Promoting Economic Diversification, Subprogram 3 (RRP CAM 38421-072) SECTOR ASSESSMENT (SUMMARY): PRIVATE SECTOR AND SME DEVELOPMENT Sector Road Map 1. Sector Performance, Problems, and Opportunities 1. Economy. Cambodia s economy has undergone significant growth and structural transformation since 1990, but remains narrowly based, with three subsectors garments, construction, and tourist-related services accounting for more than 40% of nonagricultural gross domestic product (GDP) in 2008. The share of industry increased from 11% of GDP in 1990 to 27% in 2008, while dropping to 22% in 2011. During the same period, agriculture s share declined from 50% to 31% and the service sector expanded from 33% to 40%. 1 Cambodia s structural transformation has been dependent on a few products. Unrestricted access to markets in the European Union and the United States during the 1990s jump-started the garment subsector, and preferential access (or a less restrictive arrangement relative to other countries) to the United States market after 1999 also drove this growth. Garments account for 70% of manufacturing (12% of GDP) and 75% of export revenue. The ancient temples at Angkor Wat have attracted a continuous flow of international tourists and became the catalyst for growth of the services subsector. While garments and services attracted significant foreign direct investment, construction is now assuming that role. This pattern of structural change is expected as an economy grows and develops; resources move from low-productivity activities in subsistence agriculture and traditional services to higher-productivity activities in industry and other modern services. This process, and the associated rural urban migration that occurs with this transformation, contributes to poverty reduction. 2. Despite a continued global recession and the most severe flooding in more than a decade, overall economic growth remained strong, due primarily to steady exports of garments and footwear, and tourism. While the narrow concentration of the sources of growth has made Cambodia vulnerable to external shocks and the economic cycles of the European Union and United States, the sector has begun to recover and is expected to continue to grow. The second-round effects of the 2009 global financial crisis and in particular the severe economic recession in the United States had a significant impact on garment exports and tourism. However, exports of garments and footwear to the European Union increased by 51% in 2011 due to the relaxed rules of origin for imports; this provided duty-free access to the market as of January 2011. 2 At the end of 2007, the country had 353,000 jobs in the garment industry. While this number decreased to 319,000 at the end of 2010, it recovered to approximately 330,000 by the end of 2011. 3. The global financial crisis and its impact on Cambodia s real sector exposed structural and competitiveness weaknesses in the economy. For example, garment exports from Cambodia contracted more than in other countries in the region (such as Bangladesh), indicative of a possible decline in competitiveness. Similarly, while tourism in Cambodia held up much better than in Thailand and Viet Nam in 2009, signs of a sharp slowdown in tourism revenues began to show up 9 months prior to the global financial crisis. Excessive appreciation of the exchange rate during this period contributed to the slowdown in exports of garments and tourism. 1 Global finance, country economic reports, and GDP data, Cambodia (data released February 2012). 2 Asian Development Bank. 2012. Asian Development Outlook 2012. Manila.
2 4. Recent investment surveys, several value-chain studies, and sector studies have identified impediments for Cambodia to realize its medium-term growth potential and economic diversification 5. The World Bank s 2007 investment climate survey suggests that, among other factors, regulatory uncertainty and excessive bureaucracy, distortions in the trade regime, electricity costs, inadequate labor force skills, and corruption are major obstacles to private sector growth and development. Value-chain studies identify poor product quality, an inadequate sanitary and phytosanitary standards (SPSs) policy framework, limited access to technology and business development services, underdeveloped links between the rural and modern sectors of the economy, and relatively costly logistics as constraints to export diversification. A common thread in many value-chain studies is Cambodia s weak competition policy framework, broadly defined to include remaining distortions at and beyond the border. 6. Competition in domestic markets. The 2010 Asian Development Bank (ADB) study, Cambodia: Competition Policy in a Transitional Economy, highlights the importance of promoting competition in domestic markets to enhance private sector competitiveness. 3 While Cambodia is an open economy with limited state-owned enterprise presence, creeping regulatory restrictions on competition in domestic markets are evident. Recent decisions by the Ministry of Economy and Finance and the Ministry of Communications restricting price competition in the mobile phone subsector is one example. As Cambodia advances, new and more sophisticated competition policy issues are emerging, especially in nontradable goods such as utilities (e.g., energy, telecommunications); an institutional framework to address these issues is needed. The Ministry of Commerce (MOC) is aware of the emerging competition policy issues. Under subprogram 2, it established a working group on competition policy development, responsible for developing a competition policy framework and drafting a competition law. The World Bank and International Finance Corporation s Doing Business 2012 indicates a slight improvement in the business climate as Cambodia ranks 138 of 183 (an improvement from its rank of 145 in 2011 but still lagging based on the fact that the country ranked 142 of 175 in 2005). 4 In 2011 Cambodia strengthened its credit information system through a new regulation allowing credit bureaus to collect and distribute positive as well as negative credit information a particularly positive step. 7. High cost of regulations. A 2010 ADB study surveyed 180 enterprises in four provinces to collect data on the cost of compliance with key regulations and licenses. 5 The study estimated that business compliance costs of regulations and inspections amount to about 3% 5% of GDP, which is relatively high for an emerging economy. Similarly the World Economic Forum s Global Competitiveness Report for 2011 survey of executives identified the most problematic factors for doing business as corruption, inadequately educated workforce, access to financing, tax regulations, and inefficient government bureaucracy. 6 These costs are more burdensome on SMEs and are a barrier to private sector growth and economic diversification. Best international practice on licensing reforms suggest that programs aimed at reducing the business compliance costs of licenses and regulations are more likely to fail if the institutional architecture for promoting good practice in regulations is not in place first. An effective institutional architecture requires an oversight agency to provide advocacy information to 3 E. Ginting. 2010. Cambodia: Competition Policy in a Transitional Economy, paper presented at the ADB Conference on Stock Taking Competition Policy in Southeast Asia, Manila, 11 12 January 2010. 4 World Bank and International Finance Corporation. 2012. Doing Business 2012: Doing Business in a More Transparent World. Washington, DC. 5 ADB. 2010. Cambodia: Options for Regulatory Reform. Manila. 6 World Economic Forum. 2012. Executive Opinion Survey 2012. City.
3 regulators and monitor compliance with regulatory impact assessments (RIAs). 7 Best international practice suggests the following sequence of reforms: (i) establish an oversight agency (such as the Australian Office of Best Practice Regulation or the United Kingdom Office of Better Regulatory Practice) to provide advocacy information to line ministries on good practice in regulation, and develop national guidelines for good practice and RIA, and templates for regulators to complete when assessing the impact of proposed regulations for the business community; (ii) ensure line ministries and agencies implement good practice regulation guidelines and carry out RIA on proposed regulations; and (iii) once good practice regulation and regulatory impact statement architecture is established and institutionalized, implement a bureaucracy reduction program. Experience from Australia and the United Kingdom shows that a bureaucracy reduction or regulatory reform program should include quantitative targets, line ministry action plans, and performance-based incentives for line ministries to meet targets and action plans. 8. Small and medium-sized enterprise innovation and technology. A recent World Bank study showed that innovative activity is a critical part of private sector development. 8 While innovation and technology adoption will be driven by demand from the private sector, governments have a role in creating a policy framework that is conducive for technology adoption and innovation. Cambodia ranks low in global surveys of technology adoption, even compared with similar developing economies. A 2010 ADB study, Cambodia: Small and Medium-Sized Enterprise Access to Technology, surveyed 150 SMEs located in Phnom Penh and operating in food processing. Key findings of the study are (i) SME investments in innovation activity are very low, averaging around $200 per employee in SMEs where the owners perceive themselves as innovative, (ii) awareness of and access to technology services when provided by the public or private sectors is limited in Cambodia, (iii) firms that access incentives tended to innovate more than firms that did not, and (iv) firm and owner characteristics are important determinants of the propensity to innovate. The study findings have four policy implications: (i) technology policy and programs should target entrepreneurs that are more likely to innovate in the first place; (ii) incentives should be properly defined and targeted; (iii) active publicly-funded interventions are less likely to work; and (iv) a broader national technology framework should focus on improving the determinant factors, such as education of the population including science and technology, removing obstacles to business development investments, and creating an enabling environment for firms to grow. 9. Trade facilitation. The performance of trade logistic services is critical to determine whether Cambodia can trade goods and services on time and at low cost. A cross-country study conducted by the World Bank suggests that high logistics costs and, more importantly, poor services are barriers to trade and, hence, growth. 9 Available indicators suggest that Cambodian businesses bear a higher cost of logistics than other countries in the region. The logistics performance index ranks Cambodia above most countries in the region, meaning it is less efficient. This index is based on a comprehensive survey of supply chain performance, including customs procedures, logistic costs, infrastructure quality, timeliness of reaching destination, and competence of the domestic logistics industry. The government has taken several steps to streamline import export procedures. As a result, days required to process documents for imports and exports, as well as costs to export per container, have declined. However, 7 A RIA is a process and record of the steps carried out by the regulator in preparing new legislation or regulations. The regulator will provide a regulatory impact statement on major proposals. The statement will assess the impact of the proposal on the business community and record stakeholder consultations. 8 World Bank. 2008. Global Economic Prospects: Technology Diffusion in the Developing World. Washington, DC. 9 World Bank. 2007. Connecting to Compete Trade Logistics in the Global Economy. Washington, DC.
4 Cambodia is still significantly behind other countries in the region in terms of import export times and costs. 10. Sanitary and phytosanitary standards. Cambodia ranks low on global performance measurements for food safety. This is a substantial barrier to private sector trade and development. The World Health Organization indicators for the incidence of food and drinking water illness rates Cambodia s food safety performance very poor. With 84% of industrial enterprises engaged in food and beverages and more than 60,000 enterprises engaged in the food subsector altogether, improving SPS systems will benefit private sector development. International experience demonstrates that improving food safety and food standards in the domestic market is a prerequisite for success in international export markets. While much has been done in the last 5 years to improve SPS management related to food products such as establishing the Institute of Standards of Cambodia and upgrading laboratory testing at the Ministry of Industry, Mines and Energy (MIME) much needs to be done to improve the food policy, regulatory framework, enforcement capacity, and private sector involvement in the provision of SPS services. The government recognizes that further reforms are required. A recent Food and Agriculture Organization strategic policy document for Cambodia highlights the three strategic issues for enhancing SPS: (i) strengthening the regulatory framework for SPS and in particular achieving agreement among relevant SPS agencies on delineation of roles and responsibilities in policy, regulation, and enforcement; (ii) improving governance in the enforcement capabilities of SPS agencies; and (iii) strengthening the capacity of SPS providers such as the standards institute of Cambodia and laboratories. 10 2. Government s Sector Strategy 11. The government s development policies for the fourth legislature, 2009 2013 are provided in the Rectangular Strategy on Growth, Employment, Equity, and Efficiency, Phase II. The overarching objective of the National Strategic Development Plan Update 2009 2013, launched in mid-2010, is to reduce poverty to 19.5% by 2015. One of the major thrusts is private sector development and employment, including (i) strengthening the private sector and attracting investment; (ii) promoting small and medium-sized enterprises (SMEs); (iii) creating jobs and ensuring better working conditions for workers and employees; and (iv) establishing social protection for civil servants, employees, and workers. Relevant to the Promoting Economic Diversification (PED) Program cluster are the government s sectorwide approach to trade (trade SWAp), SME Strategy, and the Regulatory Reform Strategy. 12. The trade SWAp aims to mainstream trade in economic policy and is built around three pillars: cross-cutting issues, such as sanitary and phytosanitary standards (SPS) and trade policy formulation; capacity development in trade; and product development. MOC will coordinate the SWAp through the Private Sector Development Steering Committee. Relevant line ministries (i.e., Ministry of Mines, Industry and Energy; MIME; Ministry of Agriculture, Forestry and Fisheries; and MAFF) are committee members responsible for developing and implementing trade capacity development outputs of the SWAp. The PED program cluster provides assistance in selected areas of the SWAp, such as supporting preparations for the World Trade Organization trade policy review, competition policy, and SPS activities (risk management) with Camcontrol. The program is also working with MIME on activities related to SPS (food safety) during agro-processing. 10 Food and Agriculture Organization of the United Nations. 2010. An Action Plan on Strengthening the Cambodian SPS Management System. Rome.
5 13. MIME coordinates the SME Strategy through the SME secretariat of the Private Sector Development Steering Committee. The strategy focuses on creating a business-enabling environment for SMEs to grow and operate efficiently; developing SME capacity; and strengthening service providers for the SME subsector, such as business development services. MIME is advancing the strategy to include technology and innovation, and has drafted a strategic framework for technology and innovation for SMEs. The program cluster provides assistance in selected areas of SME development such as licensing reform, SPS (food safety), and most recently technology and innovation for SMEs. 14. The Office of the Council of Ministers (OCM) coordinates the Regulatory Reform Strategy. The strategy focuses on institutionalizing good practice regulation in the national government with the aim of improving the quality of regulation and policy development at entry. The strategy includes the establishment of an oversight office the Office of Regulatory Impact Assessment (ORIA) at OCM. ORIA will provide advisory information to line ministries on good practice, issue national guidelines on good practice, provide templates for carrying out regulatory impact assessments, and monitor compliance with the RIA. It will provide capacity building to line ministries. The first phase of the strategy is to build capacity at ORIA, followed by voluntary participation of four to six line ministries and later mandatory rollout to line ministries that produce regulations. 11 The strategy draws on best international practice in RIA systems such as in Australia, Switzerland, and the United Kingkom. ADB provided (TA) to OCM to develop the strategic framework including arranging an exposure visit to Australian federal and state government offices to learn about best practice regulations, and organizing training sessions on RIA and good practice regulation. 12 15. The government has outlined the following strategies, supported by the program cluster, to improve the business environment and enhance trade facilitation. 16. Competition policy and regulatory efficiency. OCM has outlined a strategy to institutionalize principles of good practice regulations and RIAs within the national government. This includes the establishment of ORIA to ensure the sustainability of RIAs. It has adopted a time frame for eventually mandating RIA implementation. MIME has piloted RIAs. The Ministry of Environment and MOC will formulate action plans to institutionalize RIAs in their ministries. MOC has introduced the draft competition law to the public for their comments. 17. Investment climate and innovation. The General Department of Taxation at the Ministry of Finance is committed to developing double tax agreements with major trading partners to improve policy predictability for investors. MIME has developed a strategic policy framework for technology policy and innovation. 18. Trade policy and trade facilitation. MOC continues to implement World Trade Organization commitments and trade policy, including drafting trade remedy legislation, commencing notification of tariff barriers to trade and SPS, and collaborating with the World Trade Organization on Cambodia s first trade policy review. For SPS, the government has established an interministerial committee to set the broad policy framework and to improve coordination among agencies. In this regard, Six ministries have signed an Interministerial Prakas (regulation) on the institutional arrangements for food safety based on the farm-to-table approach. The prakas outlines the roles and responsibilities for food safety within the supply chain and will be the basis for a better-coordinated SPS management system. The government 11 Currently three ministries have agreed to participate: MIME, MOC, and Ministry of Environment. 12 ADB. 2008. Technical Assistance to the Kingdom of Cambodia for Enhancing Private Sector Competitiveness. Manila.
6 has designed, endorsed, and started implementing an action plan to commercialize the Industrial Laboratory of Cambodia Center (ILCC) to ensure financial sustainability, among other measures. The program cluster provides TA to the government to support its SPS reform agenda. The Customs and Excise Department has a customs reform agenda, including implementation of ASYCUDA and customs transaction valuation. 3. ADB s Sector Experience and Assistance Program 19. Country strategy and program. Private sector development is one of a theme of the ADB country strategy and program (CSP), 2011 2013 13 and is reiterated in the country operations business plan, 2011 2013. 14 The CSP emphasizes that ADB will help the government improve the climate for private sector development through a combination of technical and program support for policy, institutional, and regulatory reform in key sectors where ADB operates. It seeks to transform agriculture from subsistence to a commercial orientation, improve basic transport and power infrastructure, strengthen the regulatory regime governing financial institutions, develop SMEs, and promote greater regional integration through ADB s Greater Mekong Subregion program. Intertwined with private sector development is good governance through the promotion of a competition policy. 20. ADB s engagement with the government on private sector development issues began in 2003 with the SME project preparatory TA, the Small and Medium-Sized Development Program loan (SMEDP) in 2004, the PED program cluster for 2008 2012, and other advisory TA projects and ADB missions. Much has been achieved through this process. Under the SMEDP, the government developed an SME development strategy that provided the vehicle for development partner coordination on SME issues, reformed enterprise registration procedures and modernized the enterprise registry resulting in a six-fold increase in annual registrations in Phnom Penh, and improved SME access to finance through implementation of several measures such as the secured transaction registry. 21. Key lessons from ADB s engagement have helped shape the design features of the PED program cluster. 15 The key lesson is that reforms should be sequenced to ensure sustainable policy reforms including enhancing the capacity of implementing agencies to maintain and update reforms after the program period. This suggests a program should include (i) policy reforms; (ii) capacity building of implementing agencies; and (iii) development of modern, market-based institutions to lock in reforms. Based on these lessons, the PED program cluster focuses on policy reforms, capacity building, and institutional development. Some examples under the PED program cluster include the RIA and establishment of ORIA, drafting of a competition law including establishment of a competition council, and commercialization of the MIME industrial laboratory center of Cambodia to ensure it is responsive to private sector demands. 13 ADB. 2011. Country Strategy and Program: Cambodia, 2011 2013. Manila. 14 ADB. 2011. Country Operations Business Plan: Cambodia, 2011 2013. Manila. 15 ADB. 2009. Completion Report: Small and Medium Enterprise Sector Development Program in Cambodia. Manila.