Coming together

IFR Asia - Asian Development Bank 2016
10 min read

The launch of the ASEAN Economic Community has brought the goal of regional integration one step closer, but ASEAN’s progress is still too slow and uneven to challenge Asian giants India and China.

The Association of Southeast Asian Nations has long been a slow-burn project. For decades the organisation, which comprises 10 member states from tiny Brunei to sprawling Indonesia, has promised much while consistently underperforming. As an economic and financial entity, ASEAN has managed to be less than the sum of its parts.

Yet, could this be about to change? Are the varied and vibrant economies of South-East Asia finally set to realise their vast collective potential by learning to work in harmony with one another – to embrace economic integration in the name of greater regional trade, while expunging their protectionist tendencies?

The region’s supporters – and there are many – believe so. When the ASEAN Economic Community took effect on the last day of 2015 after years of delay, its purpose was clear, its chief goals ambitious. Using the AEC’s legal framework, regional political leaders would set out to liberalise the flow of goods, services, capital and workers, and improve infrastructure. In time, the hope was to transform South-East Asia into a single market and production base, with the aim of rivalling and even replacing China as the workshop of the world.

Ambitious? Certainly. Achievable? Just possibly – but only if everyone buys into the project and sticks by the same rules. This is after all a region where neighbourly trust often seems in short supply. So whether the new economic community is achievable in reality, rather than just looking pretty on paper, remains to be seen.

“Almost every regional nation state is guilty of protecting its own industries and resources at the expense of greater regional trade. All this did was to undermine their own competitiveness.”

On one issue everyone can agree: the region’s enormous, manifold promise. Were ASEAN a collected entity, its economy would be valued at north of US$2.5trn, making it the world’s sixth largest after the United Kingdom. If current trends prevail, the region’s powerhouse-in-the-making, Indonesia, is set to become the world’s fourth largest economy by 2050, after India, China and the United States, according to the US Census Bureau.

South-East Asia is both populous and young. It is home to more people (630 million) than the United States (320 million) or the European Union (510 million) and has the world’s third largest labour force after China and India. It boasts multinationals fully embedded in global supply chains, and deep reserves of every conceivable commodity, soft and hard. In 2014, ASEAN absorbed US$138bn in inward foreign direct investment, according to data from the United Nations Conference on Trade and Development, surpassing China’s figure of US$128bn for the first time this century and underlining its allure to global portfolio and institutional investors.

Policy clashes

Still, achieving further strides will not be easy. Since its formation in 1967, ASEAN has progressed with stultifying languor. Formal summits are few and far between. Trade barriers were allowed to develop, cloistering one country’s energy, transport, mining, and financial sectors from the next’s. Deregulation and liberalisation seemed pointless when every state was engaged in protectionism.

The AEC aims to do away with all of this. There is recognition at the official level that protectionism is not an answer.

“The policies ASEAN governments pursued in the past clashed with the urge to boost regional integration,” said Tony Nafte, senior Asia economist at CLSA. “Almost every regional nation state is guilty of protecting its own industries and resources at the expense of greater regional trade. All this did was to undermine their own competitiveness.”

The region has lagged as a result. In its latest yearly outlook, published in March, the Asian Development Bank tipped Asia’s economy as a whole to expand by 5.7% this year and next. ASEAN, by contrast, is set to grow by 4.5% in 2016 and 4.8% in 2017, far short of the rates of growth prevalent in India and, for all its woes, China.

In the run-up to the introduction of the AEC, legislators have done much to cut trade barriers. In a December 2015 report, Gareth Leather, senior Asia economist at London-based Capital Economics, said “more than 70% of total trade between member countries is currently conducted with zero tariffs”.

Other analysts note that goods can, by and large, be freely traded across the region: the net result, said Jayant Rikhye, head of international and strategy and planning, Asia Pacific, at HSBC, of “decades of incremental work done since ASEAN’s inception.”

But far more needs to be done. Non-tariff barriers – rules that impose, say, often arbitrary linguistic or product-safety requirements on importers – still abound. These insidious forms of protectionism, said HSBC’s Rikhye, “hamper the flow in services” and raise cross-border financial transaction costs.

Analysts say one of three possible scenarios could unfold in the coming years. In the first, ASEAN is blessed with greater regional cooperation and an elevated level of intra-regional trust. Growth rates will rise sharply: HSBC tips the AEC to boost regional gross domestic product by 5% by 2030. That should lead to further trade liberalisation as the benefits of greater economic cooperation become clear.

There will be more free trade agreements. ASEAN states will embrace of the US-led Trans-Pacific Partnership, original signatories of which include Brunei, Malaysia, Singapore and Vietnam. As China slows further, and with many Western nations mired in stagnation, the “imperative to trade regionally” will become ever clearer to ASEAN’s leaders, said Ganeshan Wignaraja, an adviser at the ADB’s economic research department.

Indonesia in charge

To become reality, this scenario requires a sovereign cheerleader infusing direction and impetus. That role might fall to Indonesia, the region’s largest economy. President Joko Widodo campaigned on a reformist ticket; since coming to power in 2014, he has looked to break up old industries, foster capital formation, and instil greater competition.

Indonesia, said CLSA’s Nafte, “is looking to open up a host of sectors to foreign investment, from logistics to e-commerce, cold storage to film making, rubber processing to waste management. This is a bold policy move: they really believe in a more competitive, more deregulated, more liberalised economic landscape.”

Nafte thinks other nations will follow suit.

“Once the big domino falls, the others will follow,” he said. “In the past, Indonesia acted as the region’s brake pedal, stopping any hope of genuine progress. Now, it is shaking off its protectionist mantle and becoming the region’s accelerator pedal. Where Indonesia goes, others will follow.”

As the spectre of protectionism fades, political leaders will need to introduce “regional rules to liberalise services, the flow of foreign direct investment, and the movement of skilled professionals,” said the ADB’s Wignaraja. A host of deep structural reforms were needed, he said, from improving trade facilitation, to making it easier to form up a business or invest in infrastructure.

ASEAN’s infrastructure ranges from the excellent to the downright shoddy. Capital is needed to fund the construction of new toll roads, rail lines, port facilities and airports.

“Our research shows if we increase regional infrastructure investment by US$73bn, it will boost regional incomes by US$375bn,” said Wignaraja.

This, however, requires a leap of faith. The fear for many will be that ASEAN’s leaders either fail to grasp the nettle, or revert to their old protectionist ways at the merest whiff of a recession, regional crisis, or trade dispute. This is the second scenario. The AEC’s promise would remain unrealised as governments struggled to push through unpopular reforms. Growth would stay in the low single digits. Each nation would be “focused on its own issues, dealing with its own pressing economic problems, rather than seeing the wider picture,” said CLSA’s Nafte. Economic integration would stall.

The third scenario is perhaps the most likely. A few reforms are pushed through. Pan-ASEAN trade rises at a solid, but not spectacular rate. Thanks to the “extra lubricant from the AEC”, the region becomes “ever more important as a location to manufacture in, source from, and sell to”, said HSBC’s Rikhye. However, sectors such as financial services would remain domestically siloed, preventing national lenders from becoming pan-regional powerhouses. A European Union-style customs union would remain a pipe dream. (The ADB’s Wignaraja said that was always a long shot, and would “not happen any time soon”).

In time, the introduction of the AEC on the final day of 2015 will come to be seen, said Joseph Incalcaterra, an economist at HSBC, “as a milestone rather than an inflection point”. In a November 2015 report, he said that “key pillars such as the free flow of skilled labour and free flow of investment may not be fully realised for years, if not decades, to come”.

The region is slowly starting to grow into its own skin, thanks in large part to the advent of the ASEAN Economic Community. In time, it will become more than the sum of its parts. But only just.

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Coming together