Seminar on Infrastructure and Financing in the Context of Avoiding Middle Income Trap

Speech by Rajat M. Nag, ADB Managing Director General, at the Centre for Strategic and International Studies, 13 June 2011, Jakarta, Indonesia

I.  Introduction

Distinguished participants, ladies and gentlemen,

I would like to thank the Center for Strategic and International Studies for inviting me to this seminar. It is a great honor and privilege for me to be here this afternoon to speak to you.

You may have heard the expression "the 21st century will belong to Asia." Given the region's enormous growth in recent decades, the idea of this Asian century is certainly feasible. But it is not preordained. Many Asian countries are still very poor, and many others are in danger of being caught in the so-called middle income trap. So this is an opportune time to focus on the region's remaining – and large – development challenges, and what we can do to make this truly an Asian century.

II.  The Middle Income Trap

Asia today is in the midst of an historical transformation. If it continues to grow on its recent trajectory, it could by 2050, account for more than half of global Gross Domestic Product (GDP), trade and investment and enjoy widespread affluence. Per capita income could rise six fold to reach the global average and be similar to European levels of today. Some 3 billion additional Asians could become affluent by today's standards. By nearly doubling its share of global GDP from 27 per cent in 2010 to 51 percent by 2050, Asia would regain, to a large degree, the dominant global economic position it held some 250 years ago.

However, as I said, Asia's rise is by no means preordained. To reach its potential, Asia must deal with multiple risks and challenges. These include large inequities within countries, intense competition for finite natural resources, global warming and climate change, and in almost all countries, the overarching challenge of developing governance and institutional capacity. The challenge I will focus on today is avoidance of the middle income trap.

The middle income trap refers to the situation in which countries have grown for a considerable period to the middle income level, and then stagnated and not grown to advanced country levels. Countries caught in the middle income trap are unable to compete with low income, low wage economies in manufacturing exports. At the same time, they are unable to compete with advanced economies. In other words these countries are unable to make a timely transition from resource driven growth, based on low cost labor, to knowledge and productivity driven growth.

The costs of falling into the middle income trap are staggering. If today's fast growing Asian economies can break through that barrier, developing Asia's total GDP could reach $148 trillion by 2050, with per capita GDP of $38,000. If they cannot, total GDP in 2050 would reach only $61 trillion and per capita GDP would be only $20,300 – thus denying billions of Asians a life time of affluence and well being.

Given the huge opportunity costs involved, it is no wonder that there is now a rapidly growing literature on how the middle income trap can be avoided. It is clear that Asia's march towards prosperity requires policy makers to undertake long term, bold and innovative efforts to sustain high levels of growth.  In an increasingly connected world economy, these policies must internalize global and regional issues as well as national considerations. The policy matrix will differ by country but the contours are roughly similar.

The main factor determining failure or success will be the ability of countries to innovate and upgrade their production processes. This crucial shift requires flexibility in setting policy, and large investments in human capital and research and development. Relevant basic education must be available to all.  In higher education, more investment in science and technology education is needed with a view to creating a skilled and innovative work force.  At the same time, traditional policies such as providing good physical infrastructure to deal with increasing demands and promoting new developments and advances in technology will continue to be critical.

III.  Physical Infrastructure

Provision of adequate physical infrastructure is a necessary condition that each and every Asian middle income economy must meet to achieve high income status. It is easy to see why, although considerably more difficult to ensure it. Infrastructure provides the foundations of economic growth and improves access to services and opportunities. It enhances trade and investment by reducing the costs of doing business and promotes private sector development by creating markets. Without road access, adequate lighting, clean water and sanitation, children find it hard to attend and complete primary school let alone secondary levels. Poor physical infrastructure also prevents farmers from improving productivity, marketing their produce better and earning higher incomes. Innovation and entrepreneurship will be hobbled by poor physical infrastructure.  Middle income Asia has come a long way in providing basic infrastructure but more needs to be done, particularly in the light of climate change and rising expectations.

Physical infrastructure will play a critical role in meeting the challenges of massive urbanization. Between now and 2050, Asia will be transformed as its urban population nearly doubles from 1.6 billion to 3.1 billion. Asia's cities, which already account for more than 80 per cent of economic output, will be the centers of higher education, innovation and technological development. The quality and efficiency of urban areas will thus increasingly determine Asia's long term competitiveness and social and political stability.

The reality at present for too many countries, however, is one of inadequate shelter, clogged streets and power shortages. Clearly, more has to done through both provision and efficient management of new urban infrastructure. In supporting urban infrastructure, ADB places great importance on environment and sustainability. For this, we support sustainable urban infrastructure including water and sanitation, as well as sustainable transport investment. In 2008, for example, ADB established a Cities Development Initiative for Asia, which invests in public transportation, methane capture from solid waste, energy efficiency in buildings, alternate energy sources, and eco-industrial estates and systems.

Physical infrastructure is also a key element in achieving higher levels of regional economic cooperation which offers the prospect of rapid growth and global competitiveness through increased connectivity and static and dynamic gains. ADB has taken a leading role in the promotion of regional economic cooperation and connectivity. The Greater Mekong Subregion program and the Indonesia-Malaysia-Thailand Growth Triangle were initiated almost twenty years ago and the ADB is proud to have been there at their birth and so closely associated with them over nearly twenty years. We have also played a key role in the development of the Brunei Indonesia Malaysia Philippines - East ASEAN Growth Area, commonly called BIMP-EAGA.

Our collective efforts are paying off as is demonstrated by the near completion of many multi country economic corridors crisscrossing mainland Southeast Asia. In the BIMP-EAGA, three ADB projects are now at an advanced stage of preparation: the Trans-Borneo Power Grid, the Pontianak-Entikong transport project link in Indonesia, and the Tanjung Selor border road project linking Indonesia with Malaysia. These and many other similar projects, together with bilateral or regional policy reforms which address issues underlying cross border movements, will play a critical role in the establishment of a connected and competitive ASEAN Economic Community by 2020.

IV.  Financing

The physical infrastructure which will be needed to ensure that Asian countries escape the middle income trap will not come cheaply. The 2009 ADB publication 'Infrastructure for a Seamless Asia' estimated that the region would need $8 trillion in infrastructure finance through 2020 to support current levels of economic growth. Energy and electricity will take up about 40% of the total followed by transport at about 25% and social infrastructure for education, health, water and sanitation and other public goods another 25%.

Infrastructure is one of the core areas of operations under ADB's long-term strategic framework, Strategy 2020. During the 2007-2009 period, ADB's annual infrastructure lending averaged $7.2 billion or 65% of total lending. This is projected to increase to $9.3 billion per year by 2013. Lending for regional cooperation and integration will rise as well during this period from $1.4 billion a year to $2.0 billion. ADB has targeted public and private lending operations at the regional and subregional levels to increase to at least 30% of total lending by 2020. Although these sums are substantial, private sector participation including through public- private partnerships is still essential. We estimate that private investment will have to cover 40% of total needs. The majority of this still derives, however, from commercial banks. Equity developers account for about a quarter of financing while bonds may cover about 15%.

Given the immensity of needs for infrastructure development, mobilizing adequate finance remains a key challenge. But, in this, we are fortunate that Asian savings rates are exceptionally high. It is estimated that annual gross domestic savings in emerging Asia are close to $5 trillion. China and Singapore save over 50% of GDP a year while Malaysia, India and Thailand save over a third. So, how do we better use these savings for infrastructure developments? At ADB, we try to address part of this question, if not all.

Development of domestic capital markets and encouraging local currency lending will play a key role in tapping into the region's vast domestic savings. As you know, we have supported the ASEAN+3 Asian Bond Markets Initiative, which has been working to deepen domestic capital markets and promote local currency bond issues. This will also help address currency mismatches, a problem which hampers stable, long term financing.  The new Credit Guarantee and Investment Facility, which was established by ASEAN+3 with ADB support, will also make it easier to promote public -private partnerships and obtain better financial terms.

Infrastructure funds can also channel Asian savings to help finance infrastructure projects. In 2008, we established the Asian Infrastructure Financing Initiative with support from the Republic of Korea and the Islamic Development Bank which have contributed $3.5 billion and $1 billion respectively, for both sovereign and private projects. Mention should also be made of the proposed ASEAN Infrastructure Fund which ASEAN and ADB are working hard to establish this year and which will significantly contribute to meeting the financing requirements of the ASEAN Master Plan for Connectivity.

V.  Conclusion

Ladies and Gentlemen,

I fervently hope that the Asian child who is born today can look forward to a long and prosperous life in the Asian Century. Her life will be immeasurably different from that of her grandmother or even her mother. But Asia's future prosperity must be earned through pragmatic policy choices and sustainable investments in both human capital and physical infrastructure. The stakes are high and the sooner we address these challenges individually and collectively, the greater the assurance that this child will indeed live in the Asian Century.

Thank you.