Keynote Address by DPM Lee Hsien Loong at the Morgan Stanley Asia-Pacific Summit 2002, 22 Oct 02, Ritz-Carlton Millenia Singapore

Distinguished Guests

Ladies and Gentlemen

INTRODUCTION

1. For two decades during the East Asian miracle, Southeast Asia grew rapidly. Large volumes of foreign investments helped to transform the economies, creating jobs and expanding exports. This ended abruptly in 1997, when the Asian Crisis swept through the region. The crisis has passed. But since then, Northeast Asia's economic performance has outshone Southeast Asia's. In Southeast Asia, growth has been weaker and more disparate, both direct and portfolio investments have fallen, and ebullience has been replaced by pessimism. There are three main reasons.

2. First, China. A large part of Northeast Asia's strong performance reflects the continuing growth and transformation of the Chinese economy, which largely escaped the Asian Crisis. The past few years have witnessed rapid market liberalisation in China, as it prepared itself to join the WTO and bring 1.3 billion people into the global trading system. As the Chinese economy grew and showed tangible progress, MNCs have become euphoric over China's potential, both as a production base and an enormous market. Accordingly, foreign direct investments have poured into China. China still faces daunting problems, for example, in its banking system, state-owned enterprises, and intellectual property rights regime. But the dramatic and ongoing changes give investors hope and confidence that these problems will in time be overcome, making them feel that they cannot afford not to be in China.

3. A second reason for Southeast Asia's under-performance is the regional political and security situation. The Asian Crisis precipitated major social and political changes in many countries, deterring MNCs from committing to new investments in an uncertain climate. These overriding political concerns also distracted the governments from tackling urgent economic problems and implementing painful structural reforms to remedy weaknesses uncovered by the crisis. In contrast, South Korea's aggressive post-crisis restructuring of its corporate sector has spurred a more rapid recovery.

4. Most crucially, the Asian Crisis brought down the Suharto Government in Indonesia, and launched Indonesia on a new and uncharted path. For thirty years, a stable Indonesia, with a strong government focused on economic development, had provided a critical basis for confidence and peaceful cooperation in the whole of Southeast Asia. Suharto's fall changed this. The subsequent Indonesian government abandoned Suharto's longstanding policy of restraining political Islam, thus opening Pandora's box. Islamic groups, including the militant ones, now wield considerable influence in Indonesia's body politic. Indonesia's political and social landscape has altered drastically and permanently, affecting the whole region.

5. More recently, Southeast Asia has faced security problems from extremist Islamic terrorist groups linked to Al Qaeda. After September 11, such groups were discovered in Malaysia, the Philippines, Singa-pore and Indonesia. They are linked to one another in a network which seeks to create an Islamic state in Southeast Asia through violence and terror. The recent bomb attack in Bali was a tragic reminder that Southeast Asia is at the frontline of the worldwide war against terrorism.

6. A third, more cyclical, factor underlying Southeast Asia's under-performance, has been weakening external demand.Although Southeast Asia's economies have been diversifying their sources of demand, they are still heavily dependent on external demand, unlike China. But Southeast Asia's main export markets - US, Japan, and the EU - are all languishing. The timing and strength of a pick-up in the US economy is uncertain, especially given the possibility of a war in Iraq, and the concomitant impact on oil prices and the international security climate. The Japanese economy is still mired in difficulties, with no imminent prospect of decisive fundamental change. With fiscal and monetary policies constrained by the Maastricht Stability Pact and a stringent inflation target, the EU economy too remains weak.

Southeast Asia's Response

7. These three factors - China's rise, regional political and security problems, and weak external demand - explain Southeast Asia's under-performance, but they do not condemn Southeast Asia to perpetual stagnation. How can Southeast Asia overcome these problems?

China

8. First, Southeast Asia should not see China only as a challenge, but also as an opportunity. A rising China is a formidable competitor for investments and in global markets, but Southeast Asia is better off with a prosperous and modern China, than with a poor and backward China.

9. International trade is not a mercantilist zero sum game. As China's exports have grown, so have its imports. Southeast Asian exports to China have been expanding rapidly. Between 1999 and 2001, Singa-pore's own exports to greater China (i.e. PRC, Hong Kong and Taiwan) grew by an average of 14% p.a., and now exceed our exports to the US. These exports range from integrated circuits, disk drives, scientific measuring instruments, oil and chemical products to food and beverages.

10. In services too, China's rising affluence offers great opportunities to Southeast Asia. China is one of the fastest-growing sources of tourists to Thailand, Malaysia and Singa-pore. A growing Chinese middle-class will want high-quality healthcare and education services. And wealthy Chinese - whose numbers are already not insignificant - will need more sophisticated financial services.

11. In manufacturing, China is rapidly expanding into activities previously carried out in Southeast Asia. But that does not mean that Southeast Asia will revert to agriculture and primary production. Attractive as China is to investors, it will not soak up all manufacturing investments, nor will it out-compete all other countries in every industry and every product. More likely, Southeast Asia and China will complement each other in an international division of labour, for example, with Southeast Asia providing the components and intermediate processing, and factories in China doing the final assembly for the Chinese market. The desire of MNCs to diversify their investments beyond one or two countries will also promote such an outcome.

12. For our part, Singa-pore is actively positioning itself to benefit from China's growth. When Chinese Vice President Hu Jintao visited Singa-pore recently, he proposed four areas for increased bilateral cooperation: high-tech industrial sectors, the economic development of China's western provinces, helping Chinese enterprises to exploit international opportunities, and the training of personnel and exchange of talent. Officials from both countries are pursuing these ideas.To help Chinese companies go international, Singapore has mooted the idea of setting up a base in Singapore to help Chinese companies market their products to the region and beyond. We are actively facilitating Singa-pore business ventures interested in China, providing market information, office space and consultancy services, and maintaining business networks. We have also launched an Asian Business Fellowship Programme, to develop a talent pool with operational experience, and network and market knowledge in China.

Politics & Security

13. Second, Southeast Asian governments must tackle the security problems resolutely and decisively. Terrorism is not unique to Southeast Asia. It is a global problem, originating in the Middle East, and spreading to every continent. Southeast Asia cannot be immunised against the terrorism virus. The large Muslim populations in the region are a natural host which extremist Islamic groups will exploit for concealment and political cover. Fortunately, the vast majority of Southeast Asian Muslims are peaceful and moderate in their beliefs. The problem therefore lies in dealing with the extremist elements in a way which does not alienate the majority of peaceful Muslims. This calls for deft political handling.

14. Southeast Asian governments are already taking action. In Malaysia, with a Muslim majority, the govern-ment has acted with despatch, arresting members of extremist groups and rooting out their organisations. The Malaysian government also controls the outflow of Malaysian students studying in madrasahs in Pakistan, where they may pick up extremist ideas.

15. In Singa-pore, with a sizeable Muslim minority, the govern-ment has arrested extremists belonging to the Jemaah Islamiyah group, and severely disrupted their operations. We have gone beyond security actions and taken pains to explain the problem to the population, so that Muslim Singa-poreans do not feel that they are all under a cloud of suspicion, and the non-Muslims do not treat their Muslim fellow citizens any differently than before. Muslim community leaders have come together to publicly condemn the extremists as doing great harm to the Muslim community. Their clear and unequivocal collective stand has been enormously helpful in maintaining confidence and avoiding a rupture in racial and religious harmony.

16. In Indonesia, where 90% of the population is Muslim, the govern-ment has been extremely circumspect in acknowledging and dealing with the problem. The extremist groups have skilfully used religious and nationalist sentiments to garner political support and protect themselves against arrest. However, the Bali bombing has changed the situation. President Megawati has promulgated tough anti-terrorist decrees, including powers to detain suspected terrorists. The Indonesia govern-ment has arrested Abu Bakar Ba'asyir, who is the emir, or leader, of the Jemaah Islamiyah group, who had till now defied the Indonesian authorities to act against him. Government action in the aftermath of the Bali bombings has won the strong backing of key local institutions and the Indonesian population. Parliamentary leaders concurred with the passing of the anti-terrorism decrees, and the leaders of the two largest Muslim groups in Indonesia, the Nahdlatul Ulama and Muhammadiyah, have also voiced their support.The people of Indonesia know that if the militants succeed, not only will international confidence plummet and economic progress grind to a halt, but their country will be torn asunder.

17. Southeast Asian govern-ments will act because they know that the objectives of the terrorists are totally beyond the pale. These are not innocent political dissidents exercising their democratic rights. They are ruthless fanatics, quite willing to destroy innocent lives in order to create civil strife and animosity between communities and countries, shake confidence in Southeast Asian economies and their legitimate governments, and weaken the basis of the states. They cannot succeed, but they can cause great harm in trying. Provided the governments respond vigorously to the extremist threat, they can contain the problem and gradually restore confidence to the region.

Access to Markets

18. Third, Southeast Asian economies need to boost external demand by strengthening their access to the major developed markets. In the short term, there is little we can do about the cyclical downturn. But for the longer term, favourable and assured access to key trading partners will allow Southeast Asian countries to maximise benefits from free trade and globalisation, and make themselves more attractive to investors.

19. One basic approach is to promote multilateral trade, and contribute to a successful outcome of the Doha Development Agenda of the World Trade Organisation (WTO). But we need to complement the multilateral approach with bilateral Free Trade Agreements (FTAs) with our key trading partners. This is why Singapore is actively pursuing an FTA strategy. We have concluded FTAs with New Zealand, Japan, and the European Free Trade Area (EFTA), and hope to conclude agreements with the US and Australia very soon.

20. Singa-pore's aim is not just to boost our own trade links with our FTA partners, but also to catalyse broader economic engagements between ASEAN and its trading partners. This is indeed happening. After New Zealand concluded its FTA with Singa-pore, Australia and New Zealand proposed starting a Closer Economic Partnership Agreement with ASEAN. Last year, ASEAN and China agreed to set up an ASEAN-China FTA within 10 years. Weeks later, Prime Minister Koizumi of Japan proposed a Japan-ASEAN Comprehensive Economic Partnership, to be modelled on the Japan-Singapore bilateral agreement. Similarly, we hope that the US-Singapore FTA will become a model for a US-ASEAN FTA in the longer term. These link-ups show that ASEAN is not turning inwards and away from the global economy, and will give ASEAN a valuable edge as an investment destination.

Singapore's Economic Restructuring: Philosophy & Initiatives

21. Given this bracing environment, Singa-pore is at a turning point in our economic development. The whole landscape has changed. We need to change our strategies to continue to thrive. This is why we convened the Economic Review Committee (ERC), to carry out a comprehensive review of our economic policies, and to identify ways to develop a vibrant and competitive private sector. We have concluded that the key tenets of our economic strategy are as follows:

22. First, we must enhance the competitiveness of our economy. This means keeping direct taxes as low as possible. There is a worldwide trend towards lowering taxes to attract and anchor companies.We also need to cut personal tax rates to spur entrepreneurship, risk-taking and wealth creation, and to attract and retain talent. Hence we undertook a major restructuring of our tax system, reducing corporate and personal tax rates from around 25% to 20% over three years. We will tax individuals who are not ordinarily resident in Singa-pore, based on the number of days they actually spend working in Singapore. To make up part of the revenue shortfall, we are raising our consumption tax from 3% to 5%.

23. Tax incentives have also been enhanced. Qualifying high-growth and high value-added financial activities will enjoy a concessionary tax rate of 5%, while a 10% rate will apply to tax-sensitive but mature activities. We have also enhanced incentives for specific activities, such as fund management, trustee and custodian services, insurance and capital market and treasury activities.

24. We also undertook a fundamental review of the Central Provident Fund (CPF) Scheme, which is our social security and pension fund scheme. We refocused the CPF on its core objective of providing for the basic needs of the majority of Singaporeans, in terms of retirement needs, healthcare expenses and home ownership. We are tightening the use of CPF for buying properties, so as to leave more for retirement needs. We are reducing the coverage for high-income Singaporeans, who should be able to plan and provide for their own retirement. We are lowering contribution rates for older workers, who are most vulnerable to losing their jobs. These measures will make our labour market more flexible, and contribute to our economy's overall resilience and competitiveness.

25. Second, we want to encourage entrepreneurship in order to develop more local and foreign start-ups and emerging enterprises to complement our strong base of MNCs and established local companies. In this rapidly changing, unpredictable environment, the best way to spot and exploit new opportunities is not by centralised direction, but through the dri ve and entrepreneurship of our people. According to the 2001 Global Entrepreneurship Monitor Report, Singapore ranked 27^th out of 29 countries in terms of entrepreneurial activity. We need to do better.

26. We need to imbue our young with entrepreneurial instincts and attitudes, through their school education and life experiences. At the same time, the government should cut red tape, create more economic space for private enterprise, nurture high-potential local enterprises and develop a culture tolerant of risk-taking, experimentation and honest failure.

27. A self-renewing, self-sustaining entrepreneurial culture will not emerge overnight, but we are making some headway. Ten Singapore companies made it to this year's list of Forbes' Global 200 companies with revenues under US$1 billion. This ranks among the largest number of companies for any country.

This speech is continued here.