It should be the key principle of public policy and governance in the Asian century.

Let us consider the following three key planks of contemporary policy.

First, financial-market policies. Most of Asia’s financial systems are outdated. Command-economy controls restrict opportunities for all but the politically well-connected. They do a bad job of turning savings into productive investments. Worse, they restrict the transition from catch-up growth to more advanced, sustainable growth based on productivity gains. More financial freedom is necessary to enable the transition to a more prosperous, sophisticated economy — and this calls for liberalisation. This demands removing interest-rate controls, opening to new entrants, including foreigners, broadening capital markets, and, ultimately, capital-account liberalisation. These measures, however, need to be balanced with prudential controls to reduce vulnerability to extreme external shocks.

‘Financial repression’ is at the core of ‘unbalanced growth’ in several Asian economies — notably in China. It promotes over-saving and over-investment while repressing private consumption, real wages and employment growth. China’s financial system channels — and wastes — massive amounts of capital through state-owned banks to state-owned enterprises while more efficient, labour-intensive private-sector firms are starved of funds. Carefully managed financial liberalisation would liberate domestic private-sector growth, especially in services.

Second, trade and foreign-investment policies. Trade and investment liberalisation across the region has created dynamic, globally integrated, world-class sectors, especially in manufacturing in East Asia. But there are still large pockets of protectionism, with huge variation across Asia. Tariff barriers are still a problem, but a plethora of non-tariff barriers obstructs trade and foreign investment even more. Most of these are embedded in complex domestic regulation. They include domestic red tape for property rights, contracts, licensing arrangements, paying taxes, opening and closing businesses, labour laws and customs procedures. These barriers to trade and investment make for a business climate that is much more stifled than in the West. This is reflected in the World Bank Group’s Doing Business Index, where 8 of the top 10 places are occupied by OECD countries, with Singapore and Hong Kong in first and second place. Malaysia, Thailand and Japan are in the top 20, but China is 91st, Indonesia 129th and India 132nd.

Such red tape also restricts economic freedom. The Fraser Institute’s Economic Freedom of the World Index has only two Asian economies (Hong Kong and Singapore) in the top ranks; the others are way behind. Generally, Asian economic institutions — public administration, enforcement of property rights, domestic regulatory authorities — are relatively weak and keep business and trade costs high, repressing entrepreneurship, innovation and consumption. They also result in badly integrated regional markets beset by high intra-regional barriers to trade, investment and the movement of workers — a far cry from the EU and NAFTA.

Third, energy and environmental policies. Energy consumption in developing Asia is expected to double over the next two decades. This will translate into greater demand for fossil fuels — oil, natural gas and coal. China and India will import much more of all three, especially oil and natural gas, for which they will become even more reliant on the Middle East. But energy markets are throttled by government intervention and state-owned enterprises. Price controls, subsidies, export restrictions and inward-investment restrictions are the norm. Energy is hardly covered by WTO rules. China and India are attempting to secure energy supplies through command-economy rather than market instruments — sending out highly subsidised national oil companies, striking long-term contracts with foreign governments, and pledging loans for oil. These measures make energy markets pricier and more volatile, and they exacerbate geopolitical tensions.

Greater energy freedom is required to make energy supplies more stable, secure and cost-effective — and to preserve peaceful international relations. That calls for liberalisation measures such as removing price controls and subsidies, encouraging private-sector and foreign investment, ‘unbundling’ generation, transmission and distribution in the power sector, and freeing international trade.

Looking ahead, Asia’s poorer economies — those in the low-income and least-developed brackets — should concentrate on ‘first-generation’ reforms for catch-up growth. This involves a combination of macroeconomic stabilisation and market liberalisation. That will provide the right environment for mobilising savings and investment, labour and capital, for growth. Asia’s middle and high-income economies should focus on ‘second-generation’ reforms — more complex structural reforms in the thickets of domestic regulation — to boost competition, innovation and productivity gains.

Both first and second-generation reforms will result in expanding economic freedom. But structural reforms demand deeper institutional reforms in order to deliver productivity-led growth.

Will Asian institutions adapt? Or will political sclerosis keep countries stuck in a middle-income trap — or worse? This is the mighty challenge of the Asian century — not least for China.

Razeen Sally is Visiting Associate Professor at the Lee Kuan Yew School of Public Policy and at the Institute of South Asian Studies, National University of Singapore. He is also Director at the European Centre for International Political Economy, Brussels.

This post is part of the series on the Asian Century which feeds into the Australian government White Paper on Australia in the Asian Century.