Can East Asia Sustain Its Growth Miracle? World Bank Maps a New Fiscal Strategy for the Region

The World Bank says East Asia and Pacific must move beyond its low-tax, infrastructure-led growth model by investing more effectively in human capital, social protection and climate resilience while strengthening fiscal sustainability. For governments, development partners and businesses, smarter taxation, digitalisation and targeted public spending could unlock new growth opportunities, but rising debt, aging populations and climate risks demand urgent reforms.

East Asia and the Pacific's long-standing economic formula of low taxes, controlled government spending and strong infrastructure investment helped create one of the world's biggest development success stories. But that model is increasingly struggling to meet new challenges, including declining productivity, rising public debt, climate change, aging populations, and gaps in education, healthcare, and social protection.

The World Bank's 2026 report, Small Governments, Big Ambitions: Fiscal Policy in East Asia and Pacific, prepared by researchers from the Development Economics Office of the Chief Economist for Asia, Development Economics Research Group, and East Asia and Pacific Poverty and Equity Global Practice, calls for a new "growth-enhancing fiscal compact". Instead of simply expanding government, the report argues for governments that collect revenue more efficiently and spend it where economic and social returns are highest.

A Successful Growth Model Is Reaching Its Limits

The region's economic record is impressive. Between 1999 and 2019, East Asian economies grew by an average 5.6 per cent annually, compared with 4 per cent across emerging market and developing economies and 2.6 per cent in advanced economies.

This growth was achieved with relatively small governments. Government revenue averages about 20.4 per cent of GDP in East Asia, compared with 25 per cent in middle-income countries and 37 per cent in high-income economies. Primary government expenditure averages just 14.1 per cent of GDP.

Yet public investment averages around 6.5 per cent of GDP, higher than the 4.4 per cent average in middle-income countries and 4.6 per cent in high-income economies.

The strategy helped build infrastructure and encourage private investment, but lower spending on health, education and social protection has created weaknesses. The report estimates that increasing education spending towards average levels in Japan and South Korea could raise annual GDP per capita growth in EAP economies by around 0.97 percentage point on average.

Infrastructure quality also remains a concern. In Indonesia, infrastructure gaps contribute to logistics costs estimated at about 15 per cent of firms' total expenditure, directly affecting competitiveness.

Rising Debt and Climate Risks Are Shrinking Fiscal Space

Governments now face the difficult task of increasing productive spending while public finances are under pressure.

In developing EAP excluding China, public debt increased from around 35 per cent of GDP in 2008 to 45 per cent in 2019 and 54 per cent in 2024. China's public debt rose from approximately 27 per cent in 2008 to 59 per cent in 2019 and 88 per cent in 2024.

This matters because fiscal strength has historically allowed East Asian governments to respond to economic downturns. Around 89 per cent of East Asian economies have shown either countercyclical or acyclical government spending patterns, close to 91 per cent among advanced economies and well above 41 per cent among other emerging and developing economies.

Climate change creates another major fiscal burden. Pacific Island economies already experience annual losses from natural disasters exceeding 2 per cent of GDP. Governments will need greater investment in resilient transport, energy, urban infrastructure and social protection while preserving enough financial capacity to respond when disasters occur.

The report recommends stronger debt management, medium-term fiscal frameworks, credible fiscal rules and adequate liquidity buffers rather than relying on abrupt spending cuts during crises.

Smarter Taxes and Better Spending Can Support Inclusive Growth

The World Bank sees considerable room for governments to raise revenue without simply increasing headline tax rates. Priorities include broadening VAT bases, reducing poorly targeted exemptions, improving tax compliance among high earners and strengthening property taxation.

Carbon taxes and taxes on health-damaging products can also generate revenue while addressing environmental and health costs.

On spending, governments are encouraged to shift resources from broad subsidies towards targeted assistance. Fuel and electricity subsidies may appear to protect poorer households, but richer households often receive significant benefits because they consume more energy. Targeted cash transfers can provide support at lower fiscal cost.

Digitalisation could make these reforms easier. E-filing, electronic invoicing, digital payments, automated audits and integrated taxpayer databases can strengthen tax collection. Digital identification and payment systems can simultaneously help governments identify vulnerable households and deliver benefits more accurately.

For policymakers, the key message is that tax and spending reforms should move together. Raising revenue without improving services could reduce public trust, while increasing expenditure without improving efficiency could worsen debt pressures.

New Opportunities for Development Partners and Private Investors

The changing fiscal agenda also creates a larger role for international development partners. Support will be needed not only for infrastructure financing but also for tax administration, digital public infrastructure, beneficiary databases, pension reform, public investment management and climate-risk planning.

Development finance institutions can use guarantees, blended finance and other risk-sharing tools to attract private capital into climate-resilient infrastructure and other projects that may otherwise struggle to secure commercial financing.

For businesses, the transition offers significant opportunities in digital infrastructure, transport, healthcare, education, financial services, renewable energy and climate-resilient construction. Better infrastructure and stronger fiscal institutions could also reduce operating costs and improve the overall investment environment.

However, there are risks. Businesses dependent on tax exemptions, energy subsidies or preferential treatment could face greater scrutiny. Carbon pricing and stronger tax enforcement could increase costs for some industries, particularly carbon-intensive sectors.

The report's broader recommendation is therefore not simply to make East Asian governments larger. It is to make them more capable. Governments need to invest more effectively in people, infrastructure, and climate resilience, mobilise revenue with fewer economic distortions, strengthen social protection, and maintain sufficient fiscal space to handle future shocks.

For policymakers, development partners and investors, the message is increasingly clear: the fiscal model that helped East Asia achieve middle-income prosperity must evolve if the region is to sustain growth, improve productivity and manage the economic pressures of climate change, demographic aging and a more uncertain global economy.