Asia is at a crossroads. After years of heady growth, the engine needs retuning. Debt is no longer a recipe for sustained growth, and it is unclear if it ever was.
With the Fed likely to tap the monetary brakes next year, credit will become more expensive, exposing the shaky foundation of the region's recent advance. Productivity growth, the key to lasting prosperity, has slowed as easy gains stunted any sense of urgency for reform.
Challenging times lie ahead for Asia. This doesn't mean officials should sit idly by, letting events take their course. Adjustments can be made to avoid a bigger slump. And there are signs that the message is settling in: across the region, reforms are being talked about.
In recent months, China has launched a number of initiatives aimed at increasing the efficiency of state-owned enterprises, firms that were arguably the main drag on productivity. In Japan, corporate governance reform, a key pillar of Abenomics, seems to be moving ahead. India's Prime Minister Narendra Modi has finally started to comb through the country's sprawling bureaucracy. President-elect Joko Widodo, set to take office in Indonesia next month, has already indicated he will prune fuel subsidies.
That's a start. Yet much more needs to be done to revive productivity and wean economies off cheap credit. Amid the long list of proposed reforms, however, a key step remains absent: greater openness to foreign direct investment. That this is urgently required may seem surprising. In China and ASEAN, FDI has long been a key engine of growth. But opening these economies up further, as well as their more closed neighbors Japan, Korea and India, would spur growth and drive efficiency.
The advantages are obvious. First, allowing foreign firms greater access to local markets raises competition. In the past, the bulk of FDI in Asia has been concentrated in the manufacturing sector, with products mostly exported. This was useful in introducing modern assembly techniques and management practices.
But local markets remained largely sheltered, often dominated by state-owned or politically well-connected firms. Foreign companies have long faced severe restrictions in the services sector, including telecoms, retail, utilities, the professions and finance. It is here where competition is more restricted and, as a result, productivity lagging.
Second, FDI provides reliable funding. With the dollar strengthening and interest rates likely climbing in the coming years, the portfolio financing tide of late might reverse.
This can be a harsh process. One only needs to remember the global financial crisis, the eurozone wobble or last year's 'taper tantrum'. Throughout, however, foreign direct investment has continued to pour in, accounting for some 40 per cent of foreign funding in 2013. To secure a steady inflow of capital, greater foreign direct investment is essential.
It is surprising, then, that Asia has more restrictions on foreign direct investment than any other region. According to the World Bank, foreign ownership is on average limited to 77 per cent of equity. This is below the 92 per cent in Latin America and Sub-Saharan Africa.
These numbers, of course, mask wide variations across countries and sectors. Singapore and Hong Kong are among the world's most open, while Thailand (52 per cent), the Philippines (60 per cent) and Malaysia (68 per cent) are well below the regional average.
China has long been open to manufacturing firms, especially in its export processing zones. When it comes to services however, now the economy's largest sector, the country remains relatively closed, scoring only slightly better than Saudi Arabia but worse than Kenya and Pakistan.
Meanwhile, despite gradual liberalisation over the last two decades, India has seen FDI inflows drop more than 40 per cent over the last five years. Even Japan, never a prominent destination for foreign investment, would benefit from cutting back restrictions and exposing its sheltered local market to more competitive pressure.
A worrying trend in recent years has been the proliferation of restrictions, with research by the United Nations Council on Trade and Development suggesting that governments are reducing access, especially to services, faster than they are opening up to manufacturing. Moreover, there is a sense that the playing field has shifted against foreign companies, even when no new rules were adopted. To attract foreign direct investment and its attendant benefits, tax regimes need to be enforced with transparency, investment requirements stipulated clearly in advance and trust regulations fairly enforced.
There is a lingering worry, of course. Foreign companies may seek to exploit loopholes, stifle the emergence of powerful local firms and cut corners on environmental or labor laws. But these are issues of governance, and that needs to be strengthened regardless of who regulations affect. The benefits of properly regulated FDI outweigh its risks. Asia would do well to open up further.
This article appeared in the Wall Street Journal. Reproduced with permission.