Cambodia's Economic Transformation: Selecting Winners for Sustainable Growth

Key messages:

• Cambodia's economy has undergone rapid growth and poverty reduction since the mid-1990s, driven by strategic government policies, particularly economic openness, and targeted industrial promotion.
• The economic structure has shifted from agriculture to industry, but sustaining growth, innovation, and structural transformation requires an industrial policy aligned with Cambodia's comparative advantage.
• Industrial policy plays a crucial role in "picking winners." However, pioneering firms face high risks with uncertain success, necessitating government facilitation to identify industries with latent comparative advantages, allocate resources to compensate pioneers, develop industry-specific infrastructure, and promote clustering for global competitiveness.
• New Structural Economics (NSE) promotes structural transformation by identifying sunrise industries based on endowment structures and guiding policymakers through the Growth Identification and Facilitation Framework (GIFF) to target industries with comparative advantages, address constraints, attract foreign investment, utilize industrial parks, scale up self-discoveries, and provide limited subsidies to pioneering firms.

Over the past decades, Cambodia has demonstrated impressive economic performance, maintaining an average growth rate of 7 percent between 1994 and 2023. Per capita GDP has risen from USD188 to nearly USD2000, and the poverty rate fell from 50 percent in 2000 to below 10 percent in 2019. While Cambodia was among the world's poorest countries in the early 1990s, as of 2023, over 50 countries now rank below it in income. This significant progress can be attributed to several government policies promoting openness to the global economy, macroeconomic stabilisation, high savings and investment rates, market allocation, and effective leadership and governance (Commission on Growth, 2008). More notably, the government's "picking winners" strategy was crucial. In the late 1990s, the government prioritised the strategy of utilising abundant labour forces by attracting investment toward labour-intensive sectors, including the targeted garment and textile industries, where the country had comparative advantages (Kenh & Wei, 2025)

The country is transforming from an agriculture-based economy to one driven by industrialisation. Data indicates that the agriculture sector's contribution to GDP declined from 46.4 percent in 1993 to 18.1 percent in 2022, shifting away from the agrarian economy. Meanwhile, the industrial sector's share grew​from 13.0 percent to 36.0 percent of GDP over the same period, underscoring the rising importance of industrial activities. The service sector remained ​stable, contributing around 40 percent to GDP ​, while manufacturing doubled from 8.6 percent to 18.1 percent. These trends reflect Cambodia's potential transition towards a more diversified and industrialised economy, with reduced reliance on agriculture and increased contributions from industry and manufacturing. Given its performance and unique endowment structure, people remain optimistic about Cambodia's future, believing that the economy has the potential to grow by 8 percent annually in the coming decades.

Industrial upgrading and transformations are endogenous to endowment structure,   determined by an economy's factor endowment. Adopting a strategy aligned with comparative advantage while involving the state as a facilitator offers a promising path toward productivity growth, industrial advancement, job creation, income growth, and poverty reduction. Sustainable growth and transformation require continuous technological innovation and structural change. The recipe for innovation and transformation involves leveraging latecomer advantages by developing industries where Cambodia holds comparative advantages within a well-functioning market economy, with the state playing facilitating roles. To achieve these latecomer advantages, Cambodia requires an effective industrial policy grounded in its unique endowment structure. In the process, the principles of new structural economics can be instrumental in identifying and nurturing industries with potential to drive technological and productivity growth.

A nation's endowments, often called the budget constraints of an economy, are a combination of production factors, natural resources, and institutional endowments. These endowments determine the areas in which an economy is likely to excel. Regarding factor endowments, Cambodia benefits from a young, rapidly growing labour force, though with relatively less capital. This demographic benefit provides comparative advantages in labour-intensive industries, including garments, textiles, apparel, and assembly manufacturing. This demographic dividend has been instrumental in attracting foreign direct investment (FDI) and driving economic transformation and growth, especially when supported by an effective industrial policy.

Cambodia's natural resource endowments include abundant agricultural land, forests, and water resources, supporting key primary sectors, including rice, fisheries, and rubber. The country also possesses mineral resources like gold, oil, bauxite, and iron ore, though largely underexploited. Regarding institutional endowments, the government has improved the regulatory environment and governance structures, updated investment laws, reduced rent-seeking behaviour, integrated into global and regional trade blocs, and expanded technical and vocational education and training (TVET) programmes. Additionally, the government has strengthened trade relationships through free trade agreements while preserving trade privileges. Institutional improvements are evident in approving 32 special economic zones (SEZs) in 2024 to create a more favourable business and investment climate. These endowments highlight Cambodia's potential to identify and support winning industries, diversify industrial structure, and enhance competitiveness.

Why is the continuous picking of winners significant?

Picking winners involves designing and supporting industrial policy, especially after Cambodia's remarkable transformation over the past two decades. To drive technological innovation and structural changes, each stage of industrial upgrading requires pioneers willing to innovate and bear certain risks. Being an innovation pioneer is inherently risky. Whether their risk-taking activities succeed or fail, pioneer firms provide valuable information. If they fail, they bear all failure costs, signalling to others to avoid the market. If they succeed, competitors may enter the market, preventing the pioneer from earning extra profits. Due to this asymmetry between failure costs and success gains, firms have little incentive to be pioneers. Therefore, targeting industries with latent comparative advantages and picking the following winners is crucial. Broad government coordination often fails to compensate pioneers, leading to resource misallocation. Infrastructure improvements are typically industry-specific, as sectors require different infrastructure types. Given developing countries' limited fiscal resources, the government must prioritise industries, select the winners, and allocate resources to improve infrastructure accordingly.

To compete globally, new industries should align with the country's comparative advantage to minimise production costs. Moreover, the sector must reduce transaction costs by grouping and clustering industries. However, without government coordination and winner selection, firms may enter industries only partially aligned with the country's latent comparative advantage. As a result, industries may fail to form large, effective clusters, leading to high production costs and reduced competitiveness in domestic and international markets. Indeed, when a market approach is adopted to select and scale-up industrial clusters with comparative advantages, a successful cluster may eventually emerge after many 'trial and error' failures. However, this process is lengthy and costly, reducing firms' expected returns and disincentivising upgrading and diversifying into new industries, slowing down industrial transformation. Therefore, it is crucial to establish an industrial policy that effectively identifies and supports the winners.

To continuously identify the winners, several theories guide policymakers in developing countries, including randomised control trials (Banerjee & Duflo, 2011), institutional theory (Daron & Robinson, 2012), the flying geese paradigm (FGP) (Akamatsu, 1962) and growth diagnostics (Rodrik, 2005). Among these, the FGP has been particularly successful in explaining the economic development. This paradigm models the international division of labour based on dynamic comparative advantage, suggesting that developing countries can catch up by taking over the production from more advanced economies. As income and labour costs rise in the leading economy (the "lead goose"), it loses comparative advantage in low-productivity, labour-intensive production. Consequently, it shifts toward capital-intensive activities, passing low-productivity production to developing countries. FGP effectively describes regional production patterns in East Asia, where like garment, textile, apparel, transitioned from Japan to South Korea, Taiwan (China), Hong Kong (China), and eventually to mainland China.

To some extent, new structural economics (NSE) principles are consistent with those of the FGP. Both seek to transform labour from low- to higher-value-added, capital-intensive industries. However, NSE differs by its capability to identify sunrise and sunset industries aligned with a nation's comparative advantages based on endowment structure. After World War II, many developing economies in Asia, Africa, and Latin America struggled to modernize because they defied comparative advantages instead of fostering private sector industries aligned with them. NSE also considers local spontaneous self-discovery industries with latent comparative advantages and emphasises the government's roles in promoting sunrise industries and facilitating structural transformation dynamics—concepts not well-introduced in the FGP. To tackle the challenge of selecting the winners, NSE introduces the Growth Identification and Facilitation Framework, outlining six steps for policymakers (Lin, 2012).

• Step 1: Policymakers should select dynamic reference economies with similar endowment structures and between 100-300 percent higher per capita income. Using these reference economies, they should identify tradable industries in those economies that have performed well over the past 20 years. After decades of rapid growth, these economies have likely lost comparative advantages in sectors that were once emerging due to rising costs, particularly labour. Thus, the targeted industries have become sunset industries in the reference economies but are now sunrise industries in emerging economies.
• Step 2: If domestic firms operate in targeted industries, policymakers should identify and address binding constraints to technological upgrading or firm entry (Hausmann & Klinger, 2008). However, firms' constraints are often sector-specific and vary over time (Lin & Xu, 2018). For instance, Cambodian firms currently face high tax rates, tax administration issues, and transportation problems (World Bank, 2023), whereas in 2016, they struggled with political stability, poorly educated workers, and access to finance (World Bank, 2016).
• Step 3: If no domestic firms operating in the targeted industries, policymakers should attract FDI from the reference countries identified (Step 1) or organise firm incubation programmes. Encouraging domestic investors to support sector-specific targeted industries with comparative advantages is crucial (Kenh, 2023).
• Step 4: Besides the targeted industries identified in Step 1, policymakers should support private firms' spontaneous self-discovery and scale up successful private innovations in new industries based on market demands.
• Step 5: The government should leverage existing SEZs across the country to remove entry barriers, attract foreign investors, reduce operational and transaction costs, facilitate knowledge sharing, promote industrial clusters, and address inadequate infrastructure issues.
• Step 6: The government compensates pioneering firms in identified industries with temporary incentives like tax exemptions, co-financing, or foreign exchange access. These targeted subsidies prevent inefficiencies from broad-based resource allocation. The framework minimises resource waste from rent-seeking, promotes self-sustaining private firms, and opens the economy to global competition by strengthening actual and latent comparative advantages. Meanwhile, it reduces market entry, production, and export barriers, limiting rent-seeking opportunities.

Conclusion

Development involves industrial upgrading and structural transformation, leading to higher productivity and income. Cambodia has made remarkable progress over the past two decades. However, for continued industrial upgrading, Cambodia needs pioneering firms, particularly domestic ones, willing to bear risks in technologically innovative activities. Risk-taking generates valuable information about the market potential, yet firms bear the costs. When the cost outweighs expected profit, pioneers cease efforts, in innovation. Incentivising pioneering firms should not be halted. A facilitating government should support technological innovation by assisting pioneering firms in industries with latent comparative advantages to overcome losses. This can be achieved by setting a clear, effective industrial policy that serves as a roadmap for risk-taking firms, reducing costs associated with "trial and error," and promoting industrial upgrading. Leveraging Cambodia's unique endowments—abundant labour, rich natural resources, and institutional benefits, including government support for existing active TVET programmes, startup programmes, and state-led bank financing export activities—can drive growth through well-crafted industrial policies.

References

• Akamatsu, K. (1962). A historical pattern of economic growth in developing countries. The developing economies, 1, 3-25.
• Banerjee, A. V., & Duflo, E. (2011). Poor economics: A radical rethinking of the way to fight global poverty: Public Affairs.
• Commission on Growth. (2008). The growth report: Strategies for sustained growth and inclusive development: World Bank Publications.
• Daron, A., & Robinson, J. A. (2012). Why nations fail: The origins of power, prosperity, and poverty. New York: Crown Business.
• Hausmann, R., & Klinger, B. (2008). Growth diagnostics in Peru. CID Working Paper Series.
• Kenh, S. (2023). The impact of development strategy choice on capital mobility and economic growth. Journal of international development, 35(7), 1782-1813.
• Kenh, S., & Wei, Q. (2025). Industrial impact analysis of foreign direct investment on economic development in Cambodia. Journal of Business and Socio-economic Development, 5(1), 20-36.
• Lin, J. Y. (2012). New structural economics: A framework for rethinking development and policy: The World Bank.
• Lin, J. Y., & Xu, J. (2018). Rethinking industrial policy from the perspective of new structural economics. In (Vol. 48, pp. 155-157): Elsevier.
• Rodrik, D. (2005). Growth strategies. Handbook of economic growth, 1, 967-1014.
• World Bank. (2016). Enterprise Surveys: Cambodia Country Profile: Washington DC: World Bank Group.
• World Bank. (2023). Enterprise Surveys: Cambodia Country Profile: Washington DC: World Bank Group.