I had a remarkably good experience on an ANA flight from Phnom Penh to Tokyo for a business trip in early February this year. The new Coronavirus outbreak caused some inconvenience for traveling. However, I found the services of the whole trip satisfactory, from check-in to landing. What amazed me even more was their in-flight meal, which included at least two Cambodia’s local products: ANGKORMILK Strawberry Yogurt and Vital Premium pure water. It was a rare occasion for a Cambodian national like me to have witnessed my country’s local products being served on a major international airline. The anecdote also showed Cambodia’s ongoing efforts to establish and develop its regional and global value chains or GVC integration.
The vision of connecting Cambodia to the GVC is not new but a result of decades-old strategic decisions about the future. The country has been pursuing policies and reforms to integrate itself into the GVC since its adoption of a market-oriented economy in 1989. This article aims to provide a comprehensive understanding of the challenges in promoting GVC participation of businesses in Cambodia. Based on the authors’ desk research reviewing the World Bank’s Enterprise Surveys, OECD-WTO Trade in Value-Added (TiVA) database, and other relevant economic and surveyed data, the article explores the persistence of challenges manifesting in many forms at different levels of private sector capacity and business environment and regulation domains.
These enduring challenges continue to hamper growth in Cambodia’s private sector and preclude them from fully engaging with the growing GVC activities in ASEAN and beyond and from benefiting from the opportunities presented by the evolving regional and global environments, such as the removal of trade preferential treatments, Industry 4.0, and the growing number of regional and sub-regional cooperation and integration initiatives.
Two Decades of Growth and Industrialization Progress
Cambodia has witnessed significant economic growth and transition over the last two decades. Since 2001, the annual GDP growth rate has averaged 7.7% and has been at least 6% every year except in 2009 during the global economic slowdown.
Figure 1: Real GDP growth rate, 2001–2018
The share of the industrial sector increased from 22% in 2001 to 36% in 2018. The service sector increased marginally from 38% to 39%, while agriculture declined almost halfway down to 18% from 34% during the same period.
Figure 2: Sectoral share of the economy, 2001–2018
The success in the garment and textile sector has long been a telling story of industrialization progress in Cambodia. The sector began in the mid-1990s, as the country started to embrace the ‘Factory Asia’ growth model, relying on inexpensive labor, openness to trade and investment, trade preferential treatments such as the European Union (EU)’s Everything But Arms (EBA) and the Generalized System of Preferences (GSP) which grant Cambodia duty and quota preferential access to the EU and US markets, and incentive policies such as Qualified Investment Projects (QIP). The sector has subsequently grown to become the largest industry in Cambodia, with apparel and footwear now dominating the country’s merchandise export.
The government’s efforts to accelerate economic diversification have been reinforced by the arrival of large Japanese corporations which have over the last few years opened their factories in the country as part of their ‘China+1’, ‘Thailand+1’ and ‘Vietnam+1’ strategy while at the same time taking advantage of Cambodia’s proximity to their major plants in neighboring countries. The cases in point include Minebea (motor manufacturing), Denso (automotive and motorcycle component manufacturing), and Yazaki (automobile wire harnesses), among others. As such, Cambodia’s manufacturing sector has experienced a noticeable transition toward higher value-added products, such as automotive parts, light manufacturing machinery, and equipment products.
The rapid growth and economic transition have significantly contributed to the country’s poverty reduction, bringing down the poverty rate from the realm of 50% in 2004 to 13.5% in 2014, measuring based on the US$1.90 threshold daily consumption expenditure. Cambodia attained the status of a lower middle-income country in 2015 based on the World Bank’s classification, and it set out an ambitious development vision of becoming an upper-middle-income country by 2030 and a high-income country by 2050. This vision has added momentum to the government’s reforms toward further industrial development and deepening Cambodia’s integration into the GVC.
Cambodia’s Limited GVC Participation
GVC participation can facilitate industrialization progress in developing countries helping them to further integrate into the global economy at relatively lower costs by producing only certain types of components or engaging with only certain tasks, rather than with the entire production process. The benefits can be substantial in terms of economic development for developing countries, as GVC participation brings about the sophistication of production, enhanced productivity, and diversification of exports.
GVC participation is defined for a reference country as to when the country embeds its value-add in exports in both looking backward and forward. Backward participation happens when the country’s domestic firms use foreign inputs for exporting activities. Forward participation happens when the country’s exports are used as inputs by firms in partner countries for their own exports. Figure 3 shows Cambodia’s overall GVC participation is below the ASEAN average. The GVC participation is broken down into backward and forward participation measures and is expressed as shares of the country’s exports. The strong backward participation showcases the fact that the country has thus far embraced the ‘Factory Asia’ growth model, relying largely on foreign value-add, in combination with trade preferential treatments and inexpensive low-skilled labor to give thrust to boost the country’s industrialization and exports. The weak forward participation highlights the low level of upstream activities in the country.
Figure 3: Cambodia’s GVC participation
Sector-wise, the magnitude of Cambodia’s overall GVC engagement is still limited to only a few industries. The manufacturing is the most involved in GVCs, led by textile products such as leather and footwear, and followed by food, beverage, and tobacco. It is then followed by agriculture, transportation and storage, and wholesale and retail trade (Table 1).
Table 1: Magnitude of Cambodia’s GVC participation by sector, (% of gross export)
Cambodia has demonstrated a strong connection with ASEAN as a bloc and regional countries. Table 2 presents the top ten individual partners in Cambodia’s GVC participation.
Table 2: Cambodia’s top 10 partners in GVC participation
Within ASEAN, Singapore has the highest average GVC participation rate of 62.8%, followed by Malaysia at 58.0%, Vietnam at 53.4%, Thailand at 51.5%, the Philippines at 46.4%, Cambodia at 43.7%, Brunei at 42.2%, and Indonesia at 41.1%. The average rate for ASEAN stands at 49.9%.
Figure 4: Average GVC participation among ASEAN countries, 2005–2015
From a micro perspective, firms may participate in GVCs by combining import and export, investment, movement of staff, and knowledge and technology through various business cooperation with foreign firms in order to optimize their internationalization activities. To our knowledge, attempts to investigate the mode of GVC participation among firms in Cambodia are still limited. On the industrial front, for example, the FDI–driven garment sector in Cambodia relies heavily on foreign inputs and has remained focusing on highly labor-intensive and on basic, low value-added activities, with factories engaging mainly in cut-make-trim processes. Design work and higher-level production are predominantly made at the headquarters of the foreign parent companies. The emerging travel goods and handbags sector and other light manufacturing sectors have experienced a noticeable transition toward relatively high value-added activities.
On the agricultural front, agribusiness remains weak, with small and informal primary processors accounting for the majority of the agroindustry. These processors normally perform basic value-added activities (besides packaging) and sell to the markets. Cooking, grinding, drying, roasting, and/or packaging are the most common value-added activities. Modern agroindustry is emerging for rice and its exports, attributing largely to the government’s commitments to turning rice into the ‘white gold’ through the establishment of Policy Document on the Promotion of Paddy Rice Production and Export of Milled Rice in 2010. The rice milling industry also relies on imports of machinery and inputs to keep value-added processing inside its borders. Most of the other commodities are exported in raw forms, mainly to neighboring countries to be processed for their exports.
The persistence of challenges manifests in different forms at various levels of private sector capacity and business environment and regulation domains. As mentioned earlier, a large portion of Cambodia’s agro-products including cassava, maize, and cashew nut are often reportedly exported, both formally and informally, to neighboring Thailand and Vietnam where they are processed for exports. It is a clear example of the insignificant level of upstream production activities and thus weak forward GVC participation. This is largely a result of private capacity issues, including constraints in sourcing raw materials, quantity and quality issues, and poor storage facilities. Other major issues include production and delivery constraints, which include the lack of finance; inadequate processing facilities and know-how; limited knowledge about the export process; and limited information access not supporting an informed decision-making regarding market needs, access to buyers, payment terms, and certification regarding safety and standard. Across various sectors, domestic firms tend to have relatively more capacity constraints than those with foreign partners due to the different levels of know-how and technical skills acquisition.
Connecting themselves to GVC through foreign firms in Cambodia is also a challenge for domestic firms. From foreign firms’ perspective, the high rate of informality and weak production capacity among domestic businesses as well as the lack of information about suitable domestic business partners make it challenging for them to partner with domestic firms. The Qualified Investment Projects (QIP) tax incentive policy to attract foreign investment to Cambodia also has its flaws. These investment projects are entitled to receive investment incentives, including profit tax exemption for a specified period or special depreciation allowance, import tariff and export tax exemptions, and VAT exemption. However, they will not be able to reimburse VAT if their projects source materials locally.
Relevant studies also highlighted a multitude of challenges in the business environment and regulatory domains. World Bank surveyed a total of 98 manufacturing and agro-processing firms and logistic service providers to capture an overview of logistics performance and costs in Cambodia. The study found relatively higher costs and lower quality of logistics services, ranging from transportation to warehouse to inventory, if compared with regional countries such as Vietnam and Thailand. The study also highlighted significant informal charges levied by government agencies, accounting for nearly half of the firms’ logistics administration costs.
In the World Bank’s Enterprise Survey of 2016, 32% of the surveyed firms identified “Competition in the informal sector” as major constraint issues, implying the informality was the most serious business environment constraint. It was followed by Crime, theft and disorder (24.2%), Inadequately educated workforce (17.6%), Access to finance (16.9%), Transportation (12.0%), Business licensing and permits (11.1%), Corruption (10.2%), Customs and trade regulations (8.0%), Tax rates (6.5%), Tax administration (6.4%), Electricity (6.1%), Labor regulations (5.2%), and Courts system (4.0%). Among the 373 surveyed businesses also included the 131 businesses who had also participated in the preceding survey in 2013, meaning the database also allows for panel analysis which illustrates the noticeable improvement in certain constraint issues (Table 3). Despite some improvements, the extent to which the business environment constraints undermining business operations remains rampant, with the high two-digit numbers being reported on half of the issues.
Table 3: Reporting ‘major’ or ‘severe’ constraint issues – 2013 vs 2016 (%)
Business environment and regulatory challenges also manifest at the macro level as shown by various available data. For example, the country positioned at 144th out of 190 economies in the World Bank’s Doing Business Report. The country also ranked low across World Bank’s Governance Indicators, particularly in terms of Control of Corruption, Rule of Law, Government Effectiveness, and Accountability. Transparency International put Cambodia at 162nd out of 180 countries in its 2018 Corruption Perceptions Index, which aims to give scores to countries and territories by the perceived levels of public sector corruption according to experts and businesses. The country scored 0.49 in the World Bank’s Human Capital Index, positioning itself at 99th out of 157 countries. The Logistics Performance Index 2018 (LPI) ranked Cambodia at 98th out of 160 economies. The country scored the lowest at 130th for the infrastructure component of the Index. The Global Competitiveness Index’s 2019 edition ranked Cambodia at 106th out of 141 economies, positioning the country among the least competitive countries in Southeast Asia.
Embracing the Evolving Regional and Global Environment
Cambodia is in the regional and global environment that keeps evolving and becoming uncertain, which include the potential removal of trade preferential treatments, the dramatic development in digital technology, and the growing number of regional and sub-regional cooperation and integration initiatives. Such changes are both inspiring and alarming, which means Cambodia needs to optimize them to accelerate the country’s GVC participation process.
The European Commission (EC) formally announced on February 12th, 2020 that it would partially remove Cambodia from the EBA scheme, a blow to the country’s export-driven economy which counts Europe as its largest and most lucrative market. Putting aside the political narratives and implications, the impact from the withdrawal is unclear at the time of this writing. With the new decision coming into force after August 12th, 2020, tariffs will be formally imposed on roughly 20% or US$1.09 billion worth of Cambodia’s current exports to Europe. The scaledown, however, will spare some of the textile and footwear products, which are by far the largest merchandise exports to Europe. Cambodia can be fully reinstated to a full-fledge EBA scheme if civil and political rights conditions in the country improve as outlined by the Commission. Otherwise, the country will face further scale down or complete removal of the EBA and other trade preferential treatments, a scenario that will make the garment and textile industry less attractive to foreign investment and that will affect the livelihoods of hundreds of thousands of Cambodia’s vulnerable groups, particularly women and low-skilled workers. This will also intensify the need to compete with other low-wage countries producing similar products. For example, the recent free trade agreement between Vietnam and the EU will compound the pressure on the prospect of Cambodia’s export-driven economy.
Reconsidering Cambodia’s overdependence on China for production capacity and investment is as critical as reconsidering its overreliance on the EU for market access. Putting geopolitics concerns aside, such an overdependence makes Cambodia extremely vulnerable to disruptions stemming from China’s capital control. A slowdown or reversal of FDI inflows from China will significantly affect the private sector growth. The grim news about the operation suspension of as many as 91 garment factories that would result in over 60,000 job losses due to an abrupt supply chain disruption from limited access to China’s raw materials is a recent case in point.
In this regard, Cambodia’s ongoing efforts to advance bilateral Free Trade Agreement (FTA) negotiations and expedite multilateral negotiations on the Regional Comprehensive Economic Partnership (RCEP) and other trade and investment agreements will lead to mid- to long-term measures to overcome these structural weaknesses and to create greater opportunities for firms in Cambodia in terms of markets and product diversification. Low import tariffs, both at home and in export markets, and engagements in regional trading agreements (RTAs) can all facilitate backward and forward GVC participation.
Moving toward developing a technology-driven and knowledge-based modern industry has been outlined in the latest and most important ‘economic growth strategy’ – the Industrial Development Policy 2015–2025 (IDP). Embracing the dramatic development in new digital technology will enhance the potentials for all important economic sectors. With an increased level of mechanization, for example, agriculture will see a substantial improvement in productivity, diversification, commercialization, and exports. The manufacturing sector will experience a greater transition toward higher value-added products. The service sector will have the highest level of ICT utilization, led by a full-fledged embrace of digital transactions and fintech. As per their implications on GVC participation, one possibility is that they will unlock the full potentials for digital payment and e-commerce development, which will contribute to transforming traditional businesses and manufacturing and connecting them better to the GVC. An improved telecommunication technology will also allow for better coordination of complex and geographically dispersed production processes.
To seize all these opportunities, however, Cambodia needs to enhance its readiness for the fourth industrial revolution and at the same time amplify supports to local firms, which remain struggling in promoting their upstream production activities to mitigate the risks of having their tasks replaced by such new technologies as artificial intelligence, robotics, and internet of things.
ASEAN membership continues to be a catalyst for the improvement of Cambodia’s business, investment, and trade policies. It is also for the stimulation of investment and trade and for the establishment and improvement of an enabling environment for local firms to unlock their full potentials and for contributing to creating significant backward/forward linkages with overseas firms. From infrastructure development to cross-border trade and to tourism, Cambodia has benefitted greatly from the connectivity development focus of the many emerging intra- and extra-ASEAN cooperative and integration initiatives, such as the Greater Mekong Subregion (GMS), the Ayeyawady-Chao Phraya-Mekong Economic Cooperation (ACMECS), the Lancang-Mekong Cooperation (LMC), Mekong-Japan Cooperation, Mekong-Ganga Cooperation (MGC), Mekong-ROK Cooperation, the Lower Mekong Initiative, and the China-led Belt and Road Initiative (BRI). They contribute to reducing the various forms of disparities between Cambodia and ASEAN member countries while at the same time accelerating the ASEAN integration process as a whole. Cambodia’s businesses can then use the improved intra-ASEAN trade and investment relationships as a testing lab to substantiate their own strategies and learn from regional peers for their own capacity improvements in meeting international standards and requirements to ensure the sustainability of their engagements with foreign firms.
However, relevant data suggest Cambodia has not yet fully reaped the benefits from the regional integration initiatives, considering the country’s insufficient volume of intra-ASEAN trade compared with other countries in the region. Only around one-fifth of Cambodia’s exports are sold to the ASEAN Member States. This indicates the need for strengthening the reform momentum to deepen Cambodia’s trade and investment engagements with ASEAN if Cambodia aims to capitalize on the opportunities arising from an increasingly integrated and cohesive ASEAN community.
Connecting to GVC brings about economic benefits in terms of the enhancement of productivity, sophistication, and diversification of exports. The vision of having a strong participation in the GVC is not new for Cambodia but a result of decades-old strategic decisions about the future. However, Cambodia’s GVC engagement is still insignificant and limited to only a few industries due to a multitude of persisting challenges. They manifest in many forms at various levels of private sector capacity and business environment issues, which include regulatory constraints (such as business informality, licensing and tax, and corruption), infrastructure and logistics, quality and standards, and limited understanding and inadequate information on import and export methods.
These enduring challenges continue to hold off the efforts of Cambodian firms and the government to participate fully in the GVC. The potential removal of trade preferential treatments, a dramatic development in digital technology, and the growing number of regional cooperation and integration initiatives in the increasingly connected Southeast Asian region have significant implications for Cambodia’s trajectory toward the GVC integration.
The opportunities presented by these evolving regional and global environments are plenty, and so are the risks. The bottom line is that the enduring challenges still create some ‘gaps’ or ‘missing links’ that need to be linked or bridged. Attempts to narrow the gaps are not non-existent. For example, the IDP laid out ‘key reform measures’ which include the formalization of businesses, reduction in electricity cost, enhancement of connectivity in transport and logistics, and improvement of the labor market and skills. Prime Minister Hun Sen’s five recommendations for reforms– “looking into the mirror, taking a shower, scrubbing away the dirt, treating wounds and conducting surgery”– are also meant to address specifically the long-standing governance and public capacity issues regarding coordination, accountability, government effectiveness, law enforcement, and corruption. As per the policy implication going forward, efforts to bridge these missing links need to build up momentum with the aim of capitalizing on the emerging opportunities presented by the regional and global environment and connecting Cambodia better to the GVC.
This article first appeared in the Asian Vision Institute (AVI)’s Perspective Issue: 2020, No. 11. AVI is an independent think tank based in Cambodia.
 This is a business-level survey of a representative sample of an economy’s private sector, from manufacturing such as food and garment to retail to other service sectors such as hotels and restaurants and construction. Its 2016 database is the latest version for Cambodia. It collects information about a country’s business environment, covering various issues identified to be the major business constraints by each of the 373 businesses participating in the survey. The database can be accessed from its online portal at https://www.enterprisesurveys.org/.
 TiVA online database is more commonly used to assess the economy’s participation in the GVCs. TiVA is the outcome of an on-going international effort to develop measures of Trade in Value Added. TiVA indicators are published by OECD and based on the 2018 release of OECD’s annual Inter-Country Input-Output (ICIO) tables which cover the period 2005 to 2015. The database can be accessed at http://oe.cd/tiva.
 These ‘X Plus 1’ refers to a strategy whereby a corporation branches out from their plants in X by opening production facilities in other regional countries, basically to diversify risk, control cost, and access to new markets.
 ASEAN in OECD-WTO TiVA Database excludes Lao PDR and Myanmar due to data unavailability.