A S W O T Analysis Of The Cambodian Economy.Pdf

Insights for Action
A SWOT Analysis
of the Cambodian Economy

Discussion Paper No. 1
2006

© 2006, UNDP Cambodia
A SWOT Analysis of the Cambodian Economy
United Nations Development Programme Cambodia

DISCLAIMER
The responsibility for opinions in this publication rests solely with the authors. Publication
does not constitute an endorsement by the United Nations Development Programme or the
institutions of the United Nations system.

A SWOT Analysis
of the Cambodian Economy

A UNDP Funded Discussion Paper

In Cooperation with
The Supreme National Economic Council
and
Harvard’s John F. Kennedy School of Government

FOREWORD

Cambodia has come a long way in the past decade. It has achieved domestic peace and has
held elections. The economy has grown and certain sectors, such as tourism and textiles, have
taken off. Cambodia has joined the World Trade Organization (WTO) resulting in greater
access to export markets. There is a growing likelihood that Cambodia will experience
significant oil revenues in a few years.

Poverty has dropped. Primary enrolments have risen and young children spend more time in
school. HIV-AIDS prevalence has dropped and Cambodia is seen as a model of HIV-AIDS
prevention from which many other countries can learn.

The nation is unified without the separatist movements or groups that trouble many
countries. There is an increasingly vibrant civil society making critical contributions to the
country’s development.

The Cambodian people and government can be proud of these achievements. Still, many
challenges lie ahead to achieve shared prosperity and sustain long-term stability. Poverty and
near poverty remain high, especially in rural areas where the vast majority of Cambodian
people still live and work. Moreover, all available evidence suggests that inequalities continue
to rapidly widen.

In this context, UNDP’s Insights for Action (IFA) initiative was created to facilitate policy
dialogue among the Cambodian Government, Cambodian society, and Cambodia’s
development partners. Its goal is to identify innovative ideas, practical policy responses and
needed actions to help meet key development challenges.

Too often in the development community we become overly focused on delivering financial
assistance, when in fact development history shows that it is often ideas that catalyze the
changes that improve human well being.

This first Insights for Action Discussion Paper A SWOT Analysis of the Cambodian Economy is
aimed at providing a clear framework for exploring some of the most important emerging
opportunities and challenges facing the Cambodian economy. This framework will in turn
provide a guide for more in-depth solution-oriented research in selected areas.

This first Insights for Action analytical report also served as a main basis for discussion at the
first Cambodia Economic Forum (CEF) successfully launched by H.E. Prime Minister Hun Sen in
January 2006.

It is our hope that this Discussion Paper, the first in a series to be produced by Insight’s for
Action, will help to generate further innovative ideas and actions that can substantially
improve the well-being of all Cambodian people.

Insights for Action
UNDP Cambodia
January 2006

Table of Contents

Executive Summary 1

Introduction 3

The SWOT: An Overview 6

Oil and Cambodian Prospects 8
How Bad Was Nigeria’s Record? 8
Why Should Oil Be a Curse? 9
Future Oil Production and Revenues: Some Details 10
Ensuring Fuel Security 11
Waste and Corruption 12

Opportunities and Threats 13

Interactions and Complications 15

Rural and Land Issues Problems and Possible Solutions 16
Poverty: How Real is the Measured Drop? 16
Land Concentration 17
Reviving the Rural Economy 18

Connecting to Global Markets 20

Credit Costs to Medium and Large Borrowers 22

Summary and Observations 23
Low Government Salaries: The Cost of Corruption? 24

Appendix: Governance Indicators for 1996 and 2004, Selected Nations 27

i

Abbreviations and Acronyms

ACLEDA Association of Cambodian Local Economic Development Agencies
ASEAN Association of Southeast Asian Nations
EU European Union
FDI Foreign Direct Investment
GDP Gross Domestic Product
HDI Human Development Index
HDR Human Development Report
IMF International Monetary Fund
INPRES Instructions of the President - Programme providing financing for
infrastructure development at the local level in Indonesia
MDG Millennium Development Goal
MEF Ministry of Economy and Finance
MNC Multi-National Corporation
ODA Official Development Assistance
SARS Severe Acute Respiratory Syndrome
SWOT Strengths, Weaknesses, Opportunities and Threats
UNDP United Nations Development Programme
WEF World Economic Forum
WTO World Trade Organization

iii


EXECUTIVE SUMMARY

Viewed in the context of its tragic recent history, the country’s achievements over the past ten
years are notable, but moving forward it is uncertain what direction Cambodia will elect to
follow. One could argue that Cambodia is following, albeit hesitantly, the development path
blazed by its dynamic neighbors, with export-led growth fueling increases in standards of
living and steadily declining poverty. Garment exports and World Trade Organization (WTO)
accession are indicative of this trend. Alternatively, a pessimistic observer could posit that
Cambodia today in fact has more in common with the laggards of the region. Significant
evidence could be marshaled to paint a bleak picture of the future, in which corruption,
feuding elites, an uncompetitive economy, and a stagnant countryside deny the vast majority
of Cambodians an opportunity to enjoy happier, healthier, more prosperous lives.

1
UNDP Discussion Paper No. 1


This study concludes that Cambodia’s greatest opportunity is the revenue which will be
generated by the exploitation of the country’s offshore oil and natural gas deposits. The
potential for misuse of this revenue stream is Cambodia’s greatest threat. Most developing
countries have failed to take advantage of the revenue generated by oil. Indeed, the
correlation between oil and a decline in socio-economic performance is so pronounced it is
referred to as “resource curse.” With appropriate policies oil revenue could be used to address
the country’s key weaknesses, including rural decline. Without a fundamental shift in the role
of the state, however, it is unlikely that Cambodia will realize its potential.

2 UNDP Discussion Paper No. 1


INTRODUCTION1

The leaders of Cambodia feel that they can look back on the past decade with a degree of
satisfaction. Political peace has been achieved and elections held, albeit at the cost of the
creation of a large and complicated top-level bureaucracy. Economic growth has been brisk,
inflation reduced, and poverty brought down, though progress has been slower than
expected and the sustainability of the trends is questionable. Moreover, progress in health
and education is mixed; agriculture is weak and land concentration increasing. How does one
get an overall view of the progress to date and the options for the future?

There are many ways to evaluate a country. One popular method is to list the Strengths,
Weaknesses, Opportunities, and Threats facing the economy and the society. This “SWOT”
analysis, most often applied to the competitive position of a company, can also be used for a
nation. In the case of Cambodia, there could be a comparison with its recent past (of 10-15
years ago) in which case the improvements are generally impressive. Alternatively, the
comparison could be with Vietnam or India, in which case the comparisons generally show a
gap that is not always shrinking.

Complicating the analysis are the usual doubts about data. On something as basic as literacy,
various reasonable interpretations can be made. There is a considerable difference between
reported adult literacy (nearly three-quarters in 2003) and functional literacy2 (well under
50 percent). This is not just a quibble over numbers. If those with only a few years of education
fail to gain functional literacy, this means that most of the workforce and current youth will be
severely disadvantaged for long into the future. Depending on the errors and biases, one can
reach a variety of conclusions. This also applies to choosing a base year for analysis. The earlier
the base year, the stronger growth is because of the unusually depressed initial conditions. A
more recent base year often shows more modest progress.

Yet it is less for the past than the future that one does a SWOT analysis. The point of the
exercise is to identify areas that need attention or might become problematic or even
dangerous. If there has been success in some areas, does this mean that one should continue
to improve or shift gears and put more emphasis on other issues? Getting a sense of priorities,
of possibilities, and of dangers is the real purpose of the exercise. In that sense, it is less useful
as a written report than as a way for decision-makers to have a serious conversation about
their own priorities. It is a way to begin a thoughtful discussion. It does NOT identify a list of
future investments or detailed policies. That depends on its use by others. It contributes to a
strategy for, not to the tactics of development.

1
This is a report drafted for UNDP-Cambodia in cooperation with the Ministry of Economy and Finance (MEF). The primary
drafter is Professor David Dapice, but significant inputs came from Brian Quinn, Nguyen Xuan Thanh, Ben Wilkinson and
Thomas Valley. Seilava Ros and Phalla from the MEF and Panhavichetr Pok and Raksa Pen from UNDP were also very helpful,
among several others.
2
“Literacy” is often defined as the ability to read or write one’s own name or recognize a very simple word. Functional
literacy measures the ability, for example, to read a medicine bottle or pesticide can − using skills in real life.
The Cambodian Review (May 2005, p. 22) reports 36 percent illiterate and 27 percent “semi-literate” in 1999.

UNDP Discussion Paper No. 1 3

United Nations Development Programme (UNDP) has developed a “human development
index” which combines gross domestic product (GDP) per capita with health and education
achievements in a single index to compare national trends. The “Human Development Index
(HDI)” is available from 1995 to 2003 for Cambodia and most other nations. The index closely
shadows targets the government itself endorsed in the Millennium Development Goals
(MDGs), so there can be no dispute that this is a reasonable basis for reviewing both economic
and social progress. The index has the advantage of going beyond the admittedly broad and
rough single measure of real GDP per capita growth. It would be reasonable to hypothesize
that Cambodia would enjoy especially fast HDI improvements over this period since it
followed the establishment of peace and the beginning of fast growth and considerable
foreign assistance. It is also true that those starting with a lower HDI tend to move up faster
and this also favors rapid progress.

Table showing the HDI levels of various nations in 1995 and 2003 follows below:
Country 1995 HDI 2003 HDI % Change Absolute Change
Cambodia 5.33 57.1 7.1% 3.8
Indonesia 66.3 69.7 5.1% 3.4
Vietnam 66.0 70.4 6.7% 4.4
India 54.6 60.2 10.3% 5.6
Bangladesh 45.2 52.0 15.0% 6.8
China 68.3 75.5 10.5% 7.2
Mozambique 32.8 37.9 15.5% 5.1
Source: 2005 Human Development Report (HDR), Table 2

In the table, only Indonesia clearly ranks lower than Cambodia in absolute progress. Indonesia
had a major economic collapse in 1997-98 from which it is only now just recovering. The
economic collapse was followed by political upheaval, domestic violence and terrorism. All
this depressed domestic and foreign investment levels. It is disappointing that this is the only
country in the table which Cambodia decisively surpassed in terms of HDI improvement. It is
about equal to Vietnam in percentage terms, but lower in absolute improvement. For all the
others – including India, Bangladesh and Mozambique – it is far below both the relative and
absolute increases. This is a surprising and disappointing result for a country in a situation
where much greater progress could be anticipated. It raises a red flag about being too
satisfied with the progress recorded to date.

If this is true for the broad and welfare-oriented human development index, it is even more
true for the recent rating of Cambodia in the World Economic Forum’s (WEF) competitiveness
index. This index, and its companion, the business competitiveness index, use a combination
of hard data and surveys to compare how well or poorly a nation is situated relative to others
for growth and global competition. The World Economic Forum is a Swiss-based group that
brings together world leaders and provides them with an analysis of global conditions. These
include the annual attempt to measure the forward-looking conditions for growth and the
current business conditions in the two indices. In both of these indices, Cambodia ranks in the
bottom tenth of all 117 rated nations. If we compare its ratings to those of other relevant
nations, we see the following:



World Economic Forum: 2005 Competitiveness Ranking

Country Growth Index / Rank Business Rank
Singapore 5.48/6 5
Malaysia 4.90/24 23
Thailand 4.50/36 37
China 4.07/49 57
Indonesia 3.53/74 59
Philippines 3.47/77 69
Vietnam 3.37/81 80
Mozambique 3.19/91 98
Bangladesh 2.89/110 100
Cambodia 2.82/112 109

In the surveys, 80 percent of those interviewed said corruption was the most pressing concern,
followed by an inefficient bureaucracy, poor training for workers and inadequate
infrastructure. Being rated well below Bangladesh and Mozambique underlines the fact that
Cambodia’s standing is well short of what is possible and what might be expected.

5


Something THE SWOT: AN OVERVIEW
between a
weakness and a However, a policy maker might want to look at the SWOT issues in more detail and from a
threat is the strategic perspective, not necessarily only from the perspective of overall progress. What, in
apparent general, can be said about Cambodia in terms of its strengths and weaknesses? (These are
consolidation of summarized in the table on page 12). In terms of strengths, there is no doubt that Cambodia
land holdings, is in a pretty good geographic neighborhood. Many Association of Southeast Asian Nations
which do not (ASEAN) members are richer and fairly fast growing. China is nearby and rapidly increasing
imports of commodities that Cambodia produces. Cambodia sits on major trade lanes and has
appear to
access to major ports in Bangkok and Saigon. The high aid levels have already been
support
mentioned – and are extremely high in relative and even absolute amounts. If aid were used
economic well, this should be a source to upgrade both physical and human capital.
efficiency or
social equity. Official development assistance (ODA) reflects international acceptance of the current government,
a point underlined by Cambodia’s WTO membership. The rapid growth and current relative
stability of garment exports suggests that this membership will provide meaningful
opportunities. The relative stability in prices and exchange rates has also helped to create a
fairly good macro-economic environment, leading to strong GDP growth. There has also been
growth in the non-governmental organization (NGO) sector, leading to a vibrant (if insecure
and largely aid-financed) development in the voice of many elements of society. The peaceful
settling of political differences has also greatly contributed to this development. In addition,
the existence of Angkor Wat has allowed the development of a major tourist attraction with a
total annual influx approaching 1.5 million tourists – a group that might be enticed to buy
Cambodian products or spend more time at other places in the country.

Angkor also symbolizes a unified Cambodian people, with few separatist tendencies. These
are significant strengths. Against this can be set obvious weaknesses. Cambodia is one of the
few nations in the world where poverty appears to be falling rather slowly even though
economic growth is reasonably rapid. Even after a decade of aid, crop yields and health and
education indicators remain low, if improving.3

Infrastructure, while also improving, is still poor, especially in electricity – the per capita use is
among the lowest in the world. Costs of transport, power and interest rates are very high.
Corruption is certainly also very high, as the score in the 2005 Transparency International table
indicates.4 The economic and administrative cost of securing political accommodation has
been high, as positions in the bureaucracy multiply. This might help to explain the relatively
low level of foregn direct investment (FDI), especially when oil and gas investments are
excluded. Something between a weakness and a threat is the apparent consolidation of land
holdings, which do not appear to support economic efficiency or social equity. If land is handed
over almost for free in large concessions, or bought by urban elites gaining from government
spending, the result in both cases is socially destabilizing. Past experience suggests that
underemployed urban masses or a rural proletariat are much more volatile than a well-rooted
community of independent farmers.

3
Some experts argue that it takes many years to improve yields of rice, for example. Yet, rice yields did rise from 1.77 tons in
1997-98 to 2.1 tons in 2000-01, and have since dropped to 2.0 tons in 2002-04. Moreover, the gap between Cambodia and
nearby parts of Vietnam is widening.
4
Cambodia was ranked by Transparency International, a European NGO, in its most recent ranking made available in October
2005. In that table, Cambodia got a 2.3/10, where 10 is least corrupt. This put it at 130/159 or in the bottom fifth of all
nations. It was tied with Congo (Zaire) and below Sierra Leone, but was ahead of Indonesia (2.2) and Bangladesh (1.7), but
behind Vietnam (2.6), India (2.9) and China (3.2).

6


Looking forward, what advantages or opportunities does Cambodia have? In a sense, many of
the weaknesses that can be remedied are opportunities. If crop yields are low, then
investments in water control and agricultural systems can raise them. If FDI has fallen, then
improvements in governance, education and infrastructure can attract more inflows again. A
higher demand for skilled workers would create an incentive for better training, and this could
be performed inside Cambodia or, for those with some foreign language, outside at a
reasonable cost. (Of course, the quality and coverage of the existing K-12 system should also
be improved). Tourism development remains a real possibility, even if unplanned
development in Siem Reap could limit upscale and high-spending tourists. (The very rapid
growth of tourism in 2004 and 2005 was partly due to the recovery from Severe Acute
Respiratory Syndrome (SARS) in 2003 and the tsunami according to the World Tourism
Organization, but also due to more hotel capacity). There is a promising emerging private
sector. But it is the development of oil and gas production that is perhaps the most important
potential opportunity. Production of 200,000 barrels of oil a day could easily provide nearly
two billion dollars of net revenue per year – in a $4 billion economy.



OIL AND CAMBODIAN PROSPECTS

It is explained in more detail in a following section that no definitive estimate of future oil
production is as yet possible because the reserves are not yet proven. Having said this, there
are oil and gas reserves in appreciable amounts in the Thai and Vietnamese zones bordering
the Cambodian blocks. Each of the four exploratory wells in Block A have been shown to be
productive and produced oil and gas. Provisional estimates are that just the explored part of
Block A has 400-500 million barrels of oil and 3 trillion cubic feet of gas. While conservative
estimates are always safer, a more likely estimate is that production revenues will be high
enough to be large relative to current foreign aid, and perhaps several times that amount. If
that uncertain projection is correct, the revenues would be large relative to GDP.

However, there is a phrase in economics called the “oil” or “resource curse” which refers to the
fact that oil-rich countries often do poorly in terms of growth and overall development.
Nigeria is the poster child for this. [See below]. In spite of decades of large oil and gas exports
– up to $3000 per capita in recent years – its GDP has grown less than its population growth
since 1980. But it is not just one country’s experience that has created the phrase. In
complicated economic models which adjust for many variables (human capital, overall
investment levels, per capita income, etc.), the addition of oil reduces the expected growth
rate! Why should a resource which adds to government revenue and potential physical and
human capital subtract from expected growth? The answer(s) are given in the following Box
which discusses the reasons for this “curse.” However, it is important to note that while it is a
tendency for oil to interfere with growth, it is not always true. Some nations manage to do well
– Norway, Canada, Malaysia and perhaps Indonesia5 from 1970-95 all come to mind.

How Bad Was Nigeria’s Record?

Nigeria is a major oil producer. Exports, nearly all of which are petroleum, totaled over $380
billion from 1974 to 2004, or an average of over $12 billion per year. Recent oil exports were
$29 billion in 2004, before the 2005 jump in oil prices. This averages out to $150 per capita of
exports per year over the last thirty years, though GDP per capita is only $300. The World Bank
reports real GDP growth from 1980 to 2002 at 2 percent annual growth while population grew
at 2.8 percent over the same period. Even allowing for higher recent growth, real output per
capita fell over a period of 25 years. Its most recent survey puts over 70 percent of the
population living below a $1 a day poverty line.

It is ranked 158 out of 177 by its HDI, which has gained little since 1995. Nigeria is known as a
severely corrupt nation and attracts little foreign investment except in oil. Disputes over oil
revenues have led to separatist movements and violent actions in which entire regions were
suppressed and military leaders took over to stop corruption but in turn became corrupt
themselves. Oil company employees face kidnappings and oil installations face sabotage. It
appears that in spite of huge oil revenues, there has been very little to show in terms of overall
economic growth or poverty reduction. This is why it has been used so often to illustrate the
meaning of the “oil curse.”

5
From 1970-95, Indonesia reduced its poverty rate by 86 percent (58 percent to 8 percent, using $1 a day) and tripled its per
capita income. Health and education also improved markedly. These improvements were largely regained after the Asian
Crisis, which combined with a political crisis, hit Indonesia more seriously than other Asian nations. Its economic
performance over this quarter-century period is often contrasted with that of Nigeria.



Why Should Oil Be a Curse?

There is little doubt that many oil rich countries do not grow very fast. Why should this
be true? There are several reasons given by analysts, and they can be grouped into three
main types: exchange rate effects, characteristics and responses to the nature of oil
production and sales, and political economy explanations.

The exchange rate effect is often called the “Dutch Disease” because the problems
associated with it were first clearly analyzed in Holland as it increased its natural gas
exports. Because of strong gas exports, it was able to hold its exchange rate constant.
Yet the revenues from the gas flowed into government revenues and were spent. Extra
spending raised domestic prices, wages, and costs. The Dutch inflation (world inflation
was very low) put pressure on traditional manufacturing and agriculture, which found it
harder to export or even to compete in domestic markets. The Dutch inflation caused
the economy to shift to nontradable services, such as construction and trade. However,
these tend not to have the same growth potential as manufacturing. If gas revenues are
invested in ways that lower costs – education, efficient infrastructure or research and
development – then this impact can be controlled.

The oil industry often tends to be an enclave industry with limited linkages to the rest
of the economy, especially if it is located offshore in a poor country. Expensive and
sophisticated drilling rigs float in, produce oil, and the oil is exported. Few local raw
materials are purchased. The main benefit is in the revenues paid to the government
and/or domestic oil company. Yet these revenues tend to be highly cyclical, reflecting
the varying prices of oil and gas. Many governments get used to revenues when prices
are high. Some even borrow additional amounts based on the anticipated future stream
of oil income. But when oil prices fall, the country not only loses its expected revenues,
but also needs to pay debts on its borrowings based on overly optimistic assumptions.
This can create severe shortages of resources. Sometimes the nation then resorts to
deficit financing, which often results in excessive debt, money creation and inflation,
often with foreign exchange shortages. Or it cuts back severely, creating sharp
recessions and bankruptcies among private firms. Either way, it is a tough environment
for private firms to plan ahead or operate normally. This tends to slow growth. Putting
oil resources into a trust fund and only spending the income on the fund is one way to
deal with this problem.

A third problem is called the“political economy”problem. Basically, a government which
relies on oil does not have to make a contract with its people. It is free to act in an
autocratic manner, with the main issues ones of distribution within the elite. The skills
that are rewarded in such a situation are not ones of efficiency but of political infighting.
It is been called the difference between “farmers” and “treasure hunters.” In a normal
economy, it is important to invest, improve skills and technology, and create a broad
public agreement about policies. This kind of attitude is one that progressive farmers
have. In an oil economy, it is important to be good at getting a group together that
“finds” government contracts and fights off other groups that want them. An economy
that develops “treasure hunting”skills will not grow nearly so well as one with skills more
like that of a progressive farmer. That kind of an oil economy is not a stable society.



It will take Future Oil Production and Revenues: Some Details
several years
before Cambodia has had exploratory drilling in part of one of six blocks and has provisionally
appreciable estimated 400-500 million barrels of recoverable oil and 2-3 trillion cubic feet of gas. Further
drilling within block A and exploration of the other blocks, once contracts have been awarded,
amounts of oil
will certainly add to this total. It will take several years before appreciable amounts of oil and
and gas flow, gas flow, but a very rough estimate would put potential oil production as high as 200 to 250
but a very rough thousand barrels a day at full production. Another way of looking at this is that there may well
estimate would be 2 billion barrels of recoverable oil and 10 trillion cubic feet of gas. The oil at $50 a barrel
put potential oil would be worth $100 billion and the gas at $5 per thousand cubic feet would be worth $50
production as billion. (The gas price is thermally equivalent to $29 per barrel oil. Gas normally sells for less
high as 200 to than a thermally equivalent amount of oil, although the differential has been shrinking). If
250 thousand production were spread out over 20-25 years, the annual sales value of the oil and gas would
barrels a day be $6-$7.5 billion. Current GDP is about $4 billion. Thus, over time, the contribution of oil and
gas could be quite large.

Of course, it is the contribution of oil and gas to national income rather than GDP that is of
most relevance to the government and society. How much revenue per barrel of oil or unit of
gas could Cambodia expect to gain? Part of the answer depends on the cost of production.
One analysis done for this report6 assumed $10 per barrel production costs.

This is in line with production costs of $10 to $15 per barrel for offshore oil. That analysis found
that even at that assumed production cost, Cambodia would get 53 percent of gross sales
revenue if oil prices were $35 a barrel. The share was quite sensitive to the price of oil, with
Cambodia’s share rising to 62 percent at $65 a barrel. It is likely that future oil and gas contracts
could, if anything, be revised in Cambodia’s favor. The initial contract was negotiated when oil
and gas prices were much lower and Cambodia a new and therefore risky prospect. With
supplies of oil and gas tight now and with Cambodia proving itself as being in a productive
geological region and reliable partner, the risk premium should drop and the contractual
terms a rational company would accept should shift in Cambodia’s favor. Of course, the price
of oil could fall in the future or the cost of extraction could be higher. However, for purposes
of discussion, let us assume that half of all sales revenues of oil are paid to the government in
royalties or taxes. A sensitivity analysis can be used to arrive at even higher ratios in a higher
price case for oil.

The contribution of natural gas to government revenues is much harder to predict. Gas is
often used domestically and the gas price may be set at levels that do not necessarily reflect
its price on international markets. In general, the ratio of government revenue to sales is lower
for gas than for oil. Without more information concerning production costs and domestic
pricing, it is not useful to project government revenues from gas at this time. However, there
is certainly enough gas to invest in a combined-cycle electrical generating plant that could
supply a large portion of Cambodia’s electricity demand. This, plus perhaps some
hydroelectricity, would reduce the demand for expensive diesel-generated electricity and
allow more of oil production to be exported. Such a development would also reduce the need
for a small (and high-cost) domestic refinery aimed at ensuring fuel security.

6
“Review of Development Prospects and Options for the Cambodian Oil and Gas Sector” by Brian Quinn.This is a draft
report prepared in 2005 for UNDP and Cambodia National Petroleum Authority.



Ensuring Fuel Security

The issue of fuel (oil product) security is an important question, especially since essentially all
electricity and transport currently comes from diesel fuel and gasoline, all of which is
imported. Any supply disruption can have a severe impact on the Cambodian economy. If a
natural gas electricity generator or hydroelectric generator replaced most diesel generated
electricity (and they are much cheaper than diesel electricity), then the main concern would
be with the security of gasoline and transport diesel supplies. (An alternative would be to
greatly increase purchases of electricity from bordering nations under long-term contracts,
but some assert this is also risky). One way to ensure adequate fuel supplies is to have one’s
own small refinery. Another way is to sign long-term refining contracts with a nation like
Singapore, which has a strong legal system and is extremely reliable and efficient with large-
scale refineries. A third way is to buy old tankers or build fuel storage on land and store
“strategic” (more than normal commercial) fuel reserves in case of an emergency. A fourth is
to have a large export-oriented refinery that uses both imported and domestic crude oil and
sells into local and world markets.

There is currently a desire in some quarters to build a “small, cheap, quick” refinery to process
Cambodian oil, when it becomes available, for domestic demand. In order to do this,
construction would have to start almost immediately. Small refineries have higher costs than
larger refineries, so the construction of such a refinery can only be justified in terms of fuel
security or national pride. A refinery of even a small size without extensive cracking facilities
would cost $400 to $500 million, half of the total annual national investment of Cambodia. That
represents a huge gamble of national resources for security. The fuel produced would cost
more than current fuel imports, given a constant price of crude. This would further reduce the
competitiveness of Cambodian farming and manufacturing.

Alternative approaches to providing fuel security, such as long-term contracts or extra storage
would be cheaper and eliminate the need for a fast decision and a construction start-up this
year.

Cambodian crude oil is light and sweet, meaning it is well suited for many export markets and
has a higher value in those markets than in a domestic fuel mix. A large export-oriented
refinery built by private companies familiar with foreign marketing of oil products would be
one way for Cambodia to refine its oil, provide a source of domestic fuel (albeit from a mix of
imported and its own crude oil), and avoid placing a huge bet relative to its economy on the
amount of future refining margins. It would have secure access to oil products at prices equivalent
(given the cost of crude oil) to current imports. Lower prices for fuel and less financial risk are
substantial benefits, and the degree of national security would not be very different than with
a small refinery. Since the cost of this sort of large refinery would be equal to several billion
dollars, it would be much too large for Cambodia to build on its own and would require majority
multi-national corporation (MNC) investment.

A rough way to calculate the cost of strategic fuel storage is to consider that an old tanker
capable of holding 33,000 tons (270,000 barrels) of refined product was recently sold for $2.1
million. Refined product in September 2005 sold for close to $80 per barrel, so for about $24
million in product and storage costs, Cambodia could store 270,000 barrels of gasoline and
diesel fuel.



Increasing This is about one month of fuel use, assuming that electricity demand for diesel stays at its
amounts of oil current level. If other electricity generating modes are developed, it would last far longer. It is
revenue will make not at all clear if this “insurance” is worth the cost, but it is far less than an uneconomic refinery,
it possible and and the economic cost of the used oil tanker and products (if they are later sold) is the
foregone income that might have been earned if the money used to buy the product and
tempting for
storage capacity had been used elsewhere, less any value gained from having a more reliable
Cambodian
fuel supply.
leaders to indulge
their preferences
for prestige or Waste and Corruption
showy
investments, even A great deal of attention has been placed on corruption in Cambodia. This is entirely
when these are appropriate because it is a serious problem. However, much less attention has been placed on
not at all a related problem which could become equally serious – the issue of waste. Waste occurs
profitable when an unnecessary and inappropriate investment is made. Increasing amounts of oil
without subsidies revenue will make it possible and tempting for Cambodian leaders to indulge their
preferences for prestige or showy investments, even when these are not at all profitable
or protection.
without subsidies or protection. (Protection by import taxes or quotas amounts to a subsidy
paid by consumers who cannot choose to pay less for an efficiently produced competitive
product). The important difference between corruption and waste is that with waste, there
may or may not be a transfer of resources to the corrupt person, but there is certainly a loss to
everyone! If a high-cost refinery were built for its proper cost, with nothing added in
improperly padded costs or commissions, it would still create a loss for the Cambodian
economy and people. Higher prices have to be paid to cover the costs of the refinery, or it is
shut down. If it is shut down, there is a huge loss. If it operates, the price of fuel would be
higher than it need be. Nobody benefits.

Often waste and corruption are combined. In that case, those few officials able to profit from
a particular bad project derive a benefit, but society still loses. Corruption must be fought, but
it exists in almost all societies. Waste is easier to avoid if there is a serious review of public
investments and limited protection, subsidies or guarantees to private projects. Because there
are large losses from bad project selection, a leader concerned with political stability and
economic growth will try to ensure public investments are well chosen.

If there must be corruption, it might as well be on needed and appropriate projects rather
than “white elephants” that become a costly embarrassment. A competent group that will not
be involved directly with a costly project should be required to review its economic feasibility.
While this is costly, it is much less costly than the “free” feasibility studies provided by potential
contractors or financiers who stand to benefit if the project is built. Such free feasibility studies
tend to ask what kind of project should be built, rather than if any project of that type is
sensible. They are often a rich source of technical data but a weak guide to the underlying
economics of the project. The surest way to avoid waste is to have private groups invest their
own money without any special support. While environmental and safety concerns must still
be checked, they are unlikely to put their own money into an unprofitable venture. Such
constraints are much weaker with government-owned or guaranteed projects.

Successful nations manage to insulate investment choices from corruption, in the sense that
they manage to build what should be built at about the right cost, rather than what should
not be built at a wildly inflated cost. (They also avoid wildly inflated costs even on well-chosen
projects). Nigeria, as noted above, is a poster child for a nation that got hundreds of billions in
oil revenues, but failed to grow because of both waste and corruption.



OPPORTUNITIES AND THREATS Ironically then,
the “opportunity”
Ironically then, the “opportunity” of greater oil revenues is also a potential threat. If aid has of greater oil
resulted in only slow progress in reducing poverty in recent years, then oil may actually further revenues is also a
concentrate and even destabilize the society.7 Serious thought about ways to improve the use potential threat.
and broaden the impact of any forthcoming oil revenues are therefore part of any relevant
SWOT analysis. This analysis should include not only government spending but also
investments by the national oil company. Overall, though, the “threat” of oil is that governance
would become worse and spending would further concentrate wealth, fund capital flight, and
increase social tensions.

It is also possible that aid would be reduced. The end of the international conflict period is
now over 15 years ago. The obligations felt by the international community may not hold so
strongly after years of poorly used aid and increasing amounts of oil revenues. While a dollar
to dollar offset is not likely, the net increase in resources could end up being much less than
the net revenues expected from oil. This would make the efficiency of use – and a political
strategy for stability and equity as well as growth – of even higher priority than it is now.

What of other threats? The loss or reduction in garment exports is one such possibility. While
there may be temporary quota put on Chinese garment or textile exports, this is at best only
a temporary reprieve. Likewise, when Vietnam joins the WTO, it will be a significant
competitor. Building up a real competitive advantage by lowering port and other transport
costs, electricity, informal charges and other costs that are now much higher than in
neighboring states is the best and only response. The idea of building an integrated supplier
network is not a bad one, but is more likely to work if combined with the network already
evolving in Binh Duong (a province of Vietnam) bordering Cambodia. As roads improve and
red tape is reduced, the garment industry can become a regional one, and reduce costs more
effectively together than either nation could alone. The interest in investing in border export
processing and industrial zones illustrates this potential.

It is very hard to improve education in a country that has had so much of its educated
population moved or killed, just as it is hard to provide good health services when qualified
care providers are few. Poor health and education, if they persist, are likely to create another
threat. Cambodians can see their well-off neighbors, at least in the cities, and know how
people in other places live through watching television and DVDs. But with poor education
their prospects for earning much above the poverty level are not good. Indeed, many jobs will
be insecure as well as low paying. In addition to poor jobs, they have the threat of ruinous
health care costs if they become ill or injured. Many who lost land did so because of health
costs – another example of poor (health) services increasing insecurity and poverty. The rise
of HIV-AIDS, recently slowed, shows that progress is possible. To help the growing number of
young workers find decent jobs, to increase competitiveness, and to improve poor health
levels, finding a way to improve these critical services of health and education is necessary to
avoid a threat of restless workers with little to hope for. Current health and education workers
are poorly paid and typically charge users for their services (of uncertain quality) rather than
provide them for free. This means lower levels of use by the poor. If better salaries were paid
to providers, and combined with better training and supervision, accessibility would improve.
A realistic discussion of how to improve these services will also have to be part of a SWOT that
responds to popular concerns.

7
Paul Collier, a well known development economist, wrote a paper, “Is Aid Oil? An analysis of whether Africa can absorb more
aid ” (June 2005) in which he asked if oil and aid had similar impacts. He found that aid, except debt relief, was better than oil
in part because the donors had some influence. [http://users.ox.ac.uk/~econpco/research/aid.htm]



Perhaps we can put these various general comments together into a single table. Of course, a
table does not show the interactions among and between the various elements. Still, it is a
start for visualizing the overall situation.

Strengths: Weaknesses:

Good geographic location Corruption/poor governance
International acceptance Falling foreign direct investment (FDI)
WTO membership Low crop yields
High aid levels High/slowly falling poverty
Political and economic stability Land concentration
Emerging democratic society Poor health and education
Rapid export, economic growth Low electricity use/high price
Angkor Wat attraction High costs (transport/port/finance)
Cambodian unity/identity

Opportunities: Threats:

Oil and gas exports “Oil curse”
Higher crop yields Worsening governance
FDI potential Loss of aid
Tourism development Garment exports competition
Better governance Growing unemployment/insecurity
Emerging private sector



Cambodia
INTERACTIONS AND COMPLICATIONS should seek to
learn from
It is all very well to list various elements, but like a good recipe, a well-functioning economy Nigeria’s
or society needs the proper mixture and sequencing of policies to be just right. Furthermore, mistakes. It is
the outcomes (low crop yields, high poverty) are distinct from and rely upon the causes (poor even more
health and education, corruption) that contribute to them. Of course, poor health and
important
corruption might accelerate land concentration, which likely also aggravates poverty.
because of its
Lower FDI also is partly due to some combination of corruption and poor education and small population
health. Getting the causality clear, which can and often does flow in both directions, helps us size, limited
understand the importance of combinations of policies. Rather than trying to do everything market, and the
equally all at once, it helps to have a sense of priorities. Putting the prioritized elements difficulty of
together in a mutually supportive and logical package creates a strategy. The desirable seeking self-
outcome of a SWOT for Cambodia, combined with subsequent discussion, is a coherent sufficiency at a
strategic plan consistent with the Rectangular Strategy.8 reasonable cost
in an economy of
However, there is also the question of feasibility and timing. Lowering corruption is an its size.
excellent idea, but one that requires a complicated set of policies that take effect only over
time. Raising educational quality (as opposed to coverage) requires training and retraining
teachers and developing curricula that fit current circumstances. Then salaries, supervision
and management need to be improved. This too can take several years.

A further element concerns the urgency or pace of change of negative or positive
developments. Is land concentration proceeding very rapidly? That would suggest moving
aggressively to deal with it. Is the garment industry in need of dramatic cost reductions in
transport and port charges? This too could be dealt with quickly, so that more of the existing
base could be preserved and later expanded. When discussing the particular elements of a
SWOT, the magnitude and velocity of the issue needs to be factored into a final set of actions.

All of these complications might seem to make any useful outcome unachievable. However,
by identifying key issues and establishing their relation with each other, a degree of clarity is
often possible. And being clear about priorities and the time a policy will take is clearly useful
in fashioning any plan.

The next sections review particular aspects of the various SWOT elements in more detail. After
these sections, a synthesis section will lay out major decision items.

Cambodia should seek to learn from Nigeria’s mistakes. It is even more important because of
its small population size, limited market, and the difficulty of seeking self-sufficiency at a
reasonable cost in an economy of its size. If Nigeria seems too remote, the alternatives of
Vietnam or Malaysia on the positive side and Myanmar on the negative are perhaps closer to
home. One is developing rapidly and with a degree of equity. The other is unstable, stagnant
and weak. These two countries are roughly the alternative futures for Cambodia.

8
The Rectangular Strategy, introduced in 2004, has good governance; social and macro stability and integration, including
global; development of human and infrastructural capital; and growth in agriculture and the private sector as its main
elements. Poverty reduction would follow from these elements.



RURAL AND LAND ISSUES – PROBLEMS AND POSSIBLE SOLUTIONS

Agricultural output has not risen much in recent years, and rice yields were little higher in
2004 than in 1999 – about 2 tons per hectare compared to 4-6 tons in Vietnam. While most
Cambodians live in rural areas, for many their lives have not gotten much better. Water control
and fertilizers are still not much used, and fish yields have been declining. Real agricultural
output in 2004 was lower in per capita terms than in 2000. This reflects a lack of needed
investments and high input costs. For example, diesel fuel is expensive in Cambodia relative
to its neighbors. This would be a major input to water pumps, tractors and rice hullers – if it
were not so costly. An alternative for pumping would be to make electricity available over
central lines, but electricity is also very expensive relative to Thailand or Vietnam, where prices
below ten cents per kilowatt-hour are normal. Farmers pay over twenty cents when they can
get power at all. Poor roads compound the difficulty of making much profit from even higher
value-added products. On the Thai border, a few kilometers of bad roads prevented farmers
from selling their crops at a profit. The result is a high level of rural poverty and very slow rural
growth.

Poverty: How Real Is the Measured Drop?

The SWOT team visited many different parts of Cambodia and observed deep and significant
deprivation. A serious and highly professional recent household survey estimated poverty in
Cambodia in 2004. It found that the overall national poverty rate was 34.7 percent.
Comparisons with 1993 are tricky, because the earlier survey covered only 56 percent of
Cambodia. If the same area is used as in 1993, the poverty rate fell from 39 percent to 28 percent.
As this SWOT points out in its first page, there seems to be uncertainty about effective literacy
in Cambodia. Measuring poverty is harder, and there may be problems even with good
surveys that only time and additional measurement will reveal and correct. It is plausible that
the rapid expansion of employment in garments and tourism have helped lower rural poverty,
as some wages are sent back home to rural households.

However, there is another rough measure of well-being that is quite independent of these
problems: the food balance sheet data collected by the United Nations Food and Agricultural
Organization. This data lags somewhat – it is only available now for 2002 – but does report on
the amounts of various foods that the nation as a whole appears to be consuming. The
reported caloric intake was up 10 percent from 1995-97 to 2000-2002. However it rose to only
2060 calories per capita per day, which falls well short of requirements and was below the
levels in Myanmar, Laos and Chad.9

Moreover, there is a universal tendency for fat and oil consumption to rise relative to other
foods as real household incomes rise. However, the share of the diet in 1995-97 and 2000-2002
attributed to fats and oils stayed at 13 percent. This suggests that there was not much
improvement in real incomes over that time for most people. (Groups in the top fifth or tenth
tend to have their food spending patterns less influenced by rising incomes, as their diets are
already adequate). These data do not extend to 2003 and 2004, but do suggest that the
poverty data needs to be seen in the context of low average levels of rural living that are
highly variable.

9
Adult males from 16 to 60 years require about 2900 calories per day and females about 2100. The national requirement,
adjusting for children and age and sex structure, is 2200 calories per day. Typically, the average intake is above the median
caloric intake, meaning that a majority of people consume less than the already inadequate average amount.



Land Concentration

There has apparently also been an alarming increase in the concentration of land holdings in
Cambodia in the past four years. Data from recent household surveys showed the top tenth of
holdings accounted for about 45 percent of total land held in 1999 and about 65 percent in
2003. The top fifth of landholders held 59 percent in 1999 and 70 percent in 2003.10 While the
rural land shows much less of a tendency to concentrate holdings, this is likely to be due to
concessions not being included in “rural” as they were not in the household survey. While
these and other data issues need checking, there can be no reasonable doubt that there has
been a considerable concentration of land holdings due both to concessions granted and
land purchases.

The table below is perhaps better for indicating the direction of land ownership changes than
the actual magnitude of those changes:

Land Ownership in Cambodia by Decile Group, 1999 and 2003
Share of Land Owned by Each Group

1999 2003
Bottom 40% 8.4% 5.4%
Middle 20% (40-60) 11.0% 8.6%
Next 20% (60-80) 21.6% 16.0%
Top 20% 59.0% 70.0%
Of which: top 10% 44.6% 64.4%

Should this matter? After all, many Cambodian farmers are poor and might be reluctant to risk
trying better techniques or improved inputs. It could be argued that larger landholders would
have the capital to be able to take risks and improve yields. If this were true, then there would
be a conflict between the desire for greater output and the cost in terms of reduced equity.
Economists sometimes confront challenges of this sort.11

However, in this case, there is very little evidence that land is being bought or acquired most
often for use as a productive asset, as opposed to speculation. (If it were otherwise, agricultural
output per capita would not be falling!) The large concessions granted have not as yet
produced much in the way of major investment or output, with a few notable exceptions.
Even the well-known palm oil plantation near Sihanoukville appears to be a mixed success
due to the climactic conditions there that do not favor competitive palm oil yields – and that
is one of the few recent examples of major concession investment.12 However, recent gains in
the price of palm oil may make this particular investment viable.

10
The implied holdings by the 80-90th percentiles are 14.4 percent of land in 1999 and 5.6 percent in 2003. The 2003 figure is
very low, not even equal to half of the 60-80th percentile holdings. This is a contradiction that needs to be studied and
resolved.
11
It is possible that some small-scale farmers sold out because nonfarm activities promised a better living. This, in fact, has
happened in the Mekong Delta region of Vietnam. However, research in Cambodia suggests the landless have never had
land or have lost it due to illness or other misfortune. See, “Potential Poverty and Social Impacts of Cambodia’s proposed
Social Land Concession Program − Presentation and Discussion of Results and Recommendations from the PSIA exercise”,
June 2004. See especially pages 7 and 26. Also, the number working in agriculture grew 700,000 from 1998 to 2002,
a 19 percent gain vs. 30 percent overall.
12
Standard advice on planting palm oil is that yields fall off above 10 degrees from the equator, and that a steady rainfall of at
least 150 mm a month is ideal. A long dry season decreases yields, even with good care. The area near Sihanoukville is above
10 degrees north. While it is the most humid part of Cambodia, it has a 2-3 month dry season. This tends to depress yield
relative to Malaysia and Indonesia, the major producers. However, increasing use of palm oil instead of crude oil, has raised
palm oil prices and should help profitability.



One woman, In addition to concession land, there are also many reports of land being bought up by
with a sick individuals in amounts of a few to dozens of hectares. In most cases, these appear to be
husband, was wealthy investors from Phnom Penh who are speculating or perhaps buying land for later use.
not using It is hard to measure the extent and cumulative importance of this type of activity. It is
important to distinguish between these two types of land acquisition, as they have different
fertilizer on her
mechanisms and perhaps different required policy responses.13
small plot, even
though the If the reported trend in concentration in land holdings is indeed accurate, it would be a major
benefit/cost ratio shift towards inequality, and one very seldom observed in peace time anywhere in the world.
was ten to one. If the apparent lack of productivity of the new concession accumulations is not simply a short-
She was afraid of term transitional issue but (as seems likely) a longer-lasting structural issue, that would
borrowing and suggest that both output and equity are suffering. This would be undesirable from all
losing her land. perspectives. Two questions arise. First, why is it happening? Second, for the government,
what can be done?

Reviving the Rural Economy

The problems of poor roads, expensive inputs and credit have been mentioned. Yet beyond
this, is a lack of ability of farmers or of the society to take advantage of obviously desirable
bargains. In Siem Riep province, only 10 km on a good road from the city, we talked to
villagers. Many did not have enough food to last the year. Fish catches in Tonle Sap were
falling. One woman, with a sick husband, was not using fertilizer on her small plot, even
though the benefit/cost ratio was ten to one. She was afraid of borrowing and losing her land.
She knew what she was doing, or not doing.

Another group of farmers was growing eggplant in the dry season but only for their own
consumption. Markets in the city had eggplant from Vietnam. No connection had been made
between those poor farmers, who had all of the needed knowledge of growing, and the
markets. This lack of social or financial “wiggle room” in using credit for fertilizer, or in social
entrepreneurship in connecting farmers and nearby markets suggests a fundamental failure.
The farmers seem to resemble people up to their lips in water. A small wave will sink them.
That is why so many of them are losing land. What can be done?

The simplest step has already been taken. There is a temporary freeze on issuing of new land
concessions. This will prevent further transfers of “empty” lands. Often, these “empty” lands are
already being cultivated by farmers, so the transfers result in displacement and loss of
livelihoods, since the new employment generated (if any) is typically less than the number
previously working the land. Such transfers often cause unrest and demonstrations, as farmers
resist losing the land they have farmed. Thus, the government was wise in stopping these
concessionary transfers.

A second step would be to charge a modest annual land tax on holdings above 5 or 10
hectares. The purpose of this would not be to tax small landholders, but to remind large
landholders that there is an annual cash cost to holding land. The problem with this
suggestion is that if there are farmers renting or sharecropping the land, the landowner might
transfer the tax onto them. This would make their lives even harder and cause no change in

13
The increase in total farm area was about 10 percent during the 1991-2001 period, so if the data in the table are correct,
then the upper fifth in effect acquired all new lands plus an additional amount nearly as large.



behavior for the landowners. In any case, many of the concessionaires are powerful and are
said not to have paid fees or taxes for which they are now legally liable. If this is true, it would
underline the difficulty of imposing even a modest annual land tax.

A third step, although it is of only long-term benefit, would be to accelerate the formal land
titles being issued to small farmers. These are cheap when done in an entire area, but there are
relatively few teams now doing the work and it will take about twenty years to finish. Farmers
do appreciate having a formal title and seem to feel it provides more security for them than
the locally provided land-use right certificate. If a farmer is more secure in his or her land
ownership rights, more intensive investment in the land is likely.

A fourth step, also likely to pay off in the medium to longer term, would be to further
accelerate the extension of better-quality rural roads and to maintain the ones already built.
This is likely to be more important than investing in gravity-fed water systems. (The large
water systems should be compared to electricity-driven water pumps, which tend to have
fewer coordination problems14). If produce cannot be brought cheaply to market, then few
improved inputs will be used to grow it. Road construction and upkeep can use local labor,
providing jobs during the dry season.

A fifth step would be to extend rural electrification much more rapidly than currently planned.
The extension of power lines from Thailand and Vietnam, and the eventual construction of a
large thermal or hydroelectric power plant, will be most effective if many more villages are
connected to the main grid. Water pumping should be cheaper than with diesel pumps and
rural industrialization will be more feasible. Given the size of Cambodia and the density of
settlements close to major roads, the distribution of electricity to most people should not take
decades, as is currently planned.

Finally, for the poor, a “starter pack” of rice seeds and fertilizer could be given. This has been
tried in Malawi and provides enough inputs for a small plot. Since the poor usually have to buy
additional food, they are not able to sell excess rice paddy and pay off a loan. The normal
problem with this is getting the distribution right. However, since there is a very high payoff
to using fertilizer on rice in most cases (nearly ten to one in terms of revenues to costs if water
is available), the social profitability of this is likely to be high.

Many of these suggestions are costly. However, donors are likely to respond well to proposals
with high economic returns that also promote equity. In the medium term, there is a
possibility that oil revenues could fund some of these suggested initiatives. They would
provide an attractive set of high-return and pro-poor investments to compete against low-
return heavy industry investments. The main problem, as with many other types of
government spending, is to plan and to execute the projects so that they minimize waste and
corruption and provide the intended benefits. This could be less difficult with projects where
progress is clear, such as the provision of electricity or the improvement and upkeep of roads.
The costs of these activities are reasonably well understood and local oversight (if allowed)
would help keep local authorities honest. There are examples of central grants for local
infrastructure projects, such as the successful Instructions of the President (INPRES) programs
in Indonesia. This could also support the efforts to upgrade local governments.

14
A common problem with large, centralized irrigation systems is that water fees are not collected and maintenance is
neglected. The area effectively irrigated shrinks and the returns to the investment fall. Better outcomes are possible,
but only with a high degree of organization and management.

19


One major area CONNECTING TO GLOBAL MARKETS
for progress
would come from One recurring complaint we heard was that Cambodia was a “high-cost economy.” That is, the
using Saigon interest rates on dollar loans for normal businesses (not micro-credit) were often very high,
port rather than even for good credit risks. Trucking and shipping costs were high. Electricity and diesel prices
Sihanoukville, were higher than in neighboring countries. All of these problems lead to a lower level of
investment and less job creation than if costs could be reduced. There is no doubt that
especially if
investment could be higher, as interest in border export zones attests.
customs red tape
could be reduced One major area for progress would come from using Saigon port rather than Sihanoukville,
at border posts. especially if customs red tape could be reduced at border posts. Saigon port is close to having
“mother ships”15 call and load containers directly for delivery to Japan, the US and the
European Union (EU). This is much cheaper than delivering a container to Sihanoukville and
then shipping it to Singapore for the mother ship. Once the bridge is built connecting Phnom
Penh with Saigon, it could be very cheap and easy to deliver a container directly to Saigon. To
get some idea of the excess costs, consider the following prices (quoted as of August 2005) for
a twenty-foot container:

Costs of Shipping a Container from Phnom Penh via Sihanoukville to Singapore
Cost to truck one container from PP to Sihanoukville: $150
Cost to ship container from Sihanoukville to Singapore: $325
Total cost to ship to “mother ship” in Singapore: $475

Alternative Cost of Shipping: Phnom Penh via Saigon to Singapore
Cost to truck one container from PP to Saigon (with bridge): $95
Cost to ship container from Saigon to Singapore: $185
Total cost to ship to “mother ship” in Singapore: $280

Compare this to the reported appropriate cost of taking a container to Saigon (once a bridge
is in place) without excess payments ($95) and the cost of shipping a container from Saigon
to Singapore [a longer distance] of only $185 for a total cost of $280. That means, once a
bridge is available, it would cost about $200 a container more just to ship out of Phnom Penh
through a Cambodian port instead of going directly to Saigon, even with no “mother ships” in
Saigon. Once the larger ships do come, it will be even cheaper, since the shipping then will be
direct to the rich-country ports without any intermediate maritime connection. When truckers
and shippers we interviewed considered the possibility of shipping through Saigon, they
were extremely positive. Once the bridge (already planned) is built, the main issue will be
getting customs on both sides of the border to waive inspections and allow the containers to
go direct to the port for export. This will require some negotiation, but should be in the self-
interest of Vietnam since with more container traffic they will attract more mother ships and
better rates. This would benefit both Vietnam and Cambodia. One shipper even said that he
expected Sihanoukville to become a “suburban port16” in the next several years as container
traffic would shift to Saigon, given the distances and costs.

15
A “ mother ship” is a very large container vessel, carrying 5,000 to 10,000 containers. It is not economical for them to call except
at very busy ports − even Bangkok only started getting service in the later 1990s. Ships that call on Saigon now and
Sihanoukville carry only a few hundred to a few thousand containers and deliver those containers to a major port, such as
Hong Kong or Singapore. This adds to costs.
16
A “suburban port” is one that carries relatively light traffic and is supportive and secondary.

20


It is important to focus on the purpose of ports and roads. They exist to minimize transport
costs, not to maximize tonnage passing through a particular port. If a garment manufacturer
is more competitive with lower transport costs shipping through Saigon, then that “solution”
should be supported. There will be more jobs, more output and more exports. Therefore, it
should be a priority to negotiate improved customs clearance through Vietnam (or Thailand)
for containers bound for export. On the Cambodian side, customs could follow the
Vietnamese example of posting factory-paid inspectors at the factory where the containers
are packed and sealed. This acts as a guarantee that the container has what is on the manifest
and does not require additional inspection. If the cost of unpacking and repacking the
container is avoided, along with the pilferage often associated with such activity, then the
underlying benefits of better roads and bridges will be fully realized and Cambodia will find it
easier to attract investment.

A related, though separate, question concerns the planned $80 million upgrade to the port in
Sihanoukville. If the completion of a bridge over the Mekong to Saigon and some improved
customs procedures do indeed lead to a lower use of Cambodia’s main port, then the upgrade
now planned might be unnecessary in the near term. It is true that an industrial park close to
the port is planned, but the success of this is uncertain, quite aside from the possibility that it
might conflict with tourist development in that area. Perhaps a slight delay in the upgrade
should be allowed for while the situation is reassessed. If it turns out that Sihanoukville will
not be a “suburban port” but instead grow in importance, then there would still be time to
make the upgrade just a few years later.



CREDIT COSTS TO MEDIUM AND LARGE BORROWERS
We were often told that credit was costly. Visits to an Association of Cambodian Local
Economic Development Agencies (ACLEDA) bank branch confirmed this. Their cost of funds
was 4-6 percent a year from deposits, while their lending to those with collateral, but under
$1500 was 3 percent a month. Those without collateral up to $10,000 also paid 3 percent a
month, while those borrowing over $10,000 paid 1.5 percent a month. The branch had no bad
loans, so the cost of bad loans was not a significant issue. Interest rates doubled if the
payment was more than four days late. They said they could make more loans and had
expansion plans. They borrowed money from the Phnom Penh branch due to low deposits.

It is one thing to charge 3 percent a month for micro credits of up to a few hundred dollars. But
with low inflation and a modest cost of funds, it is much harder to see why the current spreads
of close to 2.5 percent a month (30 percent a year) with no bad loans should be justified on
larger loan sizes. In Battambang, even quite large and solvent rice millers wanting to borrow
hundreds of thousands of dollars faced interest rates of 2 percent a month, compared to 1 percent
for Thai rice millers. Given that normal interest spreads are 3-6 percent a year, it is hard to see
why the lending rates are so steep. One answer might be that domestic savings, even in
dollars, are scarce. (Balance of payments data from the International Monetary Fund (IMF)
show a capital outflow of nearly $700 million from 1998 to 2004). If Cambodia had to attract
foreign money at 1 percent a month, then interest rates of 1.5 percent a month (but not
2 percent) are understandable. But if it could draw back money earning 4 percent a year in
foreign banks and greatly increase loans, that might provide cheaper loanable funds. Bank
competition is one issue, but the larger one is getting more domestic savings at reasonable
costs. This requires confidence in the future of the country and its policies.

One trucker we talked to, obviously well connected, was located in Phnom Penh and he was
able to borrow at 8.4 percent a year, or about 3 percent a year over the deposit rate. While
trucks are easy to value and resell (and so lower risk), this example illustrates how more
reasonable rates are possible to achieve. His rapid expansion and profitability suggested that
the impact of reasonable loan rates could be quite important for private sector growth.



SUMMARY AND OBSERVATIONS The cost of
political peace
Cambodia has managed to grow at a rate of 6-7 percent a year in the past decade, and the has been a kind
latest data indicate a decline in poverty. The nation is at peace with its neighbors, who are of paralysis in
mostly richer with growing economies, providing a good economic environment. Garment progress on, or
exports have held up after the end of quotas and significant oil exports are a real possibility. even
Given all of this, a Cambodian leader might feel that he had done well and had the means to
backtracking
do better in the future. Against this are several cautionary trends. The cost of political peace
from, improving
has been a kind of paralysis in progress on, or even backtracking from, improving governance
and reducing corruption. governance and
reducing
This has contributed to slow and irregular growth in agriculture; mixed progress in social corruption.
indicators; and widening inequalities in income and, even worse, land ownership. Much of the
reduction in poverty appears to us to be tenuous. Exports essentially rely on garments and
tourism. Costs of fuel and energy are high and use is very restricted. Lofty real interest rates
are also a drag on investment,17 which is only a fifth of output. In short, progress, while real, is
partial and not clearly sustainable.

There have been a number of criticisms of donors spending too much on technical assistance
and not enough on construction. Donors have responded that simply budgeting funds, even
for simple construction projects, would not necessarily produce the desired results. Even now,
there is a real possibility of declining assistance due to a growing chill between some donors
and the government. If oil revenues grow to anything near the levels projected in this paper,
then the government will have its own, larger, revenues and have to assume responsibility for
its own spending decisions.

In that likely reality lies the greatest hope and the greatest threat to Cambodia. Given the
recent tendency to use new government positions to buy peace, the advent of new revenues
from oil, free of any donor pressure, could lead to an explosion of overlapping positions and
authorities and wasteful and corrupt spending. If Cambodia were to combine a government
of low responsiveness and efficiency with sharply higher public spending, the results would
be growing inequality and political tensions. Even if this unrest could be held down, the cost
of doing so and the resulting crime and insecurity would make Cambodia an unattractive
location for investment or tourism. Only a political understanding of the danger of this, and a
strong response to this danger, would help to prevent its likely occurrence.

A recent overview of the Cambodian situation by the former Ambassador of Singapore, Mr.
Verghese Matthews, was titled,“Cambodia – wasted time and lost opportunities.” It focused on
the lost opportunities caused by political bickering. However positive one might be about
past growth, it is hard to deny that some opportunities for economic progress have slipped
away in the complicated consolidation of political power. If this consolidation is now largely
accomplished, then there is an urgent need not to repeat the delays. It would be tragic to
waste an even larger opportunity presenting itself with probable growing oil revenues. While
no mistake is everlasting, a failure to move aggressively and use oil revenues effectively would

17
Using Asian Development Bank data, Investment/GDP declined from 21.2 percent in 2001 to a projected 18.5 percent in 2005.
Meanwhile real GDP growth is estimated at about 6.5 percent a year from 2001-2005. This implies a sluggish rate of growth
in real investment of under 4 percent a year. The Asian Development Outlook 2005 Update is used, available online at
www.adb.org. It was released in the second half of 2005.



set Cambodia back significantly. Donors would be exhausted. Investors would be skeptical.
Ordinary Cambodians would be frustrated and angry. Elite Cambodians would choose to
invest their savings elsewhere as a hedge against instability and uncertainty.18 It is easy to
envision such a future. The rubber and other tree crop areas would be like the Philippines with
absentee ownership and agricultural workers. The rice farms would have low productivity
with poor farmers in risk of losing their land, much as Myanmar is today. Health and education
levels would be low, reflecting the meager incomes of most of the rural people. The elites
would contest for the oil rents, as in Nigeria. Such a hypothetical society could not be called
successful. It is very far from Vietnam or Malaysia.

Fortunately, there are many productive and equality-increasing investments that would
create broad benefits, growth and stability. Rural roads including both new roads and
maintenance of older ones would accomplish this. So would rapid national electrification,
improved health and education, lower fuel and transport charges, and more competitive
interest rates, and they would all be possible with well-directed government spending. These
improvements would create higher levels of induced investment and output growth, and
create jobs for many of those who are already drifting out of agricultural employment. In
addition, focused programs for poor farmers could introduce small packages of inputs via
grants or help them invest in longer-duration crops such as rubber. Taken together, these
initiatives could add legitimacy to the government that implements them with reasonable
efficiency and create a more stable and sustainable development path than the current one.

If there are government revenues, there will be no lack of suggestions on how to spend the
money. The problem will be selecting a sensible mix of policies and getting them
implemented with reasonable efficiency. If some program starts to go bad, there needs to be
a mechanism to report this and to get it back on track or to terminate it. It is here that the
growth of the NGO and journalist communities could become a national asset. Allowing these
groups to ferret out poor performance and corruption and to report on it would help ensure
that the government’s efficiency does not deteriorate to dangerously low levels. If the
government cannot always detect and clean its own house, it would benefit from the
information and pressure coming from non-governmental groups, even if they are sometimes
wrong.

Low Government Salaries: The Cause of Corruption?

Government workers in Cambodia are very poorly paid. It is not reasonable to expect officials
with subsistence salaries to handle large amounts of government funds without augmenting
their own inadequate incomes. Even private sector entrepreneurs said they did not mind
paying extra (modest) amounts to government workers, as they thought it a reasonable fee
for service. Would higher salaries reduce corruption? Experience in other countries suggests
that higher salaries are only one step in a long journey.

Rational and meritocratic structures and promotion, oversight and accountability, law
enforcement, and public inquiry all help create a low corruption environment. Ignoring low
salaries dooms any anti-corruption drive to failure. Ignoring the other variables would make
simply raising salaries an expensive, but unproductive gesture. Fighting corruption is a difficult,

18
Official balance of payment data from the IMF shows a cumulative $684 million outflow from Cambodia from 1998 to 2004
in the line “short term outflows and errors and omissions.” Unrecorded outflows often show up as an error or omission and
it is common to estimate unrecorded outflows from such data. It should be noted that this $684 million excludes any
outflows in 2005 and is a net and not a gross figure. To the extent that there were gross short term capital inflow, the gross
outflows would be larger by that amount.



long-term problem. It has to have both carrots and sticks, with consequences for anyone The biggest
found involved in criminal activities. Without a high probability of punishment, there is threat to progress
impunity. in Cambodia is
that large
One observer argues that the tendency to use government positions and spending to cement
amounts of oil
political relations and develop patron-client relationships is deeply embedded in Cambodian
money will tend
culture and will not easily be dislodged.19 Others challenge this view. At one level, this is a
judgment that can only be made in the future, when a history of this period is written. to accentuate
However, it is clear that if there is a large amount of oil revenue, there will be the danger of weaknesses and
repeating a Nigeria-like experience, and that this can be avoided by moving on from political negative
consolidation to more of an emphasis on governance and long-term stability. tendencies that
are evident in the
For those who believe that it is simply not necessary to improve the level of government current
services or to implement policies that further spread the benefits of growth, one need look no environment.
further than public health. A major source of revenue in Cambodia is tourism. Is it likely that
tourists will flock to a country that finds itself unable to control bird flu, malaria, or other
infectious diseases? A concerted effort has already helped to control HIV-AIDS, so we know
that such programs can and do work in Cambodia. Beyond tourism, reducing the high levels
of mortality and morbidity would improve welfare and productivity, and reduce the
pernicious disease-poverty cycle that leads to so much inequality. In general, it is hard to plug
into one part of the global economy (tourism) without also bringing other parts of the society
up to some acceptable level. And in order to achieve better health and education levels, a
better-performing governmental apparatus has to be developed. This is difficult and time
consuming, but is certainly possible with money and commitment.

This SWOT concludes that the biggest threat to progress in Cambodia is that large amounts of
oil money will tend to accentuate weaknesses and negative tendencies that are evident in the
current environment. Oil funds, on the other hand, will also provide the means to break out of
this current tendency for development to narrowly concentrate benefits, and could provide
the leadership with a free hand and funds to spread the benefits of growth more widely and
secure a longer-term political and economic stability that has so far proved hard to attain.
While donors can play a useful supportive role in helping point out the benefits of aid
programs in a path leading to prosperity for all, the real decisions will be made by
Cambodians.

If these conclusions are accepted, then there should be a chance for the government and the
donors to move forward on an agenda that would include improving governance and
reducing waste; developing programs to improve the productivity and incomes of those who
are currently lagging; and to improve and maintain the infrastructure so that costs are lower
and investment is more attractive. Indeed, these are already part of current strategy, though
the balance and implementation are still being worked out.

In particular, attention to improving the distribution of land, and perhaps reversing to some
extent the concentration of land observed in the last several years, would be a priority. This is
true because the concentration appears not to be economically or socially productive, at least
for the most part. The object is not to reduce the size of holdings if they are well-run and
productive, but to discourage speculative holdings of land. Simply giving land to poor people

19
This view, along with the opposite view that foreigners were largely to blame for recent trouble, is covered in a useful survey
and analysis in “ Understanding pro-poor political change: the policy process-Cambodia” by Caroline Hughes and Tim
Conway. It is a 2004 Overseas Development Institute paper.



without also providing access to other inputs is likely to result in small, unproductive holdings
that would again be sold. Improving rural electricity, credit, and roads would help avoid that
outcome.

In summary, Cambodia has had both notable successes and also significant problems. Unless
the problems are addressed, the nation could suffer rather than benefit from a potential oil
windfall, and fail to capitalize on its potential strengths. It would choose to resemble nations
that are not well regarded, even by their own citizens. Avoiding that outcome requires a shift
from buying short-term political stability to investing in a more efficient and inclusive kind of
economic growth, which should also have benefits for longer-term political stability. Such a
shift is not easy, but the benefits of the change would be very high. The question is if it is
possible. The reaction of one government official to the poor showing in the World Economic
Forum ratings was that to be accurate, the report’s compilers should cooperate with the
government. This attitude denies problems and avoids solutions. It is perhaps the real threat.


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