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Reassessing Asia's economic miracle
Friday, 13 April 2012 23:20

Economic growth is a not a guarantee of a nation's development.  Too many resource-rich countries have experienced growth without development, as citizens have gained little in terms of well-being, and the natural environment has suffered greatly.  But in the case of Asia, the region's massive reductions in poverty are principally due to its rapid economic growth, whose benefits have been spread widely, though unequally, among Asian peoples.

Now, as we look back on several decades of dramatic economic growth, how do we assess East Asia's performance, and what are the main challenges looking ahead?

Let's go quickly back to the beginning.  When Chairman Mao Zedong proclaimed the People's Republic of China on 1 Ocober 1949, after the Chinese Communist Party's victory in the country's civil war, he was presiding over a country whose GDP per capita was little higher than 2000 years before.  The growth of the Chinese economy over the millenia was mainly reflected in a higher population ("extensive growth"), and the previous century of internal conflict and colonization by Japan and European powers had also set the country back.

The Japanese economy had been substantially destroyed through its losses in World War 2.  Much of the rest of East Asia had also suffered greatly through the war, and was in the midst of throwing off colonial powers.  And the Korean peninsula was on the verge of its destructive war.

Thus, it was not surprising that most economists at the time saw few bright prospects for the Asian economy.  Resource-rich Africa was seen to have much brighter prospects.

History has shown that these economists could not have been more wrong.

In fact, a closer and more nuanced reading of the evidence might have pointed to a more positive assessment of Asia.  For example, back in the seventeenth, eighteenth and first half of the nineteenth century, even before the Meiji Restoration, Japan demonstrated its immense capacity for economic growth as it caught up with and overtook China in per capita income.

And after the Meiji opening of Japan, the government sent "learning missions" abroad to absorb as much Western knowledge as possible.  For example, the Iwakura mission spent two years (1871-73) touring the US and Europe, studying all systems of governance and business.  Rapid economic progress ensued enabling China to colonize Korea, Taiwan and part of China, win a war against Russia and mount a formidable challenge to the West in the Pacific side of World War 2.

As the post-war decades instantly proved, Japan was more than capable of bouncing back again.  From the 1950s through to the 1980s, Japan was the original miracle economy, with very rapid economic growth that enabled it to almost catch up with the US by the late 1980s.

Japan was able to mobilize large investments in human, financial and physical capital through close cooperation between business, banks and government (a version of "state capitalism").  It was also able to achieve very rapid industrial upgrading and productivity improvements by absorbing foreign knowledge and capital.  In just one generation, Japan transformed itself from a nation of transister radio salesmen to global leaders in automobiles, consumer electronics and other high technologies.

Japan initially exploited its comparative advantage in labor-intensive manufacturing, and over time, its comparative advantage dynamically evolved to high-skilled and high-tech manufacturing.  It's export orientation was a key factor in upgrading production to world standards.  Foreign competition and economies of scale improved efficiency, as did foreign importers' detailed product specification.  And imported capital goods also played a role through the access to technologies embodied in them.  Export revenues created a virtuous circle as they boosted savings which were then used to finance investment and more exports.

Government industrial policy played a major role in its successful upgrading through many means, most notably by supplying large enterprises with privileged access to bank finance, maintaining an undervalued exchange rate, protecting the local market, providing first class infrastructure, and educated and training its diligent work force.  Open markets in the US and Europe also played a critical role.

Japan's rise was important.  It provided the US with a strong ally in the dangerous Asian neighborhood.  Moreover, it demonstrated to other Asian countries that a fast path out of poverty was possible.  And ultimately, it showed the Chinese Communist Party the intellectual bankruptcy of central planning.  Nationalism was a major motivational force for economic growth in Asia as countries reacted against the intrusion of Western countries.

Korea, Taiwan, Singapore and Hong Kong (the Asian NIEs, newly industrialized economies) would follow in Japan's footsteps, with the first three pursuing Japan's model of a strong state, cooperating closely with business and banks.  Hong Kong would follow its own path of very open and free markets, although even here the government played a very important role in providing infrastructure, education and social housing.

Japan's success was so stunning that it began to be perceived as a threat.  In 1985, its G7 partners pushed it to raise the value of its undervalued yen that had given it a masive competitive edge.

This launched the next phase of East Asia's development as Japanese firms started offshoring the lower-cost, labor-intensive parts of its manufacturing industry to South East Asia and China.  As the Asian NIEs climbed the development ladder, they would also offshore much manufacturing to the same countries which provided incentives to attract this export-oriented investment, such as prize locations in export processing zones with good infrastructure, tax breaks and tariff-free imports.

We thus saw a "flying geese" pattern of development, as new countries would become the fastest developers.  Today, countries China and Vietnam are leading the flock, while looking ahead, countries like Cambodia, Laos and Burma could become the fastest flying geese.

A financial crisis would push India to start economic reform in the early 1990s.  This opening up enabled India to exploit its comparative advantage in information technology, substantially acquired by Indian students and workers in the US.

The emerging pattern of economic development Asia was basically one of manufacturing supply chains and production networks that targeted mainly Western markets.  Many products were designed in the US or other advanced markets, high-tech components produced in Japan, Korea and Taiwan, and product assembly occurring in China.  Low-tech products like toys, clothing and footwear were produced in countries like China, Cambodia and Bangladesh.  India and the Philippines are playing a growing role in economic networks through business process offshoring and other IT services.

Sure, there was more to these economies.  International tourism had become a big driver in several countries like Thailand, and Malaysia.  Hong Kong and Singapore emerged as important financial centres.  And the opening up of domestic markets boosted growth.

But the limitations of the Asian model started to show with Japan, the country that has always led the way in Asia.  Its bubble economy starting bursting in 1990.  It was very slow in sorting out its financial woes, with growth being adversely affected by various policy errors along the way.  Japan dug itself into deeper problems by trying to keep the economy afloat by government spending.  It built up a very large government debt, when it should have been doing the reverse because of its rapidly ageing population.

More fundamentally, Japan never made the transition to a dynamic, innovation- and service-based economy.  Its development is stunted, and it is stuck in a "high middle income trap", with labor productivity and GDP per capita one-third less than the US.

The Asian financial crisis of 1997 hit very hard Korea, Indonesia and Thailand.  And while the IMF's initial policy prescriptions were not appropriate, the many structural reforms subsequently undertaken laid the foundations for a new phase of economic growth.

The big issue for the Asian economy today is whether the Japanese syndrome represents the future of other Asian countries, or whether they can stay the course in their structural reforms.  Here are some of the big issues that Asian economies have to face.

(i)  how to develop dynamic service and efficient agricultural sectors, when these sectors have been somewhat forgoten in governments' drive to buildup efficient, export-oriented manufacturing sectors.

(ii) how to reduce reliance on Western export markets and make domestic demand a bigger driver of growth when much of the benefits of growth have gone to corporate and government savings to finance investment.

(iii) how to transform from knowledge and technology absorbers to innovation-driven economies.

(iv) how to develop efficient financial sectors which can channel savings to their most efficient use, and support risk-taking and innovation.  In most Asian countries, financial sectors are bank-dominated, and have been used too often as an instrument of government policy for allocating finance to favored sectors and businesses.

(v) how to adjust to rapidly ageing populations when past growth has benefited greatly from the demographic dividend due to work forces growing faster than the overall population.

(vi) how to get the role of the state "right" at a time when the limitations of "state capitalism" are becoming evident.

In short, Asia has a full plate of policy challenges before it in order to realize the Asian century.  We are now examining these and many other issues in other articles.


Yoshitomi, Masaru.  Post-crisis Development Paradigms.  Asian Development Bank Institute.


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