COM 03/2016

AEC 2015: Challenges and Opportunities for Local Governments in ASEAN

Alvin Ang, PHD, Department of Economics, Ateneo de Manila University

Introduction

At the start of January 2016, the ASEAN Economic Integration took effect in the ten countries in the region. This is a big step towards consolidating regional cooperation among member countries and providing support to each other towards a common goal of a trade block. Along this line, this presentation provides the general framework of what ‘AEC 2015’ is all about and what it will mean to the region and how countries like Vietnam can benefit from it and more importantly, how local governments with- in Vietnam can connect and adjust to this new economic environment.

I would like to commend the Tay Ninh Department of Trade and Industry, the University of Social Sciences and Humanities and the Konrad-Adenauer-Stiftung for coming up with this seminar. To my mind, this is the first that a local government is working ahead of the changing economic environment in the region.

Let me provide the context of my presentation. First, I will review ASEAN Integration and provide the framework on how this operates. Second, I will provide perspectives on the role of local governments in integration. Third, I will look at the different key entry points for local governments and its relationship for inclusive growth. Fourth, I will demonstrate how to improve local governance in relation to small and medium enterprise development and finally, what does it mean to measure the competitiveness of local governments.

The Association of Southeast Asian Nations (ASE- AN) was established in 1967 with originally five countries composed of Malaysia, Indonesia, Philippines, Singapore and Thailand. In 1994, Brunei joined the group, followed by Vietnam in 1995, Laos and Myanmar in 1997 and Cambodia in 1999. In 2007, during the ASEAN Meeting  hosted  by the Philippines in the island of Cebu, the countries agreed to pursue the ASEAN Economic Community (AEC) by 2015 instead of the original target of 2020. Before we can discuss the ASEAN Economic Com- munity, we need to understand the three key pillars of the ASEAN. The ASEAN is a community of nations interconnected with the following pillars and objectives:

1. a) ASEAN Political-Security Community (APSC) – enhance rules and good governance for ASEAN,
2. b) ASEAN Economic Community (AEC) – enhance integration and competitiveness of ASEAN, and
3. c) ASEAN Socio-Cultural Community (ASCC) – enhance the well-being and livelihood of ASEAN people. (See Figure 1 from the Philippine Department of Foreign Affairs).

Hence, it can be seen that the AEC, which is ASE- AN 2015, is only one of the three pillars of ASEAN. However, it is one of the most influential and signif- icant of the three pillars because it allows more con- nections and improves trade among member coun- tries. Within the AEC, there are also sub-pillars that provide sectoral foci. These sub-pillars more or less provide a road map of the critical components that describe the completion of AEC. They also provide a guide for the different governments in ASEAN to gauge their current status and find how they can catch up with the requirements.

What has been accomplished until 2015?

Most of the accomplishments by the countries were based on the growth of production among the countries. Average growth has reached 5.6%, 80% of the measures proposed in the AEC plan has already been implemented: signing of the ASEAN Agreement on the Movement on Natural Persons (MNP), implementation of the ASEAN Single Window, work pro- gram for non-tariff barriers, financial inclusion and the negotiations for the Regional Comprehensive Economic Partnership (RCEP) with other countries in the Asian region.

To illustrate what happens in the AEC, it will be good to consider how the IPhone and hard drives are made. The Iphone is a product finished in China but produced using components from different parts of the world. The idea is produced in California, USA, and the components come from its own competitor Samsung of South Korea which produces the mem- ory and processor, three other companies within the USA, and other key components from Italy, Taiwan, Japan and Germany. In the same perspective, the hard disk is produced from components in different parts of the world. In Fig 2, we can see the production of a hard drive with their key bases.

This high end production supply chain is the key idea of the AEC. To be able to have different countries contribute to the global supply chain, the AEC aims to address issues that limit the participation of each member country to the process. This is because ASEAN markets are small, there are large trans- action costs, and policies are inconsistent across countries and they are not stable. Similarly, it is important for the AEC to address the issues that relate to the priority integration sectors. There are eleven priority sectors, as follows: electronics, e-ASEAN, healthcare, wood-based products, automotives, rubber-based products, textiles and apparels, agro-based products, fisheries, air travel and tourism. These sectors were selected on the basis of comparative advantage in natural resource endowments, labour skills and cost competitiveness, and value-added contribution to ASEAN’s economy. They account for about 50% of intra-ASEAN trade.

In terms of services, free flow of trade in services is one of the important elements of AEC. There will be substantially no restriction to ASEAN services suppliers in providing services and in establishing companies across national borders within the region, subject to domestic regulations. The priority sectors in services are air transport, e-ASEAN (IT), health, tourism and logistics. About 80 sectors are already open with only about 24 sectors remaining. In terms of Mode 4 or the movement of natural persons, there are already eight mutual recognition agreements (MRAs) signed in eight major professional services covering engineering, accountancy, nursing, dentistry, medicine, architecture, surveying and tourism.

All told, these are the major broad opportunities of cooperation under the AEC. From these, we can now try to connect to the other sub-pillars, particularly the initiative for more local government participation.

Local Government in the AEC

The key element of the entry of local governments in the AEC is in the aspect of sub-pillar 3 which is the framework for equitable economic development. It is understood that the process required by the sub-pillar on free flow of goods and services would impinge on the local economy and particularly at the local levels. Hence, the framework raised the perspective that AEC should not in any way bene- fit only the richer ASEAN member countries. Thus, the AEC has recognized the need to narrow devel- opment gaps within and between member countries. This is where local governments can start supporting the national objectives for the AEC. Specifically, local governments should ensure that there will be better access to opportunities for human development, social welfare and justice. This means that better in- vestments of local governments to ensure education and health is accessible and affordable and also al- low participation in the process of ASEAN integration by providing avenues for community building.

In addition to ensuring social support, local governments also need to provide equal opportunities among its constituents regardless of income, gender and size of enterprise. It also has to partner with the national governments to ensure that connectivity is done in physical infrastructure, human capital mobility, technology transfer and access to markets. Connectivity is not just a national concern. Localities must be ready to connect with the national network, hence, it must identify where and how the national government can further link the local governments to the national network and to the international net- works.

Inclusive Growth

The discussion above clearly points to a concept that is commonly used nowadays in development. This is the concept of ‘Inclusive Growth’. According to the Commission on Growth and Development (2008), it is about equity, equality of opportunity, protection in markets and employment transitions. Ianchovichina and Gable (2011), meanwhile, suggest that it is raising the pace of growth and enlarging the size of the economy by providing a level playing field and increasing productive employment opportunities. Hence, the role of local governments in ASEAN and inclusive growth is to support national government particularly in providing productive employment opportunities. By working together with national governments, local governments can achieve economies of scale and integrate. We should not worry about the ASEAN regional identity at the moment, since the region has no common religion, language and land mass (Wu). The priority is to ensure that the member country has local economies of scale. What is important therefore is to ensure that economic growth is happening at the local level and reducing inequality and poverty at the same time. This is what member countries should focus on – ensuring domestic capacities to harness competitive advantages.

Since not all regions and localities are the same, local governments must be well aware of what is happening in their areas. It will require that prepa- ration for the AEC must have area specific preparations. For example, provinces with high proportion of poor require social assistance programs, while those prone to hazards must have social insurance and income diversification. There must also clear knowledge on how to improve sectoral outcomes such as agriculture which requires improved food security, financial access and ensuring balance for the environment through sustainable and climate resilient localities.

Local Government Challenges in AEC

When the full force of the AEC is in place, there will be possibilities for firms from other local governments or from other countries to compete with the firms in the localities. Initially, it is expected that large firms from other countries will take advantage of the AEC. They will have more financial capacity and better technical products and services. Most likely they will also be supported by their national governments. Hence, local governments must know the firms and industries within their areas and help them win in the competition. The winners are those firms who link with the market, workers who are in the growing sectors leading to more choices for consumers and allowing local government to collect more revenues. But inefficient firms will lose out. Thus, local governments need also help small and medium enterprises (SMEs) in their localities. In particular, most SMEs lack access to finance, technology, skilled labor and inability to comply with local, national and more importantly with international standards. Most SMEs also have weak linkages to high tech sectors and therefore have difficulty penetrating the export market.

The following figures from the presentation of Widnaraja (2015) during the Philippine Economic Society (PES) Meeting clearly show the challenges of SMEs in the connecting with the global environment. Figure 3 shows that SMEs dominate the firms around the world. In Asia, about 62.2% of firms are small and adding the 30% of medium, it will already be about 92.2% of total. Figure 4 meanwhile shows the importance of SMEs in the economy and trade. In terms of total employment, SMEs have significant shares such as in Indonesia, Korea, Thailand and Vietnam of above 75%. In terms of share to GDP, it is highest in Indonesia, Germany and Japan. Finally, in terms of total exports, it is largest in Germany and Japan but low in ASEAN. This is where ASEAN is lagging behind in the global market making the AEC important in helping SMEs connect to the global economy. In Vietnam, for instance, SMEs provide 77% of employment, but contributes only 40% to GDP and only contributes 20% to trade.

LGU Strategy in Supply Chain Trade

According to Wignaraja (2015), it is important to consider how local governments can help identify firms in their localities and connect them to the supply chain trade. This is because the size of firms is important for joining the supply chain trade. It is based on scale of production, better access to technology, ability to pay for skilled labor and pro- vide extra for marketing. The objective is to organize the small SMEs, prepare them to cooperate and provide help to each other until the SMEs can be considered a subcontractor to a foreign buyer. Local governments can also help in identifying the weaknesses and strengths of SMEs in their areas and find ways to support them in financing a common agenda like improving training or to get consultants to upgrade skills. Local governments can also help start business associations by clustering common agenda and help firms cooperate by coordinating common actions. Vietnam is already successful along this line. Major industrial clusters in Ho Chi Minh have large firms supported by thou- sands of SME suppliers and subcontractors making garments, agricultural machinery and electronics. In addition, local governments can help SMEs by assisting in providing better external finance. Most SMEs are internally funded, meaning they do not raise money from outside. They do so because banks are too tight in their requirements. However, without formal banking support, SMEs also cannot access export markets. LGUs can provide partial credit guarantees, scaled up microfinance, expand collateral and finally teach financial literacy.

In summary, LGUs need to provide the following policy environment for SMEs in the AEC mode according to Wignaraja (2015). Firstly, the environment for business must be predictable and trans- parent market institutions and transactions. This requires open trade and investment regimes. So LGUs must also implement market reforms in their localities. Second, the legal system must be good for the business sector. Third, business processes must be streamlined and easy to accomplish. Fourth, there must be affordable and high quality technical, marketing and other support. Fifth, LGUs must provide good financial backbone support for access to funds. Finally, infrastructure must be modern, cost competitive physical infrastructure in the aspects of ICT, transport and electricity.

To make these happen, LGUs must build capacities. The capacities include standardization of processes, aligning domestic laws and regulations with ASEAN commitments and provide constant information access through social media and the internet beyond the physical information campaigns.

Competitiveness in the LGUs

One of the key processes to understand how to link to ASEAN is to ensure that the localities are competitive. The bottom line of the AEC is competitive- ness of the ASEAN region. It therefore requires that the member countries are competitive and that local governments within the member countries are competitive too.

What is competitiveness? According to Porter (2004), competitiveness is based on location and is essentially the productivity that companies there can achieve. Location is the underlying source of the re- sources of a governance unit and productivity is how the LGU is using these resources. Related to this, I helped developed a Cities and Municipalities Competitiveness Index (CMCI) for the Philippines. See the snapshot of the CMCI website below The CMCI is a system that allows the government – national and local, private sector and the academe to evaluate the current state of competitiveness of an LGU in the Philippines. The process is voluntary and is implemented through the National Competitiveness Council (NCC) of the Philippines. The idea of the NCC is to assist the Regional Competitive- ness Councils (RCCs) in the seventeen regions of the Philippines composed of provinces, cities and municipalities. This idea is based on a framework that competitiveness in a city or a municipality is the starting point of the competitiveness of a country. The competitiveness is just a summation of the cities then of the provinces, then of the regions, then of the country. The country competitiveness is then matched with global competitiveness of other countries. The essence of competitiveness is determined through three components which are: economic dynamism, government efficiency and infrastructure.

Each of these components comprised 33.3% of the total index score. Hence, the score of each local government is based on these three components.

The following show the elements of local competitiveness per component. The LGUs should be able to monitor and carefully analyze each of these components. Economic Dynamism refers to the activities that create stable expansion of businesses and industries and higher employment. Conceptually, it refers to the combination of the entrepreneurial spirit and the financial institutions that will cha nel it (Edmund Phelps). Localities are the centers of economic activities. Business expansion and job creation are easily observable in local settings.

• Size of the economy – refers to the total output and services produced in the locality. It can be rep- resented by the increasing number of business establishments and productive capacities.
• Growth of the economy and investments – refers to the improvement of the total output and services produced implying more investments and savings in the locality.
• Increase in employment – the necessary outcome of a growing local economy is the creation of jobs by both existing and new establishments.
• Cost of living – Stable prices based on essentials

– food, housing and human capital services are es- sential to sustain productive expansion.

• Financial deepening – refers to the channels by which expanding capital and investments can be dispersed quickly to business and productive units requiring them the most. Long term investments re- quire more of financial institutions to support expan- sion.
• Productivity – measures the quality of the local labor force in relation to its total output. Low pro- ductivity imply high cost of labor and eventually, doing business.
• Presence of business and professional organiza- tions – active localities need organized private sec- tor groups to participate in the growth process. They signify the intention to stay longer in the locale and reveal their concern for implications of progress considering social, economic and environmental is- sues.

Government Efficiency refers essentially to the qual- ity and reliability of government services and sup- port for effective and sustainable productive expan- sion. Conceptually, this looks at government as an institution that is largely not corrupt; able to protect and enforce contracts; apply moderate and reason- able taxation and is able to regulate (La Porta et al, 1999).

• Transparency and accountability – As with the national government, it is expected that local gov- ernments exhibit behaviours that dissociate itself from corruption by opening processes and systems to all stakeholders and allowing openness in all its activities.
• Capacity to generate resources – LGUs able to raise their own resources will be independent and creative to find ways to generate further economic activities for its locale. With it responsible for its own resource, it will be prudent and will use said resource efficiently.
• Recognition of performance – the quality and reliability of LGUs have to be recognized through competitive standards and awards at the peer level, sub-national, national and even global competitions. It can be at specific services or as an aggregate mea- sure.
• Responsiveness to productive expansion – A key measure of efficiency is the ease of process for ex- isting and future business locators. Every new pro- ductive endeavour requires a number of interactions with LGUs from registration to renewal. A respon- sive LGU should be responsive in every step of its dealing with business.
• Basic government services – Efficient LGUs are also observed not only on the basis of its services to business but its basic provision of safety, natural and human security, human capital formation. The presence of such services affirms commitment to sustainable productive expansion by securing future resources both human and natural.

Infrastructure refers to the physical building blocks that connect, expand and sustain a locality and its surroundings to enable the provision of goods and services. It critically involves basic inputs of pro- duction such as energy, water; interconnection of production such as transportation, roads and com- munications; sustenance of production such as waste, disaster preparedness, environmental sustain- ability and human capital formation infrastructure.

• Provision of basic infrastructure – refers to the availability, reliability and predictability of infra- structure inputs needed for production, interconnection and expansion.
• Availability of technological infrastructure – These are group of physical networks that serves as the core communication links between and among value chains including basic knowledge and infomation transmission among households, business, production process and private services. These net- works help faster connections between human, social, financial and natural capital.
• Provision of social infrastructure – supportive of the provision of basic services for future and sustain- able human and natural capital, social infrastructure focuses on the physical support for the development of social assets such as hospitals, educational institutions and housing, among others.

Last 2015, a total of 1,120 local governments partic- ipated in the CMCI. From its inception in 2013, the number of LGUs has consistently increased show- ing the importance of the competitiveness concept in the local areas. With only 285 in 2013, it increased to 534 in 2014 and to 1,120 local governments in 2015. For 2016, it is expected that 1,300 LGUs will participate leaving just about 300 LGUs not covered by the CMCI.

Conclusion

LGUs in the ASEAN region have to upgrade them- selves and understand the rules and requirements of ASEAN Integration. The province of Tay Ninh is taking a critical step way ahead of other LGUs in the region in this regard. The LGUs should provide and lead the SMEs in their locality and cooperate with LGUs of other ASEAN countries. They could encourage businesses to cooperate and work within supply chains in their country and eventually connect with other countries LGUs and SMEs. To do this, LGUs should prepare programs that will ensure employment sustainability in the midst of increased competition through investments in trainings and in health insurance. In the final analysis, the LGU that understands these processes first will be the first to reap its benefits and that of ASEAN 2015.