Goh Xue Qi (S10170734B)
Goh Yi Feng (S10173554C)

Jordon Sim Yong Zhi (S10171214K)

Wong Shiya, Shania (S10170874E)

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1.2 Current Situation in Laos
Currently, Laos has a sizable export from both the industrial sector and the agricultural sector, with more than 25% coming from its export of gold, copper and rubber  for its industrial sector and 28% from its agricultural sector  as reflected in Appendix 3 (MIT, 2018).  In addition, it has another 16% of the export coming from electricity.  (Appendix 4) The export of electricity is expected to further increase by 2020 given Laos’ aim of being the ‘Battery of Asia’. Currently, Laos have 46 operational hydro power plants with a total power generation capacity of 6,444 megawatts and around 35,000 million KWh generated annually. To attain its goal, Laos will has started on projects to construct 54 more plants to ramp up capacity to 28,000 megawatts and around 77,000 million KWh annually, some of which is expected to reach Singapore following completion (Mekong Eye, 2017). 

However, in order to sustain the present growth rate of 6.8% annually or even reaching the target of more than 7%, Laos would need to look beyond the exploitation of natural resources. Firstly, while Laos is very rich in its natural resources, increasing evidence of depleting resources are surfacing. According to The Economist, Laos is reducing its gold production (The Economists, 2013). This is mainly due to the depleting ore reserves in the country. Also according to the World Bank, Laos is depleting its natural at 6% of its gross national income in 2016 (World Bank, 2018). Secondly, while Laos’ agricultural sector is steadily falling in terms of contribution to GDP, 62% of its population is still concentrated in the Agricultural sector in 2017. This figure represents an untapped potential for its economic growth if the government is able to include the population as part of its economic growth plan (World Bank, 2018). 

Laos could potentially not only hit its target of 7% economic growth annually, it could also undergo an economic decline if it does not do more to diversify its economy. This is attributed to its over-reliance on natural resources and the depleting resources available in the country. A diversified economy of Laos would not only reduce the dependency of the resource, it could give better jobs to the population which is more effective in driving the economy.

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Currently, Laos faces critical labor issues in both its skill and unskilled labor sector. On the side of unskilled labor, many Laotian people are not moving over to the manufacturing sector due to low productivity in the agricultural sector. The low productivity in the agricultural sector has meant that more workers are tied up and less able to move to the urban areas for work. Also financial incentives have not been enough to attract these workers into the cities. Productivity level in the manufacturing sector is only about 3 times higher than its agricultural sector, compared to the 15 times in Thailand in 1980s (Emerging Markets Consulting, 2016). This low productivity level has translated to lower wage levels. More importantly, Laos faces a drain it its manpower, with Laotian people crossing the border to Thailand to work in the agricultural sector, as the pay is 3.09 times higher per hour (Emerging Markets Consulting, 2016).

For the skilled sector, the government regulation has made it difficult for foreigners to train the workforce, where it imposed a number of red-tapes on these professionals entering the country. Also, Laos do not have an effective labor market information which meant that institutions, governments and citizens have an inadequate understanding of the types of occupation and skills in demand. This has made it difficult for the workforce to be trained and supplying the right workers to the companies.

With the shortage of labors and the ability to provide useful training, Laos would face great obstacle in diversifying its economy. This is because a diversified economy place greater ability on the human resource of the country to produce and drive the economic growth. With a lack of basic skills numeracy and literacy skills, it is difficult to implant technical skills to these workers. Hence, the government would need to improve their education system before they can diversify their economy.

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Falling above the average deficit of 2-4%, Laos’ 6.43 percent of fiscal deficit has affected the government’s ability to effectively lay out plans to diversify its economy. Attributed mainly to the increase in government spending in building hydroelectric dams and the narrow government revenue sources and macroeconomic mismanagement, the deficit is likely to create huge economic instability. This is because with fiscal deficit, there is an increase in borrowing in an economic, and this would increase the cost of borrowing, which would discourage potential business owners from setting up any businesses to diversify and generate growth to the economy. Furthermore, the increase in borrowing would also increase the money supply in the economic which would be inflationary. As such, the government may find greater obstacles as investors both local and foreign-based may not be inclined to invest under such economic conditions.

1.3.3 Infrastructure
Another challenge that hinders the diversification of the economy would be the poor infrastructure of Laos. In terms of transportation infrastructures, the network is far from comprehensive. Till date, there is no train system in Laos (Advameg, 2018). Instead, the country is served by a network of 21,534 kilometers (13,381 miles) of roads, of which only 16.5 percent are paved. Laos also fares badly in other aspects of infrastructure. Currently, Laos has not officially joined the World Wide Web (Advameg, 2018). These shows that Laos is currently unable to support complex logistics operations and has much ground to cover before it can effectively facilitate cross-border trading. However, efforts have been made by the government to improve its current situations and these would be discussed in section 4.5. 

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Income refers to revenue streams from various channels such as salaries, wages, rent, profit from selling something etc. Income inequality of a country is defined as the unequal distribution of income among an economy’s population and is commonly measured by the Gini coefficient index that compares the deviation with a perfectly equal distribution..

According to a OECD analysis, there is a correlation between income inequality and economic growth and that countries where income inequality is decreasing experience rapid growth in the economy as compared to those with rising inequality (OECD, 2013).

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 3.2 Income Inequality in Laos

3.2.1 Current Situation

Despite strong growth and a reduce in poverty in recent decades with the estimated incidence of absolute poverty decreasing by half from 46% to 23%, there is an increase in the Gini index from 34.3 in 1992 to 36.4 in 2012 which is an indication that the income gap between the rich and the poor in the country is widening over the years (World Bank, 2012). (Appendix 6) This indicates that while the poor are now better off with higher income levels, proportionately the rich have benefited even more than them.

Furthermore, Asian Development Bank’s 2015 report noted that if the real expenditure of all household groups had increased at the same rate as the decline in poverty over the research period, poverty incidence would have declined by an even more significant amount from 46% to 17%. Thus, this demonstrates that the rising income inequality has undermined the extent of potential poverty reduction by 6% which prevented further economic growth of Laos (Asian Development Bank, 2015).

With a relatively large proportion of 23.2% of the population still living below the national poverty line, it may indicate that a significant portion of the labour force is either underemployed or unemployed. Additionally, 59.4% of the employed population has purchasing power parity of lesser than $1.90 daily in 2012, thus these could potentially affect the sustainability of Laos’ economic growth process in the near future (Asian Development Bank, 2017).

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 3.2.2 Inequality in Access to Public Services

The income inequality has led to the unequal provision of educational services to households. With economic growth over the years, the participation rates for 6-10 years old children in primary education who come from both the poorest and richest households in the population has significantly increased. However, the disparity of participation rates between the rich and poor has also increased from a difference of 12.64% in 1998 to 31.11% in 2013
(Appendix 7 ) (Peter Warr, 2015).

The unequal access to education will result in the poorer citizens to be less productive as they will have less developed literacy and critical thinking skills, thus resulting in lower efficiency levels and the economic growth of Laos to be hindered.

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3.3.1 Lack of Human Capital 

Laos has neither been able to grow its own talent pool. Income inequality causes demotivating effects such as decrease in investment in education and reduced effort to work harder. People with low income cannot afford to invest in income enhancing activities such as education to better themselves which result in them to be trapped in the vicious cycle of poverty with a lack of employability skills. Additionally, the poor education system in Laos has caused citizens to have a poor grasp of foundational skills in terms of both literacy and numeracy (Emerging Markets Consulting, 2016). This has made it difficult for these people to acquire technical and cognitive skills required for the workforce as a result, business cannot be hinders the business’ growth as companies need qualified workers to develop the company which will eventually affect the economic growth of Laos.

3.3.2 Social Tension

If income inequality persists in the long term, it could increase social tensions and disrupt the peace and order. Social tensions will cause an increase in property crimes and political unrest which leads to the destruction of infrastructure. As a result, investor’s investments in the country will decrease and production potential will grow more slowly which will harm the economic growth and undermine further attempts at reducing poverty in Laos (Bertelsmann Stiftung, 2015).

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After months of discussion and consideration, Laos’ Prime Minister Thongloun Sisoulith announced that as of May 2018, the country’s minimum wage will increase from 900,000 kip to 1.1 million kip per month. Previous negotiations by the government to raise the minimum wage in Laos have seen unions pushing for a one-third increase in the current minimum wage of 900,000 kip ($108) a month set in 2015. Represented by the Lao Federation of Trade Unions, locals are asking for 1.2 million kip a month to cope with the increase in the cost of living. However, Lao National Chamber of Commerce and Industry argued that any increase beyond 1 million kip would see factories shutting down and owners pulling out of the country due to high cost. 

Laos have been facing a lack of labour force within the country as most of the workers, especially skilled ones, leaves Laos in search of higher paying jobs in neighbouring countries. At least 170,000 Laotians are thought to be legally working in Thailand alone due to higher pay. The increase in minimum wage is to encourage workers to return and contribute to Laos economy and prevent others from leaving. As a result, there could be a potential growth in the country’s manufacturing industry now that there is a reliable stock of employees (David Hutt, 2018). 

Due to the wage rise, Laos is able to fulfil two of the three criteria to leave the Least Developing Country (LDC) status according to the United Nations. If the economy runs smoothly, Laos could be upgraded to a middle income country by 2024. Hence, for the communist party, the decision for minimum wage rise could be seen as a victory in terms of labour and capital (Erin Cook, 2018).

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Ease of doing business is expressed as how easy it is for businesses to start up in a country. To measure this, an ease of doing business index has been created by Simeon Djankov from the World Bank Group. The higher the ranking, the better the indication that the particular country has simpler regulations for businesses and stronger protections of property rights

The business environment in Laos remains to be opaque and political interests block the entry into some sectors. Although the government promotes special economic zones with tax and customs incentives, foreign investors still lack confidence to start their businesses and invest in Laos. Various issues such as weak property rights, high corruption rate, burdensome bureaucracy and strict regulatory controls are huge obstacles to Lao’s achievement of economic freedom (2018 Index of Economic Freedom, 2018).

According to the ease of doing business index, Laos’ economy is ranked 141/190. This means that it is not very easy to start up a business in Laos as businesses would have to go through tedious procedures to get construction permits, the lack of electricity and the registration of property. Many documentations are also required which further drives companies away from the thought of starting up in Laos (World Bank, 2017).

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This translates into a deterrent for potential companies expanding into the country. This thus hinders the Laos economy from growing as larger businesses are unwilling to invest in the country. According to Trading Economics, the Gross Domestic Product (GDP) growth rate has decelerated from 8.3% 2012 to 6.9% in 2016 (Trading Economics, 2016). 

Furthermore, it is difficult to gain credit, trade across barriers, enforce contracts, or even close a business. Thus showing that with the Laos economy, it is difficult for firms to establish or clarify property rights, as well as reduce the costs of resolving disputes.  

Additionally, investors have very little protection, and with the unpredictability of economic interactions and rules that protect contractual partners against abuse, many would not dare to risk their business expanding into Laos. 

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There are 2 main pieces of legislation that restricts foreign direct investments into Laos. Firstly, there is a list of reserved businesses for Laos citizens, which prohibits foreign investments in a range of activities and areas such as manufacturing, construction, transport, tourism, finance, professional services, education and health. Secondly, there is a list of conditional businesses for foreign investors, which imposes additional equity restrictions and minimum capital requirements in a range of activities considered to be sensitive (Emerging Markets Consulting, 2015). 

Furthermore, foreign investors also face many of the same difficulties and challenges that domestic businesses face with regards to obtaining the necessary approvals and permits. Additionally,  foreign investors who have registered their business in the Laos is subjected to various requirements if they decide to exit the country. Thus, small and medium- sized foreign investors often test the waters by commencing operations without formally registering their business (Emerging Markets Consulting, 2015).

4.4.1 Minimum Wages
One of the regulatory challenges would include the minimum wage policy as mentioned in 2.4 implemented by the Prime Minister. The policy which would see minimum wage increase from 900,000 kip to 1.1 million kip, increases labor cost and reduces the profits of foreign owned businesses. While the effects of the recent policy is not yet visible, based on the steep drop in FDI as shown in Appendix 8 due to the previous increase in minimum wage in 2015 from 626,000 kip to 900,000 kip, we can infer that this recent change in policy will take its toll in sustaining the current economic growth.
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Inadequate infrastructure in Laos has affected business’ decisions to venture into Laos. Road transport is a frequently used mode for freight transport, accounting for more than 80% of total freight transport in Lao (Lucy Styles, 2018). 

Lao PDR Road Sector II Project is a partnership between World Bank and Laos’ Ministry of Finance since December 2016 to strengthen road systems and improve road connectivity within the country and is estimated to complete in August 2022 (World Bank, 2017). 

With Laos being highly vulnerable to flash floods, droughts and storms and the frequency and intensity of climate-related natural disasters to increase recently, the US$47.4 million project will support road maintenance work in six poor provinces including Phongsaly and Houaphan. This will provide year-round access to basic services such as schools and markets for around 1.6 million people and bring greater convenience to their daily lives (World Bank, 2017).

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At present, Laos relies on foreign direct investment (FDI) in hydropower dams along the Mekong River, mining, textile industries and tourism as the main drivers for the economy. An estimated 80% of Lao’s rural population works in subsistence farming whereby its economy relies heavily on capital-intensive natural resource exports such as copper and gold. (2018 Index of Economic Freedom, 2018)

However, it remains as one of Asia’s poorest nations with a GDP of US$15.8 million due to many economic challenges such as undiversified economy, widening income inequality and ensuring the ease of doing business in the country which will be explored in detail within the report. (Facts and Details, 2014)