI is also constrained by the economy's high rate to macroeconomic stability of dollarization. Adopting the managed-float regime has been beneficial in reducing the exchange-rate risk. With the An FDI-led investment strategy also exposes the United States being the primary trading partner for many economy to risks associated with macroeconomic years, dollarization also preserved the competitiveness of stability. Cambodia carries a persistently high current Cambodia's exports. But with the EU recently replacing the account deficit. The current account deficit averaged United States as Cambodia's top export destination, the around 9 percent of GDP over the last decade and has strong United States (US) dollar makes exports to other further enlarged in recent years (figure 3.5). FDI flows countries less competitive, limiting export growth and have financed the lion's share of the deficit over the years investments in export-focused sectors. Research shows that (figure 3.6). A perennially high current account deficit episodes of US dollar appreciation relative to the Euro (and exposes the country to macroeconomic risks. Countries other currencies) are associated with a net fall in garment lugging higher deficits bear the risk of sharp economic exports. The tourism industry also bears the brunt, as visits contraction in the event of a financial crisis. High rates of from non-United States’ tourists become more expensive. credit expansion and borrower indebtedness in Cambodia Specifically, a one standard-deviation increase in the in the past years and sharp income declines resulting United States federal funds rate (~0.45 percentage points), from the Covid-19 shock are further risks to Cambodia’s which leads to the appreciation of the US dollar, reduces macroeconomic stability (although average capital positions Cambodia's trade balance with the EU by 0.15 percent.189 In of banks and microfinance institutions/microfinance deposit effect, an increase in the US dollar value indirectly erodes the taking institutions [MFIs/MDIs] nevertheless remain fairly competitiveness of the FDI-favored tradeable sectors due to strong—that is, above the 15 percent regulatory capital Cambodia’s high dollarization. Furthermore, as returns on requirement). Countries are also likely to experience an investment in these sectors diminish, investment decisions erosion of their creditworthiness with the banking sector get distorted in favor of non-tradable sectors. Dollarization coming under severe stress.191 Financial crises can trigger is likely to be one of the main drivers of the rise in the share a reversal of capital flows or create sudden stops, not of credit flowing to construction and real-estate sectors only disrupting economic activity in the near-term but also (figure 3.4).190 In fact, Cambodia’s large and relatively stable causing a protracted stagnation in the medium-term.192 FDI inflows may in part be owed to dollarization minimizing Besides, FDI flows are volatile, and their sustainability in the the risk of depreciation in asset prices compared to other long term is subject to tremendous uncertainty. However, countries that require investments in their own currency. the evidence that links FDI flows to volatility comes from Because the non-tradable sectors are geared towards other countries and may not apply to Cambodia, especially domestic consumption, US dollar appreciation deals a blow in the short to medium term. Moreover, the uncertainty to domestic savings as well. associated with non-FDI capital flows is often higher. These two reasons caution against overestimating the FDI-related risks, particularly because inflows have been fundamental FIGURE 3.4 to Cambodia's growth over the years. FDI has increased faster in non-tradable sectors FDI inflows by sector, 2013-19 The massive disruption in the international credit market brought on by the Covid-19 pandemic can 1,500 threaten investment activity for years to come. The outbreak of Covid-19 has led to unprecedented outflows of capital from developing economies (figure 1,000 3.7). The IMF reports that during a short period of five KHR billions weeks, these economies saw more than US$100 billion of foreign investment—equaling 3.5 percent of total 500 external financing—leave their shores.193 The sudden flight of capital during the Global Financial Crisis pales in 0 comparison, as only 2.0 percent of total foreign investment 2013 2014 2015 2016 2017 2018 2019 was pulled back. In Cambodia, the loss of financing is felt strongly in the construction and real-estate sectors. Activity Financial activites Construction and real estate in these sectors has almost come to a standstill. Moreover, Manufacturing Agriculture, mining, and quarrying recoveries from crises in the past have only been partial, and FDI flows will likely rebound at a slow pace. Hence, it becomes critical to look beyond FDI finance to prevent the Source: World Bank staff calculations using official data. capital accumulation process from stalling. RESILIENT DEVELOPMENT: 69 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL FIGURE 3.5 FIGURE 3.6 Cambodia’s large current account deficit… …has been largely financed by FDI Composition of current account, 2015-19 Composition of capital and financial account, 2015-19 25 20 20 10 15 0 Percent of GDP Percent of GDP 10 -10 5 -20 0 -30 -5 -40 2015 2016 2017 2018 2019 -10 2015 2016 2017 2018 2019 Services (net) Private transfers Officials transfers Net foreign assets of deposit money banks Trade balance Income (net) Current account Foreign direct investment Other short-term flows Medium- and long-term loans Capital and financial account Source: World Bank staff calculations using data from IMF International Source: World Bank staff calculations using data from IMF International Financial Statistics. Financial Statistics. FIGURE 3.7 FIGURE 3.8 Covid-19 threatens foreign investment in developing Cambodia’s savings rate is lowest among comparator economies countries… Cumulative portfolio flows from emerging markets, 2020 Gross national savings rate, 1995-2018 20 40 0 30 -20 Percent of GDP 20 -40 US$ billions -60 10 -80 0 -100 -10 -120 1995 1998 2001 2004 2007 2010 2013 2016 -140 Bangladesh Cambodia India Indonesia Malaysia Myanmar Phillippines 21 04 18 03 17 31 14 28 12 26 09 23 07 21 1/ 2/ 2/ 3/ 3/ 3/ 4/ 4/ 5/ 5/ 6/ 6/ 7/ 7/ Thailand Vietnam Month/day Source: IMF (2020b). Note: Data not available for Lao PDR. Source: World Bank staff calculations using data from IMF World Economic Outlook. CHAPTER 3: 70 FINANCING THE NEXT PHASE OF GROWTH Domestic savings can provide an alternative FIGURE 3.9 to external finance, but the savings rate …and is low given income level remains low Gross national savings vs. GDP per capita, 2018 60 Another avenue to finance investment is to grow Gross national savings (percent of GDP) domestic savings, which will also help in mitigating 50 the aforementioned macroeconomic risks. Reducing the burden on FDI inflows with domestic savings to fuel 40 investment will keep the current account deficit within reasonable limits, thereby reducing the economy's exposure 30 to a financial crisis. 20 Still, adopting a savings-led investment strategy is 10 Cambodia not devoid of challenges. Gross domestic savings as a share of GDP has always remained below 20 percent, 0 placing Cambodia's savings rate lowest among comparator 5 6 7 8 9 10 11 12 countries (figure 3.8).194 Moreover, it has remained Ln GDP per capita (current US$) stubbornly stagnant over the years and has failed to breach the 15 percent mark since 2007. Malaysia holds a leading Source: World Bank staff calculations using data from IMF World position with its savings usually fluctuating between 30-40 Economic Outlook and World Bank World Development Indicators. percent of GDP. The average savings rate during the last ten years (2009-18) in India and Indonesia has been above 32 percent of GDP and their annual rates have never fallen below FIGURE 3.10 29 percent. Cambodia's average during the period lies more Cambodia’s savings trajectory falls below that of high- than 20 percentage points below that of these countries. growth countries Cambodia has fallen significantly behind Myanmar, which Gross national savings vs. GDP per capita, 1980-2018 has steadily increased its savings from below-zero levels 60 to above 30 percent of GDP by the late 2010s. As savings typically rises with GDP per capita, Cambodia’s low income partly explains why its savings rate lags behind that of its comparators. However, income differences are not enough. Saving (percent of GDP) 40 The savings rate remains 5 percentage points below trend even after accounting for income variations (figure 3.9). Nonetheless, like with investment, a low base also provides an opportunity to emulate the savings path undertaken by the Republic of Korea and Malaysia. These two countries 20 managed an average savings rate of around 30 percent in the 15+ years after they were at Cambodia’s current level of economic development. Thailand had a similar savings rate to Cambodia when at Cambodia’s current level of 0 development, but was able to gradually grow its savings 4 6 8 10 12 rate over a decade to reach that of Malaysia (figure 3.10). Ln GDP per capita (2011 US$, PPP) All Cambodia Thailand Malaysia China Note: Cambodia from 1995. PPP = Purchasing power parity. Source: World Bank staff calculations using data from IMF World Economic Outlook and World Bank World Development Indicators. RESILIENT DEVELOPMENT: 71 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL A steady and substantial increase in the savings rate is FIGURE 3.11 thereofre essential to sustain the growth momentum. Growth declines without an increase in the savings rate It is unlikely that the country will catch up with the gross Real GDP per capita growth under various scenarios, 2020-50 fixed capital formation rates of high-growth comparators projections without any considerable shift in saving patterns. Growth simulations show that at Cambodia’s current savings 8.0 profile, GDP growth could drop to 4.8 percent by 2031 7.0 (figure 3.11, see box 3.1 for more details). The country Real GDP per capita growth (percent) can maintain its high GDP growth if it is able to replicate 6.0 the Republic of Korea’s or Malaysia’s savings—and thus investment—experience. Average annual GDP growth in the 5.0 next decade is projected to be just under 6.5 percent under a weak surge scenario in which the savings rate expands to 4.0 18.5 percent by 2030. If savings undergo a strong surge, 3.0 with the savings rate growing to 23.5 percent, GDP growth is projected to average 7 percent. 2.0 In summary, both instruments—FDI and domestic 1.0 savings—offer opportunities to finance the required high rate of investment that will sustain the growth 0.0 momentum. FDI inflows already constitute a large share 2020 2025 2030 2035 2040 2045 2050 of fixed capital formation as preferential trade agreements Strong surge Weak surge Baseline (PTAs) have funneled external capital into export-oriented sectors. On the other hand, the savings rate in the Note: Simulations do not reflect the Covid-19 shock. country remains extremely low and lags behind that of its Source: World Bank staff calculations. comparators. But the low-level savings base also provides ample legroom, which makes a substantial expansion less daunting. However, both financing options come with their own set of challenges. Cambodia is bound to lose its preferential trade status with its eventual graduation out of LDC status, which will make it a less attractive FDI destination. Moreover, efforts to raise FDI, especially high quality FDI, are likely to be frustrated under the current weak investment climate and muted global capital flows triggered by the Covid-19 pandemic. Kick-starting the savings boom is also going to be challenging as the savings rate has remained stagnant over the years. Hence, it is essential to understand what causes savings to be depressed in Cambodia. The next section takes a comprehensive look at the country’s savings situation to identify the barriers. CHAPTER 3: 72 FINANCING THE NEXT PHASE OF GROWTH BOX 3.1: Required savings for meeting upper middle income 2030 and high income 2050 targets While weak and strong surges in savings help sustain the growth momentum, meeting long-term targets to transition into upper-middle-income and high-income statuses require an even higher savings path (figure B3.1). To attain upper-middle-income status in 2030, savings will have to be higher than 40 percent of GDP by then. Transitioning into high-income status by 2050 also makes sufficiently higher demands. On average, required savings rates in the next 10 years exceed the strong surge scenario by 6 percentage points. FIGURE B3.1 Cambodia falls short of its growth targets without significant increases in savings Gross national savings under various scenarios, 2019-50 projections 50 45 40 Gross national savings (percent of GDP) 35 30 25 20 15 Upper middle income 2030 requirement 10 High income 2050 requirement 5 Strong surge 0 Weak surge 2019 2024 2029 2034 2039 2044 2049 Note: Simulations do not reflect the Covid-19 shock. Source: World Bank staff calculations. The projections are obtained using the World Bank’s Long-Term Growth Model, which helps assess how the economy grows under various savings scenarios. The Long-Term Growth Model builds on the Solow-Swan growth model and accounts for projected demographic dynamics, together with many other factors that are critical in driving growth.195 For the baseline case shown in figures 3.10 and 3.11, the model assumes the current account deficit as a share of GDP decrease over the long term as short-term demand effects wane—reaching 8.9 percent (near to the 10- year average) by 2025 and 5.0 percent by 2030. Moreover, private savings recover from 4.0 percent of GDP to 8.0 percent by 2025, but do not increase further. Government savings are assumed to decline gradually to a long-term steady-state level of 5.5 percent of GDP by 2025. The resulting effect of these dynamics is that the investment rate declines steadily to reach a steady state of 18 percent by 2030. The savings profiles associated with weak and strong surge scenarios are shown in figure B3.1. Other drivers of growth include human-capital accumulation, productivity expansion, and demographic dynamics. Projections assume an annual human-capital growth of 1.5 percent. This human-capital growth rate is considerably high and is similar to what the Republic of Korea achieved over the decades (1960-2014). Annual rate of TFP growth is assumed to be 1 percent and demographic dynamics are adopted from the United Nation’s population projections. RESILIENT DEVELOPMENT: 73 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Analysis of Cambodia’s savings The diagnostics use data from multiple sources to cover as much ground as possible. These data fall situation under two broad categories. The first type corresponds to macroeconomic-level indicators. These include national A comprehensive approach to savings income accounts aggregates, which have been traditionally diagnostics used in analyzing saving behavior, as well as other financial and socioeconomic variables. The second class of data The diagnostics that follow aim to uncover the takes a micro approach and focuses on household and ultimate causes of low savings in Cambodia and individual decisions directly through surveys. The study employ several complementary approaches. For primarily relies on two sources of microdata—the World instance, the analysis weighs Cambodia relative to other Bank Findex Database and the World Bank Cambodia countries to identify where it falls short. The investigation Socio-Economic Surveys (CSES)—and a small qualitative also considers the within-country variation of saving survey of households commissioned for this report. The behavior. This exercise not only helps separate households World Bank Findex Database is a collection of nationally and individual characteristics associated with marginal- representative surveys that aims to capture details of how to-no savings but also enables the identification of factors adults save, borrow, make payments, and manage risk. The leading to such behavior with certainty. Finally, when CSES are also nationally representative but have a much possible, the diagnostics look at the time trend to uncover broader scope and provide useful information that sheds the variables that have lost steam over time. light on saving decisions of households. In addition to simple measures, the diagnostics use rigorous econometric techniques that are suitable to address the savings query under consideration (see box 3.2 for more details of these empirical approaches). CHAPTER 3: 74 FINANCING THE NEXT PHASE OF GROWTH BOX 3.2: Econometric analysis of saving behavior in Cambodia Methodology 1: Cross-country analysis using macro panel data Methodology 1: Cross-country analysis using macro panel data Methodology 1: Cross-country analysis using macro panel data The principal The principal objective objective of the the econometric of econometric analysis analysis isisto toseeseehow how savings saving behavior behavior in Cambodia in Cambodia compares compares to other to other The principal countries. Specifically, two possibilities can explain the low savings rate in the country. First, it may be thatto countries. objective Specifically, of thetwoeconometric possibilities can explain is analysis theto see low how savings savings rate in the behavior country. in Cambodia First, it may be compares that factors other factors countries. that that promote Specifically, promote savings are saving two are possibilities ineffective. ineffective. For For can explain the example, example, savings savingslow savings not responding rate in the not responding to tocountry. increases in increases income,First,orit may be rising in income, at orthat a lower risingfactors at a that rate thansavings promote in other countries. are Second,For ineffective. it may be that the example, factor is savings notpotent but not developed. responding to increases For instance, in income, the national or rising at a lower rate savings thanis in other low because countries. of low Second, income since ititmay rises be with thatincomethe at factor a rate is potent but consistent with not the developed. global experience.For instance, lower the rate than national savings in other is low countries. because of Second, low income it maysince be that the factor it rises with incomeis potent at a butratenot developed. consistent with For instance, the global the national experience. savings is low because of low income since it rises with income at a rate consistent with the global Based on literature, the empirical exercise exploits the macro panel data to shed light on the low savings rate. experience. Following Loayza, Schmidt-Hebbel, and Servén (2000) and more recently Grigoli, Herman, and Schmidt-Hebbel Based on literature, the rate empirical exercise as exploits the macro panel data to shed light on the low savings rate. Based (2018), Followingon Loayza the savings literature, et al.the (2000) yit is modeled empirical and more exercise recentlyexploits Grigolitheet macro panelthe al. (2018), data to shed savings ratelight !"# on the low savings is modeled as rate. Following Loayza et al. (2000) and more recently Grigoli et al. (2018), the savings rate !"# is modeled as !"# = %!",#'( + *+",# + ,-",# + ." + /# + 0",# !"# = %!",#'( + *+",# + ,-",# + ." + /# + 0",# where +",# and -",# represent the set of endogenous and (strictly) exogenous variables, and where the subscripts 1where and 2 ",# and -",# represent +correspond where Xi,t and Z to time-periods represent the set of the set endogenous (years) and (strictly) and countries. of endogenous and (strictly) exogenous test To exogenous whether variables, Cambodia variables, and where the subscriptsfrom and the deviates subscripts i and other correspond 1 and t2 correspond countries, an interaction to time-periods i,t to countries term andwithyears, (years) both and countries. endogenous respectively. To test andwhether To test exogenous whether Cambodia variables deviates Cambodia is from deviates introduced. other The countries, from analysis an other countries, compares an interaction Cambodia interaction termto with the both term global with sample endogenous both as well and endogenous as to the exogenous and is countries variables exogenous in the East introduced. variables TheAsiaanalysisand iscompares introduced. Pacific (EAP). Cambodia The The to analysis analysis compares uses allthe the Cambodia global exogenous to sample and the as well global sample as to the countries endogenous as variables well in theas Eastthe fromto the countries and Pacific AsiaGrigoli in et al. the (EAP). East (2018) Asia analysis Thestudy. and Pacific Inuses addition, (EAP). all the it The exogenous complements analysis uses all them the and by exogenous endogenous bringing data and on in variables endogenous from the Grigoli, business variables Herman, environment, from andtheaccess Grigolito et Schmidt-Hebbel al. micro (2018) (2018) study. finance, study. and Intheaddition, In addition, it complements it complements banking sector. The them by bringing parameters of the dynamic panel model are estimated using the two-step system, generalized sector. them by bringing in data in data on on business business environment, environment, access access to to microfinance, micro andfinance, the bankingand the sector. banking The parametersmethod The of parameters moments of the (GMM) of the dynamic dynamic panel method model (Blundellpanel model are estimated and Bond, are using the two-stepusing estimated 1998). system, the two-step generalized system, method generalized of moment method.method of 196 moments (GMM) method (Blundell and Bond, 1998). Methodology Methodology 2: Analysis 2: Within-country using CSES micro analysis data using CSES microdata Methodology 2: Analysis using CSES micro data This econometric This econometric analysis analysis focusses focusses on Cambodian on Cambodian households to households to identify identify characteristics characteristics associated associated with withsaving savings This econometric behavior. analysis Comparing the focusses findings on from Cambodian this exercise households with behavior. Comparing the findings from this exercise with what is already obtained for other countries shedswhat is to identify already obtainedcharacteristics for other associated countries sheds with light on savings light behavior. on whether whether Comparing the the household household the findings from this saving behavior saving behavior exercise in Cambodia in Cambodia with is anywhat is different. is already obtained for other countries sheds light any different. on whether the household saving behavior in Cambodia is any different. FollowingFollowing the existing the existing literature, literature, the the following equation following equation isis estimated estimated Following the existing literature, the following equation is estimated 3" = 4 + *+" + 5 3" = 4 + *+" + 5 where 3" is household 1’s saving rate. The vector +" are the household-level controls, which are posited to where 3"saving influence is householddecisions. saving 1’sThese The vector rate. owning include the land+" are and the house household-level where the household controls, which the resides, are household posited to influence size where saving and location, S i is decisions. household i’s and characteristicsThese include savings rate. of the owning The vector the X household i land are the and house head household-level where the household (age, education, controls, which occupation, are resides, posited gender, to the household influence and marital size and location, saving status).location, decisions. The regression and characteristics These introduces include owning controls of the the landhousehold for geospatial and house head where features (age,the education, household resides, of occupation, villages where occupation, gender, the household a household size isstatus). located. andandmarital Among status). The regressionand characteristics introduces the household of controls for head (age,features geospatial education, of villages where gender, and marital is a household located. TheAmong these, distance to the nearest bank or MFI is of particular interest. these, regression distance to introduces the nearest controlsbank for MFI is of features orgeospatial particular of interest. villages where a household is located. Among these, distance to the nearest bank or MFI is of particular interest. The analysis truncates the saving rate 3" at both ends. A lower bound of 0 is set for negative household rates, and The analysis an upper bound truncatesoftruncatesthe saving 1 applied ratethat tosavings rates 3" atlie both aboveends. A lower unity. Under bound of 0 is set truncation, the for negative Tobit household estimates rates, and are superior to an upperThe analysis bound of 1 applied the to rate that lie ratesSquares, S at both ends. A lower bound of 0 is set i above unity. Under truncation, the Tobit estimates are superior to for negative household rates, those obtained and an upper using Ordinary bound of 1 applied Least to Squares, rates that as as the lie above latter are unity. areUnder biased and truncation, inefficient. the Tobit estimates The findings are superiorof the Tobit to Tobit those obtained model are checked using Ordinary Least the latter biased and inefficient. Thereports findings of results the those obtainedfor usingrobustness Ordinary Least using Probitas Squares, andtheHeckman latter are biased selection models. and inefficient. Table The B3.1 findings of the Tobit the model of model the Tobitare checked for robustness using Probit and Heckman selection models. Table B3.1 reports the results of regressions. are checked for robustness using Probit and Heckman selection models. Table B3.1 reports the results of the Tobit the Tobit regressions. regressions. Table B3.1: Results of the Tobit regressions Table B3.1: Results of the Tobit regressions Variable Model 1 Model 2 Model 3 Model 4 Variable Model 1 Model 2 Model 3 Model 4 Land D D -0.99 1.25 -1.50*** 0.66** Land -0.99 (0.94) 1.25 (1.03) -1.50*** (0.23) 0.66** (0.28) House ownershipDD (0.94) 0.68 (1.03) 1.86 (0.23) -0.53 (0.28) 0.19 House ownership 0.68 (1.47) 1.86 (1.61) -0.53 (0.36) 0.19 (0.43) RuralDD (1.47) 2.48*** (1.61) 4.81*** (0.36) 1.69*** (0.43) 2.40*** Rural 2.48*** (0.96) 4.81*** (1.05) 1.69*** (0.25) 2.40*** (0.30) No of HH members aged 15-64 (0.96) 4.74*** (1.05) 6.13*** (0.25) 2.66*** RESILIENT DEVELOPMENT: (0.30) 4.25*** No of HH members aged 15-64 4.74 (0.28) *** 6.13 (0.31) *** A STRATEGY TO 2.66 (0.07) DIVERSIFY ***CAMBODIA’S (0.08) GROWTH 4.25 MODEL *** 75 No of dependent HH members (0.28) -1.94*** (0.31) -1.50*** (0.07) -0.90*** (0.08) -0.80*** TABLE B3.1: Demographics and other household characteristics correlate with higher savings Variable Model 1 Model 2 Model 3 Model 4 Land D -0.99 1.25 -1.50 *** 0.66 ** (0.94) (1.03) (0.23) (0.28) House ownershipD 0.68 1.86 -0.53 0.19 (1.47) (1.61) (0.36) (0.43) RuralD 2.48 *** 4.81 *** 1.69 *** 2.40 *** (0.96) (1.05) (0.25) (0.30) # of HH members aged 15-64 4.74 *** 6.13 *** 2.66 *** 4.25 *** (0.28) (0.31) (0.07) (0.08) # of dependent HH members -1.94 *** -1.50 *** -0.90 *** -0.80 *** (0.31) (0.34) (0.07) (0.09) Age of HH head -0.39 ** -0.11 -0.22 *** -0.21 *** (0.19) (0.21) (0.04) (0.05) Square of age of HH head 0.00 ** 0.00 0.00 *** 0.00 *** (0.00) (0.00) (0.00) (0.00) HH head in formal sectorD 7.95 *** 8.67 *** 4.42 *** 5.83 *** (0.84) (0.92) (0.22) (0.26) HH head in agricultureD -1.88 ** -3.93 *** -1.32 *** -3.41 *** (0.93) (1.03) (0.22) (0.27) HH head educatedD -0.17 3.36 *** -0.15 1.68 *** (0.98) (1.08) (0.26) (0.31) HH head maleD 1.22 0.67 -0.86 ** -1.19 *** (1.51) (1.67) (0.37) (0.44) HH head marriedD -4.81 *** -3.78 ** -1.87 *** -1.10 ** (1.56) (1.71) (0.38) (0.46) Distance to nearest bank (kms) -0.06 -0.05 -0.02 ** -0.03 *** (0.04) (0.04) (0.01) (0.01) HH received remittancesD 2.59 *** 3.42 *** 1.16 *** 1.76 *** (0.78) (0.86) (0.20) (0.24) Constant 13.55 *** 9.19 * 6.54 *** 4.94 *** (4.73) (5.20) (1.06) (1.27) Observations 3,785 3,790 49,140 49,215 Note: D=dummy variable. HH=household. Standard error in parentheses. *** p<0.01, ** p<0.05, * p<0.10. Savings is defined as the difference between annual net income and consumption in Models (1) and (3), while Models (2) and (4) also treat durable goods, medical, and educational expenses as savings. Negative savings are set to zero. Models (1) and (2) are for 2017 and Models (3) and (4) are pooled across the CSES 2009-17. Models (3) and (4) feature year fixed-effects. Source: World Bank staff calculations. CHAPTER 3: 76 FINANCING THE NEXT PHASE OF GROWTH National savings are low primarily because FIGURE 3.13 of private-sector savings Government savings have been growing while private savings have been declining The aggregate savings rate in Cambodia lags behind Private and public savings rate, 2010-18 those of comparator countries primarily due to 16 differences in private sector savings. Private savings as a share of gross private disposable income averaged below Gross national savings rate (percent of GDP) 14 15 percent during 2000-12 (figure 3.12). Barring Myanmar, the corresponding figures are considerably higher in each 12 comparator country. For instance, Cambodia's average is almost half that of Thailand and Vietnam, countries in the 10 middle of the spectrum. In general, a percent increase in 8 gross private disposable income per capita raises private savings by 17 basis points. But Cambodia's low income 6 does not fully explain its depressed state of private savings. Private savings rates have been below the expected levels 4 in most years, even after accounting for income variations. 2 More alarmingly, the private savings rate has been 0 decaying in recent years. While public savings have grown substantially over the last decade, a relatively 2010 2011 2012 2013 2014 2015 2016 2017 2018 stronger contraction in private savings has dragged the Gross government savings Gross private savings aggregate rate downward (figure 3.13). Public savings as a share of GDP stood at a meagre 0.5 percent in 2010. Since Source: World Bank staff calculations using data from IMF Article IV for Cambodia. then, the public savings rate exhibited a phenomenal surge to reach 6.3 percent by 2019. Yet, the aggregate savings rate has shrunk by over 2 percentage points over the same Mechanisms that foster (or hinder) saving period due to a severe decline in private savings. The private savings rate in 2018 was around 7.5 percentage points are relatively less (or more) active lower than at the beginning of the decade. Some dimensions of the saving behavior in Cambodia vary markedly from those observed in the EAP FIGURE 3.12 region and create barriers for savings expansion. For Cambodia’s private savings is lowest among example, the savings rates decline with the share of the comparator countries old-age population in both Cambodia and the EAP. However, Private savings, 2018 the channel is more vigorous in Cambodia as a percentage increase in the old-age dependency ratio leads to a larger 35 reduction in savings. The finding suggests that the elderly in 30 Cambodia rely more on accumulated savings in the absence Private savings (percent of GDP) of social safety nets. Like in the EAP, a rise in bank credit 25 depresses savings in Cambodia as well. Credit expansion makes it easier to finance consumption and investment and 20 reduces dependency on private savings. Still, the analysis shows that Cambodia realizes relatively larger savings 15 contractions as a result of similar increases in credit.197 10 Finally, an increase in foreign lending by an EAP nation reduces its domestic private savings but that reduction is 5 greater in Cambodia.198 0 ia sia d ia am h es r ia ma an es Ind es od pin lay tn lad ail an on mb Vie ilip Ma Th My Ind ng Ca Ph Ba Note: Data not available for Lao PDR. Source: World Bank staff calculations using data from Grigoli, Herman, and Schmidt-Hebbel (2018). RESILIENT DEVELOPMENT: 77 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL On the other hand, improvements in the business Cambodia is among the most dollarized economies environment generate a watered-down impact of the world, which might be creating roadblocks on savings in Cambodia. The cross-country analysis for domestic savings growth. The dollarization rate in extends the standard model by bringing in data on the the country exceeds that of Nicaragua, the Democratic business environment, which relates to several facets of Republic of Congo, and Uruguay (figure 3.14). Economic production activity—incorporating an operation, obtaining theory suggests dollarization can bear an inverse impact utility connections and necessary permits, receiving on savings. Cross-country evidence has established that judicial support in contract enforcement, etc. Advances savings increase with an increase in the income level and in the business environment make production more income growth.199 But income growth is lower in economies rewarding and encourage firm entry and growth, which that experience higher output volatility,200 and a higher rate catalyzes investment activity in the economy. The cross- of dollarization is associated with an increase in volatility.201 country analysis of macro data confirms the presence of Hence, it is via this channel that dollarization hampers this channel in Cambodia. Nonetheless, the channel is national savings. Dollarization-induced volatility can be not as effective as in the EAP region, which may be due severe, especially during a financial crisis, and economies to non-linearities where the effects remain muted below a with high dollarization rates are increasingly at risk. They certain threshold. The business climate in Cambodia leaves carry substantial amount of currency imbalances that arise substantive room for improvement. Hence, improvements in because of a mismatch in foreign-denominated debt and the business environment may become more influential in loans. A financial crisis ensues when the exchange rate driving investment in the future as Cambodia moves beyond depreciates rapidly as US dollar denominated debt becomes the limiting threshold. unserviceable under such conditions.202 Dollarization can affect savings via other channels as well. As discussed previously, in a dollarized economy, investment decisions FIGURE 3.14 get distorted in favor of consumption-oriented non-tradable Dollarization in Cambodia is among the highest sectors whenever the US dollar appreciates. In this way, globally dollarization props consumption and disincentivizes Share of foreign currency deposits in total deposits, 2001-12 savings.203 120 Many households engage in savings but 100 Nicaragua Cambodia save too little 80 Concern about low household savings is not how The Democratic many households save but rather how much they Percent Republic of Congo Uruguay 60 are saving. The savings rate in Cambodia lags behind that of many countries at the same level of development 40 (figure 3.15), and is behind that of Malaysia, Thailand, and World 20 Indonesia by approximately 10 percentage points (figure 3.16). Yet, the World Bank Findex data show the share of 0 individuals reporting making any savings in the past year is around 10 percentage points higher than expected given 01 02 03 04 05 06 07 08 09 10 11 12 Cambodia's GDP per capita. This means that though a 20 20 20 20 20 20 20 20 20 20 20 20 relatively large share of households is saving, the actual amount saved remains marginal. Data from other sources Note: World consists of 87 countries for which data is available for each year during 2001-12. further support this possibility. According to the World Bank's Source: World Bank staff calculations using data from IMF International Living Standards Measurement Study survey conducted in Financial Statistics. 2019, only 22 percent of households had any savings at the CHAPTER 3: 78 FINANCING THE NEXT PHASE OF GROWTH time of the survey. The figure is 30 percentage points lower FIGURE 3.16 than what the World Bank Findex data suggests. However, …but below most comparators the two surveys are not consistent in the definition of Percent of adults who saved any money in the past year, 2017 savings. The World Bank Findex survey uses a more flexible definition of savings, and a positive contribution in the 70 past year is sufficient. On the other hand, the 2019 Living 60 Standards Measurement Study requires households to have some current balance. Thus, households in the 2019 Living 50 Standards Measurement Study are not considered savers if they saved some part of their income but ran it down over 40 Percent the year. These facts suggest that savings are often modest and elude long-term accumulation. 30 20 FIGURE 3.15 10 The share of adults saving is high given Cambodia’s income level… 0 Percent of adults who saved any money in the past year, 2017 sia d ia DR Vie s Ca am My ia r ng ia h ma e an es es od d pin lay oP n tn lad ail an on mb I 100 ilip Ma Th La Ind Ph Ba 90 Source: World Bank staff calculations using data from World Bank Findex Database and World Bank World Development Indicators. 80 70 The large and persistent negative shock to livelihood unleashed by the Covid-19 pandemic has exposed 60 Cambodia Cambodian households to dire consequences, and Percent 50 they are unable to cope given their deficient savings. Food insecurity has spiked in many developing countries as 40 a result of Covid-19. In Kenya, which is at a similar level of development as Cambodia, the share of food-insecure 30 respondents increased by nearly 40 percent.204 Not surprisingly, low-income households are more adversely 20 affected by the crisis and were more likely to engage in food- 10 based coping strategies such as missing meals or reducing overall food consumption. These facts also attest to the 0 limitations of both formal and informal credit in providing 5 6 7 8 9 10 11 12 timely relief. Yet, the pandemic could have an even more Ln real GDP per capita severe impact in Cambodia, given the economy's reliance on trade (garments, tourism) and external capital (construction Source: World Bank staff calculations using data from World Bank Findex and real estate). Recent developments have weakened the Database and World Bank World Development Indicators. labor markets considerably, and with inadequate savings, households have limited means to absorb job loss shocks without the additional support of safety nets. After the effect of the pandemic wanes and the economy starts recovering, Cambodia should aim to advance its rate of savings participation. While the amount saved remains a primary issue as far as aggregate savings are concerned, Cambodia should aim to bring more households under the savings umbrella for equity reasons. RESILIENT DEVELOPMENT: 79 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Why do households save and what factors explain the variation in saving behavior BOX 3.3:  across households? Research in developing economies has revealed that households engage in savings for a multitude of reasons. Primary functions of savings include acting as a reserve for future contingencies, preparing for anticipated change in future income and needs, building wealth, financing large consumption expenditures and speculative business investments, leaving bequests, etc.205 Households report a variety of motivations for saving in Cambodia as well (figure B3.1). Saving enables dealing with financial needs that arise on a day-to-day basis. Saving is also effective as self-insurance against future shocks. Such precautionary motives—like unforeseen healthcare-related expenditures—also drive households to save. In general, savings are a last resort to fund various expenditures if credit is not readily available. For instance, domestic savings are often the only way to pay for relatively large asset acquisitions. Many households also save to pay for their agricultural expenses. Other lesser critical factors, which are often associated with access to finance, include saving for children’s education, earning interest, accumulating wealth, and making investments. FIGURE B3.2 Household needs, health care, asset purchase, and agricultural expense are the most important reasons for households to save in Cambodia Reasons why households save in Cambodia, 2019 Asset-purchase Health-care Loan-access Child-education Wealth-accumulation Household-needs Investment Agriculture-expense Interest-earning Help-community Source: World Bank staff calculations using data from a 2019 World Bank household survey. Demographic patterns too directly affect saving behavior as higher dependency ratios imply allocating a larger share of income to consumption. With either the number of very young or very old increasing, there are fewer people who earn income. Still, income goes into supporting dependents also, thereby putting pressure on the savings rate. The share of households that save declines with the number of dependents in the family (figure B3.3). In 2017, 22 percent of CSES households with no dependents cited having savings of some kind. The savings rate fell steadily with the number of dependents and was 10 percentage points lower for households with four dependents. CHAPTER 3: 80 FINANCING THE NEXT PHASE OF GROWTH Saving decisions are also related to life-cycle effects in which people build on their savings over time and use it to fund consumption in the later periods (figure B3.4). The savings rate increases with the age of the household head and reaches a peak around 50-59 years. The rate drops after age 59, as people reach retirement age and withdraw from the labor force. The 2017 household survey shows that households with heads over 70 years of age were around 10 percentage points less likely to save than those with heads in the age group of 50-59. The post- retirement period is characterized by dissaving in which retirees use the accumulated savings as sources of income dry up. Households with higher incomes are more likely to build savings (figure B3.5). Saving essentially involves not spending the whole income on consumption. For households with low levels of income, setting aside a part of earnings is difficult due to subsistence requirements. In 2009, the bottom four deciles of households reported not having any savings. However, income at the bottom end has risen over the years due to economic growth. This expansion in livelihood is potentially enabling some of the poorest households to save. Barring the lowest decile, households at all other levels reported having savings in 2017. Nonetheless, the expansion in the share has been faster for higher-income households leading to an increase in the savings gap across the income deciles. FIGURE B3.3 FIGURE B3.4 FIGURE B3.5 The dependency ratio is nega- Saving patterns follow the Savings rate increases with tively correlated with savings life cycle household income decile Savings rate by number of dependents, Savings rate by age of household head, Savings rate by income decile, 2009 2009 vs. 2014 vs. 2017 2009 vs. 2014 vs. 2017 vs. 2014 vs. 2017 25 25 50 20 20 40 Savings rate (percent) Savings rate (percent) Savings rate (percent) 15 15 30 10 10 20 5 5 10 0 0 0 2009 2014 2017 1 2 3 4 5 6 7 8 9 10 29 9 9 9 9 70 -3 -4 -5 -6 < > 30 40 50 60 Year Income decile Age of household head 0 1 2 3 4 2009 2014 2017 2009 2014 2017 Note: Any observed savings rates below Note: Any observed savings rates below Note: Any observed savings rates below zero are set to zero. zero are set to zero. zero are set to zero. Source: World Bank staff calculations using Source: World Bank staff calculations using Source: World Bank staff calculations using data from World Bank CSES. data from World Bank CSES. data from World Bank CSES. RESILIENT DEVELOPMENT: 81 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL When saving, households prefer informal FIGURE 3.17 instruments over formal Formal savings is far less prevalent in Cambodia than in comparator countries Formal savings is far less prevalent in Cambodia Percent of adults with savings by saving method, 2017 and the phenomenon appears to be related to low 70 aggregate savings. Global evidence shows that the two variables are tightly linked, that is, informal methods 60 are less popular in countries where a larger share of the population engages in savings. For instance, on average, 50 70 and 40 percent of adults report saving in developed and developing countries, respectively. Of these, more 40 Percent than three quarters do so via formal means in developed 30 economies. In contrast, less than 50 percent use formal means in developing economies. The relationship between 20 formal savings and savings indicates that how people save influences aggregate savings. A mechanism that explains 10 the connection operates through differences in risk-adjusted returns of formal and informal instruments, with the former 0 being more rewarding. Hence, the inability to access formal sia d ia DR es am ia r ia h ma an es es od Ind pin lay oP tn lad products not only limits saving in them but also savings ail an on mb Vie ilip Ma Th La My Ind ng Ca Ph Ba on aggregate if the informal risk-adjusted return is lower than the marginal utility of consumption. If so, Cambodian Informal and other Semi-formal (e.g. savings association) households' reliance on informal instruments seems With financial institution ominous. Saving using formal or semi-formal techniques remains far less prevalent. Of all the adults who save, Source: World Bank staff calculations using data from World Bank Findex almost 70 percent reported doing so via informal means, Database. for example in the form of cash or jewelry at home (figure 3.17). Barring the Philippines, no other comparator country exhibits such skewed dependence on informal methods. example, or remains confined to multiple small exchanges Only 9 percent use informal instruments in Thailand, and as the interaction between informal groups is lacking. less than 30 percent of savers use informal means in Hence, a conversion of informal savings to formal will lead developing economies on average. to more credit flowing to productive investment projects, even if the aggregate level of savings remains unchanged. Even more concerning is the depressed level of participation at financial institutions. Cambodia's formal participation rate of 5 percent is the lowest among Lack of access contributes to low all comparator countries. In contrast, 8 and 12 percent participation in formal savings vehicles of adults reported saving formally in Myanmar and the Philippines. The developing country average is much higher Access to basic financial services—a prerequisite for at 21 percent. formal savings—remains widely unavailable. Fewer than one in four adults in the country have an account at a A bias towards informal savings impedes efficient financial institution (figure 3.18). From a low base of around allocation of credit, which drags down productivity 4 percent in 2011, financial inclusion grew substantially growth. A well-functioning financial system contributes during the first half of the decade to reach 22 percent to economic growth by allocating capital efficiently across in 2017. Still, Cambodia lags behind many countries as the economy. It serves as a central market in which inclusion grew elsewhere as well. Inclusion in Cambodia borrowers and suppliers of credit interact indirectly through is 41 percentage points lower relative to the developing intermediaries. With competing projects vying for scarce country average. More concerning is the fact that the credit, ones with higher returns drive out investments with inclusion rate in lower-middle-income countries exceeds inferior returns. Suppliers gain from the expertise of the that of Cambodia by 36 percentage points. Furthermore, intermediaries who act as arbitrators of credit and have the Cambodia's low GDP per capita is not sufficient to account know-how of distinguishing between projects. In general, for the low inclusion (figure 3.19). Cambodia sits around countries with developed financial markets invest more in the 20th percentile of the world income distribution. Yet, its their growing sectors. The informal financial sector fails to position drops to the 6th percentile of the global inclusivity perform this fundamental function. Aggregate credit may be distribution. Hence, the country's low level of inclusion is lower if savings are held in the form of jewelry or cash, for not because of its income level, but despite it. CHAPTER 3: 82 FINANCING THE NEXT PHASE OF GROWTH FIGURE 3.18 The rise in financial inclusivity over the years has Financial inclusion has grown… been widespread, with most groups reporting higher access. The expansion in the financial inclusivity Percent of adults with an account, 2011-17 of women has kept pace with that of men, and there was 80 40 no discernible gender gap in inclusion in 2017. Account East Asia and Pacific ownership has also increased for rural residents, and the 70 inclusion rate in rural areas is close to the national average. Financial inclusivity of the poor has advanced extensively Percent of adults with an account Percent of adulst saving formally 60 30 over time—from almost 0 percent in 2011 to 14 percent 50 in 2017. Still, there exists an inclusion gap between rich Developing and poor Cambodians. The recent trend in inclusivity across 40 20 income groups raises some concerns. While access has Lower middle income increased for the richest by 60 percent since 2014, there 30 has been a decline in account ownership for the remaining 20 10 populatoin that has dragged the national rate down. Cambodia 10 Still, the widespread extension in account ownership has not translated into an equally strong expansion 0 0 of savings at financial institutions. The increase in the 2011 2014 2017 share of adults engaged in formal savings from 2011 to 2017 (by less than 5 percentage points) was substantially Note: Dashed lines denote the share of adults saving formally. milder than the increase in the inclusion rate (by 18 Source: World Bank staff calculations using data from World Bank Findex Database. percentage points). The evidence of account ownership not necessarily leading to saving formally extends to other countries. Formal savings declined during 2014-17 in the FIGURE 3.19 EAP and developing economies at large, even when financial …but lags behind most countries inclusion was swelling. Share of adults with an account vs. GDP per capita, 2017 The relative ineffectiveness of financial access in 10 generating savings is related to a deterioration in account activity. According to the FinScope survey, 20 percent of accounts were not accessed even once during 2014. In contrast, only 8 percent of accounts exhibited 8 such dormancy in 2011. The share of accounts with more than three uses per month was only 18 percent in 2014, Share of adults with an account representing a 3 percentage point decline since 2011. The 6 survey also shows that more than three in five accounts are treated as mailboxes akin to checking or payment accounts. Households exclusively use them to receive funds and withdraw them almost entirely and immediately. Hence, 4 these accounts do not serve as vehicles for long-term savings. It is important to note, however, that the inclusion- savings link is not absent in Cambodia. It is just that the 2 Cambodia savings response has been mild, and further extension is likely to foster savings (see box 3.4 for more details on the inclusion-savings link). 0 400 3,000 22,000 160,000 GDP per capita (current US$) Source: World Bank staff calculations using data from World Bank Findex Database and Penn World Tables 9.1. RESILIENT DEVELOPMENT: 83 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL BOX 3.4: Exploring the inclusion-savings link A large share of households and businesses do not have access to even the most basic financial services in developing economies. Instead, they often resort to saving in assets like jewelry or livestock, which carry relatively higher risks. Given this, it is reasonable to assume that expanding financial access to the excluded population will promote savings. But does the inclusion-savings link hold up in practice? In other words, does expanding financial access lead more households to save, and others to save more? Indeed, some studies do find evidence of financial inclusivity leading to higher savings. In 2007, mobile banking services were introduced by M-PESA in Kenya. The use of these services became near-universal over the next decade, with 96 percent of the households having at least one member who used the service. Suri and Jack (2016) find that financial inclusion had a quantitatively significant impact on savings, which also led to consumption growth and poverty alleviation. Total financial savings (cash and balances in accounts, savings clubs, and mobile money) increased with access, and the effects were more potent in female-headed households. In another study conducted in the same country, Dupas and Robinson (2013) randomized access to non-interest-bearing bank accounts among self-employed individuals. A substantial share of female market vendors used their accounts and managed to build up savings, which helped them increase their investment expenditure. However, the evidence of inclusion leading to higher savings is far from perfect, and the inclusion-savings link is very context-specific. For instance, randomized access to bank accounts was also provided to self-employed bicycle-taxi drivers in the Kenyan experiment. In most cases, the drivers were men. The study found no statistical impact of access on the saving behavior of these self-employed workers. In another study, rural individuals in three countries—Malawi, Uganda, and Chile—were offered basic account services for free.206 The focus was to isolate the effect of safekeeping benefits on saving behavior. As such, these accounts provided low interest on deposits. The rate of account opening was high in the two African countries. In contrast, less than 20 percent of the treatment households opened an account in Chile. Among the unbanked who participated, the share of active users was marginal in each country. Bank balances increased in Malawi and Uganda. Unsurprisingly, the effects were larger for active users. However, the increase in bank balances was not associated with a corresponding rise in aggregate savings. Approximately half of the expansion was coming from users converting their informal savings into formal. The increase in total savings was quantitatively meaningful (from 20 to 26 percent) for active users. Yet, there was no evidence that financial access led to statistically significant changes in business inventory or investments in education and health. Why did financial access exert only marginal effects on savings and resulting outcomes? A primary explanation is that financial exclusion is often voluntary. Like in Cambodia, nearly 90 percent of the households in Malawi and Uganda reported not using the accounts because they did not have enough surplus. In Chile, the universality of store credit and a functioning social safety program reduces the need for formal savings. Though playing a secondary role, barriers exist in Malawi and Uganda that make exclusion involuntary (distance to banks, low interest in the presence of high inflation). Finally, the absence of treatment effects could be due to the small scale of intervention, as any general equilibrium effects continue to be dormant. In India, where a large-scale program extended account access to 255 million of the unbanked population, regions with low banking presence ex-ante experienced an increase in aggregate lending.207 In summary, providing access to finance can be a powerful tool for encouraging savings and promoting investment growth. However, this inclusion-savings-investment link is sensitive to the contextual factors that lead households into the unbanked territory. CHAPTER 3: 84 FINANCING THE NEXT PHASE OF GROWTH Financial inclusion suffers from both FIGURE 3.20 voluntary and involuntary barriers Financial sector issues are among the top reasons cited for not banking… A variety of factors are responsible for the low Reason for no financial account, 2017 financial inclusion in the country, many relating to the financial sector. Ultimately, these different reasons Insufficient funds for lower financial inclusion impede efficient allocation of credit, which drags down productivity growth, and ultimately Documentation requirements savings. However, the insufficiency of funds is by far the Too far most prevalent reason, with nearly three in every four adults citing it as a barrier (figure 3.20). Households do not have Too expensive any surplus left since almost all income is spent on meeting Lack of trust in financial institutions subsistence requirements. Analysis of the World Bank CSES data reveals that saving depends heavily on the availability Religious reasons of household resources, which makes saving considerably Someone in the family has an account arduous for lower-income households. The bottom four income deciles reported having no savings in 2009. The No need for financial services situation has improved since then, and only the bottom- 0 15 30 45 60 75 most decile was without any savings in 2017. Still, savings is highly skewed. Nearly one in every two households in Percent of adult population the top decile had some savings in 2017. In contrast, the Source: World Bank staff calculations using data from World Bank Findex corresponding share for the fifth and sixth decile ranges Database. between 10-15 percent (see box 3.3 for more details). While this constraint will dissipate as Cambodia develops, other fators related to the fiancial sector explain low financial FIGURE 3.21 inclusion. Many adults report not having an account …posing a larger constraint in Cambodia than in because of religious reasons or because someone in the other countries household already had one. Such voluntary non-ownership Percent of adults with an account, 2011-17 is not a barrier to saving, and non-lending mechanisms 80 might be more effective in addressing these concerns. Yet, not all of the financial exclusion in Cambodia is voluntary. 70 Documentary requirements and distance to financial institutions prevent a third of adults from participating in 60 Percent of adult population the formal sector. One in every four adults also foregoes opening an account because of the direct costs of availing 50 banking services, with lack of trust also among the top five 40 reasons for not having a financial account. 30 Involuntary barriers to financial inclusivity in Cambodia are higher than in many other countries. 20 More than 30 percent of adults report lack of documentation as a binding constraint to account ownership in Cambodia. 10 On average, only 18-20 percent of adults in developing, 0 low-middle-income, and EAP economies cite this reason Cambodia Developing Lower middle East Asia (figure 3.21). Distance to financial institutions is also a income and Pacific concern for 30 percent of Cambodian adults, a figure which is 7-10 percentage points higher than the other country Insufficient funds Documentation requirements groups. On average, the cost of ownership is as prohibitive Too far Too expensive in Cambodia as in other developing countries. The country Source: World Bank staff calculations using data from World Bank Findex lags marginally behind the lower-middle-income country Database. average but substantially lower relative to EAP economies. RESILIENT DEVELOPMENT: 85 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Opening a deposit account requires satisfying Distance to financial institutions raises the cost of documentary requirements that are deceptively engaging in formal savings methods and is among benign. Many residents face difficulties in presenting the primary reasons behind not owning an account official IDs, often an essential document for opening an (figure 3.20). The econometric analysis of the World Bank account. National IDs are not ubiquitous, which compounds CSES microdata provides further support for the above the problem. Around 11.5 percent of the population finding. Specifically, a one-kilometer increase in distance does not have a national ID. This share is higher than in to a bank decreases a household's savings rate by 2-3 all comparators except Bangladesh and Lao People’s percentage points. According to the FinScope data, for over Democratic Republic (Lao PDR) (figure 3.22). As yet, there half of the nation's population, the time to reach the nearest is no digital ID application, making procurement even formal financial services provider exceeds 30 minutes. more burdensome. Filing a formal application for a deposit Anecdotal reports also suggest that branches of commercial account demands a certain level of literacy that may also and specialized banks and MDI branches are mostly located create obstacles for some segments of the population, near the urban areas. For example, the largest Cambodian especially in rural areas. MFI, PRASAC Microfinance Institution, collected US$1.8 billion in deposits in 2019. However, only a small share of it came from rural areas, with Phnom Penh contributing 80 FIGURE 3.22 percent alone. As such, the rural use of formal financial A large share of Cambodia’s population does not have services remains scarce. a national ID Percent of population without a national ID, 2017 Lower confidence in the financial system may be a possible reason why households refrain from Thailand depositing with formal institutions. According to the World Bank Findex survey, nearly 20 percent of adults cite India mistrust as a reason for not owning an account (figure Malaysia 3.20). Policies that would aid financial sector stability are not in place yet. Except for Myanmar, Cambodia is the only Viertnam Association of Southeast Asian Nations (ASEAN) nation that Indonesia does not have a deposit protection fund. Myanmar The inability to understand the benefits of formal savings instruments impedes household participation. Cambodia The lack of financial literacy is a concern for Cambodia. Bangladesh A 2016 survey placed the country last in financial literacy compared to 30 other countries. While the nations in the Lao PDR comparator sample consist primarily of Organisation for 0 10 20 30 40 50 60 Economic Co-operation and Development (OECD) countries, Percent of population Cambodia performed worse than some other ASEAN countries like Vietnam with a prevalent informal saving Note: Data not available for Philippines. behavior. Relatedly, the analysis of the World Bank CSES Source: World Bank staff calculations using data from World Bank Findex data shows that saving is associated with education, as Database. households headed by more educated members are more likely to save. Thus, Cambodia's low level of human capital might also be accountable for its low private savings. Digital financial services (DFS) that can help overcome challenges associated with the direct and the indirect costs of account ownership remain nascent. Currently, DFS are limited to payment services, and products enabling borrowing, saving, or lending remain largely absent. Weak infrastructure also make the adoption of DFS arduous. While 70 percent of Cambodians without a bank account have access to a mobile phone, only a third of them have access to the internet via their phones (figure 3.23). CHAPTER 3: 86 FINANCING THE NEXT PHASE OF GROWTH FIGURE 3.23 and makes informal methods more attractive, in case DFS remain nascent income from them is either not subject to the same tax structure or escapes tax enforcement. Still, the tax rate Percent of adults with a mobile phone and internet access via on deposit interest remains low but can potentially be a mobile phone, 2017 removed altogether. Barring Indonesia, the Phillippines, 80 and Thailand, the tax policy in all other ASEAN countries exempts residents' interest income from taxation. 208 70 60 Non-bank financial instruments remain largely undeveloped Percent of adults 50 40 Financial instruments—bonds, insurance, etc.—that originate outside banks and MDIs/MFIs are still in 30 their early stages of development. Except for the few issuances of corporate bonds in 2019, the debt market 20 remains inert. The idleness is not only restricted to the 10 corporate sector but extends to government issuances as well. Large investment thresholds and high transaction 0 costs of the debt instruments reduce their viability. These Mobile phone Mobile phone with internet markets also lack liquidity and do not allow for a benchmark Yes No yield curve against which other retail savings products can be priced. As a result, the predictability of returns and the Source: World Bank staff calculations using data from World Bank Findex Database. term profile of debt issues remain low. This makes it difficult for investors to assess the relative returns of the various offerings, leaving debt instruments an underdeveloped Tax policy and banking sector regulation channel for long-term savings in Cambodia. create distortions that favor the informal sector While Cambodia's insurance market has experienced rapid growth since 2016, its size continues to be Formal institutions have to compete with the marginal. Insurance has the potential to substitute unregulated informal savings sector. Community precautionary informal savings instruments like keeping savings groups (for example, Tong Tin), village cash as contingency or holding non-financial assets moneylenders, and door-to-door bankers offer similar that help mitigate shocks to income. Yet, the aggregate services and offer a more competitive interest rate partly value of collected insurance premiums accounts for only because they are not subject to regulations. However, 0.5 percent of financial sector assets. Participation in the higher interest rate conceals the incremental risks insurance schemes is limited, as only 5 percent of adults of such instruments. The informal financial sector often report using them. However, like with savings, the absence engages in predatory lending and charges an extreme rate of insurance take-up is not entirely involuntary. Around 35 on its lending, which makes servicing loans difficult and percent of adults have no insurable assets and, as such, raises the likelihood of defaults. Thus, savers are always have no real demand for insurance products. at risk of losing their savings should an informal group be precipitated by defaults. Relative to formal institutions, the The social security system is still in its planning informal sector offers simplified loan procedures together stage, and its successful roll-out requires substantial with less stringent documentary requirements, making work. Contributions to social security programs can them a convenient one-stop location for financial services. serve as an instrument of domestic savings. Economic theory suggests that myopic individuals fail to save for Taxes on interest income might discourage the retirement period, even when pension benefits do not households from using formal savings instruments offer a superior rate of return relative to other investments. and drive them towards the informal sector. Residents Cambodia has made progress towards satisfying the initial are subject to a 4 percent tax on interest income earned requirements. For instance, the recently enacted Social via savings accounts, and income from fixed deposits is Security Law establishes the principles and mechanisms liable to a 6 percent tax. For non-residents, a tax rate of that will execute a social security system for pensions 14 percent is levied on interest income, regardless of the beyond the public sector employees, though the scheme savings vehicle. The taxation distorts saving decisions is not yet implemented. RESILIENT DEVELOPMENT: 87 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Weakness in enterprise savings might also Though relatively modest, FDI outflows have been be a bottleneck increasing over the years. This may suggest that savings by firms is increasingly flowing out. Even as the country Lack of data on the savings made at private benefitted from increased FDI inflows, a share of capital enterprises makes it difficult to evaluate the role has left the Cambodian shores in search of investment of corporate savings in keeping aggregate savings opportunities abroad. The country reports substantially lower depressed. Nonetheless, robust enterprise savings growth rates of FDI outflows compared to Malaysia, the Philippines, can help the country achieve its financing requirements, and Thailand, but outflow growth outpaces many other thereby boosting growth. Corporate savings have the comparator countries. More concerning is the fact that potential to provide an impetus to economic expansion in the outflows have been growing over time. The average developing economies. For instance, as a share of GDP, share increased from almost nothing during 2000-09 to private enterprise savings in India grew to 7.9 percent just about half a percent of GDP during 2015-19 (figure during 2008-11 from a paltry 3.9 percent during 1997- 3.24). In contrast, FDI outflows have either been shrinking 2003.209 The surge in savings coincided with the rapid rise or growing much slower in other comparator countries. It is in economic activity elsewhere. Productivity growth enables possible that these flows are originating from the surplus firms to become more profitable, which generates business generated at private enterprises. If so, steps should be taken surpluses. Hence, business savings may be underperforming to uncover the factors that drive these resources across the potential in Cambodia, given that the overall productivity borders so that appropriate responses could be designed. levels remain dampened (as discussed in Chapter 1). Policy recommendations for raising FIGURE 3.24 FDI outflows have been growing finance FDI outflows, 2000-19 Higher investment rates are needed in the range seen in the Republic of Korea for Cambodia to progress Myanmar towards its growth targets. A number of policy areas can help Cambodia increase investment needed to finance Bangladesh the next phase of growth. These include promoting FDI into productive and export sectors; promoting higher domestic Lao PDR savings rates; improving financial inclusion through greater Indonesia access to savings institutions; supporting digital access through digital technologies; lowering the costs of savings India accounts; and supporting financial sector stability and development more broadly. Policy measures in each of Cambodia these areas focus on improving capabilities, strengthening regulations, and investing in infrastructure. Philippines Malaysia Promote FDI into productive and export sectors Thailand While FDI has supported capital accumulation in the past, Cambodia will need to promote inflows into -1 0 1 2 3 4 5 productive and export-oriented sectors to achieve FDI outflows (percent of GDP) the maximum impact in the next phase. Although attracting FDI at the levels needed to sustain future growth 2000-04 2005-09 2010-14 2015-19 will become more difficult, FDI can nevertheless continue Source: World Bank staff calculations using data from IMF Balance of to play an important role in Cambodia’s gross fixed Payments and International Investment Position Statistics. capital formation going forward. As discussed in previous chapters, measures that improve the business environment and investment climate can reduce the cost of operating a business for firms and can also help attract more and better FDI into desired sectors. And doing so will also help Cambodia take advantage of its recently signed FTAs and increase FDI-led exports to these markets. CHAPTER 3: 88 FINANCING THE NEXT PHASE OF GROWTH In the short term, Cambodia could enforce property In the short term, expanding and strengthening an and unused land taxes to curb rising land and property agent-based model can improve access for rural speculation. It is critical to limit speculative investments in populations, an initiative that could be led by the land and property that create sharp increases in the price National Bank of Cambodia. In the agent-based banking of real estate. This, in turn, increases the costs of operating model, licensed institutions engage third parties to offer a business, which discourages investors from undertaking certain banking services on their behalf. These third-party new projects, or in the extreme case abandoning the agents are generally retail outlets and include pharmacies, existing ones. Enforcing taxes on property and land can supermarkets, convenience stores, lottery outlets, and post prove effective, which could be considered by the Ministry offices, among other channels. The recent pilot initiatives of Economy and Finance. aiming to expand access to locations distant from branches via the agent-based banking model have delivered mixed Promote higher domestic savings rates results. However, a comprehensive framework to implement the agent-based model has not yet been introduced, nor The experiences of the Republic of Korea and Malaysia has the National Bank of Cambodia developed the set show that higher domestic savings rates can support of regulations that will guide the use of the model in the higher and sustained investment. While income microfinance sector. Results of agent-based banking models dynamics will be key to growing Cambodia’s private savings can be improved by having the National Bank of Cambodia rate, several policy measures could help boost domestic establish a clear and comprehensive framework and set of savings rates. Doing so would also provide households regulations for agent-based banking in the microfinance immediate relief and resilience to income shocks like those sector. caused by Covid-19. Establishing rules to regulate informal finance can Saving campaigns and reminders can serve as cost- raise financial inclusion, thereby bolstering formal effective measures to boost savings, both through savings. By instituting a clear and comprehensive formal and informal instruments. This is a medium-term framework in the short term that will monitor the agent- policy priority that could be led by the Ministry of Economy based banking model in the microfinance sector, the and Finance. For instance, a field experiment in Colombia National Bank of Cambodia can lay a fertile ground for the shows that saving reminders had a persistent effect on the practice to propagate. Similarly, implementing a framework behavior of low-income youth.210 Their account balances in the short term to regulate the operations of Community increased as a result, with no depletion seen in the post- savings groups to protect their members will lift households' campaign period. confidence. Proposals to mandate the registration of savings groups beyond a certain threshold (having more than 50 Efforts to improve financial literacy will help promote members and more than US$6,250 and US$25,000 in domestic savings. Cambodia should provide financial group capital and loan portfolio) with the Ministry of Rural literacy to its citizens through increased financial education, Development have already been put together in a draft law. financial planning, and promoting savings mechanisms and However, the articles that will regulate such groups post- products. The Ministry of Education, Youth, and Sports can registration still need to be designed. play a vital role by incorporating financial literacy into the school curriculum. The literacy program, due to its nature, Financial literacy can also spur the adoption of formal will need a longer time horizon. savings vehicles and financial inclusion. Households are more likely to employ formal savings instruments if Improve access to savings institutions they fully comprehend the benefits of using formal finance. Development and dissemination of materials explaining Improved access to savings institutions can support the practical details of leasing, mobile banking, and using greater formal financial savings. For rural populations, new technologies will help households gain familiarity with physical access to savings institutions remains largely these instruments, which are novel for them. Furthermore, limited to those who can regularly travel to urban areas to literacy efforts that are being undertaken by the National use formal MDIs, while others generally resort to informal Bank of Cambodia, Association of Bankers Cambodia, and savings mechanisms. Anecdotally it appears that even the Cambodia Microfinance Association that target low-income province and district-level branches are largely in urban and rural clients need to be supported and supplemented. areas. This is a medium-term policy priority. RESILIENT DEVELOPMENT: 89 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Support digital access through digital technologies Policy reform can reduce the documentary burden of opening an account. Allowing students to open their Digital technology can serve as a powerful tool for accounts using their school IDs will reduce the documentary expanding financial access. Such measures have burden on the younger population. Letting parents use their been effective in driving savings in other countries. For IDs to open accounts on behalf of their children till the latter instance, women-headed households in Kenya raised their obtain their IDs will have a similar effect. For the general savings by 20 percent after being given access to mobile population, the documentary handicap can be alleviated money.211 Moreover, Covid-19 has impressed the need of by extending validity to any photo-document issued by faster digital adoption. Development of the digital financial the local/national authority. These extensions need not be system can more broadly support Cambodia’s economy permanent and can serve as a stop-gap arrangement until (beyond savings) in a post-Covid-19 world. And Malaysia’s national IDs become ubiquitous. Financial institutions can earlier postal savings system shows how improved access also make provisions for annual account reviews that use can be successful at increasing savings with a system that these interim relaxations. However, universal national ID attracted multitudes of small savers by giving them secure coverage should be the ultimate goal in the medium term. and convenient access. The integration of digital identity authentication mechanisms into the national ID system can help expand the coverage In the short term, Cambodia can aim to develop a and should be explored accordingly. legal framework that will regulate DFS operations. Confidence in DFS is impacted by an inadequate consumer Support financial sector stability payment and protection framework. As such, hesitancy on the part of households endures and prevents them Domestic savings can increase with the stability of from embracing the technology. The framework should the financial sector. There have been no major systemic ensure that customers' funds in e-money meet protection disruptions or institutional bankruptcies in the recent past standards. The framework needs to put in provisions that to exacerbate distrust. The National Bank of Cambodia allow deposit-taking institutions to pursue digital savings supervises and regulates all operating banks, MDIs, and partnerships with nonbank entities. Regulations can also MFIs. It has taken action to respond to a rapid credit permit retail agent networks to provide limited-purpose expansion, high borrower indebtedness, and multiple loans digital banking services. This is an agenda to be led by the in the past few years including with the interest rate cap National Bank of Cambodia. policy in 2017. Nevertheless, further efforts are needed to continue strengthening financial sector stability. These will In the medium term, sustained efforts are needed to also make the system more robust to shocks and should be develop the interoperability channels of DFS. Non-bank a key priority in building economic resilience in the aftermath issuer-to-bank interoperability constitutes the backbone of of Covid-19. Moreover, ensuring macroeconomic stability digital savings partnerships and distribution strategies, but can also promote savings. In addition to ensuring security of such infrastructure is currently lacking. Here, Cambodia, banks (and making them more convenient to small and rural with the National Bank of Cambodia in the lead, should savers), low inflation in Malaysia, Indonesia, and Thailand support the development of nonbank e-money issuer-to- provided a foundation for high and rising savings rates. bank interoperability. Establishing a national deposit protection fund and Address financial and administrative costs of enacting the related laws to regulate it will make the savings accounts / products sector more stable. This is a short-term priority led jointly by the Ministry of Economy and Finance and the National Easing financial and administrative costs will reduce Bank of Cambodia. Establishing a deposit protection fund the indirect costs of owning accounts and using other comes under the crisis preparedness regime, which is formal savings products and may prompt households currently being developed for the consideration of the to participate more. Although requirements do not National Financial Stability Committee. A feasibility study appear particularly burdensome, there is nevertheless an has been commissioned to recommend the organizational opportunity to make small, short-term adjustments that structure and modalities (including coverage, funding, fees, could be led by the National Bank of Cambodia. etc.) of an appropriate deposit protection fund for banks and MDIs. Legislative planning to regulate the deposit protection fund is also underway for consultations with policymakers. CHAPTER 3: 90 FINANCING THE NEXT PHASE OF GROWTH Similarly, efforts at strengthening the crisis bonds in 2022 to boost the local bond markets and initiate preparedness regime for the whole financial sector the yield curve. Deepening the corporate bond market can are another short-term priority led by the Ministry follow the successful roll-out in the government sector. In of Economy and Finance and the National Bank addition to the legal framework, the Royal Government of of Cambodia. Annual crisis simulation exercises are Cambodia (RGC) should consider revising the institutional conducted irregularly and the last such joint exercise by the arrangement for debt management functions both regarding Ministry of Economy and Finance and the National Bank of bond issuance and market operations including clearing Cambodia was in 2013. The joint simulation exercises need and settlement processes. For a successful issuance, it to be done more frequently, potentially annually. These steps is advisable to understand demand for government bonds can be undertaken in the next couple of years. Thailand, in the market (like clientele / investor base, currency for example, imposed several regulations to enhance the denomination, tenor, pricing, size, etc.) through a market solvency of financial institutions, which improved both the survey conducted by either the Ministry of Economy and savings rate and the efficiency of resource allocation, and Finance or the National Bank of Cambodia. introduced the Government Saving Bank with a special focus on kids and students that guaranteed savings accounts. Second, it will be important to wrap up the Sub-decree on the micro-insurance industry. This is a short-term Other policies to support financial sector stability priority led jointly by the Ministry of Economy and Finance include enhancing the regulatory and supervisory and the National Bank of Cambodia. The Ministry of Economy framework, improving the financial reporting system, and Finance is taking steps to promote insurance adoption and developing good corporate governance practices. in the country. These include issuing a basic framework These actions require a long-term horizon. for the licensing and regulation of micro-insurance. Doing so will bolster the regulatory and supervisory regime and Support financial sector development more broadly will build confidence as policyholders feel more protected. Furthermore, there have been discussions regarding Addressing gaps in the regulatory environment can expanding the distribution channel, so the needs of lower- support financial sector development more broadly, income households are better served. Insurance take-up can allowing other options to grow domestic savings further be enhanced by broadening the range of insurance outside of banks and MDI/MFIs. These include reforms products and expanding these distribution channels. in the bond and insurance markets, together with the expansion of Social Security policies. Third, the RGC should also aim to finalize the sub- regulation details of the new Social Security Law First, Cambodia should implement the legal that are a prerequisite for its implementation. The framework for government bonds as planned. This is country needs to push through the next stages, starting with a short-term priority led jointly by the Ministry of Economy finalizing the sub-regulations of the pension program in the and Finance and the National Bank of Cambodia. Both short term, which could be led by the Ministry of Labour and corporate and government bond activity is sluggish in the Vocational Training. A longer-term objective could be to set country. Implementing the legal framework guiding public up a voluntary provident retirement fund that fosters regular bond issuance will likely catalyze the broader debt market. A savings of longer duration. The Malaysian government, for reasonable strategy to ignite the activity will be to start with example, used compulsory pension plans to boost domestic improving the market infrastructure surrounding the debt savings. Offering tax incentives to participants can make the market. Plans are already underway to re-issue government voluntary program attractive. RESILIENT DEVELOPMENT: 91 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Promote FDI and savings to finance the next phase of growth Objective Improving capabilities Strengthening regulations Investing in infrastructure Promote Enforce property and unused land FDI into taxes to curb rising investment in productive land and property speculation [ST; and export MEF] sectors Promote Jointly provide financial literacy, Undertake a campaign to promote higher financial education, and financial higher savings [MT; MEF & NBC] domestic planning to Cambodians through savings increased financial education; rates promote savings mechanisms and products by incorporating financial literary education into the curriculum and textbooks of schools under the purview of the Ministry of Education, Youth, and Sports [MT; MOEYS] Improving Improve understanding of the Establish a regulatory framework Expand and strengthen agent- access to benefits of formal savings for community savings groups to based banking models by having savings including: (i) developing financial protect their users, including how the National Bank of Cambodia institutions literacy materials on leasing, these groups will be regulated once establish a clear and comprehensive mobile banking, and use of new they are registered with the Ministry framework and set of regulations technologies for access to finance; of Rural Development [ST; MRD & for agent-based banking in the and (ii) supporting the efforts of NBC] microfinance sector [ST; NBC] the National Bank of Cambodia, Association of Bankers Cambodia, and Cambodia Microfinance Association for financial literacy to clients, particularly low-income clients and those in rural areas [MT; NBC] Support Develop legal and regulatory Support the development of digital frameworks that: (i) ensure nonbank e-money issuer-to- access customer funds protection standards bank interoperability, which is the through are robust for bank deposits and technological backbone for digital digital e-money accounts; and (ii) allow savings partnerships and distribution technologies deposit-taking institutions to pursue strategies [MT; NBC] digital savings partnerships with nonbank entities and conduct limited purpose banking services through retail agent networks [ST; NBC] CHAPTER 3: 92 FINANCING THE NEXT PHASE OF GROWTH Objective Improving capabilities Strengthening regulations Investing in infrastructure Address Allow students to open an account financial with their own ID document or allow and parents to open an account on administrative behalf of their children; allow any costs of photo-document issued by local / savings national authorities to be used for accounts opening a retail deposit account, and with annual review until the national products ID is issued [ST; NBC] Expand national ID coverage so more people can meet financial account documentary requirements, which includes exploring the integration of digital identification authentication mechanisms into the national ID system [MT; NBC] Support Establish a national, functioning financial deposit protection fund and enact sector the associated laws and regulations stability to regulate it [ST; MEF & NBC] Strengthen the crisis preparedness regime for the whole financial sector with annual joint crisis simulation exercises [ST; MEF & NBC] Enhance the regulatory and supervisory framework; improve the financing reporting system; develop good corporate governance practices [ST; MEF & NBC] Support Implement the legal framework for Consider setting up a voluntarily financial government bonds as planned [ST; provident retirement fund for regular sector MEF & NBC] long-term savings with some development attractive tax incentives [MT; MLVT] Promulgate the Micro-insurance more Sub-decree to strengthen the broadly regulatory and supervisory regime, broaden insurance products, expand distribution channels, and protect policyholders [ST; MEF & NBC] Finalize sub-regulations of the new Social Security Law that supports its implementation [ST; MLVT] Note: ST=short term; MT=medium term. MEF=Ministry of Economy and Finance; MLVT=Ministry of Labour and Vocational Training; MOEYS=Ministry of Education, Youth, and Sports; MRD=Ministry of Rural Development; NBC=National Bank of Cambodia. RESILIENT DEVELOPMENT: 93 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Endnotes 185 World Bank (2018a). 186 Jeong (2017). 187 Similarly, developments that have nothing to do with Cambodia can also lead to temporary loss of specific exemptions. While not directly impacting FDI, such events destabilize the economy and may discourage FDI if managing the impending volatility becomes arduous. In early 2019, the EU re-introduced temporary import duties on rice from Cambodia and Myanmar. The decision was motivated based on a significant increase in Indica rice imports that caused economic damage to European producers. 188 IMF (2020c). 189 Samreth, Sánchez Martín, and Ly (2019). 190 Ahmed, Kim, and Suphaphiphat (2014). 191 Lane and Milesi-Ferretti (2011). 192 Benigno et al. (2020). 193 International Monetary Fund (2020a). 194 Deposits in the banking sector should not be used to proxy for savings. This is because only a fraction of deposits into individuals’ or firms’ accounts represent savings. 195 Complete documentation on the Long-Term Growth Model is available at www.worldbank.org/LTGM/. 196 Blundell and Bond (1998). 197 The deposit rate does not empirically explain the savings rate in Cambodia, consistent with global empirical evidence as well as the ambiguous theoretical prediction, based on offsetting substitution, income, and human-wealth effects (Grigoli, Herman, and Schmidt-Hebbel 2018). The nominal rate of return on KHR and US dollar deposits has been relatively stable at around 6 percent and 4.5 percent, respectively. Banks have cut into their interest margins in recent years by lowering the lending rate and maintaining the deposit rate. This suggests neither a lack of competition nor too much competition, but rather a fairly efficient market for deposits where pricing is being set broadly in line with reference (lending) rates. 198 The cross-country analysis of savings determinants looked at a range of variables in addition to the traditional controls in Grigoli, Herman, and Schmidt-Hebbel (2018) based on savings literature including: current account balance, capital account openness, inequality, unemployment rate, public health and education expenditure, government debt, trade openness, trade taxes, real interest rate, bank branches, bank concentration, bank deposits, life insurance, MFI credit, MFI deposit and loan accounts, MFI branches, among others. Following Grigoli, Herman, and Schmidt-Hebbel (2018) these were interacted with a dummy variable for Cambodia, indicating whether their impact on saving behavior differed for Cambodia than the global or regional average. Results were not significant except for those mentioned above. 199 Loayza, Schmidt-Hebbel, and Servén (2000) and Grigoli, Herman, and Schmidt-Hebbel (2018). 200 Ramey and Ramey (1995). 201 Yeyati (2006). 202 Krugman (1999), Organsation for Econmic Co-operation and Development (2001), and Hausmann and Velasco (2005). 203 Dynamic panel-data analysis (box 3.3), which uses data from 111 countries, finds no evidence of a statistical negative relationship between dollarization and savings. While this finding is robust to several specifications, it should be treated with caution. Bringing dollarization under analysis leads to a significant loss of information (~2/3 relative to Grigoli, Herman, and Schmidt-Hebbel (2018)) due to data availability. Some variables that are significant in the original dataset lose their statistical power in the reduced sample. 204 Kansiime et al. (2020). 205 See Kim (2001) for a comprehensive list. 206 Dupas et al. (2018). CHAPTER 3: 94 FINANCING THE NEXT PHASE OF GROWTH 207 Agarwal et al. (2017). 208 Deloitte (2020). 209 Mohan (2019). 210 Rodríguez and Saavedra (2019). 211 Suri and Jack (2016). RESILIENT DEVELOPMENT: 95 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL References Acemoglu, A., S. Johnson, and J. Robinson (2004). “Institutions as the Fundamental Cause of Long-Run Growth.” NBER Working Paper No. 10481, National Bureau of Economic Research, Cambridge, MA. Agarwal, S., S. Alok, P. Ghosh, S. Ghosh, T. Piskorski, and A. Seru (2017). “Banking the Unbanked: What do 255 million new bank accounts reveal about financial access?” Research Paper No. 17-12, Columbai Business School, New York, NY. Ahmed, F., J. Y. Kim, and N. Suphaphiphat (2014). “What Can Go Wrong? Shifting vulnerabilities as Asia rebalances.” In O. Unteroberdoerster (Ed.), Cambodia: Entering a New Phase of Growth, Washington, DC: International Monetary Fund. Arnold, J. M., B. Javorcik, M. Lipscomb, and A. Mattoo (2016). “Services Reform and Manufacturing Performance: Evidence from India.” The Economic Journal, 126(590): 1-39. Arnold, J. M., A. Mattoo, and G. Narciso (2008). “Services Inputs and Firm Productivity in Sub-Saharan Africa: Evidence from Firm-level data.” Journal of African Economies, 17(4): 578-99. ASEAN Secretariat and World Bank (2015). ASEAN Services Integration Report. Washington, DC: World Bank Group. Baldwin, R. E., and R. Forslid (2019). “Globotics and Development: When manufacturing is jobless and services are tradable.” NBER Working Paper No. 26731, National Bureau of Economic Research, Cambridge, MA. BDlink (2017). “Taking Stock: A detailed review of agriculture challenges and opportunities in Cambodia.” EuroCham Cambodia, Phnom Penh, Cambodia. Balino, T., A. Bennett, and E. Borensztein (1999). “Monetary Policy in Dollarized Economies.” IMF Occasional Paper No. 171, International Monetary Fund, Washington, DC. Barro, R. (1991). “Economic Growth in a Cross-Section of Countries.” The Quarterly Journal of Economics, 106(2): 407-43. Barro, R., and J.-W. Lee (2021). “A New Data Set of Educational Attainment in the World.” Available at https://barrolee.github. io/BarroLeeDataSet/OUP/OUP_proj_MF1564_v1.xls/. Barseghyan, L. (2008). “Entry Costs and Cross-Country Differences in Productivity and Output.” Journal of Economic Growth, 13(1): 145-67. Benigno, G., A. Foerster, C. Otrok, and A. Rebucci (2020). “Estimating Macroeconomic Models of Financial Crises: An endogenous regime-switching approach.” NBER Working Paper No. W26935, National Bureau of Economic Research, Cambridge, MA. Blundell, R., and S. Bond (1998). “Initial Conditions and Moment Restrictions in Dynamic Panel Data Models.” Journal of Econometrics, 87(1): 115-43. Bordey, F., P. Moya, J. Beltran, and D. Dawe (2016). “Competitiveness of Philippine Rice in Asia.” Philippine Rice Research Institute, Los Baños, Philippines. Cadot, O., and M. Malouche (2012). Non-Tariff Measures: A Fresh Look at Trade Policy’s New Frontier. Washington, DC: World Bank Group. Caselli, F. (2005). “Accounting for Cross-Country Income Differences.” In P. Aghion and S. Durlaud (Eds.), Handbook of Economic Growth Volume 1a, Amsterdam: North Holland Publishing Company. Chang, R., L. Kaltani, and N. Loayza (2009). “Openness Can Be Good for Growth: The role of policy complementarities.” Journal of Development Economics, 90(1): 33-49. Chenery, H. B. (1960). “Patterns of Industrial Growth.” American Economic Review, 50(1): 624-54. Crane, B. (2016). “The Studio Drawing in World-Class Animators.” The Phnom Penh Post, May 17, 2016, available at https:// www.phnompenhpost.com/post-weekend/studio-drawing-world-class-animators/. Cusolito, A., and W. Maloney (2018). Productivity Revisited: Shifting paradigms in analysis and policy. Washington, DC: World Bank Group. Cusolito, A., R. Safadi, and D. Taglioni (2016). Inclusive Global Value Chains: Policy options for small and medium enterprises and low-income countries. Washington, DC: World Bank Group. RESILIENT DEVELOPMENT: 96 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Dall'Olio, A., M. Iootty, N. Kanehira, and F. Saliola (2013). “Productivity Growth in Europe.” Policy Research Working Paper No. 6425, World Bank, Washington, DC. Deloitte (2020). “International Tax: Cambodia tax highlights 2020.” Deloitte Touche Tohmatsu, London, United Kingdom. Diaz-Ros, L., and S. Jaffee (2013). “Raising Competitiveness via Sustainable Practices and Product Differentiation in Agricultural Value Chains: Lessons for Vietnam from public-private initiatives in other middle-income country experiences.” World Bank, Washington, DC. Divanbeigi, R., and R. Ramalho (2015). “Business Regulations and Growth.” Policy Research Working Paper No. 7299, World Bank, Washington, DC. Djankov, S., C. McLiesh, and R. M. Ramalho (2006). “Regulation and Growth.” Economic Letters, 92(3): 395-401. Duggan, V., S. Rahardja, and G. Varela (2016). “Services Sector Reform and Manufacuring Productivity: Evidence from Indonesia.” Policy Research Working Paper No. 6349, World Bank, Washington, DC. Dupas, P., D. Karlan, J. Robinson, and D. Ubfal (2018). “Banking the Unbanked? Evidence from three countries.” American Economic Journal: Applied Economics, 10(2): 257-97. Dupas, P., and J. Robinson (2013). “Savings Constraints and Microenterprise Development: Evidence from a field experiment in Kenya.” American Economic Journal: Applied Economics, 5(1): 163-92. Dutz, M., I. Kessides, S. O’Connell, and R. Willig (2011). “Competition and Innovation-driven Inclusive Growth.” Policy Research Working Paper No. 5852, World Bank, Washington, DC. Easterly, W., and R. Levine (2001). “It’s Not Factor Accumulation: Stylized factors and growth models.” The World Bank Economic Review, 15(2): 177-219. Easterly, E., and R. Levine (2003). “Tropics, Germs, and Crops: How endowments influence economic developments.” Journal of Monetary Economics, 50(1): 3-39. Echandi, R., J. Krajcovicova, and C. Z. Qiang (2015). “The Impact of Investment Policy in a Changing Global Economy: A review of the literature.” Policy Research Working Paper No. 7437, World Bank, Washington, DC. Fernandes, A. M., and C. Paunov (2012). “Foreign Direct Investment in Services and Manufacturing Productivity: Evidence for Chile.” Journal of Development Economics, 97(2): 305-21. Fontagné, L. (1999). “Foreign Direct Investment and International Trade: Complements or substitutes?” Working Paper No. 1999/03, Organisation for Economic Co-operation and Development, Paris. Frederick, S. (2018). “Apparel Skills Mapping and Functional Upgrading in Cambodia: Jobs diagnostic.” World Bank, Washington, DC. Gootiiz, B., and A. Mattoo (2015). “Regionalism in Services: A study of ASEAN.” Policy Research Working Paper No. 7498, World Bank, Washington, DC. Grigoli, F., A. Herman, and K. Schmidt-Hebbel (2018). “Saving in the World.” World Development, 104(1): 257-70. Hall, R. E., and C. I. Jones (1999). “Why do Some Countries Produce So Much More Output Per Worker than Others?” The Quarterly Journal of Economics, 114(1): 83-116. Hausmann, R., and A. Velasco (2005). “The Causes of Financial Crises: Moral failure versus market failure.” In M. A. Centeno, H. James, and J. Londregan (Eds.), The Political Economy of Recurrent Debt, Princeton, NJ: Princeton University Press. Hidalgo, C. A., and R. Hausmann (2009). “The Building Blocks of Economic Complexity.” Proceedings of the National Academy of Sciences of the United States of America, 106(26): 10570-5. Hoekman, B., and A. Mattoo (2008). Services Trade and Growth. Washington, DC: World Bank Group. Hoekman, B., and A. Mattoo (2011). “Services Trade Liberalization and Regulatory Reform: Re-invigorating international cooperation.” World Bank, Washington, DC. Hoekman, B., and A. Mattoo (2013). “Liberalizing Trade in Services: Lessons from regional and WTO negotiations.” International Negotiation, 18(1): 131-51. RESILIENT DEVELOPMENT: 97 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Hollweg, C. H., and S. Sáez (2019). Services for Trade Competitiveness: Country and regional assessments of services trade. Washington, DC: World Bank Group. Hsieh, C.-T., and P. J. Klenow (2009). “Misallocation and Manufacturing TFP in China and India.” Quarterly Journal of Economics, 124(4): 1403-48. International Monetary Fund (2020a). “Cambodia: Public Investment Management Assessment.” Washington, DC. International Monetary Fund (2020b). “EM Capital Flows Monitor April 1 2020.” Washington, DC. International Monetary Fund (2020c). World Economic Outlook 2020. Washington, DC: International Monetary Fund. International Trade Centre (2004). “Challenges and Opportunities in Export Development of Creative Industries: ITC’s future technical assistance for the product sector.” Geneva. Javorcik, B. S. (2004). “Does Foreign Direct Investment Increase the Productivity of Domestic Firms? In search of spillovers through backward linkages.” American Economic Review, 94(3): 605-27. Javorcik, B. S., and Y. Li (2013). “Do the Biggest Aisles Serve a Brighter Future? Global retail chains and their implications for Romania.” Journal of International Economics, 90(2): 348-63. Jeong, H. (2017). “Korea’s Growth Experience and Long-term Growth Model.” Policy Research Working Paper No. 8240, World Bank, Washigton, DC. Kansiime, M. K., J. A. Tambo, I. Mugambi, M. Bundi, A. Kara, and C. Owuor (2020). “Covid-19 Implications on Household Income and Food Security in Kenya and Uganda: Findings from a rapid assessment.” World Development, 137(1): 105-99. Kim, Y.-H. (2001). “The Asian Crisis, Private Sector Saving, and Policy Implications.” Journal of Asian Economics, 12(3): 331- 51. Kim, Y. E., and N. Loayza (2017). “Productivity and its Determinants: Innovation, education, efficiency, infrastructure, and institutions.” World Bank, Washington, DC. Krugman, P. (1994). The Age of Diminished Expectations. Cambridge, MA: MIT Press. Krugman, P. (1999). “Balance Sheets, the Transfer Problem, and Financial Crises.” Journal of International Tax and Public Finance, 6(1): 459-72. Lane, P. R., and G. M. Milesi-Ferretti (2011). “The Cross-country Incidence of the Global Crisis.” IMF Economic Review, 59(1): 77-110. Lee, S., N. Vanndy, and S. Peou (2017). “Understanding the Implications of Market Distortions on Aggregate Productivity and Competitiveness of Cambodia.” In Policy Recommendations for Strengthening the Foundations of Sustainable Development in Cambodia, Sejong City, Republic of Korea: Ministry of Strategy and Finance. Lewis, W. A. (1954). “Economic Development with Unlimited Supplies of Labour.” The Manchester School, 22(2): 139-91. Lewrick, U., L. Mohler, and R. Weder (2014). “When Firms and Inudstries Matter: Understanding the sources of productivity growth.” BIS Working Paper No. 469, Bank for International Settlements, Basel, Switzerland. Loayza, N., K. Schmidt-Hebbel, and L. Servén (2000). “What Drives Private Saving Across the World?” Review of Economics and Statistics, 82(2): 165-81. Markusen, J. (2005). “Modeling the Offshoring of White-collar Services: From comparative advantage to the new theories of trade and FDI.” NBER Working Paper No. 11872, National Bureau of Economic Research, Cambridge, MA. Mattoo, A., A. Subramanian, and R. Rathindran (1999). “Measuring Services Trade Liberalization and its Impact on Economic Growth: An illustration.” World Bank, Washington, DC. Meitzner, L., M. Price, and C. Sobel (1996). Amaranth to Zai Holes: Ideas for growing food under difficult conditions. Sulphur Springs, TX: ECHO Inc. Ministry of Education, Youth, and Sports (2018). “Education in Cambodia: Findings from Cambodia’s experience in PISA for Development.” Royal Government of Cambodia, Phnom Penh, Cambodia. RESILIENT DEVELOPMENT: 98 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Mohan, R. (2019). “Moving India to a New Growth Trajectory: Need for a comprehensive big push.” Research Paper No. 072019, Brookings India, New Delhi, India. Niu, Z., C. Liu, S. Gunessee, and C. Milner (2018). “Non-tariff and Overall Protection: Evidence across countries and over time.” Review of World Economics, 154(2): 675-703. Organisation for Economic Co-operation and Development (2001). “Economic Survey of Turkey.” Paris. Organisation for Economic Co-operation and Development (2017). “Interrelations between Public Policies, Migration, and Development in Cambodia.” Paris. ProTrade Consult and International Economics (2015). “Strategic Options Paper for Export Development.” Grenada National Export Strategy Review and Strategic Options for Export Development Project, Kingston, Jamaica. Ramey, G., and V. A. Ramey (1995). “Cross-country Evidence on the Link between Volatility and Growth.” American Economic Review, 8(1), 1138-51. Rodrik, D., A. Subramanian, and F. Trebbi (2004). “Institutions Rule: The primacy of institutions over geography and integration in economic development.” Journal of Economic Growth, 9(1): 131-65. Rodríguez, C., and J. E. Saavedra (2019). “The Persistent Effects of Youth Savings Reminders: Experimental evidence from text-message campaigns in Colombia.” Journal of Development Economics, 139(1): 135-56. Sáez, S., and D. Taglioni (2016). “Nurturing the Competitiveness of Service Exports: Metrics and policy options.” In P. Sauvé and M. Roy (Eds.), Research Handbook on Trade in Services, United Kingdom: Edward Elgar. Sáez, S., and M. Vaillant (2010). “The Negotiation and Management of Regulations in the Trade in Services.” In Sáez, S. (Ed.), Trade in Services Negotiations: A guide for developing countries,Washington, DC: World Bank Group. Samreth, S., M. E. Sánchez Martín, and S. Ly (2019). “Dollarization Dilemma: Price stability at the cost of external competitiveness in Cambodia.” World Bank, Washington, DC. Sauvé, P., and M. Roy (2016). Research Handbook on Trade in Services.United Kingdom: Edward Elgar. Shingal, A., M. Roy, and P. Sauvé (2018). “Do WTO+ Commitments in Services Trade Agreements Reflect a Quest for Optimal Regulatory Convergence? Evidence from Asia.” The World Economy, 41(5): 1223-50. Simatupang, T. M., S. Rustiadi, and D. B. M. Situmorang (2012). “Enhancing the Competitiveness of the Creative Services Sectors in Indonesia.” In T. S. Tullao and H. H. Lim (Eds.), Developing ASEAN Economic Community (AEC) into A Global Services Hub, Jakarta, Indonesia: Economic Research Institute for ASEAN and East Asia. Staritz, C., and S. Frederick (2014). “Sector Case Study: Apparel.” In T. Farole and D. Winkler (Eds.), Making Foreign Direct Investment Work for Sub-Saharan Africa: Local Spillovers and Competitiveness in Global Value Chains, Washington, DC: World Bank Group. Suri, T., and W. Jack (2016). “The Long-Run Poverty and Gender Impacts of Mobile Money.” Science, 354(6317): 1288-92. TechSci (2017). “Global Organic Food Market Forecast and Opportunities, 2012-22.” TechSci Research, New York, NY. Tourism of Cambodia (2019). “Phom Penh’s Burgeoning Animation Start-up Scene Tackles Khmer Classics.” March 6, 2019, available at https://www.tourismcambodia.com/news/events/27436/phom-penh-s-burgeoning-animation-start-up- scene-tackles-khmer-classics.htm/. United States Department of Agriculture (2019). “Organic Market Overview.” March 16, 2019, available at https://www.ers. usda.gov/topics/natural-resources-environment/organic-agriculture/organic-market-overview.aspx/. Van der Marel, E. (2016) “Ricardo Does Services: Services sector regulation and comparative advantage in goods.” In P. Sauvé and M. Roy (Eds.), Research Handbook on Trade in Services, United Kingdom: Edward Elgar. Van der Marel, E., and B. Shepherd (2013). “Services Trade, Regulation and Regional Integration: Evidence from sectoral data.” The World Economy, 36(11): 1393-405. World Bank (2014). Cambodia Services Trade: Performance and Regulatory Framework Assessment. Washington, DC: World Bank Group. RESILIENT DEVELOPMENT: 99 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL World Bank (2015). “Cambodian Agriculture in Transition: Opportunities and risks.” Washington, DC. World Bank (2017a). Cambodia Systematic Country Diagnostic: Sustaining strong growth for the benefit of all. Washington, DC: World Bank Group. World Bank (2017b). “Doing Business Reform Memorandum: Cambodia.” Washington, DC. World Bank (2017c). Doing Business 2017. Washington, DC: World Bank Group. World Bank (2018a). Cambodia Economic Update October 2018: Recent Economic Development and Outlook. Washington, DC: World Bank Group. World Bank (2018b). “Cambodia Investment Climate Assessment.” Washington, DC. World Bank (2018c). “Firm Level Productivity Estimates.” Washington, DC. World Bank (2019a). Cambodia Economic Diversification Study: Fostering diversification, value chain participation, and upgrading. Washington, DC: World Bank Group. World Bank (2019b). Cambodia’s Future Jobs: Linking to the economy of tomorrow. Washington, DC: World Bank Group. World Bank (2019c). World Development Report 2020: Trading for development in the age of global value chains. Washington, DC: World Bank Group. World Bank (2019d). Cambodia Economic Update November 2019: Recent economic updates and outlook. Washington, DC: World Bank Group. World Bank (2019e). Cambodia Public Expenditure Review: Improving the effectiveness of public finance. Washington, DC: World Bank Group. World Bank (2019f). Global Economic Prospects January 2019: Darkening skies. Washington, DC: World Bank Group. World Bank (2019g). Microfinance and Household Welfare: Cambodia policy note. Washington, DC: World Bank Group. World Bank (2019h). Benefitting from the Digital Economy: Cambodia policy note. Washington, DC: World Bank Group. World Bank (2019i). Entrepreneurial Cambodia: Cambodia policy note. Washington, DC: World Bank Group. World Bank (2020a). Cambodia Economic Update May 2020: Cambodia in the time of Covid-19. Washington, DC: World Bank Group. World Bank (2020b). East Asia Pacific Economic Update: From containment to recovery. Washington, DC: World Bank Group. World Bank (2020c). Enabling Ecotourism Development in Cambodia. Washington, DC: World Bank Group. World Bank (2020d). “Protecting People and Economies: Integrated policy responses to Covid-19.” Washington, DC. World Bank (2020e). “Human Capital Project: Year 2 progress report.” Washington, DC. World Bank (2020f). “Cambodia: Fiscal Incidence, Inequality, and Poverty.” Washington, DC. World Bank (2020g). Doing Business 2020. Washington, DC: World Bank Group. World Economic Forum (2019). Travel and Tourism Competitiveness Report 2019: Travel and tourism at a tipping point. Geneva: World Economic Forum. World Trade Organization (2019). World Trade Report 2019. Geneva: World Trade Organization. Yeyati, E. L. (2006). “Financial Dollarization: Evaluating the consequences.” Economic Policy, 21(45): 62-118. Zheng, Y., M. K. Muth, and J. Brophy (2013). “The Impact of Food Safety Third-Party Certifications on China’s Food Exports to the United States.” RTI International, Research Triangle, NC. Zion Market Research (2018). “Organic Food and Beverages Market: Global industry perspective, comprehensive analysis and forecast, 2017 - 2024.” New York, NY. RESILIENT DEVELOPMENT: 100 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Annex Annex Annex 1: Empirical approach and data for firm-level productivity analysis Empirical approach and data for firm-level productivity analysis Dataset Dataset We work with a global cross-section, based on the latest comprehensive dataset released by the W Bank Enterprise Survey (ES) in March 2020. This is a sample of pooled data for firms from 139 coun surveyed We work with a global between cross-section, 2006 based onand the 2019. It includes data latest comprehensive fromreleased dataset 842 firms from by the Cambodia, World of which 472 Bank Enterprise This isin collected Survey in March 2020. a 2013 and sample 370 in data of pooled 2016.forThis firmsbroad sample from 139 allows countries, us to examine surveyed between constraints to performan 2006 and 2019. It includes data from Cambodia broader comparative in aCambodia, 842 firms from perspective. of which 472 firms were collected in 2013 and 370 firms in 2016. This broad sample allows us to examine constraints to performance in Cambodia in a broader comparative perspective. Outcome variables To measure firm performance, we use five indicators. The first two, (1) labor productivity and (2) Outcome variables factor productivity (TFP) are measured in levels. As additional measures of firm performance, we us (3) average we To measure firm performance, use five annual outcome growth rate indicators. The first in employment, two, (4) the(1) labor productivity average and (2) annual growth total infactor rate sales, and (5 productivity (TFP), are measured in levels. As additional measures of firm performance, we use (3) the average annual average annual growth rate in labor-productivity levels. Below we briefly describe how each of t growth rate in employment, (4) the average annual growth rate in sales, and (5) the average annual growth rate in labor-productivity indicators are calculated. levels. Below we briefly describe how each of these indicators is calculated. (i) Labor productivity: for manufacturing firms, we measure labor productivity as value added per wo (i) Labor productivity : for manufacturing in levels, and calculate firms, themeasure it as we ratio of labor valueproductivity as value added (sales minus added (sales minus intermediate intermediate goods) to the total num goods) per worker in levels, and calculate it as the ratio of value added to the total number of full-time permanent employees. of full-time permanent employees. Because data on the cost of intermediate goods are not availabl Because data on the cost of intermediate goods are not available for firms in the services sector, for these firms we calculate firms in the services sector, for these firms we calculate labor productivity as the ratio of sales to full- labor productivity as the ratio of sales to full-time workers. The World Bank Enterprise Survey collects data on sales and intermediate goodsworkers. collects The ESunits in local currency (LCUs),data on are which sales and intermediate specific goods to the survey and in local year. For currency cross-country units (LCUs), whic comparisons, these variables arespecific to the survey first exchanged into US and year. dollars For using cross-country the comparisons, official exchange rate (period these average) from theare variables first World exchanged Bank US Dollars (US$) using the official World Development Indicators. The data are then deflated to 2009 US$ using the gross domestic product (GDP) deflator for Indic exchange rate (period average) from the World Development (WDI). the United States from The data the relevant are then reference deflated fiscal year. to 2009 using the GDP deflator for the US from the relevant refer fiscal year. (ii) TFP: TFP is computed as the Solow residuals from the estimation of a log-linear Cobb-Douglass production function. (1) TFP: Formally, equation (ii) computed TFP is using is estimated as Least Ordinary the Solow Squares and then from residuals TFP isthe estimation computed of a following log-linear equation Cobb-Dou (2) for production function, establishment i in sector j in year t. 212 where Y is total output (YKLM model). Formally, equation (1) is estimated u Ordinary Least Squares and then TFP is computed following equation (2) for establishment i.200 ln #$ = & + () ln*$ + (+ ln,$ + (- ln.$ + /$01 (1) 234$ = ln #$ = & + () ln*$ + (+ ln,$ + (- ln.$ + /$01 (2) where: where: • #$0 = total sales (d2) *$0 = Total number of workers (l1) •sales; Yijt = total • ,$0 =Material input = total annual cost of raw materials and intermediate goods used in produc Lijt = total number (n2e)of workers; • . M = material Capital $0 = is input = value inputcost total annual ofmaterials of raw machinery,and vehicles, and intermediate equipment goods (n6a) used in production; and ijt Labor-productivity (iii)input Kijt = capital growth: due to data constraints, we calculate labor productivity as the ratio is value of machinery, vehicles, and equipment. sales to workers (all in US$). We then calculate the average annual growth in sales per worker over a two-year (iii) Labor-productivity growth : due using period to datathe standard constraints, wegeometric formula: calculate labor productivity as the ratio of sales to workers (all in US$). We then calculate the average annual growth in sales per worker over a two-year period using the standard geometric formula: 200 Fixed effects are included for country, industry, and year of survey. RESILIENT DEVELOPMENT: 101 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL 6789:<:9= ln G 6789:<:9=H J I 6789:_<:9=_>:9?@ℎ$ = Bexp F K − 1N O100 n 6789:<:9= ln G 6789:<:9=H J where: I 6789:_<:9=_>:9?@ℎ$ = Bexp F K − 1N O100 where: n • 6789:<:9=H = sales per worker in the last period (d2/l1) • 6789:<:9=I = sales where: laborprod worker perper = sales in in worker the first the period;(n3/l2) 6789:<:9=H lastperiod • n=2 n ln G 6789:<:9= J I • 6789:<:9= laborprod H = sales per worker in the 6789:_<:9=_>:9?@ℎ last = sales per worker in the first$ period; and ) period = ( Bexp d2/l1 F K − 1N O100 (iv) Employment growth : we apply the same geometric formula n to calculate the average annual change • 6789:<:9=I = sales per worker in the first period (n3/l2) 0 • employment in 2 = 2. levels over a two-year period: n =n where: (iv) Employment • Employment (iv) 6789:<:9=H =growth growth : we sales: per we apply worker apply thethe in same the same last geometric period ( geometric formula d2/l1 formula to calculate ) to:9?@ℎ$ = Rexp S V − 1W O100 n < (iv) Employment growth: we apply the same geometric formula where: ln T :9?@ℎ • < = employment in the last period (l1) H • :9?@ℎ I $ = Rexp S V − 1W O100 (v) • Sales < = growth: employment we apply in the the same first periodgeometric ( l2) formula to n calculate the average annual change in sales I pn = employment in the last period; levels • n=2over a two-year period: where: p0 = employment in the first period; and < • Sales (v) growth: we apply :9?@ℎ the first period (l2) $ = Rexp S n V − 1W O100 • n=2 :9?@ℎ = growth: we apply the same geometric$ formula to calculateRexp S V− 1W the O100 annual change in sales average • < = sales in the last period ( d2 ) n levelsH over a two-year period: • :9?@ℎ I $ = Rexp S V − 1W O100 Independent • 2 in perceptions question). RESILIENT DEVELOPMENT: 104 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Using these firm-level indicators of perceptions raises endogeneity concerns. That is, it is possible that poor performance affects firms’ perceptions of the constraints that they face. Following Arnold, Mattoo, and Narciso (2008) we calculate peer averages based on clusters defined by industry and size, and exclude the observation from the establishment i of the different indicators of subjective constraints.213 The resulting variables can be interpreted as the percentage of firms in each industry- size cluster that identify each constraint as a major/severe or as the top/biggest obstacle in the business environment. Major/Top_avgi =is the peer average for clusters defined by industry and size, excluding the firm’s own observation. • In other words, the variable measures the percentage of firms in the same industry-size cluster that identified the issue as a major/top obstacle. (The rationale for including the peer averages of the different indicators is to mitigate endogeneity of firm-level responses.) Obstacle_avgi = is the average score given to each obstacle (0= no obstacle; 4= very serious obstacle) by firms in a • given industry-size cluster, excluding the firm’s own score. Estimation strategy Regression analysis is used to explore the links between both subjective and objective constraints and firm performance. The parameters in the linear regression model were estimated through ordinary least squares. Although the cross-sectional structure of the data does not allow us to control for firm-level fixed effects, it is still possible to control for country c, year t, and sector j fixed effects. A dummy variable equal to one is the establishment is operating in Cambodia is interacted with the subjective and objective constraints to identify if the constraint poses a bigger impact on the outcome variable for Cambodian firms than the global average. The main specification is: yicjt= αc + γj + σt + βConstrainticjt+ ∅KHMicjt* Constrainticjt + πzicjt + εicjt where: the outcome variable of firm i (labor productivity, TFP, employment growth, sales growth, labor-productivity yicjt =  growth); Constrainticjt = the subjective or objective constraint; KHMicjt = a dummy variable equal to 1 if the establishment is in Cambodia and 0 otherwise; zicjt = a vector of firm-specific controls; αc = the country fixed effect; α γs = the sector fixed effect; and j σt = the year fixed effect. RESILIENT DEVELOPMENT: 105 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Endnotes 212 Fixed effects are included for country, industry, and year of survey. 213 The analysis was also performed for all variables (major and top obstacles) at the firm level. RESILIENT DEVELOPMENT: 106 A STRATEGY TO DIVERSIFY CAMBODIA’S GROWTH MODEL Cambodia Country Office Exchange Square Building No. 19-20, Street 106 Sangkat Wat Phnom, Khan Daun Penh Phnom Penh, Cambodia www.worldbank.org/cambodia