Abstract
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MUCH OF East Asia’s dramatic growth is due to superior accumulation of physical and human capital But these economies were also better able than most to allocate these resources to highly productive investments. They did this with combinations of policies, always including market-oriented “fundamentals,” but sometimes relying on tailored government interventions.
Outsiders have pondered the success of East Asia—what some call a “miracle”—with wonder and admiration. Never before have countries expanded so fast for so long. From 1965 to 1990, the region’s 23 economies grew faster than those of all other regions (see Chart 1), and income inequality declined, sometimes dramatically. Most of this achievement can be attributed to the stellar growth performance of eight economies: Japan; the “four tigers”—Hong Kong, the Republic of Korea, Singapore, and Taiwan Province of China; and the three newly industrializing economies (NIEs) of Southeast Asia—Indonesia, Malaysia, and Thailand.
East Asia’s stellar performance
(average GNP per capita growth rate, in percent, 1965-90)
Citation: Finance & Development 31, 001; 10.5089/9781451953107.022.A001
Moreover, these eight economies share other characteristics that set them apart from other developing economies. These include:
• more rapid output and productivity growth in agriculture;
• higher rates of growth of manufactured exports, with their share of world exports of manufactures leaping from 9 percent in 1965 to 21 percent in 1990;
• earlier and steeper declines in fertility;
• higher growth rates of physical capital, exceeding 20 percent of GDP on average between 1960 and 1990, supported by higher rates of domestic savings (see Chart 2);
Exceptional savings and investment rates
(percent of GDP)
Citation: Finance & Development 31, 001; 10.5089/9781451953107.022.A001
Source: World Bank.Note: The regional averages are unweighted.1 High performing Asian economies (HPAEs): Indonesia, Hong Kong, Japan, Malaysia, the Republic of Korea, Singapore, Taiwan Province of China, and Thailand.• higher initial levels and growth rates of human capital; and
• generally higher rates of productivity growth.
As other developing countries debate whether they can emulate East Asia’s success, key questions arise. What were the sources of East Asia’s success? What was the role of public policy in fostering growth? Can policies that were successful in East Asia be replicated by other economies?
In an effort to answer these questions, the World Bank undertook a major comparative study of economic growth and public policy in East Asia, The East Asian Miracle (see box). One of the key findings is that East Asia succeeded because it got the economic policy fundamentals right. Macroeconomic performance was unusually stable, providing the necessary framework for private investment. Policies to increase the integrity of the banking system and make it more accessible to nontraditional savers increased the levels of financial savings. Education policies that focused on primary and secondary education generated rapid increases in labor force skills. Agricultural policies stressed productivity change and did not tax the rural economy excessively. All of these economies kept price distortions within reasonable bounds and were open to foreign ideas and technology. To this extent, there was no economic “miracle;” East Asia’s success simply reflects sound economics.
But these economic fundamentals do not tell the entire story. Almost all of the East Asian economies engaged, at one time or another, in some form of policy interventions—one of the most controversial aspects of development policy. Selective interventions took many forms, including mild repression of interest rates, directed credit, selective industrial promotion, and trade policies that pushed manufactured exports.
What was the relative role of economic fundamentals and intervention in East Asia’s success? The study maintains that East Asian economies thrived because governments used a combination of fundamental and interventionist policies to (1) accumulate physical and human capital; (2) allocate this capital to highly productive investments; and (3) acquire and master technology and achieve rapid productivity growth.
Accumulating capital
The East Asian economies accumulated both physical and human capital much more rapidly and consistently than other economies, accounting for a large portion of their superior performance.
Building human capital. East Asia began its rapid growth with an educational advantage over other developing economies and sustained that advantage through explicit policies of investing in basic education. Primary and secondary education levels were higher in these economies in the 1960s than in other low- and middle-income economies. Public spending concentrated on primary and secondary education. For example, in the mid-1980s, Indonesia, Korea, and Thailand devoted more than 80 percent of their education budget to basic education. Declining fertility and rapid economic growth meant that, even when education investment as a share of GDP remained constant, more resources were available per child in East Asia than in other developing regions.
The limited public funding for postsecondary education was used primarily for science and technological education (including engineering), while university education in the humanities and social sciences was handled through the private system. Some of these economies also imported educational services on a large scale, particularly for disciplines requiring specialized skills.
Creating effective and secure financial systems. Financial sector policies in these economies were designed to encourage savings and channel the funds into activities with high social returns.
Increasing savings. The East Asian economies increased savings by ensuring generally positive real interest rates on deposits and creating secure bank-based financial systems through strong prudential regulation, good supervision, and institutional reforms. In addition, Japan and Taiwan established postal savings systems to attract small savers. These systems offered small savers greater security and lower transaction costs than the private sector and made substantial resources available to government.
Some governments also used a variety of more interventionist mechanisms to increase savings. Malaysia and Singapore guaranteed high minimum private savings rates through mandatory provident fund contributions. Japan, Korea, and Taiwan all imposed stringent controls and high interest rates on loans for consumer items as well as stiff taxes on so- called luxury consumption.
Increasing investment. The East Asian economies encouraged investment by several means. First, they did a better job than most developing economies of creating infrastructure complementary to private investment. Second, they created an investment-friendly environment through a combination of tax policies and measures that kept the relative prices of capital goods low, largely by maintaining low tariffs on imported capital goods. These fundamental policies had an important impact on private investment. Third, and more controversial, most of these economies kept deposit and lending rates below market- clearing levels, a practice known as financial repression.
Japan, Korea, Malaysia, Taiwan, and Thailand experienced extended periods of mild financial repression. In these economies, real deposit rates were zero or mildly positive and stable, but because savings were not very responsive to changes in real interest rates (above zero), governments could mildly repress interest rates on deposits with a minimal impact on savings and pass the lower rates to final borrowers, thus subsidizing corporations. This policy of mild financial repression differed significantly from the repressed financial regimes of other low- and middle-income countries because interest rates were both more stable and positive in real terms.
Allocating capital
But high levels of physical and human capital are not a guarantee for success. Resources, once accumulated, need to be allocated to high-yielding activities. Again, these economies used a combination of market mechanisms and government intervention to guide allocative decisions in both the labor and capital markets. Labor market policies tended to use the market and reinforce its flexibility. In the capital market, governments intervened systematically both to control interest rates and to direct credit but did so within a framework of generally low subsidies to borrowers, targeting of allocations to areas of presumed market failure, and careful monitoring.
Letting markets work: flexible labor markets. Government roles in labor markets in the successful Asian economies contrast sharply with the situation in most other developing countries. The governments in these economies have generally been less vulnerable and less responsive than other developing country governments to organized labor demands to legislate a minimum wage. Rather, they have focused their efforts on generating jobs, effectively boosting the demand for workers. As a result, employment levels have risen first, followed by market- and productivity-driven increases in wage levels. Because wages, or at least wage-rate increases, have been downwardly flexible in response to changes in the demand for labor, adjustment to macroeconomic shocks has generally been quicker and less painful in East Asia than in other developing regions.
Assisting the market: capital markets. Capital markets serve to allocate funds to competing investments. Each of the Asian economies made some attempts to direct credit to priority activities; all except Hong Kong gave automatic access to credit for exporters. Housing was a priority in Hong Kong and Singapore, while agriculture and small and medium-size enterprises were targeted sectors in Indonesia, Malaysia, and Thailand. Taiwan has recently targeted technological development. Japan and Korea have at various times used credit as a tool of industrial policy to promote the shipbuilding, chemical, and automobile industries.
The implicit subsidy of directed credit programs in the East Asian economies was generally small, especially in comparison with other developing economies, but access to credit and the signal of government support to favored sectors or enterprises were important. In Korea, the subsidy from preferential credit was large during the 1970s, reflected in a large gap between bank and curb market interest rates. This gap has declined sharply in recent years, as Korea has shifted away from heavy credit subsidies to selected sectors. In Japan implicit subsidies were small, and the direction of credit may have been more important as a signaling and insurance mechanism than as an incentive.
Although East Asia’s directed credit programs were designed to achieve policy objectives, they nevertheless included strict performance criteria. In Japan, public bank managers employed rigorous economic and financial evaluations to select among applicants from sectors that were being targeted by the government. In Korea, the government individually monitored the large conglomerates using market-oriented criteria, such as exports and profitability. Recent assessments of some directed credit programs in Japan and Korea provide microeconomic evidence that they increased investment, promoted new activities and borrowers, and were directed at firms with high potential for technological spillovers (see “The Role of Credit Policies in Japan and Korea” in this issue).
Directed credit programs without strong performance-based allocation and monitoring—as in some other East Asian economies—have been largely unsuccessful. The changing level of financial sector development and the increasing openness of these economies to international capital flows have caused directed credit programs to decline in importance.
Promoting productivity
The East Asian economies used several strategies for increasing productivity growth, including absorbing foreign technology, employing selective industrial policies, and encouraging rapid export growth.
Absorbing foreign technology. These economies actively sought foreign technology through a variety of mechanisms. All welcomed technology transfers in the form of licenses, capital goods imports, and foreign training. Openness to foreign direct investment speeded technology acquisition in Hong Kong, Malaysia, Singapore, and, more recently, Indonesia and Thailand. Japan, Korea, and, to a lesser extent, Taiwan restricted foreign direct investment but offset this disadvantage by aggressively acquiring foreign knowledge through licenses, overseas education, and capital goods imports.
Promoting specific industries. Most East Asian governments have pursued sector-specific industrial policies to some degree. The best known instances include Japan’s policies to promote heavy industry in the 1950s and the subsequent imitation of these policies in Korea. These policies included import protection as well as subsidies for capital and other imported inputs. Malaysia, Singapore, Taiwan, and even Hong Kong have also established programs—typically with more moderate incentives—to accelerate the development of advanced industries. Despite these actions, there is little evidence that industrial policies have affected either the sectoral structure of industry or rates of productivity change (see “Roots of East Asia’s Success” in this issue).
Encouraging export strategies. The active promotion of manufactured exports was a significant source of these economies’ rapid productivity change. Although all of them except Hong Kong passed through an import-substitution phase, with high and variable protection of domestic import substitutes, these periods ended earlier than in other economies. Hong Kong, Malaysia, and Singapore adopted trade regimes that were close to free trade.
Japan, Korea, and Taiwan halted import liberalization, often for extended periods, and heavily promoted exports. Thus, while incentives were largely equal, they were the result of countervailing subsidies rather than of trade neutrality; promotion of exports coexisted with some protection of the domestic market. In the Southeast Asian economies, in contrast, governments gradually but continuously liberalized the trade regime, supplemented by institutional support for exporters, to achieve the export push. Exchange rate policies in all economies were liberalized and currencies frequently devalued to support export growth. Because governments were credibly committed to the export push strategy, producers, even those in the protected domestic market, knew that sooner or later their time to export would come.
Manufactured export growth provided a powerful mechanism for technological upgrading. Because world markets for technology are imperfect, firms that export have greater access to technology than those that produce import substitutes or nontraded goods. Exports can confer benefits to the enterprise and spillovers to the rest of the economy that are not reflected in market prices. These information-related spillover effects are an important source of rapid total factor productivity growth. Both cross-economy evidence and more detailed studies of total factor productivity performance of industries in Japan, Korea, and Taiwan confirm the significance of exports for rapid productivity growth.
Other innovative features
The success of the East Asian economies stems partly from the policies they adopted and partly from the institutional mechanisms they created to implement them. The context within which growth-oriented policies were undertaken differs from that of most other low- and middle-income countries in two important respects. First, political leadership adopted the principle of shared economic growth as a major social goal, and, second, governments relied on the private sector.
The principle of shared growth. To win the support of the society at large, East Asian leaders supported the principle of shared growth, promising, in effect, that as the economy expanded, all groups would benefit. But sharing growth raised complex coordination problems. First, leaders had to convince economic elites to support pro-growth policies. Then they had to persuade the elites to share the benefits of growth with the middle class and the poor. Finally, to win the cooperation of the middle class and the poor, leaders had to show them that they would indeed benefit from future growth.
Very explicit mechanisms were used to demonstrate that all would have a share of future wealth. Korea and Taiwan carried out comprehensive land reform programs; Indonesia used rice and fertilizer price policies to raise rural incomes; Malaysia introduced explicit wealth-sharing programs to improve the lot of ethnic Malays vis-à-vis the better-off ethnic Chinese; Hong Kong and Singapore undertook massive public housing programs. In several economies, governments assisted workers’ cooperatives and established programs to encourage small and medium-size enterprises. Whatever the form, these programs demonstrated that the government intended for all to share in the benefits of growth.
Role of the private sector. Private, not public, investment was the major engine of rapid growth in these economies. Between 1970 and 1990, virtually all of the difference in investment between these economies and other low- and middle-income economies was due to their much higher levels of private investment (see Chart 3).
High share of private investment
Citation: Finance & Development 31, 001; 10.5089/9781451953107.022.A001
Source: World Bank.1 High performing Asian economies (HPAEs): Indonesia, Hong Kong, Japan, Malaysia, the Republic of Korea, Singapore, Taiwan Province of China, and Thailand.2 LMIEs: low- and middle-income economies.Responsible macroeconomic management, particularly low inflation and small fiscal deficits, encouraged long-term planning and investment and may have been responsible as well for exceptional savings rates. East Asian leaders built a business-friendly environment, of which a major element was a legal and regulatory structure that was generally hospitable to private investment. But beyond this, these economies have, with varying degrees of success, focused on enhancing communications between business and government. Japan, Korea, Malaysia, and Singapore have established forums, called deliberation councils, to enable private sector groups to influence the formulation and implementation of government policies relevant to their interests. In contrast to lobbying, where rules are murky and groups seek secret advantage over one another, the deliberation councils made the allocation rules clear to all participants.
Some of these economies have gone a step further, creating “contests” that combined competition with the benefits of cooperation among firms and between government and the private sector. Such contests range from very simple nonmarket allocation rules, such as access to rationed credit for exporters, to very complex coordination of private investment in the government-business deliberation councils of Japan and Korea. The key feature of each contest, however, is that the government distributes rewards—access to credit or foreign exchange—based on performance, which the government and competing firms monitor.
What can East Asia teach?
To what extent does East Asia offer lessons for other developing economies? The diversity of experience, the variety of institutions, and the great variation in policies mean that there is no one model for success. Rather, each of the eight economies studied used a combination of policies at different times to perform the functions needed for rapid growth: rapid accumulation, efficient allocation, and higher productivity growth.
While the fundamental, market-oriented economic policies can be recommended without reservation, the efficacy of more institutionally demanding strategies has not been established in other settings and is clearly difficult to imitate when the fundamentals are not securely in place. The problem is not only to try to understand which specific policies may have contributed to growth but also to understand the institutional and economic circumstances that made them viable.
The research results indicate that promoting specific individual industries was generally not successful and therefore holds little promise for other developing economies. Mild financial repression, combined with directed credit, has worked in some circumstances. Strategies to promote exports and to adapt and improve the technology available in industrial countries have been by far the most generally successful selective approaches used by these economies and hold the greatest promise for other developing economies.
For a comprehensive discussion, see The East Asian Miracle: Economic Growth and Public Policy, a World Bank Policy Research Report published by the Oxford University Press, New York, NY, USA, 1993. This report was prepared by a team led by John Page and comprising Nancy Birdsall, Ed Campos, W. Max Corden, Chang-Shik Kim, Lawrence MacDonald, Howard Pack, Richard Sabot, Joseph Stiglitz, and Marilou Uy.
