The Reality of Two East Asias: an extract from How Asia Works

There are three critical interventions that governments can use to speed up economic development. Where these interventions have been employed most effectively in east Asia – in Japan, South Korea, Taiwan and now China – they have produced the quickest progressions from poverty to wealth that the world has seen. When, by contrast, other east Asian states have set off with the same ambitions and equal or better endowments, but have not followed the same policies, they have achieved fast growth for a period but the progress has proved to be unsustainable.

The first intervention – and the most overlooked – is to maximise output from agriculture, which employs the vast majority of people in poor countries. Successful east Asian states have shown that the way to do this is to restructure agriculture as highly labour-intensive household farming – a slightly larger-scale form of gardening. This makes use of all available labour in a poor economy and pushes up yields and output to the highest possible levels, albeit on the basis of tiny gains per person employed. The overall result is an initial productive surplus that primes demand for goods and services.

The second intervention – in many respects, a second ‘stage’ – is to direct investment and entrepreneurs towards manufacturing. This is because manufacturing industry makes the most effective use of the limited productive skills of the workforce of a developing economy, as workers begin to migrate out of agriculture. Relatively unskilled labourers create value in factories by working with machines that can be easily purchased on the world market. In addition, in east Asia successful governments pioneered new ways to promote accelerated technological upgrading in manufacturing through subsidies that were conditioned on export performance. This combination of subsidy and what I call ‘export discipline’ took the pace of industrialisation to a level never before seen.

Finally, interventions in the financial sector to focus capital on intensive, smallscale agriculture and on manufacturing development provide the third key to accelerated economic transformation. The state’s role is to keep money targeted at a development strategy that produces the fastest possible technological learning, and hence the promise of high future profits, rather than on short-term returns and individual consumption. This tends to pit the state against many businessmen, and also against consumers, who have shorter strategic horizons.

The policy prescription for rapid economic development was confused for a time in east Asia by the presence of other fast-growing economies that did not conform to the pattern of Japan, Korea, Taiwan and China. In the 1980s and early 1990s, the World Bank seized on the performance of the offshore financial centres of Hong Kong and Singapore, and the suddenly faster-growing south-east Asian economies of Indonesia, Malaysia and Thailand, to argue that economic development was in fact fostered by laissez-faire policies, with a minimal role for government. Despite the fact that the offshore centres, with their tiny, dense populations and absence of agricultural sectors to drag on productivity, are not really comparable to regular countries, the World Bank used Hong Kong and Singapore as two of its three ‘proving’ case studies in a highly controversial 1987 report. ^[1]World Development Report 1987 (Washington: World Bank, 1987). Apart from the inclusion of the offshore financial centres, the economic modelling was weak because it considered industrial policy and protection only at the national level, not at the sectoral level. Sectoral manufacturing policy varied enormously within most countries, especially in Japan, South Korea and Taiwan during their fast-growth phases. In addition to the modelling, the report’s review of economic history was highly controversial. It highlighted British economic deregulation in the mid nineteenth century after the country became the world’s technological leader, but said nothing of the country’s protectionist policies deployed while it was ascending to this position. US protectionism during its rise in the nineteenth and early twentieth centuries was glossed over; only the country’s tariff low point of around 24 per cent in 1857 was mentioned, when the average American tariff across the whole period was nearer 40 per cent. In Europe there was very little discussion of German industrial policy and industrial cartels. Instead there was much discussion of nineteenth-century France’s laissez-faire economic policy – which left it in an economic condition far inferior to that of Germany. See especially, pp. 38 and 77. World Development Report 1983 was in some respects the intellectual forerunner of this publication, staking a first and highly dubious claim that South Korean development was the result of free markets. After widespread academic criticism of the report, the World Bank followed up with another one in 1993, The East Asian Miracle, which admitted the existence of industrial policy and infant industry protection in some states. But it downplayed the significance of such policies, avoided discussion of agriculture altogether, and added Hong Kong and Singapore to Malaysia, Indonesia and Thailand, thereby leaving Japan, Korea and Taiwan as the statistical minority among its ‘High Performing Asian Economies’. (China was omitted from the report.) ^[2]The East Asian Miracle: Economic Growth and Public Policy (New York and Oxford: Oxford University Press for the World Bank, 1993). The report’s inconsistencies were neatly captured by two contradictory statements made by the World Bank president in the foreword. On the one hand, Lewis T. Preston conceded: ‘The eight economies studied used very different combinations of policies, from hands-off to highly interventionist. Thus, there is no single “East Asian model” of development.’ A fewlines later, however, he got back to the World Bank’s central ideological message: ‘The authors conclude that rapid growth in each economy was primarily due to the application of a set of common, market-friendly economic policies, leading to both higher accumulation and better allocation of resources.’ This internal inconsistency continues throughout the report.

This was the ideologically charged era of the so-called Washington Consensus, when the World Bank, the International Monetary Fund and the US Treasury were united in their determination that the free market policies coming into vogue in the US and Britain were appropriate to all economies, no matter what their level of development. ^[3]The term was first used by the economist John Williamson in 1989. The headquarters of the three agencies are all located in Washington, D.C. Williamson listed ten policies which he said constituted the consensus. Among them, policies of particular interest for this book will be the use of market interest rates, freely determined exchange rates (inferring no capital controls), trade liberalisation, openness to foreign investment, privatisation of state enterprises, and deregulation. The vitriol of the debate was such that academic rigour was frequently a victim, as with the World Bank reports. Indeed, even the academic specialists on Japan, Korea and Taiwan who opposed the Washington Consensus position on economic development made suspect claims in order to bolster their case. This only added to confusion. Chalmers Johnson wrote in the preface to his seminal study of Japanese development, published in 1982: ‘[The Japanese development model] is being repeated today in newly industrializing states of East Asia – Taiwan and South Korea – and in Singapore and South and Southeast Asian countries.’ Alice Amsden, who produced the defining deconstruction of Korean development, referred in the introduction to a follow-up book to ‘the model used by Japan, Korea, Taiwan and Thailand’. Even W. W. Rostow, author of one of the earliest and most historically informed post-war books on economic development, The Stages of Economic Growth, declaimed in the foreword to a new edition in 1991 that Malaysia and Thailand were following Korea and Taiwan towards technological maturity. ^[4]Chalmers Johnson is quoted from MITI and the Japanese Miracle: The Growth of Industrial Policy, 1925–75 (Stanford: Stanford University Press, 1982), p. viii. Alice H. Amsden is quoted from Escape from Empire: The Developing World’s Journey through Heaven and Hell (Boston: MIT Press, 2009), p. 9. It is not clear why she mentions only Thailand among the south-east Asian states. W. W. Rostow is quoted from The Stages of Economic Growth (Cambridge: Cambridge University Press; third edition, 1991), p. xvii. In the argument over east Asia, everyone started to talk beyond their turf in an effort to win the debate.

The disagreement about the nature of economic development was only made possible by continued fast growth rates around the region. In the early 1980s, however, Brazil – the outstanding fast growth story of 1960s’ and 1970s’ Latin America – had shown how dangerous it is to judge economic progress by growth rates alone. Brazil is the only major economy outside east Asia which has managed to grow by more than 7 per cent a year for more than a quarter of a century. ^[5]See Michael Spence, ed. The Growth Report (Washington: World Bank Commission on Growth and Development, 2008). The publication lists thirteen states that have grown at least 7 per cent a year for twenty-five years since the Second World War. I omit three offshore financial centres (Hong Kong, Singapore and Malta), a tiny oil state (Oman) and another tiny state overwhelmingly dependent on a diamond mine (Botswana). The other seven fast-growth states, all in east Asia, are listed below. But, with the onset of the Latin American debt crisis in 1982, Brazil crumbled amid currency depreciation, inflation and years of zero growth. It turned out that too much of Brazil’s earlier growth had been generated by debt that did not translate into a more genuinely productive and competitive economy.

Beginning in 1997, with seven economies that have expanded at least 7 per cent a year for a quarter century – Japan, Korea, Taiwan, China, Malaysia, Indonesia and Thailand – east Asia entered a period of reckoning of its own, as the Asian financial crisis took hold. By this point Japan had long since become a mature economy that faced a new set of post-developmental structural problems, ones it showed much less capacity to address than the original challenge of becoming rich. Korea, Taiwan and China, however, were still in the developmental catch-up phase. These states were either unaffected by the Asian crisis or recovered quickly from it, and returned to brisk growth and technological progress. But Malaysia, Indonesia and Thailand were knocked completely off course. They suffered currency depreciation, inflation and much reduced growth. It is indicative that today Indonesia and Thailand report GDP per capita of only USD 3,000 and USD 5,000 respectively, and feature significant levels of poverty, where Korea and Taiwan report GDP per capita around USD 20,000. At the end of the Second World War, all these countries were similarly poor. ^[6]Korea and Taiwan reported GDP per capita of USD 21,000 and USD 19,000 respectively in 2010. Malaysian GDP per capita was USD 8,000. According to the World Bank’s World Economic Outlook database, in 1962 (the first year for which records are available) Indonesia, Thailand and South Korea each had GNI per capita around USD 100. The World Bank does not break out data for Taiwan. Apart from Japan (USD 610), the most prosperous states in terms of GNI per capita in 1962 were Malaysia (USD 300) and the Philippines (USD 210).

What the Asian crisis clarified was that a consistent set of government policy interventions had indeed made the difference between long-run success and failure in economic development in east Asia. In Japan, Korea, Taiwan and China, governments radically restructured agriculture after the Second World War, focused their modernisation efforts on manufacturing, and made their financial systems slaves to these two objectives. They thereby changed the structures of their economies in a manner that made it all but impossible to return to an earlier stage of development. In the south-east Asian states – despite their long periods of impressive growth – governments did not fundamentally reorganise agriculture, did not create globally competitive manufacturing firms, and did accept bad advice from already rich countries to open up financial sectors at an early stage. The Japanese economist Yoshihara Kunio had warned in the 1980s that south-east Asian states risked becoming ‘technology-less’ developing nations. This is exactly what happened, and they slid backwards when their investment funds dried up. In short, different policy choices created – and will probably further widen – a developmental gulf in the Asian region. ^[7]Yoshihara Kunio, The Rise of Ersatz Capitalism in South-East Asia, (Singapore and Oxford: Oxford University Press, 1988). In the same period, another Japanese economist, Suehiro Akira, confirmed and expanded many of Yoshihara’s south-east Asia-wide observations with respect to the Thai kingdom in Capital Accumulation in Thailand (Tokyo: Centre for East Asian Cultural Studies, 1989).

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An historical review of east Asian economic development shows that the recipe for success has been as simple as one, two, three: household farming, export-oriented manufacturing, and closely controlled finance that supports these two sectors. The reason the recipe worked is that it has enabled poor countries to get much more out of their economies than the low productive skills of their populations would otherwise have allowed at an early stage of development. Governments manipulated economies which thereby forged ahead and created wealth that paid for people – who cannot be neatly transformed by government policy – to catch up.

Neo-classical economists do not like political intervention in markets. They claim that markets are inherently efficient. But history shows that markets – with the primordial exception of what the institutional economist Ronald Coase dismissed as ‘individuals exchanging nuts for berries on the edge of the forest’ – are created. ^[8]R . H. Coase, ‘The Institutional Structure of Production’, American Economic Review, 82, no. 4, (September 1992), p. 713. The article is in fact the acceptance speech Coase gave in 1991 when he was awarded the Nobel prize for economics. Which is to say that in a functioning society markets are shaped and reshaped by political power. Without the dispossession of landlords in Japan, Korea, Taiwan and China there would have been no increased agricultural surplus to prime industrialisation. Without the focus on manufacturing for export, there would have been no way to engage tens of millions of former farmers in the modern economy. And without financial repression, it would not have been possible to pay for an accelerated economic learning process. In all of the above, markets and competition were made to serve development.

The message that east Asia – and indeed an historical understanding of development around the world – sends to economists is that there is no one type of economics. At a minimum, there are two. There is the economics of development, which is akin to an education process. This is where the people – and preferably all the people – who comprise an economy acquire the skills needed to compete with their peers around the world. The economics of development requires nurture, protection and competition. Then there is the economics of efficiency, applicable to a later stage of development. This requires less state intervention, more deregulation, freer markets, and a closer focus on near-term profits. The issue is not whether there are two kinds of economics that exist at different stages of development. The question is where these two stages meet. This is the difficult and interesting subject to which economists could more productively apply themselves.

Unfortunately, the intellectual tyranny of neo-classical ‘efficiency’ economics – the natural subject matter of rich countries – means that it is all but impossible to have an honest discussion about economic development. Poor states can only be successful by lying. They have to subscribe publicly to the ‘free market’ economics touted by the rich while pursuing the kind of interventionist policies that are actually necessary to become rich in the first place. It is a very hard thing to recommend lying, but in this instance one has to. The alternative – to rail against Western intellectual hegemony and to stick your rhetorical finger in the eye of its leader, the United States, as Mao, Sukarno and Mahathir did – is pure folly. Far better to take a page out of Park Chung Hee or contemporary China’s book: make public pronouncements about the importance of free markets, and then go quietly about your dirigiste business.

It must be said, however, that there are problems on both sides of the argument about appropriate economic development policy. In countries that have successfully combined household agriculture, manufacturing and financial repression since the Second World War there has been an unwillingness or an inability to recognise the limitations of the model. In the richest countries that employed the one, two, three approach after 1945 – Japan in east Asia and Italy in Europe ^[9]Italy introduced a significant land reform programme in 1950, backed by heavy investment in irrigation, rural infrastructure and agronomic extension. This was coupled with export-oriented manufacturing development and financial system repression. The Italian economy expanded faster than that of any other European state in the 1950s and 1960s, growing an average 5.8 per cent a year from 1950 to 1963 and 5.0 per cent a year from 1963 to 1973. For a treatment of the economic development similarities between Italy and Japan, see Richard J. Samuels, Machiavelli’s Children: Leaders and Their Legacies in Italy and Japan (Ithaca, NY: Cornell University Press, 2003). – there has been a pronounced resistance to economic deregulation until long after it was needed. In Korea, it required the Asian crisis and a fortuitously well-timed intervention by the IMF to introduce reforms that otherwise would not have occurred.

The one, two, three approach only gets an economy – not to mention a society – so far. If policies do not change, the economic sclerosis of contemporary Japan or Italy beckons. Secondly, governments which have used one, two, three to develop in east Asia have frequently, and disingenuously, pretended that economic development is the only thing that defines the progress of a society. This stance is tied up with rhetoric about ‘Asian’ values, suggesting that ‘Asian’ (who are they?) people do not want the same things as people in rich countries. This is rubbish. Economic development is only one part of a society’s development. The other parts, to do with freedom and the rights of the individual, are no less important. In China today, another government is claiming racial exceptionalism to justify deliberate institutional backwardness. China is putting off the creation of an independent legal system and more open, representative government until well after they are warranted. This is not what the Chinese people want. It does not matter that you can afford a small car or a motorbike if your friend or relative disappears into one of the country’s extralegal ‘black jails’. ^[10]Black jails – hei jianyu – are a network of extra-legal detention centres in China used to detain citizens outside the already highly repressive formal judicial system. The existence of black jails is denied by the government, but there are so many of them that citizens commonly not only know of their existence, but also their locations. Nor does a new kitchen seem so pleasant if the food you eat in it is poisoned for lack of environmental controls or by the addition of some low-cost but toxic ingredient, the use of which has been covered up with official connivance. Emerging countries could themselves help to frame a more honest debate about economic development by setting and meeting benchmarks for the other components of overall development. In China’s case, its government’s unwillingness to actively discuss political and social progress scares rich, free countries so much that a sensible discussion of the requirements of economic development becomes all but impossible.

Will we witness an economic transformation like Japan, Korea, Taiwan or China’s again? The answer is quite possibly not, for one simple reason. Without effective land reform it is difficult to see how sustained growth of 7–10 per cent a year – without fatal debt crises – can be achieved in poor countries. And radical land reform, combined with agronomic and marketing support for farmers, is off

the political agenda. Since the 1980s, the World Bank has instead promoted microfinance, encouraging the rural poor to set up street stalls selling each other goods for which they have almost no money to pay. It is classic sticking-plaster development policy. The leading NGO promoting land reform, US-based Landesa, is today so pessimistic about the prospects for further radical reforms in the world’s poor states that it concentrates its lobbying efforts on the creation of micro plots of a few square metres. These plots supplement the diets and incomes of rural dwellers who work in otherwise unreformed agricultural sectors. From micro interventions, however, economic miracles will not spring.

South-east Asia (like India) is a region in which serious land reform is off the political agenda, even if the farce that is the Philippine reform programme continues. Given this, can the Philippines, Indonesia, Malaysia and Thailand do anything else to improve their economic performance? Most obviously they could make the Association of South-East Asian Nations (ASEAN) work as a vehicle for effective industrial policy. There is no reason why the four core economies of ASEAN (and indeed Vietnam) could not run an effective manufacturing infant industry policy in what is a market of 500 million people. ^[11]Half a billion people across the five states, including Vietnam. But there is no sign of this happening. Rather than raising barriers and promoting exports to nurture local manufacturing enterprise, ASEAN is engaged in signing free trade agreements with industrially more developed states, including China. There is very little cohesion, or substantive dialogue, between the political leaders of the Philippines, Indonesia, Malaysia, Thailand and Vietnam. And the considerable influence of the offshore financial centre of Singapore in ASEAN is developmentally deeply unhelpful. It is as if Switzerland or Monaco had been granted a seat at the table when post-war European industrial policy was being planned in the 1950s. South-east Asia remains a beacon for what not to do if you want economic transformation. Allow landlordism and scale farming despite the presence of vast numbers of underemployed peasants capable of growing more. Do not worry too much about export-oriented manufacturing, which can happily be undertaken by multinational enterprises. Leave entrepreneurs to their own devices. And proceed quickly to deregulated banking, stock markets and international capital flows, the true symbols of a modern state. That is how its politicians constructed the south-east Asian region’s relative failure.

The rich world cannot be expected to save poor countries from bad politicians. But the likes of Mahathir and Suharto were not so terrible. What seems most wrong in all this is that wealthy nations, and the economic institutions that they created like the World Bank and the International Monetary Fund, provided lousy developmental advice to poor states that had no basis in historical fact. Once again: there is no significant economy that has developed successfully through policies of free trade and deregulation from the get-go. What has always been required is proactive interventions – the most effective of them in agriculture and manufacturing – that foster early accumulation of capital and technological learning. Our unwillingness to look this historical fact in the face leaves us with a world in which scores of countries remain immiserated; and in which rural poverty nourishes terrorist groups that echo those suppressed in south-east Asian countries, but which now directly threaten the citizens of rich nations. It is not easy to implement the policies, especially land reform. However I repeat what others concluded after the Second World War: that to turn away from such policies indicates that the world is acceptable to us as it is. Take a look at south Asia, the Middle East and Africa, and ask yourself if it is.

Joe Studwell is the founding editor of The China Economic Quarterly. He has contributed to the Economist Intelligence Unit, The Economist, The Financial Times, The Asian Wall Street Journal, The Far Eastern Economic Review, and many other publications. Previous books include Asian Godfathers and The China Dream.