Lecture 2: East Asian Miracle, An Overview

1
Lecture 2 East Asian Miracle, An Overview

• Economics of East Asia

2
World Bank Study

• Growth experiences of 8 HPAEs (High-Performing
  Asian Economies)
• Japan
• 4 Tigers Hong Kong SAR, Korea, Singapore, Taiwan
  (China)
• SEA late developers Indonesia, Malaysia, Thailand

3
The East Asian Miracle, Overview

• Essence of the Miracle
• Rapid Growth with Equity
• rapid growth
• equitable income distribution

4
Overview

• Rapid growth Between 1960 and 1985, real income
  p.c. increased more than 4 times in Japan and 4
  Tigers and more than doubled in the SEA NIEs. If
  growth were randomly distributed, there is
  roughly one chance in 10,000 that success would
  have been so regionally concentrated. (p.3)
• Equitable income distribution The HPAEs are the
  only economies that have high growth and
  declining inequality. (p.4)

5
What caused East Asias Success?

• Superior accumulation of physical and human
  capital by getting the basics right
• Sound development policy
• Selective government intervention

6
What caused East Asias Success? (1)

• Superior accumulation of physical and human
  capital
• High private saving and investment
• Rapid growth and improvement in agriculture
• Population growth early and fast decline
• Better educated labor force
• Effective public administration

7
What caused East Asias Success? (2)

• Sound Development Policy
• Stable and sound macroeconomic management
• Financial policy on the banking system more
  accessible to nontraditional savers
• Education policy focused on primary and secondary
  schools

8
What caused East Asias Success? (3)

• Government intervention to foster development of
  specific industries
• Targeting and subsidizing credit to selected
  industries
• Keeping deposit and loan interest rates low to
  increase profits and retained earnings
• Establishing firm-specific export targets
• Information sharing between public and private
  sectors

9
Were selective interventions good for growth?

• WB judgment government involvement, mainly in
  Northeast Asia, resulted in higher and more equal
  growth than otherwise would have happened.
  However, the prerequisites for success were so
  rigorous that policymakers seeking to follow
  similar paths in other developing countries have
  often met with failure.
• The prerequisites
• Institutional mechanism to establish clear
  performance criteria for interventions and to
  monitor performance
• The costs of intervention did not become
  excessive. The govts pulled back when selective
  interventions threatened macroeconomic stability.
• Price distortions were less extreme.

10
The Essence of the Miracle

• Public policies (Ch 2)
• Macroeconomic stability and export growth (Ch 3)
• Institutional basis (Ch 4)
• Rapid accumulation of human and physical capital
  (Ch 5)
• Efficient allocation and productivity change (Ch
  6)

11
1. Public Policies and Growth

• Did policies assist in promoting rapid
  productivity growth?
• The neoclassical view
• The revisionist view
• The market-friendly view

12
The neoclassical view

• Stress the HPAEs success in getting the basics
  right
• provide a stable macroeconomic environment
• market failure is not important
• a reliable legal framework to promote domestic
  and international competition
• international orientation
• emphasis on human capital growth

13
The revisionist view

• Industrial policy and selective interventions are
  inconsistent with the neoclassical view.
• East Asian miracles are models of state-led
  development
• EA governments led the market in critical ways.
• Market failure prohibits investment in
  growth-enhancing industries
• Government should remedy this by getting the
  prices wrong altering the incentive structure
  to boost industries that would not otherwise
  have thrived.

14
The market-friendly view

• WB Report 1991 expands on the neoclassical view
  while clarifying the role of effective but
  limited govt activism in rapid growth.
• The appropriate role of the government is
• to ensure adequate investment in people,
• provide a competitive climate for private
  enterprise,
• keep the economy open to international trade, and
  
• maintain a stable economy.
• Beyond these roles, governments are more likely
  to do more harm than good unless the intervention
  is market friendly.

15
2a. Macroeconomic stability

• The HPAEs are characterized by responsible
  macroeconomic management
• Limited fiscal deficits
• Moderate inflation - 9 (18 in other similar
  economies)
• Interest rates were stable
• Macroeconomic stability encouraged long-term
  planning and private investment.
• Flexible exchange rate adjustment to external
  shocks such as large changes in the terms of trade

16
2b. Export growth

• All began with a period of import substitution
  but each moved to establish a pro-export regime
  more quickly than other developing countries.
• Trade policies to promote manufactured exports
  export credit, duty-free imports for exports, tax
  incentives, etc
• A pro-export incentive structure coexisted with
  moderate protection of the domestic market.
• Exchange rates have been kept competitive.
  (avoided excessive overvaluation of domestic
  currencies)

17
3. The Institutional basis for Growth

• The development state model (powerful
  technocratic bureaucracy well-designed
  interventions) is misleading.
• Leaders in the HPAEs, although tended to be
  either authoritarian or paternalistic, have been
  willing to grant a voice to a technocratic elite
  and key leaders of the private sector.
• They realized that economic development is
  impossible without cooperation.
• The principle of shared growth
• To establish legitimacy and win the support of
  the general public, EA leaders pursued the
  principle of shared growth.
• All groups would benefit as the economy
  expands.
• Explicit mechanisms land reform, public housing
  programs, etc

18
The institutional basis for growth

• Creating a business-friendly environment
• to reassure competing groups that each would
  benefit from growth
• The first step is to recruit a competent and
  relatively honest technocratic cadre and insulate
  it from political influence.
• A major element is building a legal and
  regulatory structure hospitable to private
  investment.
• enhanced communication through deliberation
  councils
• Deliberation councils
• created to establish contests among firms
• the private sector participates in drafting the
  rules
• transparent process reduces wasteful rent-seeking
  activities
• facilitate information exchanges among firms,
  between the private sector and government

19
4. Building Human and Physical Capital

• Fundamentals
• provide adequate infrastructure
• education
• secure financial institutions,
• Interventions
• mild repression of interest rates
• state capitalism
• mandatory savings mechanisms
• socialization of risk (Ch 5)

20
Building human capital

• Good initial condition started with higher
  levels of human capital
• Education policy
• Education spending on the universal primary
  education first and secondary education later
• Facilitated by declining fertility and rapid
  demographic transition (slower growth in the
  number of school-age children)
• Post-secondary education focused on technical
  skills
• Contributed to more equitable income distribution
  and helped set up a virtuous circle of lower
  inequality and more education

21
Accumulating physical capital (1)

• Fundamental policies to increase saving
• Avoided inflation and volatile real interest
  rates
• Offered higher real interest rate on deposits
  than other developing countries
• Build bank-based systems that are secure due to
  strong regulation and convenient to small and
  rural savers. E.g., postal savings systems

22
Accumulating physical capital (2)

• Interventions to increase saving
• maintain high public savings rates Singapore,
  Taiwan
• mandatory private savings programs Singapore,
  Malaysia
• stringent controls on private consumption through
  high interest rates on consumer loans and taxes
  on luxury consumption Japan, Korea, Taiwan, China

23
Accumulating physical capital (3)

• Fundamental policies to promote investment
• creating infrastructure that was complementary to
  private investment
• creating an investment-friendly environment with
  tax policies that favor investment and maintain
  capital goods low

24
Accumulating physical capital (4)

• Interventions to promote investment
• Mild financial repression kept interest rates
  low. (i) minimal effects on private saving, (ii)
  excess demand for bank credit leading to
  government-guided credit allocation. Financial
  repression did not seem to have the usual
  growth-inhibiting effects in HPAEs.
• Socialization of investment risks through (i)
  government-controlled investment funds (ii)
  explicit or implicit credit guarantees (iii)
  relationship banking (iv) directed credit
  programs, etc

25
5. Efficient allocation and Productivity change
(1)

• Industrial policies such as financial repression,
  the socialization of investment risks, and
  industrial targeting could have resulted in
  extensive rent-seeking and great inefficiency.
  Apparently they did not.
• The allocation rules followed by the HPAEs are
  among the most controversial aspects of the East
  Asian success story. (p. 18)

26
5. Efficient allocation and Productivity change
(2)

• Flexible labor markets
• Capital markets and allocation
• Openness to foreign technology
• Promoting specific industries
• Export push

27
a. Flexible labor markets

• Labor market policies tended to rely on
  fundamentals.
• Governments in HPAEs have been less vulnerable
  and less responsive to organized labors minimum
  wages demand
• They have focused efforts on job generation,
  leading to increases in employment and wages.
• With flexible real wages, adjustment to
  macroeconomic shocks has been quicker and less
  painful.
• High productivity growth in agriculture helped
  keep urban wages close to the supply price of
  labor.
• The overall gap between urban and rural incomes
  is smaller.

28
b. Capital markets and allocation

• Governments attempted to influence credit
  allocation
• (i) by enforcing regulations to improve private
  banks project selection
• (ii) by creating financial institutions, esp.
  long-term development banks
• (iii) by directing credit to specific sectors and
  firms
• The implicit subsidy of directed-credit programs
  was generally small but access to credit and the
  signal of government support to favored sectors
  or enterprises were important.
• Directed-credit programs included strict
  performance criteria. They appear to have
  improved credit allocation, esp. during the early
  stages of rapid growth.

29
c. Openness to foreign technology

• HPAEs have actively sought foreign technology
  through a variety of mechanisms.
• Licenses
• Capital goods imports
• Foreign training
• FDI (foreign direct investment)

30
d. Promoting specific industries (1)

• Most EA governments have pursued sector-specific
  industrial policies to some degree through import
  protection and subsidies for capital and other
  imported inputs.
• Japan heavy industry promotion in the 50s
• Korea HCI promotion in 70s
• M,S,C,HK,K programs to accelerate development of
  advanced industries

31
d. Promoting specific industries (2)

• There is little evidence that industrial policies
  have affected either the sectoral structure of
  industry or rates of productivity changes.
• Industrial structures in J, K, and T have evolved
  during the past 30 years as would expect given
  factor-based comparative advantage and changing
  factor endowments. Industrial policy produced
  mainly market-conforming results. How?

32
d. Promoting specific industries (3)

• The govts took steps to ensure that promoted
  firms and industries were profitable and
  internationally competitive.
• Incorporated a large amount of market information
  and used export performance as a yardstick.
• Efforts elsewhere to promote specific industries
  without better information and the discipline of
  international markets have not succeeded Brazil,
  India, Indonesia (aerospace), Malaysia (heavy
  industry)

33
e. Export push

• A winning mix of Fundamentals and Interventions
• A significant source of rapid productivity growth
• The promotion of exports coexisted with
  protection of the domestic market.
• Sectoral industrial policies were geared toward
  export performance. All relied on performance
  criteria, usually exports, to judge success.
• Manufactured export growth provided a powerful
  mechanism for technological upgrading.
• Exporting firms have greater access to
  best-practice technology, which generates
  benefits to the enterprise and spillovers to the
  rest of the economy.
• These information-related externalities are an
  important source of rapid productivity growth.

34
A KEY Question

• Can the success story be duplicated?

35
Discussion

• WB admitted the crucial role of the government in
  actively fostering and directing outward
  strategies.
• What policies accounted for such performance?
• WB identifies two types of policies fundamentals
  and intervention
• Fundamentals legal structures conductive to
  private activity, government investment in
  education and health, and stable macroeconomic
  environment. This part is not controversial.
• Selective intervention (a) promotion of specific
  industries, (b) mild financial repression
  combined with some govt allocation of credit, and
  (c) export push policies

36
Financial repression and allocation of credit

• In the East Asian case, some departures from
  strict market-oriented credit allocation was
  beneficial J. Stiglitz, A. Amsden
• Korea, Taiwan, current policies in Malaysia
• Subsidized interest rates, govt lending or govt
  requirements for private lending appear to have
  improved credit allocation, especially during the
  early stages of rapid growth.
• Can this kind of policies continue in the age of
  integrated capital markets?

37
Export Push

• WB lends some credence to the more activist
  attempts to promote exports.
• The study suggests that govts provided special
  incentives to exporters or potential exporters.
  They include tariff rebates on their inputs, some
  protection of their products, and subsidized
  credit but within well-defined guidelines.
• The guidelines required that export targets be
  met Firms had to meet international competition
  through adaptation of efficient technology,
  continuous product improvement, and successful
  marketing. If a firm failed to meet targets,
  incentives were withdrawn.
• These policies become increasingly difficult to
  employ. They are in violation of the new WTO
  requirements or those of the IMF and the World
  Bank.

38
World Banks warnings

• These policies could work only in limited,
  exceptional cases
• A market-friendly environment with a stable
  macroeconomy
• A legal system conductive to the workings of the
  private sector
• The dominance of private investment decisions
• Openness to foreign investment and technology
• A competent, independent civil service
• ..industrial policy in Korea and Japan may have
  increased growth rates by a maximum of one
  percentage point under the best of
  circumstances. (Patrick, 2000)

39
Criticism of the Banks Analysis

• The WB study is controversial in 3 areas.
• The role of equity
• Industrial policy
• Export push

40
1. The Role of Equity

• HPAEs have achieved greater equality of income
  while growing rapidly.
• The Bank views this greater equality largely as a
  result of the particular type of growth achieved
  and does not acknowledge it as an important
  cause.
• S. Haggard much of the current state of income
  distribution existed before the growth miracle
  began (due to either lack of a strong landholding
  or commercial class or to vigorous govt action to
  redistribute landholdings).
• D. Rodrik (1995) notes the early equality in
  income and landholdings as well as initially high
  levels of education.

41
2. Industrial Policy (1)

• The World Bank study rejects the role of
  industrial policy.
• It concludes that there is no evidence that govt
  policies such as Koreas promotion of HCI changed
  the sectoral distribution of output beyond what
  the market mechanism would have achieved alone,
  or that they improved TFP.
• R. Wade Banks claim that the Korean textile
  industry expanded more rapidly than HCI despite
  lack of govt promotion is incorrect. Textiles
  received considerable promotional efforts.

42
2 .Industrial Policy (2)

• Wade (1996) also contends that the Banks
  objections involve a misunderstanding of what
  industrial policy means in East Asia.
• EA practice has been to look for industries that
  policy makers want to play a key role in
  development.
• The targeted industries have not been speculative
  high-tech ventures but rather postadolescent or
  mid-tech industries whose development is
  economically and technically feasible.

43
2. Industrial Policy (3)

• D. Rodrik (1995) points out a logical flaw in the
  Banks argument.
• It accepts as successful the instruments of
  industrial policy (financial repression, export
  promotion) without recognizing the targets of
  those instruments were the specific industries
  that the Bank claims were not helpful. This is a
  contradiction.

44
3. Export Push as a Strategy

• The World Bank study maintains that exports are
  one of the keys to development and recommends
  policies that will spur exports without causing
  retaliation.
• These policies call for freer trade for exporting
  firms, financial and support services for small-
  and medium-sized exporters, attracting
  export-oriented foreign investors, and improving
  the infrastructure that serves exporters.
• D. Rodrik (1995) a thorough review of the
  evidence does not substantiate the link between
  openness and growth. The chain of causation runs
  from growth to exports, not from exports to
  growth.

45
Governance in East Asia

• WB study East Asian leaders tended to be either
  authoritarian or paternalistic but were willing
  to grant a voice and genuine authority to a
  technocratic elite and key leaders of the private
  sector.
• Crucial to the Banks acceptance of authoritarian
  government is its concept of Shared Growth.

46
Shared Growth

• Shared growth includes
• Consultation with and support of business leaders
• Policies such as land reform, public services,
  and private incentives to bring people into the
  market
• Background
• Government leaders and civil servants were
  insulated from politics and rent seeking
• The government has the freedom to adjust or
  cancel policies that are not working or than
  threaten fiscal imbalance

47
Shared Growth Objections (1)

• The bank ignores the question of how govts in EA
  were able to push through the policies.
• The need for national security after the WWII and
  the Korean War provided a foundation for strong
  govts.
• They were assisted by value systems (such as
  Confusian belief) that put a greater stress on
  communal effort than individual success.
• Haggard Policy changes were usually preceded by
  a national crisis
• Taiwan defeat of the National Chinese govt and
  flight to the island
• Korea the civil war and a divided nation
• Indonesia the overthrow of the Sukarno regime,
  1966

48
Shared Growth Objections (2)

• The policy support mechanism govt direction and
  consultation with business may not be
  sustainable.
• The initial balance of strength was favorable to
  govts that were facing weak constituencies. Will
  this be as easy in a democracy?
• Rodrik govt-business consultation has usually
  consisted of very detailed, complex sets of
  understandings. This is at odds with
  prescriptions for bureaucratic success that call
  for simplicity, predictability, and arms-length
  transactions.
• The Bank accepted uncritically the view of EA
  govts that labor had to be controlled because of
  its radical tendencies.
• Labor was kept out of the political area, and
  unions were either fragmented or controlled.

49
The Future

• The Bank study takes a dim view of the prospects
  for reproducing the East Asian miracle
  elsewhere.
• The conditions under which the state was able to
  lead development are not likely to be found
  elsewhere.
• Will the growing emphasis on democracy make it
  more difficult for strong states to form and
  implement East Asia-type policies?
• Haggard Reforming democratic govts in Poland,
  Argentina, and Bolivia provide positive
  examples.
• Historically, countries have established their
  own institutions and mechanisms, and have
  succeeded under a variety of circumstances.

50
Yusuf (2002) The East Asian Miracle at the
Millennium

• Questioning the earlier consensus (p. 7)
• TFP disputes
• The advantages of an activist industrial policy
• Close symbiotic relations between banks and
  industrial corporations
• The efficacy of exports as an engine of
  productivity and growth
• The approach to governance in East Asia
• Regional integration and policy