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3.0. The Lao Economy and Poverty
3.1. Developments of the Lao economy
Since introducing the New Economic Mechanism (NEM) in 1986, Laos has been
transitioning from a centrally planned economy to a more market-oriented economy. As a
result, except during the Asian financial crisis of the 1990s, Laos has been achieving high
economic growth. Economic growth averaged about 8.02% over 2006–2011, faster than the
previous periods, namely, 6.24% in 2001–2005, 6.17% in 1996–2000, and 6.28% in 1990–
1995 (Table 3-1).
5
The rapid growth has enhanced the industrialization process. Laos GDP in
2010 was US$8.3 billion, dominated by the agricultural sector (30.3%), followed by industry
(27.7%) and services (42%). The industrial sector has grown by more than 10% since 2002,
causing the weight of agricultural in the economy to decline. Population growth gradually
decreased from 2.71% in 1990–1995 to 1.58% in 2001–2005 and to 1.48% in 2006–2011.
Table 3-1: Macroeconomic development in Laos, 1990–2011
Sources: World Bank online database ‘World Development Indicators’, available at
http://databank.worldbank.org/data/home.aspx. * Asian Development Bank (ADB) online
database ‘Key Indicators for Asia and the Pacific 2012’, available at www.adb.org/statistics
5
The engine of growth during this period was FDI inflows in the mining and hydroelectricity sectors and
mining production and exports. For a more detailed discussion of the impact of FDI in the mining and
hydroelectricity sectors on the Lao economy see Kyophilavong and Toyoda (2008).
Macroeconomic indicator
2006–2011
2001–2005
1996–2000
1990–1995
Population (million persons)
6.07
5.58
5.12
4.49
Population growth (%)
1.48
1.58
2.07
2.71
GDP (current million US$)
5,739
2,130
1,617
1,276
GDP growth (%)
8.02
6.24
6.17
6.28
GDP per capita (constant 2000 US$)
509
371
302
243
GDP per capita growth (%)
6.43
4.58
4.00
3.44
Money supply (M2)
(million US$)
1,783
409
271
148
Money supply growth (%)
29.87
20.18
66.04
30.92
Inflation, CPI (%)
5.42
10.31
57.00
15.27
Trade balance
(million US$)*
−320
−228
−276
−174
Trade balance/GDP (%)*
−5.41
−10.43
−17.03
−13.02
Foreign reserve (million US$)
875
242
138
54
External debt (million US$)
5,140
2,691
2,418
1,960
External debt stocks (% of GDP)
92.81
129.86
152.99
160.25
Budget deficit
(including grants, million US$)*
−136
−87
−79
−107
Budget deficit/GDP (%)*
−2.53
−4.13
−4.87
−7.95
Budget deficit
(excluding grants, million US$)*
−357
−125
−142
−152
Budget deficit/GDP (%)*
−6.05
−6.04
−8.88
−11.52
Exchange rate (kip per US$)
8,885
10,164
4,094
727
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With limited physical capital stock and low population growth, labor forces have been
increasingly absorbed
into the industrial sector, thereby stimulating the productivity growth
in the Lao economy. The productivity growth is reflected in the rising real GDP per capita
from US$243 in 1990–1995 to US$509 in 2006–2011. The fast growth period in the Lao
economy cannot be achieved without macroeconomic stability. The average inflation rate was
held to single digit over 2006–2011, marking a huge improvement over average inflation of
57% during 1996–2000. The exchange rate was also stable in the corresponding period. Low
inflation rate coupled with stable exchange rate can increase the confidence of holding Lao
kip instead of US dollar or Thai baht for economic transactions in Laos. Reducing the
holdings of foreign currencies is essential to implement effective monetary policy, and
thereby maintaining macroeconomic stabilization conducive for growth.
Even though Laos has been maintaining high economic growth, low inflation and a stable
exchange rate, serious macroeconomic challenges remain. Firstly, Laos has faced chronic
twin deficits in government and trade balances. Over 2006–2011, the budget and trade deficit
accounted for about 2.53% and 5.41% of GDP, respectively. The budget deficit is mainly
financed by official development assistance (ODA), while the trade deficit is compensated by
foreign direct investment (FDI) and remittances. The fiscal situation is not strong in Laos,
and continued increases in budget deficits could accelerate inflation and lower the value of
the kip (Lao currency), potentially leading to the type of economic instability experienced
during the Asian financial crisis. Secondly, there is a huge gap between savings and
investment. The savings rate is low because average income is low—GDP per capita was
about US$580 in 2007 (World Bank, 2008)—and because financial sectors are
underdeveloped. The banking sectors are inhabited by the state commercial banks, which are
not fully performing important banking functions.
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Thirdly, Laos also faces a high external
debt burden. Accumulated external debt accounted for more than 90% of GDP in 2006–2011.
If Laos becomes too dependent upon foreign finance, potential difficulties meeting its debt
obligations could cause an external debt crisis and lead to macroeconomic instability. Rapid
expansion of the resource sectors in Laos must therefore be accounted for when considering
macroeconomic management in Laos. Fourthly, as Lao economy highly depends only
resources sectors
7
, it will limit growth of non-resources sector and will have negative long-
term impact called “Dutch disease”
8
.
Four main aspects of Dutch disease can be detected: (1) real exchange rate appreciation; (2)
declining input of factors into non-booming sectors; (3) declining exports and output in non-
booming sectors, associated with; (4) declining real GDP (Corden, 1984;Corden and
Neary,1982). Data constraints lead us to looks for the presence of Dutch disease in terms of
real exchange rate appreciation and declining labor productivity. According to the World
Bank (2010), the real effective exchange rate appreciated by a total of 50% between 2001 and
6
More details about financial issues, and monetary and exchange rate policies in Laos are discussed in
Kyophilavong (2010).
7
According to the World Bank (2010), the resources sector contributed about 2.5 percentage points to the
growth rate over 2005 to 2010. The resources sector accounted for about 70% of all exports in 2010, a share that
is expected to increase under expected ongoing development in the hydroelectricity and mining sectors.
Revenues from resource sectors as a share of total revenues rose to 2.6% of GDP in 2010, a share that is
expected to rise under continued growth in the sector.
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The two main effects of Dutch disease are (1) the spending effect and (2) the resource movement effect. The
increase in government expenditures in the non-tradable sector stimulates demand in this sector, causing prices
in the sector to rise relative to prices in the tradable sector. This causes real exchange rate appreciation. The
resource movement effect occurs when increased profitability in the booming sector attracts resources (capital
and labor), leading to an increase in the price of these factors.