A decade after the financial crisis which devastated East Asia in mid-1997, the region is much wealthier, has fewer poor people and a larger global role than ever before, says the World Bank's latest East Asia & Pacific Update -- a six-monthly report on the region's economic and social health. But with this success, comes a new wave of challenges for countries trying to avoid the "middle-income trap".

The report finds that growth in Emerging East Asia reached 8.1 percent in 2006 -- the strongest in the past 10 years and it is likely to slow only modestly to 7.3 percent in 2007 (see table). Per capita incomes in the former crisis-affected economies have significantly exceeded their pre-crisis levels and are growing steadily nearly everywhere. In China and low-income transition economies like Vietnam, Cambodia and Lao PDR, incomes have grown at "exceptional rates", the report says.

"The region has grappled with and overcome the crisis to return to solid growth," said the report's principal author and lead economist for the World Bank's East Asia and Pacific region, Milan Brahmbhatt. "The past 10 years have seen the emergence of China as a major global economic power, a doubling in the value of regional output levels, a halving in poverty rates, a jump in global and regional integration and accumulation of over US$2 trillion in foreign reserves." 

But the report warns new challenges are arising which could slow or even derail growth if not handled properly. "The idea of a 'middle income trap'," said Brahmbhatt "is that the strategies that allow countries to grow from low income to middle income are not enough to get them to high income. Historically, few countries have mastered the complex technical, social and political challenges that arise." 

By 2010, more than nine in 10 East Asians will be living in a middle income economy. To move out of the middle-income trap, a key challenge is maintaining high growth in a sustainable way. In China, this means new strategies to tackle severe environmental problems and other stresses and imbalances that have emerged during the last 20 years of very rapid growth.

Elsewhere in East Asia, the challenges are different. In several economies which have been growing at 2 percent less than before the crisis, investment has been relatively weak and firms have been facing big competitive pressures in world markets, not least from China's booming economy. In these economies, a strong focus on strengthening the investment climate and improving labor force skills is key, allowing firms to find new competitive advantages.

Another challenge is to combine growth with equity. Before the crisis, half the people of East Asia lived on less than US$2 a day while today poverty is down to 29 percent of the population. But income inequality is rising in many East Asian economies -- in some cases, sharply. "High inequality can hamper growth as poor people without access to credit may be unable to exploit investment opportunities," said Brahmbhatt. "It can also be a source of political and social unrest that stymies investment and growth."

A third challenge is the need to manage vulnerability and prevent new crises. Since 1997, countries have built up large foreign exchange reserves as a buffer against further crises but this could have the unwanted side effects -- overheating economies and asset price bubbles, the report says. Further, while countries have been strengthening their financial and banking sectors since the crisis, many economies need to pick up the pace of this effort.

The report says countries in East Asia need to push ahead with their reform programs, especially in improving the governance and investment climate; developing more diversified capital markets including credit access for the poor; liberalizing services trade; boosting education systems to address skilled labor shortages; and emphasizing prudent macroeconomic policies.

"Ten years after confronting the reforms needed to rebound from the financial crisis, East Asia must now confront a new wave of reforms, some of which will be at least as challenging as those enacted in the months after July, 1997," said Brahmbhatt.

In a special focus section, titled "Sustainable Development in East Asia's Urban Fringe" the report analyzes the staggering projections for urbanization in the region. By 2025, the urban population is expected to jump by 65 percent or 500 million people, placing huge strains on already inadequate road, electricity, water and sanitation systems.

The report also looks at the smaller economies of the region, including those of the Pacific Islands, PNG and Timor-Leste. Growth has picked up in a number of these economies over the last few years, in part due to higher commodity prices. But political instability and social tensions continue to undermine the outlook in some countries.

(China Development Gateway April 5, 2007)