Comment on “The Lao Economy: Capitalizing on Natural Resource Exports”

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  • Note: Correction added on 16 May 2013 after first publication online in Asian Economic Policy Review Volume 8, Number 1. The article title has been corrected to read “Comment on ‘The Lao Economy: Capitalizing on Natural Resource Exports’ ”.

Correspondence: Sothea Oum, Economic Research Institute for Asian and East Asia (ERIA), Sentral Senayan II Building, 6th floor, Jl. Asia Afrika No.8, GBK Senayan, Jakarta Pusat 10270, Indonesia. Email: sothea.oum@eria.org

Menon and Warr (2013) contribute to the discussion of how best to utilize the proceeds from exports in the extractive products of logging and mining as well as hydroelectric power for the benefit of the poorest people in Lao People's Democratic Republic (PDR).

The first part of Menon and Warr provides an excellent review of economic reforms, structural changes, and the growth performance of the Lao economy, beginning with the transition from central planning to a market economy in 1986 under the New Economic Mechanism (NEM), followed by reforms in prices, the exchange rate regime, trade, investment, fiscal policy, and the integration of Lao PDR into the regional economy. Lao PDR aims for a graduation from the least developed country status by 2020.

Of particular note among the reforms are that the tariff and tax systems have been simplified. A more open investment law has been introduced, allowing 100% foreign ownership in most sectors and providing attractive tax incentives. Lao's integration into the subregional (Greater Mekong Subregion) economy, the regional economy (Association of Southeast Asian Nations [ASEAN]), and especially membership of the World Trade Organization all provide impetus for further reforms.

From 1990 to 2011, the Lao economy shifted from agriculture, which accounted for 60% of GDP in 1990 to 30% in 2011. The shares of industry and service sectors increased from about 16 and 24%, respectively, to more than 30% each, fueled by trade and investment. The average annual growth rate of GDP is about 7% during the same period, and real GDP per capita more than double from US$227 in 1990 to US$592 in 2011.

Lao PDR has made progress to meet some of the Millennium Development Goals. The poverty headcount decreased (Goal 1) from around 46% to 28%, albeit growing inequality as the Gini coefficient increased from 30% to 35% over the same period. Other goals which are on track are: reducing child mortality (Goal 4), and reducing human immunodeficiency virus/acquired immunodeficiency syndrome (HIV/AIDS) and other diseases (Goal 6). However, Lao PDR may miss the other goals: universal primary schooling (Goal 2), gender equality in education (Goal 3), maternal health (Goal 5), and environment sustainability (Goal 7).

The second part of Menon and Warr discusses the “Dutch disease” as the consequence of resource-based booming sectors. The expansion in resource-based exporting (mining and hydropower) sectors may hurt other non-booming exporting and import-competing (tradable) sectors, though it may benefit the non-tradable sector, through spending and resource movement effects as is commonly known in the literature (Corden & Neary, 1982).

The share of resource-based output in GDP reached over 27% in 2011 from a mere 5.5% in 1999. Government revenue associated with mining and hydropower is expected to increase from 0.4% of GDP in 2003–2004 to 9.4% in 2011–2012. Menon and Warr found a negative relationship between the relative price of tradables to non-tradables (the inverse of the real exchange rate) and the current account deficit (absorption of capital inflows). In other words, the absorption of capital inflows leads to a real exchange rate appreciation, namely, the existence of the Dutch disease.

The last part of Menon and Warr rightly argues that in order to avoid the potential “resource curse,” it is better for Lao PDR to slow the rate of absorption, given the lack of accountability. This would, in turn, sacrifice potential higher growth from utilizing the revenue. Otherwise, Menon and Warr suggest that the windfalls be spent on pro-poverty reduction targets in rural areas and in building human capital such as in education and health which remain at very low and even contracting levels. Moreover, Laos should not resort to protectionism for the affected sectors, but rather aim for productivity enhancing and skill upgrading measures.

What is not emphasized in Menon and Warr is the fact that Lao PDR has a small population and is a landlocked (or land-linked) country. More consideration should be given to the development of strategic transportation infrastructure, trade facilitation, and economic corridors linking the country to efficiently access to the region and world markets, such as those discussed by Arvis et al. (2011) and World Bank (2012).

Moreover, with the uncertainty of these nonrenewable resources, Menon and Warr could be further strengthened by providing some analysis of the ways to diversify the Lao economy to avoid overdependence on these resource-based sectors in the medium and long run. As poverty reduction is a top priority of the government and spending targeted to rural area is recommended, a discussion on whether the poverty reduction from such a policy is permanent or transitional one would also add more value to the paper.

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