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East Asia’s Real Lessons

Jomo Kwame Sundaram, a former economics professor and United Nations Assistant Secretary-General for Economic Development, received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought in 2007.

International recognition of East Asia’s rapid economic growth, structural change and industrialization ("East Asian Miracle") grew from the 1980s.

To better learn from ostensible miracles, it is necessary to demystify them. Credit: IPS

KUALA LUMPUR, Jun 21 2017 (IPS) - International recognition of East Asia’s rapid economic growth, structural change and industrialization grew from the 1980s. In Western media and academia, this was seen as a regional phenomenon, associated with some commonality, real or imagined, such as a supposed ‘yen bloc’.

Others had a more mythic element, such as ‘flying geese’, or ostensible bushido and Confucian ethics. Every purported miracle claims a mythic element, invariably fit for purpose. After all, miracles are typically attributed to supernatural forces, and hence, cannot be emulated by mere mortals. Hence, to better learn from ostensible miracles, it is necessary to demystify them.

The World Bank’s 1993 East Asian Miracle (EAM) volume is the most influential document on the subject. It identified eight high-performing Asian economies: Japan, Hong Kong, three first-generation newly industrialized economies, namely South Korea, Taiwan and Singapore, and three second-generation South East Asian newly industrializing countries, viz, Malaysia, Thailand and Indonesia. Despite a title implying geo-spatial commonality, the study denied the significance of geography and culture, and specifically excluded China, the elephant in the region.

Strategic interventions?

The book identified six state interventions as important, approving of four ‘functional’ interventions, but sceptical of two ‘strategic’ interventions. Functional interventions supposedly compensated for market failures, while strategic interventions were deemed more market-distortive.

These two ‘strategic’ interventions are in the areas of finance, specifically what it calls directed (targeted) and subsidized credit, and international trade, particularly what is often referred to as ‘industrial policy’, or more rarely as ‘investment and technology policy’.

Careful consideration of the accelerated East Asian growth and transformation experiences underscore that such interventions were mainly responsible for the superior performance of the Northeast Asian HPAEs compared to their Southeast Asian counterparts.

Industrial investments

Debates over Northeast Asian industrialization continue, but the pioneering work of American political economists Chalmers Johnson and Alice Amsden was undoubtedly seminal. Both showed that Japanese, Korean and Taiwanese government measures were quite different from typical World Bank development policy advice.

Successful finance ministry and central bank efforts to keep interest rates positive, but low, were crucial for accelerating industrial investments. From the mid-1970s, more orthodox Western economists began to characterize this as constituting ‘financial repression’, for depressing interest rates, the incentive to save and funds available for investment.

Only later did other Western economists explain this Korean anomaly in terms of ‘financial restraint’ to overcome financial market failures. But few have noted that savings rates actually follow, rather than determine investment rates. Meanwhile, cultural explanations have also been invoked to explain East Asia’s high savings and investment rates.

Ownership matters
Subsidized and directed (or targeted) credit also promoted desired investments. Fiscal and other policies also encouraged reinvestment of profits, rather than maximizing ‘shareholder value’, while other incentives encouraged desired investments. Where private investments were not forthcoming, the governments themselves made needed investments despite active discouragement by international development banks.

Strict controls on capital outflows, especially when foreign exchange resources were still scarce, also served to discourage capital flight. Northeast Asian economies were also careful to distinguish between long-term foreign direct investment (FDI) and short-term portfolio investment, or ‘hot money’.

Perhaps owing to Bank preference for FDI, ostensibly to close both the ‘savings-investment’ and ‘foreign exchange’ gaps, the EAM also favoured FDI and did not consider ownership important. However, during the early decades of high growth before the 1990s, Northeast Asian governments encouraged national ownership of industrial enterprises.

This policy served to promote vertically and horizontally integrated industrial conglomerates in the case of Korean chaebol and Japanese keiretsu. (Zaibatsu were suppressed after the Second World War as they were held responsible for the pre-war Japanese military industrial complex.) Instead of FDI, South Korea encouraged licensing and, if necessary, joint-ventures to promote technology transfer.

Singapore and Malaysia in Southeast Asia have especially sought to attract FDI, initially for political reasons. Singapore desired strong Western support after establishing a new state in 1965. Since then, FDI has been attracted as part of a pro-active technology policy complemented by government policies, including investments. Attracting FDI to accelerate technology development is quite different from capital account liberalization enabling short-term financial inflows.

Trade policies
The Japanese, Korean and Taiwanese governments pursued import substituting industrialization policies from the 1950s, but later encouraged export orientation as well. Infant industries were provided with effective protection conditional on export promotion, effectively requiring firms to quickly become internationally competitive.

By protecting firms temporarily, depending on the product to be promoted, and by requiring certain output shares be exported within pre-specified periods, discipline was imposed on firms in return for the support provided. Such policies forced firms to achieve greater economies of scale and accelerate learning to reduce production costs quickly.

Requiring exports has also meant producers have had to achieve international consumer quality standards quickly, which accelerated progress in product and process technology. This ‘carrot and stick’ approach induced many firms to rapidly become internationally competitive.

Thus, the very industrial, trade and financial policies rejected by the Bank were in fact necessary for East Asia’s achievements. Some policies were inappropriately and prematurely undermined or terminated, e.g., with Japan’s financial ‘big bang’, with disastrous consequences.

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