1993 World Bank - The East Asian Miracle

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The East Asian Miracle

EconomicGrowth and PublicPolicy
Publishedfor the World Bank

UNIVERSrrYPRS CxCORD
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Foreword
EBATESON THE APPROPRIATE ROLE OF PUBLIC POUCY IN
economic development have occupied policymakersand bcgan in economnies scholarssince the study of developing earnestat the dosc of World War IL.The successof many of the growth,oftenin rapidandequitable in achieving in EastAsia economies aboutthe questions complex raises the contextofacivist publicpolicies, relationshipbetweengovernment,the privatesector,and the markern in EastAsiausedmanyof the economies growing Seningly,therapidly same poficy instrumentsas othcr developingeconomies,but with cotheir rapid contribuced whichpolicies Understanding greatersuccess. polon development growth,and how,is a majorquestionfor research MeetAnnual 1991 the I announcedat the timeof icy.Forthesercasons of ings of the Board Govemors of the World Bank in Bangkok, unVicePresidencywould Economics Thailand,that our Development study of economicgrowthand public policyin dertakea comparative
East Asia.
ch. appears This volumeis the summary arc which intendedto Reports, of PolicyRcsearch as the firstin a series policy on development the resultsof research bringto a broadaudience carriedoutbystaffof theWorldBank.Asreportson policyissues, issues stockof what we know and we intend that theyshouldhelp us to takewhat wedo not know;theyshouldcontribureto the decIealy identifir pubon appropriate and poli-y communities bat in both the academic and economies; and instrumentsfor developing lic policy objectives theysunmarize reBecause tX nonspecialiscs. they shouldbe accessible farwill provoke Reports Research that Policy search,wealsoanticipate concemingthemethods ther debate,bothwithinthe Bankand outside, drawn. usedand the conclusions The retell us about the EastAsianmiracle? report this does What growthisdue cosuseawhshowsthat most of EastAsiasextraordinary perior accumulation of physical and human capita. But these economiesWerealso better able than most to allocatephysicaland
buman resources to highlyproductive investrents and to acquireand mastertxchnology. In thissensethereis nothing'miraculous" aboutthe EastAsianeconomics' success; eachhas perfirmed theseessential functions ofgrowthbetter than mosrother economies. The eight economics studied used very differentcombinations of policies, firom hands-ofTto highlyinterventionist. Thus, themisno single 'East Asianmoder of development. This divcrsity of experience reinforcesthe view that economicpolicies and policy advicemust be country-specific, ifthey areto be effectivec Buttherearcalsosomecommon threadsamong the high-performing East Asianeconomies. The authorsconcludethat rapidgrowthin eachcconomy was primarily due
to
theapplication of a set of common, market-friendly economicpoli-
cies, leadingto both higheraccumulation and berter allocation of resources. While this condusionis not strikinglynew,it reinforces other rcsearch that hassressed the essential need fordcveloping economics to
ger the policy fundamentals igIL The researchalso firther supports the
desirability of a two-track approach to development policyemphasizing macroeconomic stability on onehand and investments in peopleon the
ocher. The importance of good macroeconomnic management and broadly based educational systemsfor Easr Asia'srapid growth is abundandlydemonstrated. The reporr alsobreaks some new ground. It condudes that in some
economics,nainly thosein NortheastAsia,someselective interventions contibuted o grwth. and it advances our undersmading of theconditions required for interventionsto succeed. The authors argue thar whereselective intervcntions succceded they did so because of th eso sential prcrequisites.First, they addressed problems in the functioning of markets.Second,they took placewithin the contex of good,findamentalpolicies. Third, theirsuccess dependedon the abilityof governmerts to establish and monicor appropriateeconomic-performance
criteriarelated to the interYcntions-in the authors' terms, to create economic contests. These prerequisitessuggesr that the institional context withLinwhich policies are implemented is as important to their
success or failureas thepoliciesthemselvcs, and the reportdcvotes substantial artention to the institutional basesfor East Asi-a rapid growth.
While thesefactorshelp to explainwhy apparently sinilar policies did not succeedin mrany othereconomies, the report alsoleaves unanswered many importantquestions. The market-oricnted asj ctxs ofEast Asia!s polides can be recommended with few reservations, but the more
vi
institutionally demanding aspects, stich as contest-based interventions, used in other settings.Noneconomic factors, havenor been successfully induding culture, politics, and history, are also important to the East Asian successstory. Thus, there is still much to be learned about the interactions between policy choices and inscitutional capability and between economic and noneconomic factors in development. Work in theseareaswill continue beyond this report. The support of the Government ofjapan for the researchprogram on the high-performing Asian economics is gratfilly acknowledged.The report is a product of the staff of the World Bank, and the judgments made herein do not necessarilyreflectthe view of its Board of Directors or the governmentsthey rcprescnt.
Lewis T. Preston President The World Bank Augur 1993
vii
Contents
7TeRear Defmiufons Team xv xi xiii
Ack3wwkdgmnae
Overview-rThe Making of a Miracle The Essenceof the Mirale: Rapid Growth with Equity Policiesfor Rapid Growth in a ChangingWorld Economy Note 26
8 23
1 Growth, Eqrity, and Economic Change Rapid and SustainedEconomic Growth 28 Declining Income Inequality and Reduced Poverty 29 Dynamic AgriculturalSeaors 32 Rapid Growth of Exports 37 Rapid DemographicTransitions 38 High Investment and SavingsRares40 Creatng Human Capital 43 Rapid Productivity Growth 46 Appendix 1.1:Accounting for Growth 60 Appendix 1.2: What Do Tess of Cogniive SkillsShow?Notes 76
27
70
Public Policy and Growth PolicyExplanations 81 The Functional Growth Framework Notes 103
79 87
Macroeconomic Stabiity and Export Growth Pragmatic Orthodoxy in MacroeconomicManagement 106 Creatng an ExportPuLsh 123 Appendix 3.1: Economric and PoliticalTimedines 148 Notes 156
105
ix
4 An Insitutional Basisfor SharedGrowth throughSharcdGrowth Legitimacy Achicving Technocracy 167 theEconomic Insulating BigBusiness 181 Wooing Notes 189
157
158
5 Strategiesfor RapidAccumulation Forrnation HighHumanCapital EastAsia's Explaining

203 ExplainingEast Asia'sHigh SavingsRates 221 ExplainingEast Asia'sHigh Investment Rates
191 192
Appendix 5.1:Granger Causaliy TestsforSavings Rates andGrowthRates 242 beween 5.2:Technical Noteon theRelationship Appendix 245 andGrowth Rates Interest Notes 255 on Efficienty:Relying 6 UsingResources 259 Madrets and Exports 259 Use Resource Efficient EastAsiais Explaining 261 in EastAsia Labor Markets UsingtheMarken andAllocation 273 Markets theMarkctFinancial Assisting 292 Policy andIndustrial MarketTrmde theInternarional Using Productiviy 316 Exports Increased HowManufactured Appendix 6.1:Testing dhe Impact ofIndusaial 326 Change on Productivicy Policy berween TFP 6.2:TestsoftheRelationship Appendix 337 andTradePolicies Change 342 Notes in a ChangingWorld 7 Polices and Pragmatism dhe Growdh-Getting ofRapid Foundations 347 Right Fundamentals 352 Institutions toPromote Growdi Creating 353 Intervening in Markets Note 368 Note Bibligraphic 369 347
The Research Team

T
HIS POLICYRESEARCH REPORTWAS PREPAREDBYATEAM LED
by John Pagcand comprising NancyBirdsall,Ed Campos,W Max Corden, Chang-ShikKim, HowardPack,RichardSabot, Joseph E. Stiglitz,and MarilouUy. Robert Cassen,WilliamEasrerly, RobertZ. Lawrence, PetcrPetri,and L-nt Pritchettmade majorcontributions.Lawrence MacDonald wasthe principaleditor.Casestudiesof the seven devclopinghigh-performing Asian economieswerc undertakenunder the directionof DannyLeipziger. The tcamwasassisted by MariaLtiisaCicogniani, VaruniDayaratna,LeoraFriedberg, Jay Gonzalez, JenniferKeller, MayKhamis,SoniaPlaza,MyriamQuispe,Carol Strunk, and AyakoYasuda. The work was initiatedby LawrenceH. Summersand was carried our under the generaldirectionof Nancy
Birisall.
The editorial-production team for the report was led by Alfred Imlhof The support staffwas headedby Sushrma Rjan and included Milagros Divino,Jan-Marie Hopkins,Anna MarieMaranon,and Linda Oehler PollyMeansgavegraphicalassistance. BruceRoss-Larson and Meta dc Coquercaumontprovidedadditionaleditorialsupport The Mapwas designedby jeffreyN. Lecksel.MiklaIwasakicoordinatcd workin Japan.
XI
Acknowledgments
REPARATION OF THIS REPORTDREWON SLVERAL OTHER RE-
laced research projects.Studiesof theJapanesemain bank sysrcn

and civilservice werccarriedout under thedirnctionofHyung-Ki Kim.Yoon-Je Cho and DimirriVittasdirectedthe projecton the effectiveness of crcditpolicies in EastAsia.BrianLevy directedthe projecton supportsystems forsmalland medium-size enterprises in Asia,andJohn Pagecoordinated projectson lapanese perspectives on publicpolicyduring the rapid growthperiod, and tax policyand tax administrationin
EastAsia.
Manyindividuals insideand outsidethe WorldBank provided valuable contributions and comments.(Specific acknowledgmcnt of their efifrts is madein the Bibliographic Note at dceend of the book.) Particularthanksare due ro the following seniorofficials of the economies studiedwho reviewed and comment"don an earlierdrafc Seung-Chul Ahn, Isao Kubota, Shijuro Ogata, J. B. Sumarlin,Teh Kok Peng, Chilao Tsukuda,Tan Sri Dato Lin SeeYan,and CesarVirata.Vinod Thomascomnmented on several draftsand coordinated the commentsof his colleagues in the EastAsiaand PacificRegionof the Bank.CommentsbyCad Dahlmaan, Kemnal Dervis,MarkGersovitz, RalphW Harbison, Magdi kskander, Hyung-KiKim, Danny Leipziger. Johannes Linn, GobindNankani,MiekoNishimizu,Guy P. Pfeffermann, D. C. Rao,ant Michael Waltoncontributedto the improvement of the book. Preparation of the reportwasaidedby seminarsorganized by the IndonesianEconomists Association, the EconomicSociety of Singapore, the Monetary Authority of Singapore,StanfordUniversity,and the WorldInstitutefor Development Economic Researeh. The financialassistance of the Govemrnment ofJapan is gratefully acknowledged.
...
Definitions
Economy Groups
OR OPERATIONAL AND ANALYTICAL PURPOSES. THE WORLD
Bank's main criterion for dassifying economies is gross national F product(GNP) per capita. Everyeconomyis dassifiedas low-income, middle-incomc (subdividedinto lower-middleand upper-middle), or high-income. Other analytical groups, based on -:gions, exports, and levelsof extemal debt, are also used. Because of changes in GNP per capita, the economy composition of each income group may change from one Bank publication to the next Once the dassificationis fixedfor any publication, all the hisroricaldata prescnted are basod on the same economygrouping. The income-based economy groupings used in this sEudyare defined as folows * Low-income economies are thosc with a GNPpcr capit of $635 or less in 1991. * Middle-inme ecoomzies are those with a GNP per capita of more rhan $635 but lessthan $7,911 in 1991. A fijrther division,atGNP per capita of $2,555 in 1991, is made between Iouer-midlk-incow and upper-midl-income conomies. * High-incomeeconomies are those with a GNP per capit of $7,911 or more in 1991. * Word comprisesall economies, including economies with sparse data and those with fewer than 1 million people. Low-income and middle-income economies axesormetimesreferred to as developingeconomies. The use of the term is convenient; ir is not intended to imply that all economies in the groupare experiencingsimilar development or that other economies have reached a preferred or finalstage of development. Classificationby income does not necessarilyreflectdevelopment status.
'V
Groups -Anabtical
OR ANALYIICAL PJRPOSES, THISSTUDY GROUPS ECONOMIES into severalregions,defined as fIllows
led byjapan, arc iden*High-perfirmingAsian economies(HPAEs), tified by severalcommon characteristics, such as very rapid exare subclassified roughly according to port growth. The HPAES record of economic growth: the duration of their succcssfiul igersusuallyidentifiedas Hong Kong, thc Republic TheF : of Korea, Singapore, and Taiwan, China, have been growing rapidly for decadesand havejoined or approached the ranksof high-income economies. * The newly industrialidZWg economies (NIEs) are Indonesia, Malaysia,and Thailand. They havejoined the group of HPAEs more recently,within the last two decades. . vur * EastAia comprisesall the low- and middle-income economiesof East and Southeast Asia and the Pacific, east of and including China and Thailand. * South Asizr comprises Bangladesh, Bhutan, India, Myanmar, Nepal, Pakistan, and Sri Lanka. * S&zb-&harnAf5ca comprisesall econoniies south of the Sahara including South Africa but ecduding Mauritius, Reunion, and Seychelles,which are in the OtherAsia and islandsgroup. * Europe Middle F."t and North Africa comprises the middle-income Europan economies of Bulgaria, the former Czechoslovakia, Greec, Hungary,Poland, Portugal, Romania, Turkey,and the forrner Yugoslavia, and all the economiesof North Africa and the Middle East, and Afghanisan. m Latin Americaand the GCaibcancDmprisesall American and Caribbean economiessouth of the United States. The regional grouping of economiesin occasionalparts of the text or tables maydiffer from that used in the main tt of this study,described above.Such variations are nocedwhere dthy occur.
DataNotes
* Bilion is 1,000 million. * Trillionis 1,000 billion.
- Dolars arecurrent U.S. dollarsunless otherwisespecifiecd. * Growthratesarebasedon constant price dart Historical data in this study may differ from those in other Bank pubLications because of continuous updating as better data become available, becauseof a changeto a new baseyear for constant pricedata, or becauseof changesin economycompositionof income and analytimlgroups.
Acronymsand Initials
CPI
DFI
Consumerpriceindex
Direct foreign investment GDP Gross domestic product GNP Gross national product rlPAEs High-performing Asian economnies 1MF International Monetary Fund ISIC Intemational Standard Industrial Classification mI Ministry of Trade and Industry Japan NIs Newly industrializing economies OECD Organization for Economic Cooperation and Development (Australia,Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan, Luxembourg, Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, Turkey, United Kingdom, and United States) PPP Purchasing power parity R&D Research and devclopment TFP Total factor producdivity UNDP United Nations Development Programme UNESCo United Nations Educational, Scientific, and Cultural
Organization
-n.
Overview: The Making of a Miracle

RECORD OF HIGH AND AST ASIA HAS A REMARKABLE
sustained economic growdh.From 1965 to 1990 the of East Asiagrew fasterthan all twenty-threeeconomliies other regions of the world (figure 1). Most of this achievement is attributable to seemingly miraculous growth in just eight economies: Japan; the 'Four Tigeser-Hong Kong, the Republicof Korea,Singapore,and Taiwan, China; and the three newly industrializingeconomies (NiEs) of Southeast Asia, Indonesia, Malaysia, and Thailand. These eight highperformingAsian economies(HPAEs)are the subject of this study.* Selectinganysecofeconomiesand attemptingtoundesand theorigins arbitnary processes.'Botswana, growth are necessarily of their successful Egypt, Gabon, and Lesotho in Sub-SaharanAfrica have also been
among the world's top growth performers in the past two decades, as
have suchdiverseeconomiesas Brazil,Cyprus,Greece,and Portugal(see figure2). Why focuson eight economiesin East Asia? In part the choice reflectspopular interest;it has become common to see referencesto the "Asian EconomicMiracle., In part it reflectsrecentartention by the academic and development policy communities to the relationship between public policies-which some authors haveargued have a number of common threads in the eight economies,especiallyJapan, Korea,
*Recendy China, particularly southern China, has recorded remarkably high growth This vtay significant - ates using policies that in some ways resermblcthose of the HPAEs. development is beyond the scope of oursudy, mainly because China's ownership seruc. ure, methods of corporate and civil govcrnance, and reliance on markets are so differflux, that cross-economy comparison ent from the those of the HPAEs,and in such mapid is problematic. We touch on China's recent development in chapters 1 and 3. Te eco nomic transiion in China is thesubject of current reseach by the Policy Research Deparment ofthe World Bank (see Bibliographic Note).
-- :
~~~~~~~~
1jRRL
CLE
Growth of CNPper Capita,1965-90 Figure1 Average

East Asia | _ ;
_____
HPAEs HPAES EastAsiawithout South Asbi Midae EastandMeditermean.. Africa Sub-Saharan OECD ec__ andCarlbbean Amedcm Latin 0 1 5 2 3 4 rate (percent) GNPpercapit growth 6 , ;
Skwre World Bank(1992d).
Singapore, and Taiwan, China-and rapid growth. And in part it refleas the belief of those involved with this study that the eight economies do share some economic characteristics that set them apart from most other developing economies. Since 1960, the HPAEs have grown more rhan twice as fist as the rest ofEast Asia, roughly three times as fast as Latin America and South Asia, and five times faster than Sub-Sahann Africa. They also significandy outperformed the industrial economies and the oil-rich Middle East-North Africa region. Between 1960 and 1985, real income per capita increased more than four times in Japan and the Four Tigers and more than doubled in the Southeast Asian NEs (see figure 2). If growth were randomly distmbuted, there is roughly one chance in ten thousand that successwould have been so regionally concentrated. at sharing the fiuits of The HPAEs have also been unusually successfiul growth. Figure 3 shows the relationship between the growth of gross domestic product (GPD)per capita between 1965 and 1990 and changes in the Gini coefficient, a statistical measure ofthe inequality ofincome distribution. The HPAEsenjoyed much higher per capicaincome growth at the same time that income distribution improved by as much or more than in other developing economic% with the exceptions of Korea and Taiwan, Chna, which began with highly equal income distributions. The HPAEs are the only economics that have high growth anddedining
2.
in GDP per Capita,1960-85 Figure2 Change

China Taiwan, Indonesia
Hong Kong
. -
Singapore Rep.of Korea Japan Matta Lescotho Egypt CYPMUS Gabon Greece Brazil Syria
Portga
:wA
Malaysia Yugoislavia
China Thailand
__ __ _ _ _ _ __ _ _ _ _ _
~
_ _ _
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _
Norway Itay
Spain
~-.-.-.--___
Israel
Jordan Germnany..
Mexico Pakistan Colombia UnitedStatbes

United Kingdom
Philippines
----.-. . .. -----
.Middle
20:
_
________,.-----.------------
Venezuiela Keniya
-.
Peau Argentina
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India Benin__
__ _ _ _ _ _ _ _ _ __ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
Senegal
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Uberla Sudan Somalia

Zaire_
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__ _ _
NIgerfia
Afghardstan
~-*
Midi
. ___ ._ ------_ _ ..
'~~~~~~~~Bottom20
CentralAfricanRepublic
Ghana Guyana
-
Madagascar
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Zambia Angola_ Mozamibique

Kuwalt
__ _ _ __ _ _ _ _
H A s--
I
_ _ _ _ _ _
-2.
3 2 1. changeIn GDP Percentage
45
Soarae:. Summers and Heston (1988).
-RACLLE
F.gum 3 Change in Inequityand the GDPperCapita GrowthRate

Change In avenage Glni coeffcient (1980s minus ISGOs)
0.2--------
---I
Ranking byGIni coefficient1980

* Most equal third ofsample
0Q15
------------
U Middle thibd A Least equal thlrd
0.05
--
~
;
--
A Chilet
Brazil A .Repof Korea
0Argentina
40.05
______________
Mexico !
______A_Colom
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.Taiwan.
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Thailand
* Venela . * Philippines
-J1-
Malaysia
Srigapore
Hong Indonesa Kong
APeru
-0.20 0.03. 0.02 0.03 0.04 0.05 0.06 0.07
GDP per capita growth rate (average, 165-90)
NYet:Figurc3plots the relationship bcetwenaveragc per capit incomcgroth and changes in the decadeavege ofthc Gini cocfficient fim rde 1960sto the 190s; a negativenumber indicates thar incomebecume lss concentraredL The decadeavcge is used because data areavailable for different years in diffacmr conornies the decade average fbr the 1960s begins with dat from 1965. Sowrer World Bankdam.
inequality. Moreover, the fastest growing East Asian economies, Japan and the Four Tilgers,axethe most equal. As a result of rapid, shared grovth, human welfare has improved dramatically. Life expecancy in the developing HPAES increased fiom 56 years in 1960 to 71 years in 1990. (In other low- and middle-income economies, life expectancy also rose considerably, fiom 36 and 49 to 62 and 66 years, respectively.)In the HPAEs, the proportion of people living in absolute poverty, lacking such basic necessities as dean water, food, and shelter, dropped-for example, from 58 percent in 1960 to 17 percent in 1990 in Indonesia, and from 37 percent to less than 5 percent 4
in Malaysiaduring the same period. Absolutepovertyalso declined in other developingeconomies,but much less steeply,fiom 54 to 43 percent in India and from 50 to 21 percent in Brazilfronm 1960 to 1990. A host of other socialand economic indicators, from education to appliance ownership,have also improvedrapidlyin the HPAEs and now are at levelsthat sometimessurpassthose in industrialeconomies. 'What causedEastAsia'ssuccess? In largemeasurethe HPAEs achieved high growth by getting the basics right. Privatedomesric investment and rapidly growing human capital were the principal engines of growth. High levelsof domeLic financial savingssustained the HPAEs' high investment levels.Agriculture, while declining in relativeimportance, experienced rapid growth and productivity improvement. Population growth rates declined more rapidly in the HPAEs than in other parns of the developing world. And some of these economies also got a head strt because they had a better-educated labor force and a more effecrive system of public administration. In this sense there is littdethat is Kxmiraculousr about the HPAEs' superior record of growth; it is largly due to superior accumulation of physical and human capital. Fundamentally sound development policy was a major ingredient in achieving rapid growth. Macroeconomic management was unusually good and macroeconomic perfornance unusually stable, providing The essential firnework for private investment. Policies to increase the integrity of the banking system, and to make it more accessible to nontraditional savers, raised the levels of financial savings. Education policies that focused on primary and secondary schools generated rapid increases in labor force skills. Agriculural policies stressed productivity and did not tax the rural economy excessively. All the HPAEs kept price distortions within reasonable bounds and were open to foreign ideas and technology. But these fimdamental policies do not tell the entire story. In most of these econoniies, in one form or another, the government intervenedsystematically and through multiple channels-to foster development, and in some cases the development of specific industries. Policy interventions took many forms: targeting and subsidizing credit to selected industries, keeping deposit rates low and maintaining ceilings on bor.rowing rates to increase profits and retained earnings, protecting domestic import substitutes, subsidizing declining industries, establishbig and financially supportng government banks, making public investrmentsin applied research, establishing firm- and industry-specific
r1A!N. -M IRACLE
export margets, developing export marketing institutions, and sharing in-
formation widely betweenpublic and private sectors. Some industries were promoted,while otherswere not. At leastsome of thescinterventionsviolate the dicturn of establishing for the privatescaor a levelplayingfield,a neutral incentives regime.Yet thesestrategiesof selectivepromotion were closelyassociatedwith high and, in the fastest-growing economies,high rates of private investmenc rates of productivitygrowth.Were some selectiveinterventions,in fict, good for growvh? In addressingthis question, we facea central methodologicalproblem. Since we chose the HPAAEs for their unusually rapid growth, we know already that their interventions did not significantly inhibit growth. But it is very difficult to establish statistical links between growth and a specificinr.w..tion and even more difficultto establish causalityrBecause we cannot know wrhat would have happened in the absence of a specificpolii); it is difficult to rest whether interventions increased growth rates. Other economies attempted similar interventions without success,and on averge they used them more pervasively than in the HPAEs.Because the HPAEsdiffered from less successfiil economiesboth in their doser adherenceto policy findamentals and in the manner in which they implementedinterventions,it is virtuallyimpossibleto measurethe relativeimpact of findarnentals and interventions on HPAE growth. Thus, in attempting to distinguish interventions
that contributed to growth from those that were either growth-neutral or harmfil to growth, we cannot offer a rigorous counterfactualscenano. Instead, we have had to be content with whar Keynescalled an &essay in persuasion,"based on analyticaland empiricaljudgments Our judgment is that in a few economies,m ly in Northeast Asia, in some instances, govenment interventions resulted in higher and more equal growth than otherwisewould have occurred. However,the prerequisitesfor successwere so rigorotusthat policynakers seekingto followsimilar paths in other developingeconomieshave often met with First, governmentsin Northeast failure.What were theseprerequisites? Asia developedinstitutionalmechanismswhich allowedthem to esab
lish dear performance criteria for selective interventions and to monitor performance- Intervention has taken place in an unusually disciplined
and performance-based manner (Ainsden 1989). Second, the costs of interventions, both explicit and implicit, did nor become excessive. When fiscalcosts threatenedthe macroeconomicstabilityof Koreaand
6
Malaysiaduring their heavy and chemical indusrries drives, governments pulled back In Japan the Ministryof Financeacted as a checkon the ability ofthe Minisrryof IntcrnationalTrade and Indusry to carry out subsidypolicies,and in Indonesia and Thailand balanced budget lawsand legislativeproceduresconstrained the scope for subsidies.Indeed, when selectiveinterventionshavc threatenedmacroeconomicstabilty, HPAE governmentshave consistentlycome down on the side of prudent macroeconomicmanagement.Pricedistortionsarisingfrom selective interventionswere also less extreme than in many developing economies. In the newly industrializingeconomies of Southeast Asia, govemment interventionsplayed a much less prominent and frequently less constructiverole in economic success,whileadherenceto policy findamentals remained importamt These economies'capacity to administer and implementspecificinterventionsmay have been lessthan in NortheastAsia.Their rapid growth, moreover,has occurred in a very different internationaleconomic environment from the one that Japan, Korea, and Taiwan,China, encountered during their most rapid growth.Thus the problem is not only to try to understandwhich specificpoliciesmay havecontributed to growth, but also to understand the institutionaland economiccircumstances that made them viable. Indeed, the experience of the Southeast Asian economies, whose initial conditions parallel thoseof many developingeconomiestoday,may prove to have more relevanceoutside the region than thar of Northeast Asia. The book isorganizedas follows: chapter 1 describesthe distinguishing characteristicsof the East Asian economic mirade, rapid growth with equity and uscs economic models to attempt to account for this growth. Chapter 2 reviewspolicyexplanationsfor East Asia's economic success and introducesthe frameworkthat wewill use throughout to explore dte relatonship berween public policy and economic growth. Chapter 3 discussespragmatism and flexibilityin the formuation of policiesthat led to two impormnt characteristics of the HPAEs'economic performance:macroeconomicstability and rapid growth of manufactured exports. Chapter 4 disLcusses the role of institutions. Chaprer 5 looks at the role of public poliqc in the HPAEs' unusually rapid accurnulationof physicaland human capital,whilechapter 6 analyzes the means usedto achieveefficientallocation of resources and productivitygrowth. Chapter 7, in condusion, assesses the successof EastAsian policesand their applicabiliy in a changingworld economy.The remainder of this 7
-' .--
IICACLE
overview parallels the organization of the book, highlighting the central arguments and conclusions.
TheEssence oftheMiracle: Rapid Growth with Equity
HE EIGHT HPAEs ARE HIGHLY DIVERSE IN NATURAL RE-
sources, population, culture, and economic poliqc What shared characteristics cause them to be grouped together and set apart from other developing economies?First 1 as we noted above, they had rapid, sustained growth between 1960 and 1990. This in itself is unusual among developing economies; orhers have grown quickly for periods but not for decades at such high rates. The HPAEsare unique in that they combine this rapid, sustained growth with highly equal income distributions. They also all have been characterized by rapid demographic transitions, strong and dynamic agricultural sectors, and unusually rapid export growth (see chapter 1). The HPAEs also differ fiom other developing economies in three factors that economists have -traditionally associated with economic growth. High rates of investment, exceeding 20 percent of GDP on average between 1960 and 1990, indcuding in particular unusually high rates ofprivate investment, combined with high and rising endowments of human capital due to universal primary and secondary education, tell a large part of the growth story. These factors account for roughly twothirds of the growth in dte HPAEs. The remainder is attributable to improved productivity. Such high levels of productivity growth are quite unusuaL In fact, productivity growth in the FHAEs exceeds that of most other developing and industrial economies. This superior productivity performance comes from the combinadon of unusual successat allocating capimt to high-yielding investments and at catching up technologically to the industrial economies.
Public Policies andGrowth

What was the role of public policy in helping the HPAEs to rapidly accumulate human and physical capital and to allocate those resources to high-yielding investments?Did policies assist in promoting rapid produc8
tivity growth? There are several explanations for EastAsiassuccess. Geography and culturewere dearly important; however,dthy do not entirely account for the high-performing economies'success,as the presenceof unsuccessful economies in the same regionattests.Among the varietyof policy explanations, two broadviewshave emerged(seedcapter2). Adherentsof the neoclassical viewstressthe HPAEs' success in gettingthe basicsright. They argue that the successful Asian economieshave been better than othersat providinga stablemacroeconomic environmentand a reliablelegalframework to promote domesticand internationalcompetition. They also stress that the orientation of the HPAEs toward international trade and the absenceof price controlsand other distortionary policieshave led to low relativeprice distortions.Investnents in people, education,and health arelegitimateroles for govenrnment in the neoclassicalframework, and its adherentsstressrhe importanceof human capital
in the HPAEs'success.
Adherents of the renisionist view have successfillyshown that Easr Asiadoes not whollyconform.to the neodassicalmodel. Industrialpolicy and interventions in financial markets are not easily reconciled fiamework.Somepoliciesin some economiesarc within the neoclassical much more in accordwith models of state-leddevelopment.Moreover, while the neoclassical model would explaingrowth with a standard set of relativelyconstantpolicies,the policy mixesusedby EastAsian economieswere diverseand flexible.Revisionists argue that East Asiangovernments "led the m.narke"e in critical ways. In contrast to the neoclassical viev, whichacknowledges relatively few casesof market&ilure, revisionistscontend that markersconsistendy fail to guide investment to industrieschatwould generatethe highestgrowthfor the overall economy.In East Asia, the revisionistsargue, governmentsremedied this by delibemtely"getting the prices wrong"-altering the incentive struccure-to boost industries that would not otherwise have thrived (Amsden1989). The revisionist schoolhas providedvaluableinsights into the history, role, and extent of East Asian interventions, demonstrating convincingly the scope of governmentactions to promote industrial development in Japan, Korea,Singapore,and Taiwan,China. But, in generalits proponentshave not claimedto establishthat interventions per se accelcrated growth. Moreover,aswe shallshow,some important govemment interventionsin EastAsia, such as Korea'spromotion of chemicalsand heavyindustries,havehad little apparentimpacton industrialstrucmrt.
9
-4iE$AS,kAN
MIRACLE
In other instances,such as Singapore's efflortto squeezeout labor-intensive industries by boosting wages,policieshave dearly backfired.Thus neither view fiully accounts for East Asia'sphenomenal growth.
The Market-Frendly View. In describing the policies associated with
rapid growth, WorldDevelopment Report1991 (World Bank 1991b) expands on the neodassical view, darifyringsystematicallyhow rapid growth in developingcountries has been associatedwith effcctivebut
carefully limited govcrnment activism. In the 'market-friendly" strategy it articulates, the appropriate role of government is to ensure adequate investments in people, provide a competitivc climate for private enterprise, keep the economy open to intemational trade, and maintain a stable macroeconomy. Beyond these roles, the report argues, governments are likely to do more harm than good, unless interventions arc marker fiendly. On the basis of an cxhaustivereview of the experience of developing economies during the last thirty years, it condudes that attempts to guide resource allocation with nonnarket mechanisms have generally failed to improve economic performance. The market-friendly approach captures important aspects of East Asia'ssuccess. These economies are stable macroeconomically, have high shares of international trade in GDP,invest heavily in people, and have strong competition among firms. But these haracteristics are the outcome of many different policy instnuments. And the instruments chosen, particularly in the nordteastern HPAES,Japan, Korea, and Taiwan, China, sometimes induded extensive government intervention in markets to guide private-sector resource allocation. The success of these northeastern economies, moreover, stands up well to the less interventionist paths taken by Hong Kong, Malaysia, and more recendy Indonesia and Thailand. AFunctional Appmach to UndemtaingGrwth. To explore these varying paths to economic success, we have developed a framework that seeks to link rapid growth to the attainment of three functions. In this view, each of the HPAEs rnaintained macroeconomic stability and accomplished three fiunctions of growth: accumulation, efficient allocation, and rapid technological catch-up. They did this with combinations of policies, ranging from market oriented to state led, that varied both across economies and over time. We classifjrpolicies into two broad groups: fundamentals and selective interventions. Among the most important fimdamental policies are those that encourage macroeconomic stability, high investments in
I0
human capital, stableand securefinancial systems, limitedpricedisrordons, and opennessto foreigntechnology Selective interventions indude mildfinancial repression (keeping interestraces positive but low), directedcredit,selective industrialpromotion,and trade policiesthat push nontraditional exports. We try to understandhow government policies,borh fundamental and interventionist. may havecontributed to fasteraccumulation, moreefficient allocation, and higherprnducrivity growth. We maintainas a guidingprinciplecharfor interventions that attemptto guideresource allocation to succeed, theymust address filures in the workingof markets.Otherwise,marketswould perform the allocation functionmore efficiently. We idenrifya dass of economic problems, coordinationfailures,whichcan lead markersto fail,especially in earlystagesof development. Wethen interpretsomeof the interventionist policiesin East Asiaas responses to these coordination problems-responses that emphasized cooperative behavior amongpnvatefirmsand clearperformance-based standards of success. Competitivediscipline is crucial to efficientinvestment.Most economies employ onlymarket-based competition. Wearguethat some HPABs havegone a step furtherby creating conteststhat combinecompetitionwiththe benefits of cooperation amongfirmsandberween governmentand the privatesector.Suchcontestsrangefromvery simple nonmarketallocationrules,such as accessto rationed credit for exporters, to very complex coordination of private investment in the
government-business deliberation councils ofJapanand Korea.The key featureof each contest, however, is that the government distributes rewards-often accessto caedit or foreignexchange-on the basisof performance, whichthe government and competing firmsmonitor.To succeed, selective interventions must be disciplined by competition via eithermarkets or contests. Economiccontests, like all others,requirecompetentand impartial referees-that is, strong institutions.Thus, a high-quality civilservice that hasthe capacity to monitorperformance and is insulatedfrompolitical interference is essential to contest-based competition. Of course, a high-quality civilservice alsoaugments a government's abilityto design and implement non-contest-based policies. Our framework is an effortto order and interpretinlformation. We are not suggestngthat HPAE governments set out to achievethe functionsof growth.Rather,theyusedmultiple,shiftingpolicyinstruments
II
RAC
MIRACLE LAN
in pursuit of more straiglhtforward economic objectivessuch as macroeconomic stability,rapid export growth, and high savings. Pragmatic flexibility in the pursuir ofsuch objectives-the capacityand willingness to changepolicies-is as much a hallmarkof the HPAEs asany singlepolicy instrument. This is well illustrated by the great variety of ways in which the HPAEs achieved tvJ important objectives:macroeconomic stabilityand rapid export growth (secchapter 3). Achieving Macroeconomic Stabilty andExport Growth More than most developingeconomies,the HPAES were characterized by responsiblemacroeconomicmanagement.In parricular,they generally limited fiscal defcits to levels that could be prudently financed without increasinginflationarypressuresand responded quicklywhen fiscal pressureswere perceivedto building up. During the past thirty years, annual inflation averaged approximately 9 percent in dtese economies,comparedwith 18 percentin other low-and middle-income economies.Becauseinflation was both moderate and prediaable, real interest rateswerefar more stable than in other low-and middle-income
economies. Macroeconomic stability encouraged long-term planning
and privateinvestmentand, through its impacton real interest ratesai, 4 the realvalueof financialassets,helpedto increasefinancialsavings.The HPAEs also adjusted their macroeconomicpolicies to terms of trade shocksmore quicklyand effectively than other low-and middle-income economies.As a result, they haveenjoyedmorerobustrecoveries of private investment. Many of the policiesthat fosteredmacroeconomic stabilityalso contributed to rapid export growth. Fiscaldisciplineand high public savings allowedJapan and Taiwan,China, to undertake extended periods of exchangerate protection. Adjustments to exchangerates in other HPAEs-validatedbv policies that reduced expenditures-kept them competitive,despite differentialinflationwith tradingpartners. In addition to macroeconomicpolicies,the HPAEs used a variety of approachesto promoting exports.All (exceptHong Kong)beganwith a
period of import substitution, and a strong bias against exporEs. But
each moved to establisha pro-export regime more quicldy than other developingeconomies.First Japan, in te 1950s and early 1960s, and then the Four ligers, in the late 1960s,shified trade policiesto encourage manufacturedexports.In Japan,Korea,and Taiwan,China, govern12
ments establisheda pro-exportincentivestructure that coexistedwith moderate but highlyvariableprotectionof the domesticmarker.A wide varietyof instrumentswas used, includingexportcredit, duty-freeimports for exportersand theirsuppliers,exporttargets,and tax incentives. In the Sioutheast Asian NIEsthe export push came later, in the early -1980s,and the instrumentswere different.Reductions in import protection were more generalized and were accompaniedby export credit and supportinginstitutions.In theseeconomiesexportdevelopment has relied less on highly selectiveinterventionsand more on broadlybased market incentivesand direct foreigninvestment.
Building theInstutional Basis forGrowth

Some economistsand politicalscientistshave argued chat the East Asian miracleis due to the hiighqualityand authoritariannature of the regionsinstitutions.They describeEastAsianpoliticalregimes as "developmental statee'in which powerfultechnocraticbureaucracies, shielded from politicalpressure,deviseand implementwell-honedinterventions. We believe developmentalstare modelsoverlook the central role of government-private sectorcooperation. Whle leadersof the HPAEs have tended to be either authoritarian or paternalisdtithey have also been willingto grant a voiceand genuineauthorityto a technocraticeliteand key leadersof the privatesector. Unlike authoriruian leadersin many other economies,leadersin the HPAEs realizedthat econornicdevelopment wasimpossible withoutcooperation(seechapter4). The Principle ofShardGrowth. To establishtheir legitimacy and win the supportof the sociey at large,East Asian leadersestablished the principle of shared growth, promising that as the economy expanded all groupswould benefit.But sharinggrowth raisedcomplexcoordination problems.First, leadershad to convinceeconomic elitesto supportprogrowth policies.Then they had to persuadethe elitesto sharethe benefits of growth with the middle class and the poor. Finally,to win the cooperation of the middle classand the poor, the leadershad to show them that they would indeed benefit from future growth. Explicit mechanismswere used to demonstrate the intent that all would have a shareof future wealth. Koreaand Taiwan,China, carried out comprehensive land reform programs;Indonesia usedrice and ferfilizerpricepoliciesto raiseruralincomes;Malaysiaintroducedexplict wealth-sharingprogramsto improvethe lot of edtic Malaysrelativeto '3
- IRfLMIRACLE
the better-off ethnic Chinesc; Hong Kong and Singaporeundertook massivepublic housing programs;and in severaleconomies,governments assistedworkers' cooperativesand establishedprograms to encouragesmall and medium-sizeenterprises.Whatever the form, these programs demonstrated that the goverment intended for all to sharc the benefitsof growth. Cualmg a Business-Fiendly Environment To cacide coordination problems, leadersneeded institutions and mechanismsto reassurecompeting groups that each would benefit from growrth.The first step was to recruit a competent and relativclyhonest technocratic cadre and insulate it from day-ro-daypoliticalinterference.The power of thesetechnocracieshas varied greatly.In Japan, Korea, Singapore, and Taiwan, China, strong, well-organizedbureaucracieswield substantial power. Other HPAEShave had small,general-purpose planning agencies.But in each economy,economic technocratshelped leaders devise a credible economicstrategy. Leaders in the HPAs also built a business-friendlyenvironment.A major element of that enviromnenrwas a legal and regulatorystrucmre that was generaly hospitable to private investment. Beyond this the HPAiEs have with varying degreesof successenhanced communication between businessand government.Japan, Korea,Malaysia,and Singapore have establishedforums, which we call deliberation councils, in whichprivatesectorgroups are invited to help shape and implemnent the governmentpoliciesrelevantto theirinterests.In contrast to lobbying, -whererules are murky and groups seek secret advantageover one anodter, the deliberation councils are intended to make allocation rules dear to all participants. Using Deliberation Council.In Japan and Koreatechnocratsused deliberation councilsto establishcontestsamong firms. Becausethe prvate sector participated in drafting the rules, and because the processwas transparentto all paricipants, privatesector groups becamemore willing participantsin the leadership?s developmentefforts.One by-product of these contestswas a tendencyto reducethe privateresourcesdevoted to wastefulrent-seekingactivities,thus making more availablefor productiveendeavors.Deliberationcouncilsalso&cilitatedinformationexchangesbetwren the private sector and govecnment,among firms, and between management and labor. The councils thus supplemented the market'sinforrnation transmissionfunction, enabling the IPAEs to respond more quickly than other economiesto changing markets.
'14
havenot bem stacommunication Institutionsofbusiness-government ouncil is changing in Japan tic in theHPAJ.The roleof the deliberation
role,alongfincto a moreindicatve and consensus-building and Korea thecouncils appear asopposed to industry-speific lines. InMalaysia tional mechaIn Thailand the formal in importance andscope. to beincreasing becnusedto presentbusinesses' havegenerally nismsof communication ofgovtheprivate sector's suspicion togovermentand to reduce positions poliymakingEast development, asineconomic ermnent. In institutional governments havechanged withchanging circumstances. Asian
and PhysicalCapital AccumulaingHuman
EastAsianeconomies Drawing on the strengthof theirinstitutions, and interventionist policiesto used a combination of fundamental Fundaof human and physical resources. achieverapidaccumulation as providing government obligations mentalsincluded suchtraditional adequate infrastructure, education, and secure financial institutions. Interventionsinduded mild repressionof interest rates, state capitalism,
ofrisk(seechapter5). mechanisms, and socialization mandatory savings

had a head start in Bilding Human Capiti. The East Asian economies
theirleadoverotherdetermsofhumancapitalandhavesincewidened already In the 1960s,levels ofhumancapitalwere veloping economies. economies. than in otherlow-and middle-income higherin the HPAEs spending on the builton this baseby focusing education Governments lower grades; firstbyproviding universal primary education, laterbyineducations Rapid demographic the availability of secondary creasing these effortsby slowingthe growth in the number transitionsfacilirated of school-age childrenand in some casescausingan absolutedecline. Dediningferdlityand rapideconomic growthmeant that, evenwhen
education investment as a share of GDP remained constant, more re-
sourceswere avilable per child. Limited public fimding of postsecondaryeducation focused on technical skills, and some HPAEs in vocationparticularly on a largescale, services importededucational ally and technologically sophisticated discplines. The result of these well1hasbeena broad,technically inclined humancapitalbve policies development. stited to rapideconomic income alsocontributedto moreequitable .IHPAE educationpolicies distributions. To be sure, initialconditions helpedto set up a virtuous ledto educational in incomeand education circle: initiallowinequality
I5
.:~~~~~~~~~~~~~~;n
11 :t4iSjA-N
MIRACLE
expansion, which reinforced low inequality. In addition, by focusing spending on primary and secondary education, and leaving demand for tertiary education to be largely met by' a self-financed private system, governments served large segments of the population that otherwise would have lacked accessto education. The HPAEsincreased savings and inbcreasing Savniug andImnestneuL
vestment with a combination of findamental and interventionist policies. Two fundamenral policy areas provided a foundation for high and rising savings rates. First, by avoiding inflation, the HPAEs avoided volatility of real interest rates on deposits and ensured that rares were largely positive. As a result, the HPAEshave generally offired higher real interest rates on deposits in the financial system than other developing economies. Second, they ensured the security of banks and made them more cotnvenient to small and rural savers. The major instruments used to build a secure, bank-based financial system wverestrong prudential regulation and supervision, limits on competition, and institutional reforms In Japan, Korea, Malaysia, Singapore, and Taiwan, China, postal savings systems lowered transaction costs and increased the safey of saving while making substantial resources available to government. These initiatves promoted rapid growth of deposits in financial instiutions
Figu 4 Savings Ratesof HPAEs

anda Selected Eiconomies, 19704
HPAEs
(seefigure4)
(se fiur
Some governments also used a variety of more interventionist mecha-
4)
- -
nisms to increase savings. Singapore and Taiwan, China, maintained unusually high public savings rates. Malaysia and Singapore compeled high private savings rates dtrough mandatory provident fund contributions. Othor _ 'Japan, Korea and Taiwan, China, all imposed stringent contrls and high interest rates on loans for consumer items, and levied stiff taxes on socalled luxury consumption. Whether these more interventionist measures to increase savings improved welfare is open to debat On one hand, making consumers save when they would not have otherwise imposes a welfare c -r. On the other, the benefits are apparent in the rapid growth of these ecovomies. Savings, forced or not, generaed high payoffs based on
2.0 20 30 'Percenta,ge ar GDP
40
Dcrnmark, Finland, Fmncc, theE:ederol Republic of Gcmanybebore reunificaion, Greece, Iceland, Iredand.Imly, LuxemNorny, Portugal. bour, dte Netherlands, Spain, Sweden, Switxrland, and the UnitedKingdom. 'Orie indudes these &-veoping cconomies: Argenona Brazil,T developin eColombia. Carenina SEl,
Chile,Cdlombia,COre divoire, Egyp4,
Nenar.Finlind,uds Austria Bthee um.
consistendy high rates of return to investments. In conwnt to other

economies that have used compulsory savings, such as the fonrer Soviet
and Zaire
Ghana, India, Mexico, Morocco, NiScria, Pakistan, Pem,SriLnka, Turkey, Urugua. the upEra Urgan y Ycnzuels Venezuela. the fone YugosIiaI SawreuSummer andHeson (199l).
Union, welfare costs were dearly offset by substantive benefits. The HPAEs encouraged investment by several mans. First, they did a better job than most developing econom>es at creating -infastructure that was complementary to private investment. Seco.d, they created an
investment-friendly environment through a combination of tax policies
I6
ivoring investmentand of policiesthat kept the reative pricesof capion importedcapitalgoods. mal goodslow,largelyby avoidinghigh tariffs policieshad an important impact on pnvate investThese fiundamental most HPAEgovernrents held dement. Third and more controversial, posit and lending rates belowmarketdearing levels-a practicetermed financialrepression. Japan, Korea,Malaysia, Thailand, and Taiwan,China, had extended To be sure, increasinginterestrates periodsof mild financialrepression. from negativeto zero or mildlypositivereal rates and avoidingfluctuafinancialsavings.But tions (by avoiding unstable inflation)encourages to marginal changesin positive becausesavingsare nor very responsive were able to mildlyrepressinterest real interestrates, HPAEgovernments rateson depositswith a minimalimpact on savingsand to passthe lower saversweremostlyhouseholdsand borrates to finalborrowers Because rowers were mostly firms, this resulted in a transfer of income from were householdsto firns and in a changein the form in which savings held, from debt to corporateequity. Holding down interest rares on loans increasesexcessdemand for credit, which in turn leadsto rationingof credit by the governmentitselfor by privatesector banksworkingwith goverrunentguidance.This Thus there is a tradeheightensthe risk that capitalwillbe misallocated. off betweenthe possibleincreasein investmentand the risk that the increasedcapitalwill be badly invested.There is some evidencethat in Japan, Korea,and Taiwan,China, govemmentsallocatedcredit to activto exporcs. If this was the case, ities with high social returns, especially there may have been benefiEsfrom mild financial repression and government-ided allocation; mirroeconomic evidence from Japan investment to governmentcredit increased supports the view thar access (seechapter 6). Generally, financial repression is associated with low economic when realinterestratesare stronglynegative.But test growth, especially of the relationshipbetweeninterest rates and growth in Japan, Korea, and Taiwan,China, do not show the negativerelationshipbetweenincomparativ found in cross-economy terest rate repressionand growEh studies (seechapter 5). Whilewe cannotestablishcondusivelythat mild repression of interest rates at positive real levelsenhanced growth in northeastAsia, it appaently did not inhibit it. in the northeastemAsian tier, Finally,some governments,especially risksto the haveencouragedinvestmentby spreadingprivateinvestmcent
'7
s;~
A? m vLRC y ~~~~~~~~V. ZiN [.IA RC LE

-o
public In some economiesthe govern-ment ownedor controlledthe intitutions providinginvestmentfunds,in others it offeredexplict credit guarantees,and in sdll others it implictly guaranteedthe financal viability of promoted projects. Relationshipbankingby a variety of public and privatebanking institutionsin Hong Kong,Japan, Korea,Malaysia, Singapore, Thailand, and Taiwan,China, involvedthe bankingsectorin the managementof troubled enterprises, increasingthe likelihood of creditor workouts.DirectEd-credit programsin Japan, Korea, and Taiwan, China, signalcddirectionsof governmentpolicyand providedimnplicit insuranceto private banks. EffcientAllocation and Pmductity Change Somepoliciesthar favoredaccumulationin the HPA,s,induding financial repression and the socializationand bounding of risk, could haVeadversely afFected the allocationof resources. Similarly,industrial targetingcould have resulted in extensive rent-seekingand great ineffidency.Apparentlyrheydid not The allocadional rulesfolowed by H4PAE govemments-particularly the devices usedto shift mareke incentives-are therefore among the mostcontroversial aspectsof the Eat Asiansuccessstory (seechaprer 6). Like policies related ro accumulation, policies affecting allocation and productiviy change fall into findamental and interventionistcategories.Labor marker policies tended to rely on fundamentals, using the market and reinforcing irs fiexibility.In capital markets, governmentsintervened systematically, both to control interest rates and to direct credit, but acted within a frameworkof carefulmonitoring and generallylow subsidiesto borrowers.Trade policieshave indcuded substandalprotection of local manufacurs, but less than in most other developing countries; in addition, HPAEgovernmentsoffiet some disadvantagesof protection by activelysupporting exports. Finally,while interventions to support specificindustrieshave generallynot been successfil, the export-push straregyE-themix of fundamental and interventionist policies used to encourage rapid manufacured cxport growth-has resulted in numerous benefirs,including more efficient allocation,increasedacquisitionof foreignrechnology, and more rapid productivitygrowth. Feible Labor Markets. Govenment roles in labor narketsin the successul Asian economies contrast sharply with the situation in most I8
havegenerallybeen less HPAEgovernments other developingeconomies. governthan other developing-economy vulnerableand lessresponsive ments to organized labor's demands to legislate a minimum wage. Rather, they have focused their efforts on job generationseffectively boosting the demand for workers.As a result, employmentlevelshave rnsenfirst, followed by market- and productivity-drivenincreasesin wage levels. Becausewages or at least wage rate increaseshave been in responseto changesin diedemand for labor,addownwardly flexible shockshas generallybeen quicker and less justmenr to macrocconomic painfiul in East Asia than in other developing regions.Rapid adjustments helped to sustain growth, which in turn made more rapid real wage growthpossible. IHighproductiviryand income growth in agriculturehelpedto keep EastAsian urban wagescloseto the supplyprice of labor.In contrast to many other developingeconomies,wherethe gap betweenurban and rural incomeshas been largeand growing,in the HPAEs the incomesof with similarskilllevelshaverisen roughlyat the urban and rural workers the overallgap betweenurban and rural incomes same pace; moreover, is smallerin the HPAEsthan in other developingeconomies. In Sub-SaharanAfrica,Latin America,and South Asia,wherewages minimum in the urban formalsector are often pushed up by legislated wages and other nonmarket forces,urban wage earnersoften have inin informalsectors.In contrast, the gap comestwice their counterparm' between the formal and informalsectors in EastAsia is only about 20 percent. Smallerincome gapscontribute to overallsocialstability,thus enhancing the environmentfor growth. Caprtal Markets andfllocatio. Most HPAEs influencedcredit allocation in threeways:(i) by enforcingregulations to improveprivatebanks'prolong-term ject selection;(ii) by crearingfinancialinstitutions,especially credit (development)banks, and (Li) by directingcredit to specificsectors and firms through public and privatebanks. All three approaches Yeteach can be justifiedin theory,and each has worked in some IIPAES. more governmentinterventionin credit markets involvesprogressively and so carriesa higher risk. Goverrunent relationships with banks in the HPAEs have varied widely.In Hong Kong banks are privateand regulatedprimarilyto ensure their solvency.In Indonesia, Malaysia,Singapore,and-Thailand, banks areprvately ownedand exercise independentauthorityoverlendbig. While governments have broadlyguided credit allocationsthrough
I9
isACLWMIRACLE
regulations and moral suasion, project selection is generaUlyleft to bankers. In other HPAEs, banks have been subject to direct state control or stringent credit allocation guidelines. For example, Indonesia, Korea,
and Taiwan,China, tightlycontrolledthe allocationof creditby public commerial banks. Each of the HPAEsmade someattempts to direct credit to priorityactivities. All East Asian economies except Hong Kong give automatic access to credit for exporter. Housing was a priority in Singapore and
Hong Kong, while agriculurc and small and medium-sizeenterprises were trgeted sectors in Indonesia, Malaysia,and Thailand. Taiwan, China, has recently targeted technological development. Japan and organizingcontests Korea have used credit as a tool of industrial polic34 councilsto promote at various timesthe shipbuildthrough deliberative ing, chemical,and automobileinduscries. was The implicit subsidy of direcred-creditprograms in the HPAEs generally small, especiallyin comparison to other developingeconsupport to ifomies, but accessto credit and the signalof goverunment vored sectorsor enterpriseswereimportanL In Korea,the subsidyfrom preferentialcredit waslargeduring the 1970s,resultingin a largegap between bank and curb market interest rates. This gap has dedined sharplyin recentyea, as Koreahas shifted awayfiom heavycreditsubsubsidiesweresmall, and the sidiesto selectedsectors.In Japan imnplicit important as a signalingand indirection of credit may have been more surancemechanism than asan incentve. directed-credit programsweredigned to achieve AlthoughEastAsias induded strict performancecriteria. policy objectives,they nevertheless In Japan, public bank managerschoseprojectson basiceconomiccriteria, employing rigorous credit evaluations to select among applicants that fell within governmentsectoraltrgets. In Korea, the govemment individuallymonitored the large conglomeratesusing market-oriented criteriasuch as exportsand profirabiliy.In some cases,majorenterprises that filed to meet these testsweredriven into bankruptcy.Recenrassessments of the directed-creditprograms in Japan and Korea provide programsin these economicroeconomicevidencethat directed-credit
mies increased invesnnent, promoted new actvities and borrowers, and were directed at firms with high potential for technological spillovers.
Thus these performance-baseddirected-creditmechanismsappear to have improved credicallocation, especiallyduring the early stages of rapid growth (seechapter 6).
z0
Directed-credit progras in other HPAES haveusually lacked strong,perfbrnance-based alloation and monitoringand thereforehavebeen largely unsuccessful. Evenin the norther-tier economies, the increasing levelof financial sectordevelopment and theirincreasing opennessto international capiml flows havemeant that directed-credit pograms havedeclinedin irmhaveliberalized theirfinancialsectors. portance,as the economnies Openness to Foreig Technology. The HPAEshave activelysought foreign technologythrough a varietyof mchaisms. Allwelcomed technology transfersin the forn of licenses,capital goods imports, and foreign training. Openness to directforeigninvestment(DRi) has speededtechnologyacquisition in Hong Kong, Malaysia,Singapore,and, more recently,Indonesia and Thailand. Japan, Korea and, to a lesser extent, Taiwan,China, restrictedDFI but offierthis disadvantge by aggressively acquiringforeign knowledgethrough licenses and other means. In contrast, odter low- and middle-incomeeconomiessuch as India and Argentinahaveadopted policiesthat hindered the acquisitionofforeign knowledge.Often they have been preoccupiedwith supposedlyexcessive pricesfor licenss They have refised to provideforeign exchange for trips to acquire knowledge,been restictive of DFI, and have atsectors,thus tempted prematurelyto build up their machine-producing forgoingthe advancedtechnologyembodiedin imported equipment. Prmofing Specific lidusies. Most East Asian governmentshave pursued sector-specific industrial policiesto some degrce.The best-known instancesincludeJapan'sheavyindustrypromotion policiesof the 1950s and the subsequentimitation of thesepoliciesin Korea.These policies induded import prorectionas well as subsidies for capitaland other imported input& Malaysia,Singapore,Taiwan, China, and even Hong Kong have also establishedprograms-typically with more moderate incentives-to acceleratedevelopmentof advancedindustries. Despite these acions we find very litde evidencethat industial polices haveaffected either the secroralstructure of industry or rates of productivity change. Indeed, industrial structures in Japan, Korea, and Taiwan, China,have evolved during the past thirtyyearsaswe would expect ven factor-based comparativeadvantageand changingfactor endowments. It is not altogethersurprisingthat industial policy in Japan, Korea, and Taiwan, China, produced mainly market-conforming results. Wile these govemmentsslectively promoted capital-and knowledgeintensiveindustries,they also took stepsto ensurethat they were fostering profitable, intermationally competitive firms. Moreover, their
21
rRAA CVLIACLE
industrial policies incorporateda large amount of marker information and used performance,usually export performanc, as a yardstick. Efforts elsewhereto promote specific industries without better informadion exchange and the discipline of intemational markets have not succeeded.This has been the case with the ambitious industrial policy programsin Braziland India, and with the morelimited but alsodisappointing effortsto build an aerospaceindustry in Indonesiaand to promote heavyinduswtries in Malaysia. Export Push: AWinning Mix ofFundamentals andInterentions One combination of fundamental and interventionist policies practiced in the HPAEs has been a significant source of rapid productiviy growth: the active promotion of manufactured exports. Although all HPAEs cxcept Hong Kong passed through an import-substitution phase, with high and variableprotecrion of domestic import substitutes, these periods ended earlierthan in other economies,typically becauseof a compelling need for foreign exchange.In contrast to many other economies,which tried to preserve foreign exchangewith sticter import controls, the HPAEs set out to earn additional foreign exchange by increasing exports.
Hong Kong and Singapore adopted trade regimes that were dose to free trade; Japan, Korea, and Taiwan, China, adopted mixed regimes that were largey free for export industries. In the 1980s, Indonesia, Malaysia, and Thailand have adopted a wide variety of export incentives while gradually reducing protection. Exchange rate policies were liberalized, and currencies frequently devalued, to support export growth. Overall, these policies exposed much of the industrial sector to international competition and resulted in domestic relative prices chat were doser to international prices than in most other developing economies. The northem-tier economies-Japan, Korea, and Taiwan, Chinahalted the process of import liberalization, often for extended periods, and heavily promoted exports. Thus while incentives were largely equal between exports and imports, this was the result of countervailing subsiclies rather than trade neutrality the promotion of exports coexisted with protecion of the domestic market. In the Southeast Asian HPAEs, conversely, govermments used gradual but continuous liberaization of the trade regime, supplemented by institutional support for exporters, to achieve the export push. In both cases governments were credibly committed to the export-push strategy; producers, even those in the proteced domestic market, knew that sooner or later their time to cxport would come.
22
East Asia'ssectoral policies were usually geared toward export performance, in contrast to the inward-oriented policies of less successful developing economies. Japan, Korea, Singapore, and Taiwan, China, all criteria, usuallyexports, to judge success. relied on economic performrance For example, in Taiwan, China, the government suspended domesticcontent requirements that interfered with the exports of foreign investors. In addition, sectoral policies were closely monitored and frequently adjusted. Thus, many of East Asia's "industrial upgrading' programs of the lare 1970s and early 1980s were substantially modified or abandoned when they failed to produce satisfactory results. Using the export rule meant that even programs of selective industrial promotion were indirectly export promoting. Manufacmred export growth also provided a powerfil mechanism for technological upgrading in imperfect world technology markets. Because firms that export have greater access to best-practce technology, there are both benefits to the enterprise and spilloversto the rest of the economy that are not reflectedin market transactions. These informationreated extemalities are an imporrant source of rapid productiviy growth. Both cross-economy evidence and more detailed studies at the industry level in Japan, Korea, and Taiwan, China, confirm the significance of exports to rapid productivity growth. These experiencessuggest that economies that are making the transition from highly protectionist import-substitution regimes to more balanced incentives would benefit from combining import liberalization with a strong commitment to exports and active export promotion, especially in those cases in which the pace of liberalization is moderate.
Policiesfor Rapid Growth in a Changing World Economy

5 IT>71AT
'sKI/Their rapidgrowthhad two complementry elements. Firz,

vv
ARETHE BROADLESSONSOF SUCCESSIN THE HPAEs?
getting the fundamentalsright was essential. Without Jhgh
levels of domestic savings, broadly based human capital, good macroeconomic management, and limited price distortions, there would have been no basis for growth and no means by which the gains of rapid productvty change could have been realized. Policies to assist the financial 2-3
XIAIEMI -
RAC LE
sector capture nonfinancial savings and to increase household and corporate savings were cental. Acquisition of technology through openness to direct fbreign investment and licensing were crucial to rapid productivity growth. Public investment complemented private investment and increased its orientation to exporcs. Education policies stressed universal primary schooling and improvements in quality at primary and secondary levels. Second, very rapid growth of the type experienced by Japan, the Four Tigers, and more recently the East Asian NIEs has at times benefited from careful policy interventions. All interventions carry costs, either in the direct fiscal costs of subsidies or forgone revenues, or the implicit taxation of households and firms, for example, through tariffs or interest rate controls. Unlike many other governments that attempted such interventions, HPAE governments generally held costs within welldefined limits. Thus, price distortions were mild, interest rare controls used international interest rates as a benchmark, and cxplicitsubsidies were kept within fiscally manageable bounds. Given the overriding importance ascribed to macroeconomic stability, interventions that becamne too cosdy or otherwise threatened stability were quickly modified or abandoned. Whether theseinterventions contributed to the rapid growth made possible by good fundamnentals or detracted from it is the mosc difficult question we have attempted to answer.It is much easier to show that tie HPAEs limited the costs and durtion of inappropriately chosen interventionsitself an impressive achievement-than to demonstrate condusively that those interventions maintained for a long time accelerated growth. Our assessment of three major uses of intervention is that promotion of specific industries generally did not work and therefore holds litde promise for other developing economies. Mild financial repression combined with directed credit has worked in certain situations but carries high risk. Export-push strategies have been by far the most successfil combination of fundamentals and policy interventions and hold the most promise for other developing economies (chapter 7). But are these approaches feasible in the early 1990s? While limited repression of interest rates may have contributed to ovemll higher rates of investment in Japan, Korea, and Taiwan, China, these three northeastern economies undertook their initial growth spurts-and their most sustained and forceful repression of interest rates-during a period when it was possible for a developing economy to dose its financial mar24
Icetsto the outside world. Furthermore,strong bureaucracies and a genemlclimate of government-privatesectorcooperation meant that their restrictionson capitaloutflowswere more effectivethan similarrestrictions in many other economies.In today'sincreasingly global economic environment,fewgovernmentshavethe abilityor desireto closetheir financial markets. Indeed, many East Asian governments are in the -proes of liberalizing restrictions on capital flows. In such circumstances,the scope for repressinginterest rateswithout provoling capital flight is sharply narrowed.However,in some exceptional instances,very mild financial repressionof short duration to increasecorporate equity remainsa viableoptiOII. This has been the case in Malaysia,which has wide open financial markets but nonethelesssucceededwith very mild financialrepressionfor more than a year. The export-push strategy appears to hold great promise for other developingeconomies.But the conditions of market accessunder the General Agreement on Tariffs and Trade (GArr), and odlier trading arrangements, will hamper developingeconomies'use of policiesviewed as unFairin major industrial-economymarkets.Subsidiesto exports and directed-creditprograms linked to exports are not generallyconsistent with the GATrand may therefore invite retaliation from trading partners. Furthermore, like financialrepression,thesehighly directed interventions require a high level of insttutional capacity now lacking in most developing economies.Fortunately,many powerfulinstrumentsof export promotion are nor only within the institutionalcapacityof many developingeconomiesbut remain viable in today's economic environment. Creatinga free trade environmentfor exporters,providingfinance and support servicesfor small and medium-sizeexporters, improving trade-relatedaspects of the civil service,aggressively courting exportoriented direct foreigninvestmnent, and focusinginfrastructureon areas that encourageexports are allattainablegoalsthat are unlikelyto provoke oppositionfrom tradingpartners. Indeed,some or all of thesehave been part of the export push in Indonesia, Malaysia,and Thailand. These three economies,the most recent participants in the "economic mirade,' may show the way for the next generationof developingeconomiesto followexport-pushstrategies.
The phenomenal successof the HPAEs is already inspiringattemptsat imitation.We haveshown that the HPAEs used an immense variety of
25
'
_Ni1A CCLE
policies to achievethreecritical functions of growth: accumulation,allocation, and productivity ,rowrh. The sheer divenrsiy of these policies precludesdrawingany simplelcssonsor makingany simplerecommendations, exccptperhapsthat pragmaticadherenceto the fundamentalsis central to success.These market-orientedaspects of East Asia'sexperience can be recommendedw;ithfew reservations.More institutionally demandingstrategieshave often filed in other settingsand they clearly are not compatiblewith economic environmentswlherethe fuindamentals are not securelyin place.The use of contestsin Japan and Korearequired competenrand insularedcivil servants.In parts of Sub-Saharan Africa and Latin .Amnerica, and elsewherein Asia where such institutional conditions are lacking, activistgovernment involvementin the economyhas usuallygone awry.So the fact that interventionswere an element of some East Asian economies'successdoes not mean that they should be attempted everywhere, nor should it be taken as an excuseto postpone neededmarket-orientedrefonn. The successof the HPAEsbroadensour understandingof the range of policies that are consistent with rapid development. It also teaches us that willingnessto experiment and to adapt policies to changing circumstancesisa key element in economicsuccess.In the followingchapters we explore more fully the contribution of fundamental and interventionistpoliciesto East Asiis remark-able growth, and the crucial role that institutionshave playedin their evolutionand application.As we shall see,maaking a miracle is no simplematter
Note
1.Japan, which has been firmlyin the ranks of indushave been used subsequentlyby devdoping economies.
trialeconomics arguably forallofthiscentury, mayat first seemto be an inappropriate subjectfor study.However manyof the policy instruments usedby theJapanese govemmnent during the period of rapid growth, 1950-73,
Thus, notwithsranting Japan'slongerhistoryof modem economicgrowrh,it may providesome usefulinsights into the relationship between publicpolicyandgrowth.
26
Growth, Equity, and Economic Change

ml .HE EIGHT ECONOMIES OF OUR STUDY ARE HIGHLY
diversein natural resources,culmre, and political institutions. Japan, unlikethe others, wasalready a relatively mature industrial economy at chebeginning of the postvar period. Moreover,the eight differ in the degree of government intervention in the economy and the manner in which their leaders have shaped and implemented poticies.Korean policymakers, for example,have intervenedheavilyin industrial,labor, and credit markets,whilepolicymalers in Hong Kong have been consistentlyhands-off. however,the eight economieshave much Despite many differences, in common. In a number of ways, their postwar experience distinguishesthem as a group. Their most obvious common characteristicis their high averagerate of economic growth. During the same period, incomeinequality has declined, sometimes dramatically.These two outcomes-rapid growth and reduced inequality-are the defining characteristicsof what has come to be known as rhe Easr Asian economic miracle. The eight economies share six other characteristicschat set them apart. Compared with most other developingeconomies,all have had: * Morerapidoutputandproductivity growthinagriculture - Higher rates of growthof manufactured exports * Earlier and steeperdedines in ferility * Higher growth rates of physicalcapital,supported by higher rates of domesticsavings
a* IHigher initial levels and growth rates of human capital
* Generallyhigher rates of productvity growth.

2-7
LkkYI&CE
These charaaeristics are all related to their rapid, more equitable growth. Someare sourcesof growth, some are outcomesof growtl, and
some are unique features of HPAE growth, but most fall in more than one of thcse categories.
Rapid andSustained Economic Gmwth
HE EIGHT HPAEs GREW MORE RAPIDLY AND MORE CONSIS-
tendy than any otler group of economies in the world from 1960 to 1990. They averaged 5.5 percent annual per capita real
income growth, outperforming everyeconomyin Latin Americanand

Sub-Saharan Africa (except diamond-rich Borswana). Another East Asian economy, China, has grown 5.8 percent a year since 1965 and 1 could stake a claim to join the ranks of the HPAEs. Figure 1.1 shows the relationship between income level relative to the United States in 1960 and per capitaincome growth for 119 econormies during the period 1960 to 1985. Developing economies were noc catching up with the advanced economies; more than 70 percenr of the de-
velopingeconomicsgrew more slowlythan the high-income-economy 2 More disturbingly, in thirteen developing economies, per average. capita income actuallyfell. Growth among the eight HPAEsis quite different. Their growthrates are significantly above the high-income-economy average.Unlike most of the rest of the developingworld, the HPAEs were catching up to the industrial economies.Hong Kong,Japan, the Republic of Korea, Singaporc, and Taiwan, China, were particularly notable. Other developingeconomieshave grown ist fr several years,particularlybefbre the 1980s, but few others have sustainedhigh growth rates 3 Figure 1.2 shows the growth rates in per capita infor three decades. come for 119 economiesin two periods, 1960-70 and 197045. The 11 that achievedrapid growth during both periods are in the northeast corner. Of these, fiveare East Asiau successstories: Hong Kong,Japan, Korea,Singapore,and Taiwan,China Japan'sshift from exatremcly rapid growth in the 1960s to rates more typical of high-incomeeconomiesin die 1970s is apparent. The other threeIIPAEs-Indonesia, Malaysia, and Thailand-all show accelerating growth,with highergrowth rates in the secondperiod than in the first Indonesiais one of only three economies
'-28
GROWTH,
EQUITY.
AND
ECONOOM
Growth Rate,196085, andGDP perCapita Level, 1960 Fhgure 1.1 GDP

CDPgrwth rate (percent, average, 1.960.85)
Taiwan, China i
~*Rep.f
'aHongKong Kor --
*Rep.-f
Ko
ma~~~~~aa
lballand 111i
hOOh8SIB* i
2-----O----*--_
--
j
*A
0 **.
......
. ...
-.
..-
-2
*S
-PEs
----*~~~~
U HIgh4I.come econondes -* HPAEs S Other developingecononies

I
. 0 0.2
I III 0.6 038 0.4 elativepercapitaGDP, 1960 (percentag of U.& GDPpercapita,1960)
1.0
1.2
- 0.061RGDP602. N = 119: R7 = 0.036. Neo-This figuroplots this egession equation:GDPG = 0.013 + 0.OG2RGDP60 (0.004) (0.027) (0.033)
SorseSumnmersand Hestn (1991);Barnf(1989);Word BankdanL
to mnove from the bottom to the top of the distribution of growth rates between the two periods.
Poverty Declining Income Inequaliyand Reduced

HPAES HAVE ALSOACHIEED UNUSUALLY LOW AND DE-
lininiglevels of inequality, contrary to historical experience and contemporary evidence in other regions (Kuznets 1955). The positive association between growth and low inequality in the HPAEs, and the contrast with other economies, is illustrated in figure 1.3. Forty economies are ranked by the ratio of the income share of the richest fifth of the population to the income shareof the poorestfifth and per capita real GDP growdt during 1965-89. The northwest corner of the figure
29
ATSIYA!SLAN. M I RAC L E
Fruie 1.2 Growth RatePerisbence

GDP growth rate (percent), 1970-8S
Sin.s .oret
6%-
6$|-
_.!._
._ d _>_______
~~~Singapore**
Taiwan, China
*Mai*a.siaRep.
of Korea
.
4% w*,*f
*Thland
Japa
0%~~~~~
. * 4%-
U High-Income economies *HPAEs a Otherdeveloping economies
-6%--
! -2% 0% 2% 4% 1960670 6% 8% TEM
.4%
GDP growth rae (percent),
Nne: Boxesare seventy-fifth percenrilc of growdtratcsineach period. S&natvSununcrsand Heston (1991);Barn (1989);World Bamk datL
identifies economies with high growth (GDP per capit greater than 4.0 percent) and low relative inequality (ratio of the income share of the top quintile to that of the bottom quintile less than 10). There are 7 highgrowth, low-inequality economies. All of them are in East Asia; only Malaysia, which has an indexcof inequality above 15, is exduded. When the East Asian economies are divided by speed of growth, the distribution of income is substantially more equal in the fast growers (Birdsall and Sabot l993b). For the eighr HPAEs, rapid growth and declining inequality have been shared virtues, as comparisons over time of equality and growth using Gini coefficients illustrate (see figure 3 in the Overview). The developing HPAEs dearly outperform other middleincome economies in that they have both lower levels of inequality and higher levelsofgrow&h Moreover, as figures Al .7-A1.9 at the end of the chapter show, improvements in income distribution gmerally coincided with periods of rapid growth. 30
GROWTH.
EQUITY.
AND ECONOX-rO
Figure 1.3 Income inequalitand Growth of GCP, 1965!89

GOP
growtb per capita (percent)
Rep.of Korea
7
* Botswana
China Taiwan.
Singapore*. Hoagon ' Gabon
----------
apan----------
--
e Indonesie
.M
i Th.lland
:- Malaysia
_ _ _ _
;___ Brazil .
_*I
Italy I
* Austria
-
;.
.Spain o France * Belgium AuS ilia United Kingdom e Sri Lanka * iine Switzerland' Ia Pakistan
. India lMalaw_
i*
Colombia
Mec,
0Kenya '
* Venezuela _ _ .A.t--
1._
Bangladesh
ChIIe Ne * *PBolivia *
Argenttna'j
*eruge!tn
- Coted'lvoErr * Maurita nia

*. Ghana a Sudan I *
-1
--
- .-
. __--...
Za~~mbia
$_
I
20
I
35
10
15
25
30
40
45
Income Inequality
N-et Income inequality is measured bythe radoof thcincome shares of the richesc 20pexnr andthe poorest 20 percenr ofthe popularion.
dacaL Sm:n. WorldBank
31
ECLE
Twoqualificationsshould be noted herc.First, some studiesof Korea have shown increasinginequality in recentyears; however,most of this is due to dte rising value of assets, particularly land, rather than increasedvariation in incomes. Second, reductionsin inequalityin Thailand havebeen relativelyminor comparedwith chosein the other HPAEs, although Thailand's performance is still better than that of most developing economies. Givenrapid growthand dedining inequality,theseeconomieshave of coursebeen unusuallysuccessful in reducingpovertyTable 1.1 compares the declinesin poverry,definedas the inabilityto attain a minimal scandard of living (World Bank 1990b), in some HPAs and other selected in life economies (theperiodvariesdependingon data available).ncreases exptcy have alsobeen largerthan in any other region(seetable 1.2).
Dynamic Agricultural Sectors
tof he economy dedines. The six HPAEs with substantialagricultural sectors-Indonesia, Japan, Korea, alaysia,Thailand, and Taiwan, China-have been mak-ingthis transirion more rapidly 4 But the decline in the relativeimthan other developingeconomies. is not becauseagriculturehas lacked portance of agricUlture in the HPAEs share of output and dynamism.Acrossdevelopingregions,agriculture's employment has declined most and fistest where agicultral output and productvity have grown the rnost (see table 1.3). From 1965 to output and agriculmtalproductvity 1988, growth in both agricultnual washigher in East Asiathan in other regions.Many factors contributed to the successof agriculturein theseeconomies.Land reform (notablyin Korea and Taiwan, China), agriculural extensionservices,reasonably good fastructure (especiallyin the former Japanese colonies), and heavyinvestmentsin rural areas(notablyin Indonesia) all helped. East Asiangovernmentshave activelysupported agriculatralresearch and extensionservices to speed diffilsionof Green Revolutiontechnologies. Their substantial investments in irrigation and other rural infiastruct hastened adoption of high-yieldingvarieties,new crops, and and equipment, to culthe use of manufacturedinputs, such as fertilizer tivate dthne In Taiwan, China, during the 1950s, 45 percent of rhe
32
iYPICALLY,
AS AN ECONOMY DEVELOPS, AGRICULTURE'S SHARE
GROWTH,
EQUITY.-
AND ECCOiL
Table1.1 Changes in SelectedIndicators ofPoverty

PTerntage ofpoprdauion below thepoverty line F.rst Last year yar aAnge
58 37 31 59 17 14 10 26 -41 --23 -21 -30
A&vnenq HPAEs"
Indonesia Malaysia Singapore-Thailand: `
Year
197242 1973487 1972-82 1962-86
N mber ofpoor (millions) Fis Last Percent 'ar year chang

67.9 4.1 0.7 16.7 30.0 22 0. 13.6
-56
-46 -71 -18
Ot,ers
Bra4YAb : :Wolombia . CostaRica : C6reds'Iire I-ndia
Morocco-R; Pikismn0; .-. > .
0 1960-80 -1971-88 197146. 1985-86-1 1972-83

1970-84.
50 41 45 30 54
-43 ;
21 25 24 31 43
34
-29 -16 -19 1 -9

-9
Sri-Laik
C3SC5die poveyie
1962-84 . 1963-82
54 37
23 27
-31 -10
:36.1 8.9 0.8 . -3.1 311.4 . 6.6 26.5 3.9
25A 7.5 0.6 3.3 315.0 7.4 21.3.

.
29.6. -15.7 -25 .6.4 1
:12..
-19
5
4.1
:NoeThiis ableuseseconomy-specificpovertylines Officialorcommonlyusedpovertyrlines havebeenusedwhenav2iblec In other hasbeensetas 30 percentofean incomeor expeaditrc.Theenge of povertylincs, epressed in tems ofewendi. perhouseholdmemberandin tersofpursingpowrpari (P) dollars,isapproximnatdy$3004S700aycarin 1985ececptforCosaRic (S960),-Malaysia (SI 420), ind Singapore (S860).Unlessothenise indicatd, the cble is basedon expexliure perhousehold.s ember. - - ----::-.. - a. Measures for thse enties useinmcmc cAher thanexpenditure. b.Mcasurs fir dtse entries are by hhold aier than by household memnber. Sm wz World Bk (1990b,tabics3.2 and 3.3). -
growth of agriculure was due to rising productivity, much of which resulted fiom government programs (see Ranis 1993). Information on the allocation of public investment betveen rural and urban regions is limited, and it is difficult to make good comparisons among economies, but available data suggest that the HPAEs have allocated a lager share of their public investment to rural areas than did other low- and middle-income economies. Of critical importance in this respect has been the build-up of infrastructure-roads, bridges, transportation, electicity, water, and sanitation. Table 1.4 shows that there has been a more even balance between rural and urban public investment in sanitationand water &cilities in Indonesia, Korea, and Thailand than in other developing economies. The data on rural electrification also suggest that the HPAEswith rural sectors have, on average, more effectively provided electricity to rural areas. Since the early 1980s, elec-
33
I :1R.ACLE
Table1.2 LifeExpectancy at Birth,1960and1990

Lif expeeane, :&onoal rfreon -;HPAEs-1960 :,-64 78
birthnh 6a)
1.990
HongKong Indonesia -K(orea, Rep.of. Malaysia Singapor . Nailand: - -: Th:
46 53 58 65
.
59 772 71 74
.68 .62 -69
;-.
-: -
- 52 43
OtherAsW: -Chin.
.0
In&dia
-Sub-SaharnAlea . Lad Ame7ia and Cribbean
:Low-Inome econom .s
.
.47
43 54
:
.
58.
52
70. 6266 -
-Middle-lacnc ieconomies -Industnaleamenimie N- TAherCgionalpavsarweghreda.; -tExdudes Chinaandndi:L SountWorld Bankdra.t --
36 . 49
70
-
77:.
tricity has been universally available in the rural areas of Korea and Taiwan, China. Malaysia and Thailand have made great strides in rural electrification. Endonesiahas not done as well, but even there die relatve disparity between the urban and rural sectors is smaller than the disparity in econorries with approximately the same per capita income (Bolivia and Liberia) or the same population (Brazil [see table 1.4]). Table 13 Growth Rates ofAgculturalIncome,Labor Force, andShare in Output, 1965488
(percent)
Decline,Average
A
-
anased'growth rv&eof
Atcrds A'd'-:.-.:'..' kiborfirce '
rru8,,,A
:,,-;,:
t
-irc ,--:
SouhAsa
asrArn
.;-:-;:e 196 ,3 41
198
22 34 S :
1965-88l.
t,i d
2.
" <2., 6 1.l9U.::

-
:'
:-t
21~~3
LO)
2.2
:~xree..LLL2jt....
~~c:~;'nA2,
34,.,
:10"
~..
37
17
34
GROWTH.
EQUITY.
AND
ECC
Equally important, however,were the typically low levels of direct and indirect taxationon agriculturein East Asia. During the past three decades, dozensof governmentsin other regions, eager to promote mdustrial growth, have funneled surpluses from agriculture to industry through taxes,food price controls,and pro-industryallocationsof public investment. Less overtly, govemments have fivored manufacturers,
and hurt agriculture,by overvaluingcurrenciesand protectng domestic industries tharmanufactureagriculturalinputs and the goods purchased by rural households.The exchangerte chatresultsfiromrestrictionson Table IA Comparison ofRural andUrban Public investnent
dipadrics in accessto gervies, 1987-90 ARnral-urban (100= rural-urbanpaitj) -c y : . . Watrr - S- ti don 101 102 113 38.6 4665 30 S PA Es Korea, Rep. of ;54 -26 Thailand Indoncsia -168 OtcrAia Latin America SubS - bn ibwAfrica :-
164.6 58 43
.- Prcatage of rrurl adnd uran pop ukonser&d by ecaicity co~namy ' PAEr Indonesia,-1984 :M.a:ilays.;1;983 Thailand,1984
. -OrhlerAsik:
Ur 39 85
78 :40
Rura 10
: -:0: g 5-
55
-Bangradash, 1981 :20
:India, 1981 -S -Lakna,j982 LeninAme-ic

-
-.. ->95
<25 35 :
72
.
15 8 5 9
19. : ;
.
*~ArcndinaJ 1982Bolivia, 1981: .. Bra;Ail, 1981 :-.i N
.......... :0 0- - :
>95 93. 86
83
;C6tc -dvoir, 1981 i iberia,1982

-
20 ;
^
*
~-;
-~
4
.12
~0~
.; ..
Senegk1982
Soercertoppanel: UNDP
('r fariousyis); Bottompan. Muasii
(1987)
3S
_RACLE
manufacured imports reduces thc domestic currency proceeds of agricultual exports. Industrial protection acts as a hidden tax on agrculture, raising the price of agricultural inputs to subsidize industry. Figure 1.4 illustrates the lower taxation ofagriculture by contrasting three HPAEswith
large rural economies with three South Asian economies. Direct interventions include export taxes and price controls, while indirect interventions also take account of industrial protection policies and real exchange rate overvaluation. Both Korea and Malaysia have substantially lover taxation of the agricultural sector than the cornparators, and in Korea the
Figue 1A Intervembon andGmwt intheAgricultural Sector

Rep. of Kore, Malaysia
.7=,,,_T; r-,.
-------w------
Pakis-tn'
w
__.
-.
_,
.........
PSilippines
K.
. .
_. _---_
---
-'i-~~R
19709~~ 1 j
_ _ +_ _ _ _-1_ _j___________________________ Sri lanka '::H-~
__I___._________
; *
:~~~I
-60
-50
-40
-30
-20 -10 0 10 20 Levelof piotection (percent)
30
40
50
60
Rep. of Korea
alys i -............ I
...
.
Thaland . PsidalsiU PhEippines Sri lanka IE~ -2 .

.~ l_
-=96
___ ____
I
_
i
___
~~~~~N1970s 3---197ks I k
I
__ _ _
~ ~~ ~ ~~ ~~~
_ _ _
~~~~~~~~~~ I
2 4 6 Agrutural growthmte (percent)
10
Sour= Schiff(1993).
36
GROWTH.
EQUITY.
AND
EC_OO
agricultural sector receivespositive protection. Thailand's taxation of the agricultural sector was similar to South Asian levels in the 1960s and 1970s but fell in the 1980s while taxation in South Asia was rising. We are nor suggesting that the HPAEsavoided transferring any resources from agriculture to industry. Rarher, in contrast to ocher developing economics, they transferred fewer resources. Moreover, transrs were often voluntary-financial savings, for example-and were nearly always limited to levds that did not choke off agricultural gwth.
Rapid Growth of Exports

NOTHERSTRIKINGFEATUREOF THE HPAEsHAS BEEN THEIR superior export performane This is reflected in their steadily Ilk rising share of woldd exports (see table 1.5). As a group, the HPAEs increased their share in world exports from 8 percent in 1965 to 13 percent in 1980 and 18 percent in 1990. Manufactured exports have provided most of this growth. From 1965 to 1990, Japan emerged as the world's biggest exporter of manufactured goods, increasing its share of the world market fiom nearly 8 to almost 12 percent. In the 1970s and 1980s, the locus of growch shifted to the Four Tigers, whose share of manufactured exporrs grew nearly fbur tmes faster than Japan's (see
table 1.5). Beginningaround 1980, the three SoutheastAsianHPAEs (Indonesia, Malaysia, and Thailand), which had been historically dependent on commodity exports, recorded a sirnilar but so far smaller surge in manufactured exports. Some analysts have, with hindsight, attributed these achievements to unique cultural and geographical circumstances. But there was litde evidence at the outset that East Asian economies would achieve such spectacular results. In the 1950s even trade optimists were export pessimists and did not anticipate that Korea's exports would grow four times as fist as world trade during the next thirty years (see, for example, little 1982). One obvious efFec of rapid export growth has been a marked increase in the openness of thcse economies, the share of exports plus imports in GDP (see table 1.6). Malaysia has been heavily tade oriented throughout its post-colonial history while Korea, Thailand, and Taiwan,
China, had average trade propensities untdl 1965 but have since moved
wel above intemational norms. The trade orientation of Indonesia,
37
I1RAc IrE
i965-90 Selected East Asian Econonies, Table1.5 Export Penetration,

Share in wuorldeports Eeonq -Totalmg,parn
S-are iL developing-economy xporm 1990 1965

-7 6.0 6.2
:1965
1980
-1.980
1990
Japian Fourflgcr-
-7.
5.0
1.5 1.5
9.0
3.8 2.2 -13.1 28.7 100.0
SoutheastAsian HPAE subtoalAll developing economies World

: --i a-u.-:;
NEs
6.7 2.4
18.2 198 100.0 11.8 -
13.3
33.9
7.8
21.1 100.0 NA
12A
56.3 100.0 NA
7.9
.242 100.0 7.8
12.2 100.0 NA
Japan> -. --
=.- ;rsa
Fourr
1.5
0.1-
SoutieasAsian NIEsbHPArEsubtotal
*
9.4A
11.1
11. 5.3 O 17.3

11.8
7.9 1.5 21.3

12.9
13.2 1.1
44.9 3.8
14.100.0
48.6
100.0
61.5 12.0 73.5

100.0
AIIdevc1opingeconomies
*Wodd
. available.
100.0
1;00.0
-100.0
NA
NA
NA
-Nor
applicable. NA-.Nor and Taiwan. China. -ai Republicof Korea.Hong Kong,Singapore. b. Indonesia.Mala a. anlThallu:xL : ort U.N.Trade Systems darn.
w-ith its vast economy and only relatively recent export drive, is only sightly above the world average but growing.
RapidDemographic Transitions
THE DEMOGRAPHIC TRANSMON FROM HIGH TO LOW BIRTH
.1.
and dearh rameS began in Europe and North America with the Industrial Revolution, and it took nearly two centuries to com-
plete. That same transition is occurring much faster in the developing
world. In virtually all economies, deati rates have fillen substantially in the postwar period; in ali eccept Sub-Saharan Africa, birth rates have also fllen significantly (see table 1.7). However, compared with other developing regions, the transirion to low fertility began sooner in East Asia (in the 1960s in the north and in the early I 970s in the south-and of course even earlier in Japan) and has gone firther.
38
GROWTH,
EQUITY,
A-ND E
Table1.6 Ratio ofTotalTrade to GDP

Ecnousn" HPA& 'Hong Kong. ; EO1970 1980 19851.988
Indonesia- . -lorea,Rep. of: Japan Malysia

Singapore
1.50 0.25 - 0.32 0.19 0.89

2.12
1.52 0.46 :
0.63
'0.25 .1.00
3.70
1.78 2.82 -0.38 -0.42 :0.66 0.66 0.23 0.11 0.85 -1.09
-2.77 3.47
-Taiwan, China
Th1ailand
-.0.53
0.28
0.95
049
...0.82
0.44.
0.90
0.35 0.45
SubR -SSI,arnAfr-k - 0.24 : 0.30 5out6Asia -; ; :; 0.17 -: .; A-men-Amc'sa ad Caribbema 0.20 025
-
0.27 - -0.11 0.16 0.22
0.19 .0.23
N..-eTotlrade .-value ofxportsandvalueofiimpomr divided bygrass domesdc

-.- produce :-. - -t' -.SowrwWodd'Bandata. Taiwan,China,vanious issues.Nadionial Accounts SMtaddcs: AnalysisofMainAggegates, 1988-89 (Unietd Nations). -
During the period 1965-80, all the developing regions of the world experienced a marked decline in crude death rates (see table 1.7). The decline in most economies was 30-40 percent and did not vary much among regions. There was, however, substantial regional variation in the extent to which declines in birth rates held in check the potentially explosivegrowth in population from the rapid mortality decreases. In SubSaharan Afriicaduring this period, the declines in birth rates were around 2-10 percent; in South Asia, 10-30 percent; and in Latin America, 3040 percent. The sharpest declines were in East Asia: 40-50 percent. As a result, the rare of population growth declined in all the East Asian economies, in some cases quite sharply. For example, in Korea it fell from 2.6 percent a year in 1960-70 to 1. I percent in 1980-90; in Hong Kong, from 2.5 to 1.4 percent; and in Thailand, from 3.1 to 1.8 percent. In Latin America, fertility dcdines were also sufficient to reduce population growth rates, though generally not to the levels observed in East Asia.-In South Asia the picture is mixed, with fertility declines sufficient to reduce the rate of population growth in Bangladesh but insufficient in Nepal or Pakistan. In Sub-Saharan Africa, the combination of sharp declines in death rates and modest declines in birth rates resulted in an acceleration of population growth-for example, in Ghana from 2.3 percent a year in 1960-70 to 3.4 percent in. 1980-90, and in Kenya from 3.2 to 3.8 percent. 39
Table1.7 TheDemographic Transition (percent) Change in cr-de -ange in crude Aventgeannul grovtt of popadation 160-70 2.5 2.1 2.6 2.8 2.3 3.1 -2.8:3.3 2.9 3.8
23
birth
Eonomy EaswAsia rante,
eadl
rate,
19650 --52 -40 -54. -25 45
1965-80 -54
1980-90 1.4 1.8 1.1 2.6 2.2 1-.8 2.2 2.0 2.3 2.7-3A-
* HongKong Indoncsia . Korea,Rep.of Malaysia Singapore Thailand

LatinAmen'ca
-55
-
-46
-31 -40 -33 -31
-6
-58 -16 -30 -36 -55 -50 -38

:-2
Bazil Mexico
Peru
Venezueda Sub-Saaran Afri-. Ghana Kenya SierraLeone

Tanzarta SouthAj~a Banglad India Nepal .-Pakisran. I
-13: -2
-2
-50 -29-22
-3.2 -1.7
2.7
3.8 2.4
5.1
-27
-33
-13
,
-33
-45
42 -
2.5
2.3 1 2.8 :.
2.3
2.1 2.6 31
-:
-13 --
-43 -
-Nor avaibbk.So5Wrrw WorldBa dara
High Investment and Savings Rates
P
40
HYSICAL INVESTMENTINCLUDES ALLOF THE ECONOMY'SOUT-
Jput that is not eitherdirecdyconsumedor usedup in the producuion of othergoods.Machines, buildings, and infrastructure
are physicalcapital,bur elements ofworking capital,suchas inventories, are also important. Economiststraditionallyhave viewedinvestnent as one of the driving forcesof economicgrowth. In a dosed economy,savings is the only sourceof invesrmenr,and the two, by definition, must
be equaL But in an open economy, investment can be financed by bor-
GROWTH,
EQUITY.
AND ECOQi
rowing from abroad as well, that is, with foreigners' savings. Even so, inadequate domestic savings will eventually pull down investment rates, either direcdy or through constraints on the continued build-up of foreign liabilities, which must eventually be repaid firomdomestic savings. Between 1960 and 1990, both savings and investment increased markedlyin the HPAEs, outstripping -',e performanceof other developing regions (see figure 1.5). Savings rates in the developing HPAEs were lower than in Latin America in 1965, but by 1990 they exceeded Latin America's savings rates by almost 20 percentage points. Investmenc levels were about equal in Latin America and East Asia in 1965; by 1990 East Asia's investment rates were nearly double the average for Latin America and substantially exceeded the rates for Scuth Asia and SubSaharan Africa. The HPAEs are the only group of developing economies in which savings exceedsinvestment, making them exporters of capital. When we compare the HPAEs individually to all 118 economies for which investment data exist, the picrure is more complex (see figure 1.6). During the period 196045, the HPAEs' investment levels were in
Figure 5 Savings andInvestnent as a Percentage of GDP

Gross domesticinvestrnt
Developing HPAEs LatinAmerica andCauibbecn
South Asla
Sub-Sahaan Africa Gross domestic sawings
Developing HPAEs_-_
_|
i .1-...-&----I -_____________________________
Latin America ndCaribbean

South Asia Africa Sub-Sahoran
: - .
g.
e10
20
-30
40
N-eo:The regionalavages arcunweiglhted. SepurcWorld Bankdarn.
4'
RAC L E
Level, 1960 and GDP per Capita ofGDP, 1960-1985, Investment Rate asa Pementage Fgut 1.6 Average
190-8S) AverageInvestmentrate (percentageof GOP,
40
30-----
*
Rep. of Korea Chilna Talwan.
207 '.-
S
0 *Malaysia
bnga*Japan *
e
-6-- -
'
SXhalland
1'
0--
111gb-Income economnies * HPAEs economies * Otherdeveloping

U
0.2
0.8 0.4 0.6 Relativeper capitaGDP(percentageof U.S. GDPpercapita, 1960)

=
.0
2.2
N -51.88IRGDP602. equation: 16085= 10.125+ 59.12ORCDP60 Note. Regression
119: R2 = 0.295.
(12.593) *(1383) (10-344) Swrre: Summersand Heston (1991); Bam (I989): World Bluk dat.
the top quartileof all low- and middle-incomeeconomies,but sincein5 What is vestmentgenerallyriseswith incomes,this is not remarkable. remarkableis their high share of private invesrment.Figure 1.7 compares averageprivate and public investmentshares in GDP for 1970-89 in the developingHPAEsand other middle-incomeeconomies.Private than in investment is about 7 percentage points higher in the HPAES other middle-incomeeconomies.It rose from about 15 percent of GDP in 1970 to nearly 22 percent in 1974, then declinedand held at about 18 percent between 1975 and 1984. Private investment contracaed sharplybetween 1984 to 1986, reflectingthe global recession,then recoveredby 1988.6 In contrast, private investment in other low- and middle-incomeeconomies has remainedrelativelystable at about 11
percent of GDP.
.427
GROWTH.
EQUITY,
AND
The story is differentwith respectto public investment.In the 1970s overalllevelsof public investment did not differmarkedlybetween the HPAEs and other developing economies; during the decade public investment rates in all economies rosefrom about 7 to 10 percent (see figure 1.7). But during the 1980s the HPAEs and other developingeconomies diverged.In other economies, the fiscal contraction of macroeconomicadjustment was reflectedin lowerpublic investmentraces.In the HPAEs,conversely,public investmentshares actually rose between 1979 and 1982 and then remainedat a levelnearly4 percentagepoints above their 1970s average.Only after 1986 did they begin to dedine towardhistoricallevels.In short, in strikingcontrast to elsewhere,public investmentin 1980-37 in these East Asian economieswas countercyclical to the reduction in private investment.
Creating Human Capital
I-N
NEARLY ALL THE RAPIDLY GROWING
EAST ASIAN ECONOMIES,
the growthand rransformarionof systemsof educationand training during the past three decadeshas been dramatic The quantity of education children receivedincreasedat the same time that the qualityof schooling,and of training in the home, markedlyimproved.Today,the cognitiveskill levelsof secondaryschool graduatesin some East Asian econormies arecomparablero, or higher than, those of graduatesin highincome economies(seeappendix 1.2). Figures 1.8 and 1.9 present a stylizedsummaxyof the resultsof regressingprimary and secondaryenrollment rates on per capita national incomefor more than 90 developingeconomiesfor the years 1965 and 1987.7Enrollment rates are higher ar higher levelsof per capita income. But the HPAE'senrollment rates havetended to be higher than predicted for their levelof income. At the prmary level,this was most obviousin 1965, when Hong Kong, Korea, and Singaporehad already achieved universal primary education,well ahead of other developingeconomies, and even Indonesia with its vast population had a primary enrollment rare above70 percent8 By 1987, EasrAsia's supenroreducarionsystems were evident at the secondarylevel. Indonesia had a secondaryenrollnment raceof 46 percent, well aboveother economieswith roughlythe same level of income, and Korea had moved from 35 to 88 percent, 43
jA C L
EitACLE
Fgure17 Public andPrivate Investnent

Private Investment/GOP (percent) 25
.5
-D- HPAEs (excludingJapan) 0 1969 1974 1979
Other LMlEs 1984 1989
Public Investmfent/GDP (percent)

20
-
------
10
5~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
-U111FPAEs (excluding Japan)

0
-4i
OtherLMIEs
I
I i
1969
II
' }
~~~~i ;
1974
1979
1984
19
Note: LMIEs = low- and middle-income cconomics.
So=eue World Bankdami.
maintaining its largeleadin relative performance-Only in Thailand was the 28 percent secondary enrollment rate well below the incomepredicted 36 percent and the 54 percent mean for middle-income economies.9 In recentyearsThailandsweakeducationalperformance has been felt, as seriousshorages of educatedworkershave begunto threaren 44
GROWTH.
EQUITY.
AND ECC
Firm 1.8 Crss-Ecnony Regressin for Prmaiy Enrolment Rates, 1965 and 1987
Pdmatyenrollmentrates 140' - -
:120
.. ......... .
120Brazil(108)
--
Singapore (1053
U
n lindonesia (1118V . [37.0] HongKong(106)
Brazil(103)
[21.9] *
-
~~~~~~~~~~~~~[-7.5]
_Tbai95) [7.01 i7aysb(102) Rep.of Korea (101) [-7.8 [4.3]
ioo
Rep.of Korea-(101)u [29.2,1 . Malaysia(90) Thailand(78) [17-9_

8 [10.8]
Indopes15 72)1 -;
HongKong(103) [15.61
I60 ~ pesI5ji2y d -- _ _ _ *Bangladeh(4.9)

40-its
_Banigtadesh '[8
(59) (52) [O79]1 -.
,Pakistan
4-Palkistan (40) 6$2........... 1-24.5]

20--
. ------- 197---
1965
9
.
Lw
0 250 500 750 1,750 2,000 2,250 0 500 U.S.dollar) Per capita Income (198
1,000
1*500
3,500
Nater Figures in parentheses arc enrollment rates brackretd numbers show rcsiduaLs Sourre: Bchrnan and Schneider (1992).
continued very rapid growth. In part as a function of their success in increasing enrollment, the East Asian economies have also been faster to dose the gap between male and female enrollments (see box 1.1). A common, though imperfect measure of educational quality is expenditures per pupil. Between 1970 and 1989, real expenditures per pupil at the primary level rose by 355 percent in Korea- In Mexico and Kenya, expenditures rose by 64 and 38 percent, respectively,during the same period, and in Pakistn expendituresrose by only 13 percent between 1970 and 1985 (Birdsall and Sabot 1993b). These dramatic differences reflect mosdy differential changes during the period in income growth and in the number of children entering schools, both of which favored the East Asian economies. A somewhat better measure of school quality is the performance of children on tests of cognitive skills, standardized across economies. In the relatively few international comparisons available from such tests, East Asian children tend to perform better than children from other developing regions-and even, recendy, be'tter than children from high-income economies.' 0
45
& 4TIRACLE
Fimre 1.9
100
Cross-Economy Regresin for Secondary Enrollment Rates, 1965and1987

.
-.
Secondaryenrollment rates
,U
,~-
_-
-;
.
so ---
,|
',
Rep.of Korea(88)
i
-..
60
Malaysia (59)
Indonesia1 _-
(45) Singapore 40 40~~~~~~~~ Bangladesh (13) *!k [19.1] *Malaysla (28)

.-
.119.5]
-
>I
ril3s
BraA (28)
9*-[18.
Rp 're\35 --ltT
I
~slhailand
9)
77--{ ~ir3jidnf
0- 2 1 akstan
.BalI (16)f (12) 750
Bangadesh (18)Ft8
119
1,750 2,000 2,' Percpl 0 500 1000 1500 3,500
250
500
Income (In 198 US. dollrs)
Nomt Figures in parentheses arcenrollment raes;bracketed numbes showv residuals.

Seurce Bhrman andSchneider(1992).
How much a childleams isalsoinfluencedby the nature of the leaming environmentin the childcs home-Again, children in the East Asian economics had advantges in the 1970s and 1980s. Using a simple index taking into account the mother's education and the number of children at home, we estimate that the learing environment in Korea during twenty yearswas enhanced 114 percent more than in Braziland 147 percentmore than in Pakistan (Birdsall and Sabot 1993b).
Rapid Prdu
Growth
HPAFsIS
HE FINTAL OUTSITANDING CHARACTERISTIC OF THE
their rapid productivitygrowth. That labor productivity in the HPAEsincreasedrapidly is self-evident per capita GDP grwth dependsprimarilyon risingoutpur per worker Someof this increasein output per worklerresultsfrom increasesin physicalcapital per worker (for exarrplck more machines)and some reults from increases in human
46
GROWTH.
EQUITY,
AND:,F-COX0
MT VT!"12
,i Mz
rT-77
Ze.
w,Was-,FAA
IF.AJRL''
11AAHI'..MRICALLY-k6---,----!: eci c.- ene tv o cu!,adng:V .9d. es Lrsu to - oyt i'an biin subiiiiia 7 4. lop.1 o y a=,;-.,us ygra uaUj;'..'ib;gdsj gender' J--Th d il iffii:ntii f6cyiii-,., aryan sc6ndzrj'k:& -rnenriv n";'evc 1.o-ca-d6i. in -1--'-'6d---' c,-th ower ataun.-..,,.-,,,to-aiaineas-incomesmaeast ---bf thi Aia tir).Ji-I 965i at c pd-n-.---yztdj,.,1mpr6ve, I the' 'c[ rnaryp_ c ccorioriuq,-,gnder V V WM Swl"cr-,,E=ticxpected.,,-Bye'-HPAB_ e. e:gcn-':-'.,-',;;,' 'j!aI[70Wid-,-hommì" The,,;,.t-',"Jt)r,outst e,--.tlii '1987'thi,&ur jan!eqonoa,Lies-f6i.W.W&6ca. pmg ot er eV 0 aM r; ;cconomjqs,' splteZwr'u''iat,norms-,,ttl2t. put, greater--, achieveduniversai p6mary cation C, :r Wqq01Lucation-ofs6diaahi, tisci; -Oviiiiirii'n'aungthe''gendir p-at' th' a-'t-1e'%'rib7SLLbi6iL C mtes um M' dau -d6cationl., ii ai Mm dvt: I continik46" gender-gaps, C CXCCPtI0r4.-in-liow-tncom"C' M e; ra er. SUCCCSS 0r-t1MVCrsJid[7-, Is PUS 7-,C ... P-M '. -,; Z:. - , 'yucauon Sphe' thi! m c3q%=ono e,, qarrip oni ive4rgu -64c4,,th f G61 :F6v =&T.1fij,'-1991 S31S 7 lecon6nues, GNP pq.qLpibi '$500'-% -in aTsmoolv -o 0'ff m Miienr, etwccwiboys as,'no-r4n fs-,--=,a, ges-2 6fita- i pio,in, .AD"Mak-Yea 6f'Edudfialfl
p I g 10 ,i'. E. -'. r -;" -, -. - , --. 4.-, -"s. I. .......... Sl t Ca-1r0m-1
64i
'I.
-. 44
nAmi
C5
70,
4-. -jk
1-ir '(6c, cq 6 Thi gcn..d&,gaps-,-avtqe-k'di 'd'-" Iiidcc -16iill: aryschool-pp increastrig.second .2C as;mu e;M 'an Ij -,q80s!2,S1t-.1S rhl --v-166'.1-970icl ey opmg.-wo & SUCCCSS Ilh laL%ngj -Ccon6mli .98 cntsto gn !cr:ga,p V4.1 `6ii6, -wJii I Ja er 1) capim-41 -6 A-siadeconornies.5nour,stu
PV
In!;1965,
Z.1
fi
capit2l. (for cample, better schoolecl workers). In addition, however, somc may resulr fiom greater efficicncy, fiom changes in producdon practices that result in greater output from the same stock of physical and human capital. We caU the increase in productiviry thar cannot be accounted for by measured increases in inputs total factor procluctivity 47
r1;CTACLE
betrer organi(TFP) growth." Among its sourcesare bectertechnology, and innovatons on the shop floor. zation,gains fiom specialization, As we demonstrate below,about two-thirds of East Asia'sextraordinary growth is attributable to rapid accumulation;that is, to unusually rapidgrowth in physicaland humancapital.The remainingthird of ti-s growth cannot be explainedby accumulationand is tierefore actributThis is largerelativeto other econoor TrP. able to increasedefficiency mics, both absolutclyand as a share of output growth, and therefore partly explainswhy theseeconomieshave been catchingup wriththe inhave not. In dustrialeconomies,whilemost other developingeconomies box 1.2 we reviewtwo broad interpretationsof the relationbetween accumulation and output growth and the link between productvity
changeand technologicalcatchingup. Regressions Evidence fromCross-Economy IncomeGrowth of perCapita

In this section we use two statistical techniques to examine the rela-
tionship betweenaccumulationand output growth Our first model is a regression in whichwe estimate the relationshipbetween cross-economy the rate of rcal per capita incomegrowth and the share of investmentin GDP,and two measuresof educationalattainment, controllingfor dte rate of growth of the economicallyactive population, and the relatve gap between per capitaincome and U.S.per capita income in 1960 at 1980 U.S. dollar prices.'2 Our measuresof educationalattainment are primary and secondary school enrollment rates in 1960, the area of human capiral accumulationin which the HPAEs showeda substantial differencefrom other low-and middle-incomeeconomies. The results of applyingour statisticalanalysisto 113 economiesare summarizedin table1.8.The estmatesindicatethat fcror accumulation capitaland schoolingcontributesigmatters. Investmentin both physical nificantlyto economicgrowth.'3 An increaseof 10 percentagepoints of GDPin the rate of investment-about the difference in privateinvestment
rates between HPAEsand other low- and middle-income economieswould raisethe growdt rate of GDPper capita by 0.5 percent An increase
of 10 percenmgepoints in the primary or secondaryschoolenrollment rarewouldraiseper capitaincomegrowthby 0.3 percent Beyondaccumulation of physicaland human capitl, initial income
also has a significant relationship with per capita income growth.
48
GROWTH,
EQUITY,
ANDE'CO.'i
x ,Zrl%evjc,;i-.Ii_-.Ip"-."_2__
A
M77 i 7,
)NOMISTS,
1-4
ROAD,
accumuw-
mmmenr
umanan
er:
.,Jf.
onj'am Murpur -w-V
h
o e -3K
VC.'.
Flj
V4, 1. ini A
_T'. yIC
r=en
".w
3Vlcwlls"_b"l
um2n ppi
ton;t,&I ajt
a it
irk*, -o'wth' an
1.06
rexten -
p nonluesiysi &pfil&72ACt esame, -4 assem6i&bffinva= nonuc-.,gr
rz-k iE66-Er; MR
-,,-,,.amo4ccon6n3jcs_cr ccononiic,_-or
'lik" -0
r
cromki&m
P tLon
gan,=qon;,-jnnovau o ogyarc o arm y.14666i 31i
_-llFAE:f a "d zin 4
iAiii '446 ccum non-, ii'ibilbimer vict-, ruo

M
cKami)
have .. ........ gm.
CoDrifth
"W o lporpcmicnVor ccum
M, 07Ww"Ah
_9M Y
economc
Om
con-._t-,,, -,-tc
Z.-
Q
,p
LW2'CX
oil ficior---2ssum rec

J:i
i=cs 0 -nu e-mcoifi

Om t r
Oj_
(SOIW495.7)
0 f -T, P, P'. v aupajmong _7 onspi de c 19P
ll,z, ,-,'2ni
coiiiii.econoun
Cj;V;.
crcmeat&jj06, er, 6ibasji-,tVoutpu poon

f ItaL
;_2
-J
0
gt
'gro
0 .4;_
econo
V4
n
OD
'p
Sd'
49
i-MIRACLE L
':
--.
':~~~~~~r~
l'--'rr'
r:*rt
~i.
',,
,..
:.;,..:,,
?%e 7 aWe to acqwre technologyhniore~ =ie4iy; daiinical efnaen4 chan ge- Bo6htho y -and empi ic leadusto, ncludechat tol&cr pruc-- economics. evidence: prgres&more rapidlj than induiial K>Thisiis thdeindusirialecmomiioicilrer . mov dc radbe- up.. i" a vy growthl ; < U-pnid4crrybasedcatcbiiig:
j-i---
r'BuLiiiwrnadbsn4a1 be
fpraiceis uiseif amoving, .di
t. technologicacg
Z =
the-. m
-sc toie to, oc
targetTow
OM '-Co
fiictor.producvity cbangeii; el.igh
-nonal t e practic4Whileinflow-and middle-icome iic
g5wrkXChenry 1986;B.n an 192 m -liI;pm~~~~~~n a &uncV~A9)--4 i, pendix in resents acformiantan4is" oEfi rea~onow-bs
; -
j(Pacad l .nocr;
Ass*
1993XForpductrv1
on, 6te gaicing 'lo-Cand
"ltec-noloejcl r pracice, whitWChe temi bcwce slp ni#eicrsKn ~do

O&
>~~~~~~~~~
4'
banmcemanon iia b hs'd

-
mov4iidj
-moIn
ccInomits, cam-b occr,

zzG*
9; >.~movemenrs)owardbestphiice,whicWweolraech'-
-. mu st
.:
.- Ceposk,iv---:
Economies that were relatively poor in 1960 grew significandy fister than relatively rich ones, controlling for levels of education and investment So although, as shown above, poor economies did not do better on average than the high-income economies-income levels were not converging-this was partially because poor economies invested less. But an economy at 50 percent of the level of U.S. per capita income in 1960, and at average levels of education and investment, would have grown about 2.1 percentage points more rapidly thian the United Stares. We call this conditional convergence, because economies with low rates of investment and school enrollment would not catch vp despite the "advantages" apparently offered by being relativly poor. This conditional convergence can be interpreted as a measure of the gains realized as a consequence of moving from lower to higher technological levels, or "catching up" (see box 1.2). But rhe relative income variable may capture more dtan the productivity-based catch-up effict that some initially poor economies benefited fromr. One of the important empirical regularities found in the early literature on structural transformation (Kuznets 1959; Chenery 1960) is the discrepancy in the average product of labor between traditional (agriculture) and modem (industry) sectors at low income levels.A dominant share of producrivity growth in low-income economies can be attributed to intersectoral realocation of labor from agdriclture to industry (Pack 1993c). Thus the initial income variable may also be capturing the reallocation effect of this structural change on per capita GDPgrowth.
50
GROWTH,
EQUITY,
AND ECO:4I-
Table 1.8Basic Cross-Economy Regression Results

(dependent variable: average rate of realper capita income growth, 1960-85)
113 * Variable Inte'rcept RelativeGDi' to U.S.,1960 Priuary enrollment,1960 Secondaryenrolmenr, 1960' *Growth of population, 1960-85 Averageinvestmendr/CD. 1960-85
I{HPAFS'.
O&Osedns
113
obsenmign
-0.0034.
4).0070 (0.0079) -0.04O (0.01 18) 0.0264M (0.0065) 0.0262

* (0.0139) 0.1015, (0.2255) 0.0578
(0.0224)
(0.0075) -0.0293~*-0.0320 (.15)(0.0110) ~ 0.0233 (0.0062) 0.0160

(0.0132)0.0201
~~~~~~~113 obsen'aions 0.0042 .(0.0081)
0.0272 (006) 0.0069

(0.0131). 0.0998 (.03 (0.02.07) 0.0171 (0.0056)
t
~~~(0.2095)
0.450.0285 (0.0211)
0.0230
-(0.0056) *LatiAmrca
*-0.0131
(0.0039)
Sub-aharan Africae Adusted R.

~Stadrisda1y.signfl=wacrtiC 0.0f lVeL.
'6.
0.0o9.oo
0300424 0.48211
nnsdca1y.sniflc~nt2tt die0.051V& Nr:coefficlent is:top number in cach ceIllStandard crror is in p
crnhses
t.Also indiudeTun".isiand South.AMica. snffcsdnnrcs. S6an WoildBank
Armned with these statisticalresults,we can examinetwo facrs about the role of accumulationin growthin the HPAES. First,our estimatesof the parametersof the cross-economy growthequation enableus to do a simple "accountingfor growth"in the HPAEs. Table 1.9 shows the pro-
dicredcontribution togrowthofinvestment, humancapital, population

H-PAE. It alsoshowsthe share of acg'rowrh,and relativeincome for eac-h tald growthpredictedby thesevariablestExcept for Hong Kong (44 percernt),60 percent or mare of the actual growth rate in the HPAES is predicted by the accumul-ation of physicaland human capital,initial income levels,and population growth, ranging as high as 87 perce-ntfor
FML~"xN I R-A-C LE
Table1.9 Coutnbution of Accumulation to theGmwth of theHPAEs, 196045

,~~~~~~~~~~mm 11os Iha . w . , ;
-aaf hiv
Pear
*VWzh& Ian~~~x - car US.2560 -f-mapa,Imau 15%6 S 5 md -cmXular . 19S0 i - -: Gcpq&u.n2104 GM* AwpiPdUwunt 160.85 mlal
Mg.
.6
-- fa-d PedSI
uik(si (.26) {.Nz (7) (a5) (231 s1) -. (4) -1q
aeihsh
MlUe
ral prial
gush
-..
&vh
5W.
r_
rmd ugaqh
473 -W48
+X4
fl,.~A, P0f +:'
If-d pen&tu
guhw. 4.151 (1 (sw 1421 (2l (.1)la M
pia
s (-191 17-191 (10 -
(vi 4270 .e70 -ISe 20o 0.3 0X3 ex57 l 69 2A (44)(
(rf-) 4710 .1.1 -2.16 .72 1.4 0.20
~40676 .
.X7e
:~
~~~~~J -L0N12
4.030 O-.Jf e.o2 0.1025
--
476 (.1) 402 wu78 -141 4 32 (.242 1.77 -9) 0.16 (7) 2 (16) 2.10 It 1._D.108 {1918 5.7 223 =.6P
-
243 e, a19) 0.79 .4
1.40
Lin
--
AaW Ewd.A - U6 P- M& gn F* .vAwM pdiicS
5 4.69
30
cmibdn
wpz.n
vacsylwdwwAaeesI
.iwnyim XI
nbdal
enIa dwbEnul(nr
dc bienps.
flqnJul
rend Grcceyqlsdwwm
JaUsihIa-
yr.
-:dbc
.pi
.m.bl-dn.
Malaysia.On average,about two-thirds of the observedgrowth in the HPAES is predicted by our model. Primaryeducation is by far the largestsinglecontributor to the HPAEs' predicted growth rates. Between 58 percent (Japan) and 87 percent (Thailand) of predicted growth is due to primary school enrollment. Physicalinvestment comes second (berween35 and 49 percent), followed by secondaryschool enrollment. Japan's high secondaryschool enrollment in 1960 makes a particularly strong contribution to its growth (41 percent), more than investment, while the laggardsin secondary enrolhmentrates, Indonesia,Malaysia,and Thailand, have the smallestproportion of their predictedgrowth attributable to secondary enrollments(lessrhin 15 percent).Investment,conversely, is most important in Hong Kong,Indonesia,Malaysia, and-Singapore, whereit accountsfor more than 40 percent of explainedgrowth.
Second,we are also able to look for regional patterns in growth rates
that are unexplained by physicaland human capitl investment. Controlling for their performancein education and investment, and initial income,the HIPAEshave a significantlyhigher rate of growth than all other economies.Latin Americaand Sub-SaharanAfrica, in contrast, have significantly lower underlyinggrowth rates (about 1 percent),controllingfor the same variables. Thus, the expectedgrowrh rate differential between the high-performing East Asian economies and Sub-SaharanAfrica or Latin America,even if they had the same accumulation and initial income, is nearly3 percent. To assessthe contribution of the HPAEs'superior accumulation relative to other groups, we can predict growth rates in four groups of
52
GROWTH.
EQUITY.
ANDND
4.~~~'~
.I ., .=: '- i. ::, . :.
.fw
C.gi7
-~i
.Jimut.-
; ,-. * ... P -"I'

0,0284:
,.- .r., -;,.,

-. 70.
,^c>*d*.s_
.0.7 25 .S W;t2
0624 uJ -
7 .L4 231; 04 Om
MIS2s{
p(.)3
.%t
Ga(' die 442. oil
*rr
4NB
'' -X
a.77
'-;) -
(-4q -2QOb
j19J i)
(69'
t 21)
Om72
:.f
.. . lwt
- 0 ,- . 1141 1473
1;
(tv
fi)ls. X
(231
-. 57
Ax-
'.;4
13z
(36) 6.03 3310
IA9
(431 151
IG -
au
'(3m 3.45;SC e
-; S Z '-R' , .
638c
3.70
.(6)
economicsbased on level of investment,primary and secondary

school enrollment, relativeincome in 1960, anrdpopulation growth.
in actual growth rates betweenthe HPAEs and other The differences (dueto groupdifdifferences into the predicted groupscan bedivided ferencesin accumulationor initial income)and to an unexplained only someof the difexplains residual(seetable 1.10).Accumulation and ocher in per capitaincomegrowthratesbetweenthe HPAEs ference groups.For example,between1960 and 1985 averageprimaryand rates in the HPAEs ratesand investment schoolenroUment secondary
were belowthose in the oECD, leadingus to predict that growdt would be lower by 0.68 percent. Offsetting this is a conditional convergence gain of 1.2 percent and the contribution of the HPAEs'higher rate of population growth, -0.1 percent We woulld predict that the HPAEs would grow about .67 percent faster than the OECD, primarily due to their initially lower income level; in fact, they grew about 2.3 percent faster.
The effect of the HPAS' higher rates of accumuladon
is more
telling
in the comparisons benweenEast Asia and Latin America or SubSaharanAfrica.Betweenthe HPAEsand LatinAmerica,34 percent of the predicted difFerencein growth rates is due to higher investment levels and 38 percent to higher carollment rates. Far and away the major difand Sub-SaharanAfrica ferencein predictedgrowthrates btween HPABs derivesfrom variationsin primary school enrollment rates.Investment accountsfor only about 20 percent of the diflerenceand is offset by the Africa and its more advantageof Sub-Saharan oonditionalconvergence rapid population growth. Educaion is the main theme of the story of
53
ACLE
Table1.10 Accounting for Differences inGrowth Dueto Differences in Accumultion: TheHPAEs, Latn America, Africa, andthe OECD Economies
: . . .: ; -: ff : f u X : -. -- AI ;UA aSt -.-. Afie.41. 0a7m7 y : :
;~~~~
Ab~~~-
Pa r -e . .. twst
.lar
K-
O OEC :AAim-0D
G4CPIZdISIW I CtLS..9l60 IrInay.enmIm-.-. 1960 - r,tuy a9uIbnnv.1910 -
-013-:D612 -0. O. Q25 .
4tE574 .. 0*3 2 .0*015 M.U095 *73 . -
: -
.:4o
Aq.whFdpla. 156045 *-- PAEn Dl. 39.--AS

iHr:E. am. I.3 - b- mtME
*fa
-(.
2427 4003 .I3:
X4774 774 66 l
. :
-:w
et
40
Irk
-DiPkmr ad posh
.
:.
dLmImtMIbimriu tjwdkm3cW.rhto hkm6dundanJSwhA-. c : ;--T M,mtilhedSehthcrCn.lnfoawsehnwairlEa
Irk
& m.uqe wdwin
nrlm
EbnkrX
,: .wsqewmbldlucnlueln
DNbuuhudaSdnb.wbmebn&
the diferences in growth between Sub-Saharan Africa and the East Asian high performers. WhIiatis most striking, however, is how lirde we are able to account for differences in growth rates between the HPAEs and other economies 14 on the basis of conventional economic variables. We are able, in the end, to prcdka only about 17 percent of the actual difference in growth rates between the HPAEs and Latin America. We do somewhat better betweenSub-Saharan Africa and the HPAEs, predicting about 36 percent of the difference. Controlling for their superior rates of accumulation, the HPAEs stil outperform while Sub-Saran Africa or Latin America derperform the statistical relationship between accumulation and growth, leaving much of tie regional difference in per capita income growth unexplained (even though a large fiacton of HPAE success is expiained).1 5 They have been apparendy more successful in allocating the resources that they have accumulated to high-productivity activities and in adopting and mastering catch up rechnologies. Evidence from Estimates of TFP Gnxvb change captures both of these important aspects of productivity growti. Te is estmated in a neoclassical fiamework by subtracting from output growNtthe portion of growth due to capital accumulation, to human capital accumulation, and labor force growth. In keeping with this framework we estimate TFP change for eighty-seven economies
iTP
54
GROWTH,
EQUITY.
AND ECONONIIMC
9C1H .
*~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
iup,2
pwe pfnwi
.,.
UFAA.
.ad
wu,f
t-
li2
..
,s''0'
Rel-"
- -"' '';'
A.Mm
~~~~A4i.ORD
(;0) 130 0.2
.-
fm.
0.17 136)
H -1,
.<
rs ,,;:.-. () (4).
;-
-013
( 4b
., ,h
M-. P11
CM!
(11i2
L9
15i200 ;
(I 4
3,0'..
~~~~4.IM
2.32
using a produc-ion function esdimated with cross-economydata. (The techniques are discussedin appendix Li..) Figure 1.10 plots the resultingrTr growth rstimates for 196049 against relativeincome levelsin 1960. There is greatva-riance in the rates of n.' growth among low-income economies.A number of develo'ping economicsshow higher rates of TEP growth tha industrialeconomies,consistentwith the possibilityof largecatching-upgains.Many others,however,have lowor even negativi rates of productivitychange. The East Asian economiesstand out sharply, withahigh absolure levels of TF. Five HPAEs-Hong Kong, Japan. Korea,ThAand, and Taiwan,China-are in the top decile.The other three HimaEs-Indonesia, Malaysia,and Singapore-aze closer to TF' growth rates in high-incomeeconomies (about 1.5 percet), but are still in the top third of alldeveloping economrues. Presumably, in the high-incomeeconomiesmost ofthe estimated'r growth is due to advances in bestpractice,which explainsdthir relatively compact distribudtonofTFP hrates around 1.5 percent a year,and the tendency for IT? growth to dedine with rising income among the high-income coonomies (see figure 1.10). In low- and middle-income econozPrwst, howevr, changes in *rTFP must rcflect more than technical progress,othierwise we would never find negativeTF growh ratev.We have already argued that TFP growtd for low- and middle-income -economlies conains an element of catching up to (or fing behinde) bT-pracice technologies.(The relationship between technical change and catching up is discussedin appendix 1.o1.) Bu TFPgrowth rates in an 55
Relative to 11.S. GDP, 1960 Fadeor Pmodndivty Growth, 1960489, andGDPperCapita Figure 1.10 Total
1FPgrowth (percent paryear)
Taiwan. China
~~*Hong Kong
*Japan
*Rep. of Korea Thai!rd

3 -
2 -Indonsia *Malaysia U
*5
-2~~~
-2
0 0.2 0.4 0.6 Ratioof GDPto U.S.GDP, 1960 0.8 1.0 1.2
Source.World Bankdama.
one-sector, cross-economy estimate will also contain an element of allocative efficiency; economiecschar allocate physical and human capitcal to low-yielding investments will have low or negative estimat-ed TFP growth .rates. The dclarest -demonstrations of this ane the thirtee-n economies with negative output growth. and positive accutmulation. Thus our estimates of TEP growth answer the following question: on the basis of the average efficiency with which physical and human capital are used in the world economy, does accumulation over- or underpredict income growth? The answer is that for most low- andt mididle-income
economiesit overpredicts,while for the
HPAEs it underpredicts.'
Under very restrictive assumnptions(see appendix 1.1), we are able to we.recatching up offer some speculations concerning which of the H-PAEs
56
GROWTH.
EQUITY.
AND
ECONOMICC
to best practice between 1960 and 1989. To do this we assume that the elasticities of output, which should be used to calculate TIP change,are those that apply to high-income economies only. These more allocativelyefficienteconomieshave elasticitiesofoutput with respectto both physical and human capital that are higher than those for the whole cross-economy sample. We subtmct the averagerate of TFP change for
the high-incomneeconomies, which we have associated with movements in international best practice, from TFP change estimated using those higher elasticities to get an estimate of technical efficiency change. Using this metlhod, Hong Kong (2.0 percent); Japan (1.0 percent); Taiwan, China (0.8 percent); and Thailand (0.1 percent) are the only HPAEs catching up to international best practice. Korea (-0.2 percent) was essentially just keeping pace with technological progress in the highincome economies, while the investment-driven economies of Indonesia, Malaysia, and Thailand were falling behind international best practice ac rates of 1.2 percent (Indonesia) to 3.5 percent (Singapore) a year (see table A1.3 in appendix 1.1). When the HPAEs are contasted with other developing regions, however, their ability to keep pace with intemational best practice seznms somewhat more remarkable. Using the same method, we have estmated rhe average rate of technical efficiency change for Latin America (-1.4 percent) and Sub-Saharan Africa (-3.5 percent). Against these benchmarks, all the HPAESexcept Singapore stand up well in their ability to keep pace with the world's shifting technological frontier. 7 Although the absolute magnitude of TFP in HPAEs is higher, so is growth. Is the proportion of growth due to TFP high? On the basis of an analysis ofsources of growth forasample of economies, Chenery (1986) devc-cped a typology of the contribution of TFPgrowih to total output growth by income. A typical low- and middle-income economy had a relatively small contribution of TFPgrowth to total output growth, between 10 and 20 percent. High-income economies, conversely, derived about 30-50 percent of dteir total output growdt from TFPgrowdt. Figure 1.11 largely confirms this pattern for low-, midcle-, and high-income economies. Only seven of the fifty-nine non-HPAElowand middle-income economies have contributions of TFP growth exceeding 33 percent, while for the high-income economies it was much higher. The HPAEs fill into two distinct groups: investment-driven and productivity-driven economies. The investment-driven economiesIndonesia, Malaysia, and Singapore-conform to the developing-econ57
&EAAS4 ksA N M I RAC L E Figure 1.11 TotalFactorProducti Gmwth of Factor Inputs,196049

TFP Growth 1960-89 percentpar yer)
Dueto Growth and Part of Growth
v 4.
,\
4. . ".
' 8%
4.
s~~~~~~
10%
4. 4 '. 2966
4. ': . 3[
.4
2 .
4.
.4
.
64
'4
4.npan
*Ta"n.Ch1na
4.an
.*
D4
0%
Hong Ki
.
-
.4
4.
.4
'2%'
-4~~~~~~4 r _ 0 4
.4 .4.
.
4
.4 '' .
1E
4 *. 4.__ '
N .4
Highincomeecon
om.
HPAEs Othiordevelopingecornomles
.4
-2
TOtalbector hipLrt growth (percent
4 per year)
Note: Dashcd line:s tcprcscnc:
toul 2vcngF GDP growch raus, 19650 89.
Soli rays reprewnsi
Ehe contributionEotoclJgrowthby TFP growth. 11993): World B3ankd2m. S#tirees.Nchru and Dh2rcshw:ar
omy pattemnwithalowTFPcontriburion. Conversely,theproductvitydriven economies-Japan, Korea, Hong Kong, Tliailand, and Taiwan, China-are more unusual and look-more like industrial economies,
widi a highicont-ribution of TFP (above33 percent). China'srecent

growth (seebox 1.3) shows some of these characterisEics. The EIPAEs are unusualarrong developing cconlomies because of the
relatively importantrolc of TFP growth.Evenso, we find, consistent

=:
~~~~~~~~~with our previous findings with cross-economyregressions,that be-
tween60 and 90 percentof rtheiroutput growthctcrivres from accumulation of physicaland humana capital. Producdviry changehas been
higher than in other cleveloping economicsand is importat to the East
Asiansuccess stor. But it

''- s8
is nor
the dom-inant factor.
GROWTH,
EQUITY,
AND
,~~~~~~7 -: .
-..- -1
EN.FECNMI(.;OWFI.'EAST..o; ln im.est:-an-astoundiiien3-... 1 men

'@-'
G..P.. ii. rkia improvement:

-.
4.
d a
---on..of.m
B-soxn Tnhe Chnese M ac

A
,111a 'S;!
;:.tc~~~~~CtW
i
-. i-. r ;. o
I;anoa45!"26
...- 7 ] ' ,jp, =;^
Ati:wud-btcmle dout.'i cosdeaontf,: -, - - o - a~v>s i-Y:
;--tic t
;!.
smc -
17.ase
in
S . C6ns1ump'non.ldf-I
em
e.-
:-
NO--. ASSESSMENT tECns-Ofi OFapn=en GNOMiC Odm sIlas T nvest aatu n 30erearonspnit su'' i y -?-ea;.e; .. -aea. y .n-ca...r o"' .& ow.. ub -b&&mpledy,tcu.wir-thourconsideadolsm.he 7 1- 1 4-49 f4..r.; . met 17hasoa see a 1978:t.v lnlfunaln akdimrvmnt 1, Asia.e wofd: :. v_of e19i8_8 oft tZ' sinledo -, - ,/~ t.o. g~~~~~~~~~~~~~~~1gtCnM-;.. _..;ie-.t ze. ^ ,5m ;9 ,P;A,E_
4
op.
in
t
-~~~~~ Ghina's
!-
.9.s
_.
mwlgg -wcm<tj~ ra .tame~~nt pronne: , = -r { to t; --'v '.. - a -> - gpal x >; T - i fyn .. ' WrtL
fsh
te.-
gntao e .a>mos', -s -o wld tuc,:2E, - ;...s _ JWiflg'staiildsgo f r. thia.za,utOr19 comaierdmds.
-; ,: -rpDi gr.d.m7
-, :;
-j
%AAuciMAdannbaawaL.I 4 .4<. . .;;>t;!-<,.+<-=.<-2. .&zt ,'4-
e.orublihgnedpopuation oFalleigh-sbonomf mC - l sour;& W:nimal2'peror inp the > CWfiyP w; .i-heiAEwdbledYfroi 198 . !, , ^W3- . , : -s
5
'"-f
;!n
;i'9
iesebq dir als't?
>-.-
4'
Ona
ar>a.a-. lled,c-;l
evemen ;'ba and .. recorde.av-nna gewdoflocDeta;ose . Bt'.*.urdiW4oremteonents d. GNPud

-~ ' -'n
Jdp
be-at termeo d an'
eo
government-fbszeehxci&
gnll;6roucy
slXRoiinsgwing
'g
non ti tliey
ton' 'health, and ie Cinacrnoeuhhiiiicsr.'bili'ty, .,China --- ~~~gecrber wdt 2 jrcenr ihcreincrTpjancs w .:erenr'n~lso0,o :onowicjmeifChina nuiFxceibk4f%lorX televi ia ksit ?r 9.leibusexiosnS.-' iScr&Did1t0 -r.carmEa-relm.t .;: eoetsn: 1d16&arnvtlper. alddyinnually ill aulEzdiD S t- fro<i;vasmessof,CltinE.lIiaks B-, edswmgatn,oterenmdyrai&y.avo&hlltaed .~R-<ftrnEm l ta baarmcsinvsted T in.ms. Uk8 Jx:o5 in 1990.-uds,-, inXrw nsip-nd 1u.4;>pcrct}en t,;saviing 1979 Asih'soCre H'Fi growdi-n; -t zessment ass, tonenili7 ph-:h^S '&rf or .ii iah&isi Af&0MF1982wjt 198~Fo bier-retreii.chmin aeti~se.Czi il
8iehi tharS.comc.cauamlgyihsEhEr Droblcmanc. rcM'4&44eii&
p rapid -~ X-.-&WZn n iY-.U:-.-e.,;nomy;Tas 4-breald&&ckfTt2r|n
v-~~~~~~~~~~~~~~~frerLNqs gn rou, , ,-wzA; cottE tro {tsIea'te Ex St*n ovr the Ian.1,! ,e5Lrv Ttpo*k-^nm~uvcs as -- ixbiJqjig
onpmentn,,T-i.rW s
-:
3)1125
mg
anL ndshi h~iidM suFpn4dealbi.tiowih c
p"-'u
'.
tt
-ikA'r.-.--oer oftheecopnomies in-inour
stud_
-Ci
our-p si
... ,
s ofsms Ch-inniaksj
4.-
.nd~ W dof high terms reductions un rates captala ind ininequali a

DeoDkallewedEom Dvmosmce-EF
eee
e&oiiozfies r s, A
flSnr
&n2
wererrm a -r:S,
i aeynwichiuecnvinwg cmpa- od wheno %ro r

4-
t_.h.._
ip noive
jDiledyLbr.i of
-C$Qeiiid
oAtes
r..
~~~~~~~~~~~~~~p~~~~~~6~~~~--Ie
,sfxpd
;
nu"C-S
t,s.
.:y~~~~ ~~
--. .
--
'
";- iebhn comesstI i
tbknaii& chea
ha ghptr,wth
mb et44 efiuiiveN~rpsgy grwhanx-du&v

.w
aIst..aa'~~~~~~~~~~~~~~~~~~~~~5 r in achieving theEast Asian economxies' success We havedescribed hlighrates of growth and redluctions in inequality- These were accompamied by-.agricultural transbrmnaions, rapid fertility dedinci, andmau factured. export: growth; and accounted for by rapid accumulation of physical'and human capital and by productivity growth. What policies lie behind this success? In the next chapter, we examine alternative cx-.
59
CLE
planations of the relationship between public policies and economic success and particularly the ways that public policy can lead to improved economic outcomes. In subsequent chapters, we explore the relevant policies and their apparent links to the inputs and outcomes we have described in this chapter
Appendxc 1.1:Accounting forGrowth
IN
THISAPPENDIX WE BRIEFLY DESCIBE THE MET HODSUSED TO estimate the relationship between accumulation and growth using both cross-economy and producton function methods. We also compare our results with other resulrs available.
Cross-Econonm Regressions
The cross-economy regressions employ the basic specification of other cross-economy growth smudies(Barro 1991; Dc Long and Summers 1991; Dollar 1992): (1.1) GDPG= f(L ED, LFG,RGDP6O)
where GDPG is the average rate of real per capita income growth using Heston-Summers' measures from 1960 to 1985; INV is theaverage share of investmenr in GDP for the period 1960-85; ED is a measure of educational ataiunment LEG is the rate of growth of the economically active population, and RGDP60is the relative gap between per capita income in 1960 (at 1980 U.S. dollar prices) and U.S. per capita income in 1960.'; Mankiw, Romer, and Weil (1992) have recently demonstrated that this specification corresponds to the transitional dynamics of an enhanced neodassical growth model with human capital. Table Al. below reports our basic results on the relationship between accumulation and growth. The estmated equations compare fiavorably with other studies using similar specifications. The overall fir of the regressions is good, and the coefficients of the variables are ofthe expected sign and are significant at conventional levels (0.05 level).' 9 We have also estimated the basic relationship fir two subperiods, 1960-70 and 1970-85. The fit of the regression is markedly better in the earlier 6o
GROWTH.
EQUITY, AND,
Table A.1 Deterinants ofGrowth

(dependent variable.-per capita CDPgrowtl) Smp-pe
Intercept-, rio 196 Nwnberofobsennrtianr
-965 1413
-0.0070.
.19160-70 1.970-85 .11.3 11.3

0.0064. -. 16
1960-5 61
-. 04
-1960-85
"98
004
.196-55 5
0.0243*
*(0.0079):
GDPrelativeto U.S
(0.0092)
:(0.0109),
(0.0113) 0.0408** .0.0247"* 0.0082)
0.8):
(0.0094) 0.25 016)
1960
l
-0.0430"
(0.018)
:-0.0444*
-0.0422*
0(0.0103146
-
-0.0292'
(0.0133)
* Drw.xynrolircnt, 1960
0.0264*" 0.0169' (0.0065) (0.076) 0.062 (0.0139) 0.0192 (0.01G2)
0.034" 0090
~Secondary enrollment,1960 .Educational attimemnt, 1960

Grot of population, 1960-85
. -
0.09 .07 (0.0.192) -. (0.0180) 0.03 0000)

-0.0002
0.0013) .0.4290
.:
0.1015, 013 0.2738. K ~~~~~(0.223) (0.2592) 7(0.3083)

.00578*
,
-0.0450 0281
-0-3135' (.251 0.086"
(O.64
1'.-
Average InvestmendGD,. 1960-85'

. - -
0.1153"'
~~~~(0.0224) .(0.0260)
0.0201 (0.0309)
(0.0245)0.3100"
Avrge'qupmentinvestment
* GD?,.1960-85
2 Adjusted R
-0.3050"
(0.0721)
*
~
0,1893
(0.0743)
~~~0.3480 0.3424
0.1921
0.36
0.2614
Safl1ilM sgtfintt the0.01 II~ Staisdeally iignicattth 0.5 lve * Ne Coffiien istopnumber mn each ceIL.Smiinkdanirrris in parahee SOUIrcZWorld Bank staffestiniares.
two periods, but in most respects t-hc' parameter estimates have similar values and significance. The major exception is the coefficient estimate on investment, which becomes insignificant in the period 1970-85. Table AM. also reporcs on two e%frcs to examine the impact of changing the basic specification. DeLong and Sununers (1991, 1993)
have argued that equipment investment,rather than'total investment, is

a superior explanatory variable for per capita income growth-When the
investment share in GDPis replaced with the share of equipment investment, the explanatory power of the regression is improved, and the co-. efficient on the share of equipmrent investment is highly significant. Our sample size is much reduced, however, and we condude that the reduction iniresidual variance is not sufficient to justifyra change in our basic specification'. Because school enrollment may not be a good indicator of Gi
,*
1IRA
C LE
human capital accumulation, Barro and Lees (1993) measure of educa-
tion stock,basedon populationcensuses, can be usedin an alternative

specification.
Deviationsfiom the regression are estimares of labor productivity clange that cannot beattributedto accumulation-investment in physicalor hunan capiral or to the component of TFPchangeassociated with
relative income levels.The patterns of productivity change resulting from the basic specification of the cross-economy growth regressions can be seen in figure Al.1. The figure plots the partial scatter of the relationship between growth of output per capita and investment, controlling for human capital and the component ofTFPchange related to relative backwardness. Per capita income is an increasing function of the share of investment. Observations are plotted relative to tle estimated regression line, and the HPAEs are identified The estimated productivity performance of the HPAEs is remarkably siillar to the pattern derived fiom the Fgm Al.l GDPGrowth Rate and AverageInvestment
Ouithagonal componentof GDP, 1960-85
Y.06 -----
Hong Kong*
*Taiwan; China Rep.of Korea*: * 0.02 F

-
*Japan
.
indon
ia e ,
s*!
ngpo
__
O002-
I*
.halwidi
--* - - --
~~
-
''*'
-0.04
..
* .0.06. -15 -10 -5 0 5 Orthaganal componentof I/GDP,1960-85 i0
H* HPAEs * OUuerd.velopIugeconomies
i5
20
Note:The Xand Ycomponents rc orriagouai on RGDPBO,PRIM60, and GPOPGO85,wherc RGDP = eal GDPpcr c2pim relativeco US. GDcper capita, 1960; PRIM6o =primy school enl]ncart am, 1960; G0PP6085 = grwh mre ofpopulatian, 1960-85. SourccWodd Bank dat.
6z
GROWTH,
EQUITY,
AND
EGo
estimates. All seven of the economiesare positiveoutliers.A dummy variabletaking on the valueof I for HPAEs is positiveand significant.
TFP
How WeEstimate TFP Change

Suppose that every economy has access to an international crosseconomyproduction function of the form: (1.2) Q =AF(K,E,L)
whereA is totalfictor productvity,Kis a measureof capital services, Eis a measureof human capita endowments, and L isa measureof laborservices in naturalunits Then growthof output per head can be represented as:
(1.3)
q--a
+ s k-l) + s (e-l)
where lowercase lettersindicaterates of changeand sA and sE are the dlasticities of output with respect to physical and human capital.The shamweightedgrowth rates of plhysical and human capiml per head give the contributionofaccumulationto growthin output per worker.TEPchange can be then found as the residualof gowth of output per workerafterdeducting the contributionsof human and physicalcapitl accumulaton:
(1.4)
a = (q-1) - s, (k-l)- SE (e-0.
Under assumptions of competitivefactor markets and constant returns to scale,s,K and SEare equal to the income shares of factors.Thus most
empirical applications of equation 1.4 estimate the output

20 efficientswith income shares.
elasticiy co-
Sinceincome share data are not availablefor most economiesin our sample, we instead estimate s5 and sE direcdy using a simple, crosseconomyproduction fnmction.The data for this analysisindude a new constant price capital stock data set (Nehru and Dhareshwar 1993).
Measures of human capital are incorporated in the specification using
Barro and Lee's(1993) measure of educationalatainment. We regress

annual log output growth on log capital growth, log human capital
growth, and log labor growth during the 1960 to 1990 period,
constraining their coefficients to sum to unity (that is, specilig the
production function to be Cobb-Douglas).We also indude cconomy63
RLIRACLE
specific dummy variables to estimate individual rates of TFP change for each of the sample's 87 economies. Table A1.2 reports the production function parameters and the estimated TFPgrowth rates. One striking finding of our analysis is rhe low elasticity of output with respect to capital from the wholc crosseconomy sample. This is not altogether surprising. As we pointed our in chapter 1, there is a subset of developing economies that has positive net investment and human capital growth rates but negative output growth rates. In effect, the marginal product of both physical and human capital was negative in these economies, reducing the elasticity of output of both physical and human capital in the production function based on the whole sample. We have reestimated the production function on the basis of only high-income-economy input-output relationships.These results and the estimated TFPgrowth rares are displayed in table A1.2. The elasticity of output with respect to capital in the high-income-economy production function rises to more conventional levels. TFP estimates, particularly for those economies with rapidly growing capital stocks, are
to Capital ISKI,Labor(SL), TableA1.2 Elasticity of Output withRespect andHigh-Income Economies andHuman Capital (SH):FullSample
Obsations Fullsample 2,093 SK 0.178
rtaO
SL
0.669
(t-)m 6.411
. SH
0.154
(f-stat
1.49
10.895
High-income economics
Ruling
460:
0.399
10.237
0.332
1.679
0269
1.476
&ximafi r t HPAEs toasaifacuerprodsadvi4ygtou*h

0
; - - - -Eonomy/region. Hong Kong Indoncsia
TFPrwsA ; ; -0t;t(filsa5Jmpk, . parpameer 3.6470 1.2543 3.4776

3.1021
TFPwtb1 (ldg-im v:j ates) 2.4113 -0.7953 1.4274

0.2355
.te
Japan
Kore,.Rep.of
M2;ysia sing2pore1 Taiwa,China -
1.0755 1.1911 3.7604
-ThaiLnd ~+ - ~0 LatinAmerica ~
--SSub-Sahv fric'
;
2.49600 0.1274;
-1.3369 -3.0112 1.2829 0.5466 -0.9819 -3.0140
-0.9978
a. Alsoincludes Tunisia andSouth AfNic:Sor- World Binkda:L---
64
GROWTH.
EQUITY.
AND
ECONOlT
correspondinglyreduced.The pattern of productivitychange,however,

with the five productivity-driven H'AEs fiallingas outliers in the distrib-
ution of developingeconomicsis maintained. (SeefigureA1.2.) It is possible to compare the consistencyof the TFP estimates presented abovewith other independent estimatesof TFP growth in a large sample of economiesto test their robustness.Using a data basederived
from World Bank real product data and alternative estimates of constant price capital stock, Elias (1990) calculates economywide TFP growth rates for a subser of 73 economies using standard growth accounting assumptions. The relarionship benveen his results and those presented above are summarized in figure A1.3, which plots the scatter of Elias's estimate of average TIP growth during 1950-87 against our estimates. Fischer (1993) has also presented a set ofTFP growth rates for a large sample of economies. A similar plot of his results against ours is shown in figure A1.4.
Figure A112Per Capita Output Growth andCapital Stock Growth, 196089

Percapita output growth (percent)
Taiwan,China
*Rep. of Korea__---i;
*S.ong Kong
i @
*Singapore
*Japan _
-
Thailand
-
, --------
*MalaWsia-----'
Indonesia
is
0-
2 2 ~ 6--
- 4i t' ;
I
MS '-__
Capita-growth -pL _
----
_ - _ _ N4igh-Income economies
9--0
--
Se S Fl 0D sa.k
et
.06@(2*
rwh
*NPA~~~~~~~~~~~~~ tes eelpn economies
510 capita growth(percent)

--
1520 High-Income economies GDPgrOwth= 0.010 + (0.395*K growth) Full sanuple; GOP growth =0.0076.+ (0.23*K growth)
Soure.rWod d Bankdata
65
MA.-IvIR AC LE
Figure 41.3 Compadson ofTotal Factor ProductiNt Cmowth Estmates

TFPgrowth camparator (percent)(Ella) 4.
3 2-
0*
~~~~~~~~~~~~~~Singapore
-Taiwan.
Ohina*
0--
-2 -----
a Hwighicomneeconomies. A * Otherdeveloping econiomies
-3
-2
4.
0 TFP growth, 1960-99 (percent)
Snuru:vElias(1990a); World Bank data
Both samples show sim-ilarlygreat variance in rates of TrP growth among low-income economies, while the high-income economies are rather closely distributed around a mean ThFPgrowth rare of about 1.5 percent a year. There is also great consistency between the relative ranking of TEL? growth rates for the HPAES. The same productivity~-driven economies-Japan, Korea, Thailand, and Taiwan, China (Hong Kong is absent from Fischees TF' estimrnaes)-are in the upper quintile of both distributions, with the except:ion of Thaiand, which under the Fischer estimate is still in the upper half of the distribution but is not in the upper half under the Elias esrimara-
TechnicalPrmgress and Technical Efficiency Change

As we pointed out in the conduding section of chapter 1, it is difficult to disentangle the relative contributions of allocative mistakes, technical progres, arnd technological catch-up to rm'growth, especiallyin a crosseconomy, one-sector setidng.One way of separating the concepts of tech-
66
GROWT1,
EQUITY.
AND
ECCN
Productivity Growth Estimaites of TotalFactor Figure AlA Comparison

lVP growth comparator (percent)(Fischer)
3 -- __
----
-3-* O -2 --,:in I~~~~~~~~~~~~~~~~~~~~~~~~~~~awn Ch_ econoiesn ~~~~~~~~~~~ Hlg-,h4ncldoesau

of Korea
O-
~ ~~
~~
t.~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~Rp
/~~~~~~~~~~~~~~~~~~~~~
economies Whetdevlfoping
-3
-2
-1.
1 0 growth. 1960-89 (percent) TiFP
World Bankdata. Sources: Fischer (199,3);
nlologicalprgress and changing efficiency in the use of technology istO
model formally the relationship between observed output and bestprIacticetechnology;We address the relationshipbetween accumnulation,
productivity change, and growth using a simple neoclassical model. Following Nishimizu and Page (1982), we define an internationlally accessiblebest-pralcticeproduction function of the form
(1.5)
Qf(W-=F7(t#]t
is porential OUtpUt
where Qf(t)
at bestpractice, and Z(t) is a vector of inl-
F(.) satisfies puts in natural units at time t. We assume that the frmncrionx the usulalneodlassicalproperties and that an appropriate aggregate index
of OUtpUt exists.
The best-practice function defines the "stare of the art" in the sense
that fulrther increasesin output at given levels of
inputs
can.not
be
achieved without the introduction of new techniques. Firms can move along pract fnctin, incrain theuse esult of accu-
-67
MTRA CL E
mulation of inputs. The introduction and dissemination of new techniques move the best-practice frontier and is tchnological progress as defined by Solow (1956). Observed performance in a sample of 2 1 Rather, most economies or firms reveals that few are at best practice. -lie below the production frontier due to use of dominated techniques or to inefficient use of best-practice tcchniques. Observed output Qfit) For a vector of inputs Z(:) can be expressed as (1.6) Q4) = Q%ft)eu (t)
-
ON,t) e u
where U) is the level of technical efficiency [0 c eIt()= Q(t)lQf(t) < 1] corresponding to observed output Q(t). The derivative in logarithms of equation 1.6 with respect to time yields:
(1.7)
Q (tOIQ( =
(t)IZ(t) + Ft +u- ()(t)
Figure A1.5 TheGrowth

andOutputs of Inpuis
Output-labor
where F and Eare the output elasticities of F(Z(t);t) with respect to inputs Z4-) and timnce and dotted variables indicate time derivatives. Output changes in cquation 1.7 are decomposed into three main elements. The first one gives output changes due to input changes, weighted by the elasticity of output with respect to each input. This is the component of growdt due to accumulation. The second element is the rate of technological progress of the best-practice frontier, and the last element, u-et), is technical efficiency change during period t. While i; is always non-negative, u *t) can be either positive or negative. We define the rate of total flacor productivity change as the variation in output nor explained by input changes. Thus for any observation, i:
(1.8)
TFPJ(t)=
F+ u -(t).
:: fflz qo f- -0
_
S; -
is the sum of technological progress, measured at the frontier, and the change in efficiency observed at the individual level. These concepts are represented in figure Al.' 22 We assume confh stant returns to scale in capital and labor. The international bestpractice production fitnction, fJ,relates output per worker to capital (induding human capital) input per worker. Economies that are tech- k capitalout-u nically inefficient operate along functional relationships such as f in
A-
68
GROWTH,
EQUITY,
AND. EC
figureA1.5.23Catch-up can be achievedby movingfrom a point such as A to D, combining accumulation with a movement toward best
practice. T!-,s reinterpretation of TFP diange is useful in understanding the
sources of rapid catch-up in technologicallybackward economies.Industrial economies,which employ international best practice, are limited to rates of TFP change determined by the rate of technological progress, zvi(t)= 0. Economies that do not employ best practioe can have progress if technical TFP growth rates exceeding the rate of technological -efficiencychange is positive, icit) > 0. It is also possible for TFP change to be negative, if technical efficiency change is negative and greater in absolute value than technological progress. A rapid shift from average practice to best practice-positive technical efficiency change-can provide a powerful engine of growth that is recorded as high rates of (TFP) change. There are two possible approaches to the estmation of the model outlinecdabove. One wvouldbe to estimate the best-practice production function aiLdderive estimates of both the rare of technological change and the rate oftechnical efficiencychangc3 4 This approach is notsuited to the cross-economy data available, and we do not employ it. An alternative is to measure TFP change direcdy by growth accounting. Since measured TFPchange consists of both technological progress and technical efficiency change, we impose the strong assumption that technoTableA1.3 TechnicalEfficienq logical change, the movement of best praaice, is constant and does not ChangeEstimatesforthe HPAEs 2 5 I enbikid vary across economies. Under this assumption all of the variance in effdciency rates of TFPchange derives from variance in the rate of technical effiw -60-89 ciency change. ' lkEcoJomylrqov/g t-.1960L9 HongKong : 9714 We have argued, however, that allocative mistakes were partly reIndoneia -1.2352' sponsible for the low output elasticities in the cross-economy producJapan -. 9876. ton function estimates. Hence the high estimated TrrPgrowth rates of -0.2044 Ko Rep. of those economieswith rnid factor accumulation may represent allocaCM a~Mlaysia 1L7767-3;4510 Eive efficiencvmore than either technical progress and technical effi0.8431K Tanvan, China ciency change. To address this we use the parameter estimates of the high-income economy production function on the grounds that these Thaiaind 0-OI67-i-t LatinAmeca- -- i :17 economies are the most allocatively efficient. We then sub tract from the estimated TPP growth rate the average TFP growth for the high-income SubSdiaAfi 34539, -j economies, our estmate of technical change.: The residual estimate of 1 a.AI inudesi,Ttnisiada .. . tedical efficiency changeis presented for the iihPP and other regional grouping in table Al .3. -
-:~ 0 ::~ ~ ~
~ ~~~~~~~~~~~~~6
MTRA CL E
DoTests 1.2:'What Appendix Show? Skills of Cognitive

in perTests provide a convenient quantitative measure of diflFerences formnance.By providing a consistent instrument, it is possible to compare the performance of students in different learning environments. The key is objective versus subjective assessmenr. It is important, however, to recognize the weaknesses of standardized tests. First, rests evaluate only a limited range of skills, and there is no reason to be confident that the mastery of skills tested is highly correlated with the mastery of other skills that may also have an importnt influence on subsequent productivity in the labor market. Second, tcsting skills, not just cognitive skills, may influence performance; if there is significant "reaching to the test," both the predictive ability of test scores and levels of skill in areasnor tested may fail. Differences in the curriculum may also account for some of the observed differences in performance (see Hanushek and Sabor 1991). Tlhesecriticisms suggest thart whenever possible, evidence firoma variety of rests should be reviewed before reaching a general conlusion. While internationally comparable test data are not abundant, they are, however, consistent with the results already noted. Table Al .4 shows the performance of thirteen-year-old students on a stndardized test of
Age13 Years Each Level of the MathemacsScale, at or above Perfoming of Children Table AI.4 Percentage
,,,,m/nvnc _
::and
|^s m&mac!;,t,
.
simple
,'problems !
;
p0kn
two-step' ab/s
Udrtns -o.c-ptP
Ar - . -nria'
-*U
-Biish ,Irelirdant,
I
b
-
100 ;a 98-.
6 -
8t
. 95; 95
92
69 55 78 -65 58
5
- :.
24e14
2
-.
ea;-.RpNewf wkC
N-w BfÌlik.
lh
(Frenc)
JE~igIish~
100--. 100 .5
;100 .99
.
.
:4
18
12
.16-
5 1
-.
1
J Onrado
-
tquebe(Fwnch)
:::-87
.tg :-78
~100.
3222
55
70.
GROWTH.
EQUITY,
AND'E-
mathematicsadministeredby the EducationalTestingServicein a num2 6 Students from Korea ber of different economies, including Korea. of problems.The performance ranked first in cach of the five categories
gap between Korean students and the others, all of whom were from high-income economies, was greater for higher-order skills. The International Association for the Evaluarion of Educational Achievement also administered mathematics tests to thirteen-year-olds in 1980-82 and included children from Hong Kong, Japan, and Thailand among the children from twenty economics in the sample. Figure A1.6 summarizes the results for algebra,which are very similar to those for arithmetic, geometry, and measuremenL Japanese students rankled first, students fiom Hong Kong were in the top half of the distribution, and students fiom Thailand -werenear the bottom, at about the same level of performance as students fiom Nigeria. Figure A1.6 TestScores e:: Algebra Tests:Selected Economies
Swazland Luxenboug Nigei _
_
.-_______
____
______ _ -.
Sweden
Thailand
Now Zealand
England and Wales
Canada(Ontado)
-_
_;
United States Scotland

Hong
Kong
Finland
Israel
Canada (Br Columbia) Belgium (French)
Hungary
_.
. i
____
_ __ ____ *
Netherlands Belghirn France

Japan
i
_*- _ _ __ _
__
20
40
60 Mom score
80
100
Souwe Hauvsheh and Sabor (1991).
7'
- M 1 RACLE
These results reinforce the conclusion that in some East Asian economies cognitiveachievementlevelsexceedthose in other developing economiesand match, or exceed,those in high-incomeeconomies.
The results also suggest that just as Thailand has laggedthe rest of East
Asia witl respect to rates of enrollment in basic education, Thai children also lagwith respectto levelsof cognitiveachievement.
Figure AL7 #-Lii Coefficient andCW perCapita Growth Rate, 1965-70

G1nl coefficint
0.7
;-
'
* Gabon
-16 --- .
~~~~
Venezuei au
i Peru
L-eio
*Colonmbia
j Chile Malaysia
'Brazil
Singapore EZamba EHong Kang
0.5
,-
-~-
U~~~~~~~ -~~~s~Phiil;Dlr ~ U Philoianes

E Argentina
-
t 0.4A--4---
Sudanu
Sudanm
N~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ ThailandI *
*lnldia
*SrlLankau
Olcoe-
I * Pakistan ' X3---X--i
TaIan, CaJapanU Chinau *Rek'rwa
0.2-1
----
-----
'-----
-
!
* O .
'
'
:~~~~~~~~~*
-0.01
0.01
0.02
0.03
0.04 0.05 GDP per capita growth rate
0.06
0.07
0.08
0.09
0.1
SaurceWorld
Bank darm.
72
GROWTH,
EQUITY.
AND
_|O
Fire Al.8 Gini Coefficient andGOP perCapita Gmwth Ralte, 197180

rlnl coefficlent 0.6 ----- -
-enya
NCOI
IPeru
iBrazil MeVdcof
I r
EZambla
Nepal CWIie
i
enezuela
*Malaysia
I
i-t OA -
j
. . .: , *ArgenU;tinda ,_,,_hdiaE
------
EPhillippines I
* Singapore E~~~~~~~~~~~Horg Kong

Indong Idnea * Rep.of Korea Taiwan, China.
0.4j
* Banfjadesh *~ L.~
02
--1 --
1111halland
--
|1apa--
0.2-h
.
0
-- , .0.04
-0.03
-0.02
-0.
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.08
GDPper capita growthrate Source World BankdataL
73
MPI RACLE
Figre A1D9 Gini Coefficient and GDP per CapitaGowthRate, 1981-90

Gilnl coeficent
XMexiao
EChile
Venezuela
!
0.4 0.3
Argentina *
Peru* Philippines - ;>
alyi
l-~----------EPeru-O
. -
Ehilane EThailand
_-ngapo re
-
M Hong Kong
Rep.of KoreaU
I~~ .
--I n-,donesiaE r - _-**Talwan.-China -
~~~
.'-
~~~~~~~~~~
.
I .
~ ~~~~~~
U.1~~~~~~~
-0.02
-. 01
0.01
0.02 0.03 0.04 CDP per capitagrowth rate
0.05
0.06
0.07
0.08
Soun:Wo rid Bank data
74
GROWTH.
EQUITY.
AND
EC
Rates, 1965and 1987 Gapin PrknaryEnrollment for Gender Regression Fgure Al.1G Cross-Eonomy
* Pakistan 120.61
I
>-
I I
1987
1965
987
di
E Indonesia [-5,
~~~~~~~~~~-~~~~~~I
.-
E i
maliand 1nd %ralaysna

[-10.t6]
~~~~~[19.21
I
'-
*Pahistan
N [5.1] jRlof Korea t as21 Singaporeu;
\
I -
A-ndnei [8
a 14-31:3
-~~~~
^ Hong kng * \
,I
[-2.2]
2,50
0 o 500 2,0070 2,750 Pêr capita Incomer(1958 U5S doflars)
1,000
1,S0
3,500
show resiEdua Note Figue in brackets

Sowre: Behrnman and Schneder (1992).
-~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~[22 Enroilment Rates, 1965and 1987 Figure M41.1Cross-Economy Regression for Gender Gapin Seconldaiy
.
6, [7-7]At1
,,
}
* -Rep.of KoreaK,
1 ~~~~~~
4
~.a,
~~~~1965 I,
1987
i . .
a
Figre 0
*__Indonesia E37o.'j].
250
-
CosEnoIy
Soo
750
*-61
RersinfD
J-
edrGpin 2,M5 :1,750 2,000
eodr
noletRts SOD
1,000
95ad
1,500
,
30500
di
-
.L[.1, -
*P'akistani ,,
5ware. S Bdhmnan and Schncidkr (1992).

IndonesaKo3g.
913
residual Not- F4urcs in brucker show E ~~~~'Thailand * 70 77

E
.~~~~~~~~~~~~~~~~~~~16
~~ ~
~ ~ 29 P.r cap6a
-J~~~~~~~~~~~~~
1h
laysa) Mcame US. do PoakKontan

18.2]I
[-.2
.98
_ _ _ _ _
N Av~~~~~~~~~~~~26 1,750 2,000 0 250 750 500
Sn
apore__
Maayi
2,250
500~
~~~~~~~ 1,003,0 ~~~~~~ 1,00 ~ ~ ~ ~ ~ ~~3.4 rigN~~~~~~~~7
Per (In 1.998 capita U.S. Inconie dollars)Kore Nate Figures in ~ brackets ~ show residuals. ~ ~ Scarce and Behaan Schnidern(1992)
1[2.91
S I
A~~~~~XRC L E
Notes
1. As we pointed out in the Ovcrview,a strong argument couldbc made for indudingChina amongthc "mirade econorniesof East Asia. We lhavenor done so for three reasons: (a) China's recent very rapid growth has been highlyregionally concentrated;(b) the experience of and the very rapid growth is more reccnt than in Japan Four Tigers and than thar of Malaysiaand Thailand among the southeast Asian NIEs;and (c)-and most important-the nature of the economicpolicyframevwork in China is sufficiendydifferent from that of thc other eight economies, and is in such rapidflux, that it makesartempts to understandthe links bctwen public policyand growchon a cross-economy basiseven moreproblematic. We lookatsome aspectsof China's rapidgrowthin the rit as systenatmair.der of the book but have not tEratcd ally as the other economies. 2. High-income economiesare defined according to
rclative incomie to the United States in 1960. They in-
6. This basic pattern is observed in fbur individual economies-Korea, Malaysia,Singapore,and Thailand. The pattern fir Indonesia difers; real private investment dedined continuouslyduring the 1980sfroma peakof2O percent ofCDPto a low of 13 percent in 1989. 7. Behrman and Schneider (1992). The regressions control for a polynnomial in averageper capira income in the relevanryear.The authors usedper capita CNP at official cxchange ratesas the measurcof income. 8. The residualsfor Sri Lankaand Egyptare alsoabove the linein 1965. 9. Despite increasing its secondaryenrollment rate from 29 to 74 pcrcent, Hong Kong also fell wedlbelow the predictedlevelin 1987. This is becaLse,at $15,000, the per capitaincomeof Hong Kongwas sohigh that the OECD economieswere now its comparators. 10. Birdsall and Sabot (1993b) cite Stevenson and Stigler(1992),amongothers,who report resultsoftests in citiesofJapan, the United Stares,and Taiwan,China.Appendix1.2 reviews the resultsofother tcstscomparingthe cognitive skills levels of East Asian chidren to other students. 11. See appendix 1.1 for a formal definition of TPP growth.
12. This specificationis the simplest of a group of cross-economy regressionsthat have been used in recent years.These studies have also introduced other variables 3 This issue,termed"persistence," is explored by Easterly to address different questions-equipment invesrment, and others(1993),who find evenmorestiking evidence of De Long and Summers(1991); trade orientation,Dollar the uniqueness ofpersistent growdtamongthe HPAEs. (1992); endogenousinvestrment, Barro (1990). We have - not includedthesevariablesbecausetheyare not centralto 4. Hong Kong P-:d Singapore,which almost entirely our theme.This approach,whilegenerally associated with restsof endogenousgrowth theory is alsoconsistentwith lackagriculturalseaors, are exdudedfrom this discussion. neoclassicalassumptions (Mankiw, Romer, and Weil 5. Staristicalanalysisindicatesno significant (in the 1992).Arecenrconference, HowDo National PoliciesAfstatisticalsense)differenceof theseeight economiesfirom fectLong-RunGrowdt, summarizes the state of the art in other cconomiesin their share of total investment,conthis field(Eastely and Schmidc-Hebbel, forthcoming). troling for relativeincome levels.
dude Australia,Austria, Belgium, Canada, Denmarkc, Finland, France, Germany,Iceland, Isrel, Italy, Luxembourg, Netherlands, Norway, New Zealand, Sweden, Switzerland, Trinidad and Tobago, United Kingdom, and United States. Simple catching up by low-income economies,with growth rates exceedingthose in industrial economies, is defined as 'unconditional convergence' in the new literature on growth dteory (see box 1.2) and would be expectedto occur only under very restnricveassumprions,for example,equalsavingsratesand technologicallevels. Below we exarminethe concept of "conditional convergence," catch-up controlling for differencesin variablescontributingto growth.
76
GROWTH,
EQUITY.
ANND-EC
13. We have also estimated the basicrelationshipfor two subperiods, 1960-70 and 1970-85. The fit of the regrsion is mnrkedlybetter in the earlierperiod, but in most respectsthe parameterestimateshavesimilarvalues and significance.The major exception is the coefficient estimateon investment/GDP, which becomesinsignificant in the period 1970-85. 14. Easterly (1993) finds similar resultsfr the Four Tigers. 15. Useof a variablemeasuringequipment investment (DeLongand Summers 1991, 1993)enhancessomewhat the explanatorypower of the regression,though in a smaller samnple. An alternativeeducationvariable(Barro amasreo education stock, . b a ron san Lee.19) and Lee 1993), mcasurcof educationStOCK,based on population censuses,failsto perforn better than the pmaty enrollmentrare.
18. The studies cited arc listed in note 13 above.We hlavenot included these variablesbecause they arc nor centralto our theme. 19. The magnitudeof the coefficienton investmentis lowerthan thatreportedin Dollar(1992) for hissanmpie of 114 economies(0.113).The magnitudeof the coefficient foreducationis abourthat givenin Dollar'sresults,and the coefficientfor RGDP60 is essentially similar to the results (1991). obtained by Dollarand by De Long and Sumrmers 20. This literatureis brieflysurveyedin Nishimizuand Page (1987). 21Farl(95)wsoefthfittonetedvergence between observed behavior and best practice, whcheadtcnilicfcecyTrcisbnoa There is by now a which he cllled technical inefficiency. large literature on technical inefficiency. Pack (1988) summarizesmuch of rhis literature as it appliesto devel-
16. FiguresA1.8 and AI.9 (in the appendixesto this oping countries. of chapcr)r compare <:simatcs chapter compareour our srmaLes e of TFr r growh vvidir ItwihTO. 22. Mankiw, Romer, and Weil (1992) also employ a Solo other independentlyderivedestimats for a largesample wtype neoclassicalmode. Proponents of endoge of countries (Elias 1990; Fischer 1993). The pattem Of pr.oductivity growth rates in figur 1.10 is remarkablyronous growth theorywoull not acceptthe depictionof the , . ~~~~~~~production function vAr. Aminishing returnsto cpita. - i ,^, ^ busr to the specificationof the growth accountingequa23. A comprehensive reviewof the largeliteratureon tion and to the capital stock series used. IMF (1993), contrasting Asia with other devcloping economies, te measurementof best-practiceor frontier producton and theirrelationshipto traditioralestimatesof reaches similar condusions, both with respect to the esci- fiunctions the production funcdion is contained in Aigner and mated magnitudesof TFPchange and the relativecontriSchmidt (1980). bution of TFP change to output growth. Thomas and Wang (1993) and S. Edwards (1992) also reach broadly and 24. This is the approach adopted by Nishinmizu similar results concerning the pattern of productivity Page (1982) and recently applied to high-income comparedwith other economnies. changein the HPAEs economiesby Fecherand Perelman (1992). 17. Young (1992) finds similarlydisappointingresults whilestrong,may not be fir fiom Some cau25. This assumption, with respectto Singapore's Tr perfiormancc. tion is neededin interpretingtheseresults,however.Much the truth. Industrialsectorestimatesof TFP change in inof Singpore's investmrent between 1960and 1990 was in dustrialeconomiicsgenerallyyieldacompactdistributionof housingand socialinfrastructure, outputs of whichare noras with a meanvaluenear 1.5percenra year,both within ntoiously difficultto meas;:e. It is possiblethat we have: and acrosseconomnies. This may thereforebe a good first thereforeundervalued the rate of growth of output and approximation ofthe rateof technological change. hence the rate of rvp change. Similar derailedcriticsms couldbe made for other economies,both HPAEand non26. The rests wereadministeredto a random sampleof HPAE,aLwour TFP resultsare rherefore best regarded(asin2,000 students in each county. The test questionswere deedare the :ross-economy regression results)asindicatve drawn from the National Assessment of Educational of broad internatonal trends. (On problens of estimates Progress,a test designedfor U.S. students. See Hanushek of cross-economy regressions, see Sriniasan 1992). and Sabot (1991).
.
77
R.TE
Public Policy and Growth

HAT ACCOUNTS FOR THE REMARKABLE
record of rapid income growth and declining inequality described in chapter 1? Some observers attribute success to geography and culture rather than economic or other policies. But geography and culture cannot explain it all; East Asia indudes Myanmar and the Philippines as well as the Republic of Korea and Malaysia. Nor is there a simple policy story. Of the successful East Asian economies, Hong Kong and Thailand have had relatively little activist intervention in economuicsectors by their governments, while Korea and Malaysia have had a lot. in this chaprer, after examining the significance of geography and culture, we suggest a simple framework for understanding growth in the eight HPAEs. This framework explicidtly allows for diffcrenc, bur potentially successful, mixes of policies across time and across economies. To set the stage for latef chapters, we then show how very different policies can be used, if circumstances are propitious, to address the three critical functions of economic management mentioned in chapter 1-accumulation of resources, efficient allocation of those resources, and productivity growth, that is, increasingly grearer output for given resources. How much of East Asia's success is due to geography, common cultural characteristics, and historical accidenit Certainly some-but definitely not all. Ready access to common sea lanes and relative geographical proximity are the most obvious shared characreristics of the successful Asian economies. East Asian economies havc dearly benefited from the kind of informal economic linkages geographic proximity encourages, induding trade and investment flows. For example,
79
S_
MIRWACLE
throughout Southeast Asia, ethnic Chinese drawing on a common cultural heritage have been active in trade and investment. Intraregional cvnomic relationships date back many centuries to China's relations with the kingdoms that became Cambodia, Japan, Korea, Laos, Myanmar, and Viet Nam. In South and Soutleast Asia, Muslim traders sailed from India to Java, landing to trade at points in between, for several hundred years befre the arrival of European ships. Thus tribute missions and traditional trade networks, reinforced in the nineteenth and twentieth centuries by surges of emigration, have fostered elements of a common trading culturc, including two lingua francas, Malay and Hokein Chinese, thar remain important in the region today. In our own cenrury, key Asian ports were integrated into the emerging worid economic system as the result of European military and trade expansion. Cheap ocean transport and shared historical experiencesfirther knit together a far-flung, culturally disparate region. U.S. assistance in rebuilding Japan after World War 1i, followed by massive U.S. economic assistance and military spending in the region rbroughout the cold war, also helped to set the stage for rapid gowth. Positdveimpacts included enhanced security, which enabled governments not directly involved in the combat to focus on economic development Perhaps as important, the U.S. military's exensive purchases in Asia provided a ready market for emerging export industries. Japanese industry receiveda substantial boost from the provisioning of U.S. troops in Korea; just as some of Koreis biggest conglomerates got their start selling goods and services to the U.S. nilitarv during the war in Vietnam. Regional linkages fadilitated the adoption of imitative strategies, in both public and private sector activity. Policy imitation-specifically of Japans industrial strategy-was an explicit objective in Korea and Malaysia. Korea borrowed Japanese rechniques for building large trading companies and directing the structure of industry; Malaysia focused first on developing heavy industry and more recendy on building business-govcrnment relationships. Furthermore, the general model of Japanese success undoubtedly impressed policnfakers throughout East Asia, engendering a sense of confidence as well as providing models of potential instruments of gowth. Fmally, geographical proximity has facilitated capital flows, particularly in the past decade, as Northeast Asian manufacturers of laborintensive exports moved their fiictories south to take advantage of lower 80
PUBLIC
POLI
wages. A surge of inves-tment (since the real appreciation of the Japanese yen following the Plaza Accord)-flowing first from Japan and later from Hong Kong, Korea, Singapore, and Taiwan, China-has contributed significantly to the dynamism of Indonesia, Malaysia, and Thailand. From the policy viewpoint, these linkages have been encoutaged by the generally liberal treatment of foreign investment But even where foreign investment policies have been restrictive, informal credit and information networks have helped investors to move capital rela-
tivelyfreely.
In addition tO direct linkages and imitation, East Asian economies may have benefited from positive regional externalities. Through their earlier trade with Japan, Western importers had become farmiliarwith Asian business, established networks for sourcing East Asian products, and gained respect for East Asian quality. Later, U.S. trade policies imposed quantitative restrictions on Japanese products and created rare opportunities for other East Asian producers to enter international markets. Producers of garments, shoes, television sets, automobiles, and other products in Korea and Taiwan, China, took advantage of these episodes to establish lucrative market positions (Petri 1988). Of course, regional cl'2racteristics alone cannot account for East Asia'sremarkable success. If geography, history, and culture were an adequate explanation, other economies would have little to learn from Asia's success stories. Fortuntately evidence suggests that this is not the case. Indeed, cconomies that are part of the same matrix of geography, culture, and history as the HPAEs but followed different economic policies-the Democratic People's Republic of Korea and the Philippines are two widely divergent examples-have yet to share in the East Asian miracle. We turn, then, to the heart of this book, an examination of the policies that have shaped East Asia's success.
Policy Explanations
TEMPTS TO IDENTIFY THE POLICIES THAT HAVE CREATED
the East Asian economic miracle fall inco several broad categories. Below we present a summary of these, focusing on ihe differences in interpretation that have arisen among observers confronted with the same set of economic facs.
-8i
SvA
MIRACLE LSYXN
TheNeodassical View interprectaion of EastAsia's success,the markettakes In the neoclassical center stagein economic lifeand governmentsplay a minor role. For eaample,Wolf (1988, p. 27) found it 'a strikingfact that the few relatively successfuldeveloping [economies]-Hong Kong, Malaysia,Singaporc, the Republicof Koreaand Taiwan,China-have greatlybenefited from decisionsand policiesthat limit government'srole in economic decision making, and insceadallow markecs--notwithstanding their imperfections and shortcomings-to exercisea decisiverole in determining resource allocation."Similarly,Chen (1979, pp. 183-84) argucd that in Japan and the Four Tigers(Hong Kong, Korea,Singapore,and Taiwan, China) state intervention was largelyabsent. "Wha. the state has provided is simply a suitable environmentfiorthe entrrc -ne.iursto perform
tieir functions."
The neodassicalinterpretationof the axperienccof die HPAEs, and e; peciallyof Koreaand Taiwan, China, presents a coherent and powerul view of one path to successfulindustrialization.' In this view, governments in all of the HPABs provided a relatively scablicmacrveconornic environrment, characterized by limited inflatinn (except at times in Korea). Real effective exchange rates rarely appreciated, and such episodes were quickly corrected (S. Edwards 1988). Interludes of intensive importsubstituting industrialization in Korea and Taiwan, China, were brief Manufacturers were thus able to concentrate on improving productivity perfbrmance rather than coping with mpidly changing relative prices of inputs and outputs. Although neoclassical interprettions of the success of Hong Kong, Japan, Korea, Singapore, and Taiwan, China, are ofren nuanced-and advocates offer them with varying levels of consumer warnings-they stress the benefits to the HPAEs of limited policy distortions in the foreign trade regime and domestic factor markets. In the neodassical view, East Asia's export success is due to similar rewards for selling in the domestic and foreign markets. iBecause variation in incentivesacross sectors, as measured by the effc-tive rate of protection of value added, has been limited, inputs havr-flowed to sectors roughly on the basis of static comparative advantage, anti inrernational competition has provided the impetns for cost disciplne and technological upgrading. Traded inputs have been made available to exporters at international prices, and aeporters have iced an n.ternational price regime in making their deci-
-St
PUBLtC
P OTC
sions. Finally,factor markets have been roughlycompetitive,so positive real rates of interesthave prevailed,and thcre has been an absenceof duality in the wage structure by size of firm or sector of production. TheRevisionistVww In the past six years,the neoclassirl interpretation of the sourcesof rapid growth has been criticizedfor its lack of factual validity,at least as it appliesto Japan, Kor=a,and Taiwan, China (Packand Westphal1986; Amsden 1989; Wade 990). Advocatesof this new view, sometimes dubbed revisionist,have systematicallydocumented that governments in these three economiescxtensively and selecivelypromored individual sectors. They have convincinglyshown that levelsof protection and the variation of protection acrosssectorshas been greater than recognizedin 2 &> rthe i neoclassical interpretations. Indeed, governmentsin each of these three economicsat times intervened forcefiillyin marker Korea, for example, strongly encouraged heavyand chemicalindustries by setting targetsand offeringa varietyof financial incentives (Pack and Westphal 1986; Westphal, Rhee, and Pursdl 1988).Japan promoted the developmentof severalweak industries in the first fifteen yearsafter World War II, offeringprotectivemrifis and financial incentivesto encourage the introduction of advanced technologyand establishingrationalizationcartelsto &cilitatethe exit of
inefficient firms?3Taiwan, China, used public investment in large-scale manufacturing enterprises to ensure inputs for predominantly small and
medium-scaleexportng industries. Moreover, capital markets were not free in these three economies. Proponents of the neodassicalview have focusedon the reduced intervention,particularly in the 1960s,that allowedreal interestrates to shift from negative to positive levels (McKinnon 1973). Buitwhile intervennion declined, it nonethelesscontnuedL In fact, Japan, Korea, and to a lesser extent Taiwan, China, did not rely solely on markets to allocate
savings. Rather, they repressed interesr rates and directed credit in order to-guide investments. -The revisionist view, proposed by Amsden (1989), Wade (1989, 1990), and others, sees market failures as pervasive and a justification for governments to lead the narket in crtidcalways In this view, the experi-ences of Japan, Korea,. and Taiwan, China, provide evidence that governments can foster growth by "goveriing miarker and "getting prices
83
; *
- RA :
~~~~~L E
-1 -
-advantage,
wrong" and by systematically distorting incentives in order to accelerate catching up-that is, to fadlitate the establishment and growth of industrial sectors chatwould not have thrived under the workings of comparative advantage. Amsden(1989, p. 14), for ex-ample,asserts that all "economic expansion depends on state intervention to create pricc distortions that direct economic activity toward greater investment State intervention is necessay even in the most plausible cases of comparative because the chief asset of backwardness-low wages-is counterbalanced by heavy liabilities."
TheMarket-Fdendly View
WorldDevlopment Report 1991 (World Bank 1991 b), in a comprehensive attempt to describe the policies needed for rapid growth, fallsin the middle ground between the neoclassical and revisionist views. It condudes that rapid growth is associated with effectdvebut carcfully deit articasMarrkea-tendly"suategy limited government aciivism. In the lates (see box 2.1), not only do governments "need to do less in those areas where markets work," namely the production sector, they also "need to do more in those areas where markets cannot be relied upon" (p. 9). The appropriate role of government in a market-friendly strategy is to ensure adequate investments in people, provision of a competive cdimate for enterprise, openness to international trade, and stable macroeconomic management. But beyond these roles, govemments are likely to do more harm hn good.On the basis of an exhaustive review of the experience of most de-eloping economies, WorldDevelopment Report1991 condudes that in -gneral governments have been unsuccessful in improving economic performance through attempts to guide resource allocations by other than market mechanisms. Attempts to guide resource allocation in international trade, financial markets and labor markets have reduced competitive discipline, guided resources into low-productivity and internationally uncompettive sector, and resulted in widespread rentseeking. In short, though market failure is an importrant impediment to rapid growth, so is government failure-and governent failure can have high costs. A cental contribution of WorI Development Refort 1991 is the ar-gument that sustined growth :esults fiom the positive interaction of four critcal aspects of econoomic policjr macroeconomic stability, 4.4
PUBLIC
POLICY
AND
GROWTH
Box -2.1MakingtheMostofMarkets;
c nged 'produ y. TeRepor'aenergkmdaiongeconomists on the best approac' to .stressd at omesticpolCy. ou d epeennepre- economic dedoprnetn -. This zonsensus'was dp -.-... cissed'az. ngth:in WoMDev p'nt Rport 1991 -provide die infasuucure- and institutions'-at will The-TSChalnge oDv ne (WdrIdBaiik.1? ' r 1199 Ib). ,-h' 'help he respond.i_ The Repor+t highlightedte iportance of a helty-' ' Oprness to ona tr invesren nd' privarc:sector, which.-rss m investments in -ides has been cra in encouraging omnstic po ,people,tamuchreduced role or.,goveiment, opedu-r' toucutrcosts byw inrdi holopos-;:r -,nessroXd,'o eom ndvs w ) t rds Ce,oft anddeveopingnewand tcerpruct. By' esame: K'world;,and; macroeononmc-stability TIh~s'idcas -token,3protonSr erc indusa ol -'''av c#lled into;whAt is now cae te-he mark' d6elom decades .He -gon np ' rv.m rriLokvole. Injapan an.dKorea,foruinstace,gov~Y -;appro&; 0'T eReporrcnotedtrhtare economicufronim. ement :agen and-indut asaton co' bot investng mi peopplcan be high,bur manygovern-. rate to gahier and. disseminate i:normation on:.-J,. 'no..ton] ar rd-'anddeop qu aity control'Ibrp& t.. ' -ntarget thcir snbapkpmropacrod ecoanro,-in':',-Ale'rocr micc foundtionoi. on ofthe 5 did' Brazil2nd Pakistan,'f alone m,sost i ' oosihagormenrs OOpublic ca - derto; .unprovt. hie sot l indicators;i Ce.and .rovide,- as th neotpule.ot o. Wt%an ~f jamnaica,howevr to c CarS inprov eVe. i mnt ocr th o times,ofKislogw.wth..Governments must ais overspens, Mr terdui senoonowinaj st 'monetayryl n fnniscordfiute,' opnin .-prov- th 4ini fhes To, hled by inflation,choni i '''o% pvisios, o for -recurrent: pen are ' ina deof y alssof ,thel o 'p ? i, quam te rEsuldjiawasrefilu undemrutli2ation> Thdeconomies with a:bs-orof macn&o'c u"r> Motsessfuuonlei nudhJai;Si-" iaiitprruesleionthaiidd ArgeCntn.'olivia < =ic salihdter~o o' m on s~~~~~~~~~~~~~~~n ~~~iposr-,adoc~hv -sf.y>ir ie l tabedili d hnOh&nu~rj
IN-THE;AST;-TWEN YYEASA CONSENSUS.HA -;trenologi
9'
'
tt
'w
ItcP%%Y :avarae.a through rhen riors,- of~' ke,'..' doeia Koe,Maas; nTalidhiemn KL .markeslcqi .k%versely; retuctionson competition' gecLtod "keep.thefir rmacroononic:. polid&son.' I , ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~., (fo e5pe;Indsiadcensn o nappopriate. course adteir-.bioaUednoic jerfbr~ceha
ihes ?P
opeoi)
.biddk'.b > 'betarizlyo
humancapital CtiaaCion,
openness tO nternational trade,and an en'nhrmation) imprves.
romnmenr that encourages private invrestment and comjpetition. Effective
policyin one diension (suchas human capital f
the results from effectve policiesin others (such as opennessor mac o

economic stability)t In this view,the success of many economies in East Asia has been due tO teinforcing policy feedbacks. No single policy has ensured success; strong and effictive policies in all four critincal aEcas, and over a sustained period, have been hkey. f -p
. 'csumThe marke-ffiencdly. approach

Asia's
captures important
aspects
of Eastcr
succe:m.These economies are macroeconomnicallystable, havevEry .oniies are macroe-onomiay stabl, he :'~ ~ ~ ~ ~ ~~~8 v85,
...
Asia-ssuc=ss These
-, ,,. .. X ' - ' ' 0'
*,~~~~~~~~~~~vr
high leves of human capital, are thorughly integrated into the world tmc ocure economy, and have very high levels of competition among firms. Moreoe,East Asian success sometmsocurdin spite of rather than be-
causeof market interventions. Koreas heavy and chemical industries (Hcr) driveand Japan'scomputer chip push did not live up to expectations. Evenso, other interventionscombined with export targetsapparently were consistent wick rapid growth: quota-based protcaion of domestic industries in Japan and Korea; targeted industrial policiesin-. dludingdirected credit in Japan, Korea,Singapore,and Taiwan, China; heavy reliance on large state enterprises in Japan, Korea,and Taiwan, of these three northeastChina; and so on. Furthermore, the successes em economies compares favorablywith the successesof Hong Kong, Malaysia, and more recently Indonesia and Thailand, where policy choiceshave been less interventionist.
-NMultip Pathsto Gmwth

of East As these three viewsshow,while it is easyto see how elements a Asianexperiencecontributed to rapidgrowth, it is nor easvto identifyr single recipefollowed across the region. An alternativeapproach is to recognizethis diversityofpoliciesand to assess whether and how various mixes of policiescontributed to successfilimplementationof three central functions of economic management accumulation,allocation,and productivitygroth. 4 Thi4 --s approach recognizesthat policies,like tactics, can and should vary depending on the situation, while the central
functions,which are crucialto development,musr alwaysbe addressed. was the One of the hallmarksofeconomic policymakingin the HPAEs instruments with which govenmentstried -policy pragmatic-flexibility in pursuit of economic objectives.Instruments that worked were retained. Instruments that failed or impeded other policy objectiveswere abandoned. Thus, the Korean and Malaysiangovernmentsreduced intensive promotion of heavyand chemicalindusries when the fiscalcosts and strainson the financial systemthrdatenedmacroeconomicstability. Indonesia abandoned capital marker controls ancdattempts to control Japan shifted from interest rates when they werc found to be ineffeccive.
higly selective interventions to promote
exports in the 1950s and
1960s to industrial policies designed tO reducetrade friction in the. 1980s(seebox 2A later in the chapter).Taiwan,China, gradualli privato support the rapid growthof tizel key public sector investments-made
86-
PUBLIC
POLI
exports by smalland mediutm-size firms.Singaporeshifted from a policy of repressing wagesto one of promoting mpidwage growth, finallyconcluding by coordinatingthe increasein wageswith rising productivity. And Malaysiashiftedfrom policiesthat resultcdin business-government conflict to highly structured mechanisms to encourage businessgovernment cooperation. Chapter 3 discussesthe pragmatic flexibility of HPAE governments in pursuing two goals, macroeconomicstabiliry and growthof manufacturedexports. Obviously, our three functions of growth-orientedeconomic managemnentwere not objectives in themselvesfor policymakers in the rapidly growingEastAsian economies.Instead,they are simplya framework for analyzing how the varying mix of policies and instruments chosen by HPAE governments contributed to or detracted fiom rapid growdt.At the same time, we do not want to imply that growth was due to mere luck in the HPAEs. Though policiesvariedover time and place, the formulation and implementation of policieswere purposeful, with an overridingobjectiveof 'shared growth." (This tcrm is describedand discussedin chapter 4.) In contrast to the diverse,changing,but purposefulmix ofpolicies in the HPAEs, ocher economieshave either rigidlyadhered to policies that were demonstrablyunsuccessfil-fbr example,extendedperiods of import substitution in Latin America and Sub-Saharn Africa, policiesto developdomestictechnologyin India, and state-led industrializationin Easteem Europe-or have lackeda purposeful direction,as the historyof adjustment pograomsin some economies in other regions attests. Indeed, as we illustratein the next chapter, the flexibility and pragmatism ofpolicyrnakingin most of the HPAEs reflectedgovernments'willingness to try new approachesto achieveparticularpurposes,discardunsuccessfuilones, and keep those perceivedas successful.
Th Functional Growth Frameworlk

_ IGURE 2.1 PORTRAYS THE FUNCTIONAL APPROACH TO UNDERstanding growth in the HPAEs The figure shows, in four columnns, the interaction among two sets of policy choices (fiudamentals and selective interventions); two methods of competiive discpline (market and contest based); the three central fimctions of econonmic
87>
to G Apprach 21 A Functional Figure

choices Policy
-~~~~~~~~~~~~~~~~~~~
:owh
functions Growth
Hihsa.g
Comnpetitive discipline
Outcomes
and Rapid
*
Fundanmentabe
. Stable macroeconomy
Accnnmulatn
*
sustained growth
capital human * High MdHgll andsecure : Effective Metetransti systems financial Export isin distortions price Um.t-ig capital competiin human * Hlgh Openness to foreign
to foreign SOpenness
*technolrtY p
capital
Increasing
human
of growth Rapid demographic Rapid
*Hg,aigsexports
It
I ~~~~~~~~~~~~~capital
. _
ho ai Rad transformation
agricultural RFoapid
Domesc
~~~pollicis
A Ficultuial depelopment
v
Contit
.
. credit-Reduceyfective
ron of
industalizadon
Alboatin
: Directedcredit :
I
I
use capital in. ~~~~~~human laborrnart

on
<
SelectiveIntprventionsI
rI\
* High reurts
Export push vz Financial repression * Directed cedit

>
_ Contest4edtu *Export credit

* Lfwestmnent
Ilmestmrent
>Equal
Ineeme
clstributbon . Reduced poverty
* Seiectivem prormotion
Improving sorlal
InsUtUdons W Insulation o Technocratic

0. _ * H gh-ualfty civil service
coordination * Information exchange
Productty change * PmduftJvpbased up catching

R
inditrs
tec_
&
____
+_______________________.______________
I
Monitoring
managemenrt and tie outcomes of growth and equity discussedin chapter 1. Institutions are also shown as critical to the sucossful definiton and implementation of policies and to supportng high levels of com:pettive discipline. The solid lines in the figure show how policy choices contributed to outcomes via attainment of the three functions. Many policies, such as high human capital and openness, contributed simultaneouslyto two or three functions. For example, stable macroeconomic management contributed to vigorous accumulation through higher rates of investment and to improved allocation by reducing instability in relative prices. High and growing investmenEs in human capital contributed both to accumulation, since human capital is an essential input to economic grwth, and to productivity-based catchiing up by permiting better nmasteryof technology. Effective and secure financial systems helped to increasethe level of financial savings (accumulation) and channel it to high-productivity investments (allocation). Limited price distortions, by keeping domestic relative prices relatively dose to intrnational -pices, were good for alloaton andmay have provided incenives for 88-
:~~~~~~~~~~~~~~~~~~~~~~~ :
LI C7-:
firms to adopt technologiesand innovate. Openness to foreign rechnology was a major vehide for productivity-based catching up, and agricultural sector policies that promoted rural development were cental to both growth and improveddistribution ofincome. The arrows indicate that the system has numerous self-reinforcing feedbacks.For example,rapid growthand relativelyequal income distributions contributed to the HPAEs' superior accumulation by increasing -rates and generating largr and more efective investmentsin savings human capital; they also contributed to superior allocation of human
capita by fostering labor mobility and marker determinaton of wages.
parthey helped in the creationand protecton of instimtuions, Similarly, ticularlythe dcvi service,by reducingincentivesfor corruption. are so defined in the sensethat The sixpolicieslisted as fumdamentals they affectthe attainment of growti functionsprimarilythrough marketbased mechanisms of competitive discipline. Three-macroeconomic
systems,and limited price distortions-assist smbifiry, effectivefinancial.

markets. The two others-high investment in human capital and open-
ness to foreign tecLnology-require efficientmarkets to operate. But the HPAEsalso went beyond the fundamentals, interveningwith
varying degrees of intensity to alter market incentives. The broadest inrervenrions were generous incentives for manuhactured cxports. (These are discussed in some detail in chapter 3.) As part of this export push, all the HPAESpermitted exporters automatic access to imported intermediare inputs ar intemational prices. Most also offered subsidized credit, often performance-based, for exporters. In Hong Kong and Singapore, Whereinternational prices guided the domestic economy, massive public housing programs helped to keep down labor costs. In Japan, Korea, and Thailand, implicit or explicit export targets were used as the basis for awarding access to foreign exchange, investment licenses, or credit In Taiwan, China, large-scale public investments, induding in public enterprises, along with extensive support senices to small and mediumsize exporters, were used to support the export drive.
Most HPAEs also controlled interest rames on deposits and bank lend-ing. These financially repressive policies enabled governments to ration credit; favoring some would-be bonowers over others. In addition to the importance of these directed-credit schemes to export promotion, some governmentsalso directed credit to other activities, induding agriculT ture, small and medinm-size enterprises, and, in Japan and Korea, largescale imvestments.
By intervening
f
in credit makets,
governments
- - -
- -
- .
~~~~~~~~~~ -
selectively promoted industries, ownership groaps, and, in some instances, individual firms. (These issues are analyzed in detail in chapters 5 and 6.) Some HP'AEchose very narrow promotion iargets. selectively assisting knowledge- and capital-intensive industries and firms in hopes of upgrading the economjs overl level of industrial technology: In Japan andt Korea the governments at timnes concentrated on promoting private domestic investment in)heavy and c-hemicalindustries (Hcas).In Ta-iwan,China (and to some extent in Indonesia), the public sector invested directly in technologically sophisticated industries. Singapore and Thaiand have attempted to attract foreign investment in capita- and knowledge-intensive sectors. Malaysia initially undiertook public investmenus in HCI firms but has recendly shifted to a strategy of promoting private investmnentmore akin to that of japan and Korea. Some selective interventions went beyond helping markets perform better. Rather, theyrguided and in some cases even bypassed markets. In the following section of this chapter, we explain why, in light of market failures, some interventions make sense even within the neoclassical framework. We then describe how some of the interventions undertaken by HPAE governments addressed these marker fihilures,effectively (if not necessarily intentrionally) reducing the gap between social and privat-egains.
Market Failures: TheCoordinatiom Prohiem

A primary function of markets is coordination. The price systemnis a mechanism by w-hich the production decisions of the myriad firms that make up the economy are coordinated; for instance, they signal to intermediate goods producers what outputs are required by final goods producer. Whe marets arc incomplete or missing. they cannot efn this signaling function. Since the prices of outputs and inputs (including wages) depend critically on what- other firms are doing, there ar-egreat potential benefits ofsharing information. Even in well-developed market economnies,information is conveyedi in many ways other than prices.
Tradejournals,tradeassociation meehings, and information newsletters areal inportant minsitutions for the trsnsmission of informiation. AdamSmiteHs invisible hand paradigr argueso hat achindcividual, in pussuinghis or her self-inters also maidmizes the commonwelare; cooperation is therefore unne lssary-In rafiutymoderneconomies are characterized by extensive cooperation. Amongfirmsimeconomis that
'90
PUBLIC POLI'CY 44$DtN`
':belong to the Organization for Economic Cooperation and Develop-ment (OECD),for example,formal and informalsharing of information is common. Cooperation among firms is maintained whenever the gains from cooperating outweigh the gains fromi cheating. Coope-rativerelations are ensured because of benefits from maintaining a good reputation. If a firm lidls to cooperate, its reputation will be damaged, and future business chat depends on its reputation will be lost.' Institutional. arrangements for cooper-ation and information exchange in developing economics are weak-er than in industrial econominis,yet the needs for these forms of coordination are undoubtedly gre'ater. When economic change is.siow, making predictions about future prices is relatively easy: a simple projection of the recent past will do. But when economic change is rapid, predicting the future is much more diffi'cult. There is often need for coordination. beyond what markers can provide; hence there may be a greater role for govermecnt to create institutions and facilitate coordiination. Missing Infonnatio and Credit Markets. Among the markets most affectedi by information problemnsare capita markets. Even in industrial economies, equity markers generally do not finance much new investment, largely because of information asymmetries (Stiglitz 1993a). In economies where'equity markers are weak- or absent, credit mechanisms become the primary vehicle for raising capital and. diversifyring and spreading risk- But credit markects-even those flee of interest rate controls-are often characterized by credit rationing. Credit is seldom allocated to the highest bidden. This is for an obvious reason: bidders * are bidding promnises; those who bid the most may not be able to fulfill teir promiss Lenders are concerned nor with the promised return but the actual return. As a result, capital is allocated by a screening and evaluation process that is quite different from the anonymnitythat characterizes resource allocation in an idealized marker. In some oftdie IHPAEs, governiments intervened aggressivelyto address this problemnin the credit marker, going beyond the normal regulatory functions and prudential supervision that help ensure consumer confidence. For example, in Japan, Korea, and Taiwan, China, government helped establish andt aggresively supported development banks and other financial institutions,-and only later encouraged equity and bond markets. In Japan a-ndKorea, government set up and managed directedcredit programs,.and through explicit and implicit guarantees or other forms of interventions, reduced the risks borne by investors. A'
ScaleEconmnies, Externalities, andCiooperation. Coordination may yield substantial benefits when large indivisibiliries in investment lead to economniesof scale. One such case arises when investments are interdependenc. For example, if a steel plant and a steel-uising industry are needed concurrently, it does nor pay to develop the plant unless there is a steel-using industry, and it does nor pay to develop the steel-using industry unless there is a plant. If each awaits the other, nothing happens. Market failures due to incomplete markets, such as the absence of capital and risk markets, exacerbate thi~ssituation. With such largescale investments, no single entrepreneur could amass the capital
required for both investments, and capital marker imperfections mean that investors hiavedlifficuiltyobtaining the funds required. Moreover, there are likely to be large risks, and the market provides no mnechanisms by which these risks can be divested. Economists have traditionaly found exteralities a persuative argunent forsintervention in marker allocation. di My of these xtemalities are related to learninge spiovers associated with developing markets, spillovers associated wit discovering what goods can be produced, and spilloversassocated wevith the incomplete appropriability of tecnological knowledge. In each case, fims undertaking a new actvity facelong-term, noncollateralizable ivestments that are difficult to finance. Coordination failures loom especialy large where "diFuse externalities exist and there are mutiple linkags between s993a). firms (Stiglitz It is in situations where there are many participants tat markets are particularly use-fi and where the absence of markets is particularly cosdty Exampliesof hese diffuse e mrnalities indlue, for insance, dith development of hghtechnology servicesand nontraded intermediare goods. In the earlier developent liteature, the coordination problem arising from interdcpendenc investments, economies Ofscalesand exteralities wasgiene a grea dal paromipnec tThis was the argument for planning in the 1950s and 1960s. Such planning ulled in part because it attempted to concentrate all rclevant infonadvon nm the goverumenit planning bureau. This was sinply inmpossible;infrroation is too dif fuse, too complex. Plnmningministries were not adept at generating the infornation needed to support investmnt dceisions; as a rexsultemny planned investments filled. Moreover, because many of the planned investments were in monopolistic public sector companies, severe probperformance arose related to- corporate govemance lenmsof economIiic and market powec:
92.
PUBLI
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Some
HPAEs
tackledproblems of ;cale and externalities bysetting up
mechanismsthrough which businessand government could exchange Japan and Korea,and information and coordinateinvestmentdecisions. later Singapore and Malaysia,developed institutions and market relathis process.In doing so, however,these gortionships that facilitated ernments did not attempt to supplant cxisting information networks. Rather, thcy built on the superior information that firms had as dccisionmakers Their approach to these problems, emphasizinginformation and cooperation through formal and informal interactions 1 is discussedin chapter 4.5 Creating Contests Cooperation raises severalproblems, however.First, cooperativebehavior may become collusion,if firms act together to raise prices. Sccornd,cooperation may inhibit competition,leading to managerialslack cooperor a more generallossof efficiency. Third, business-government ation may encouragefirms to seek &vorsfrom government. How did the East Asian economies that encouraged cooperation avoid theseproblems?They combined cooperative behavior-indcluding sharing of information among firms and betweenthe private and public sectors, coordination of investment plans, and promotion of interdependent.investments-with competition by firms to meet well-defined institutional structures -conomic performance criteriaThey developed in which firms competed for valued economic prizes, such as accessto - credit, in some dimensions while actively cooperating in others; in compeiition short, they created contests (see box 2.2). Market-based *and contest-basedcompetition both included prohibition of monopo .' lies, although the number of competing firms was sometmes small of conEventhoughJapanand Koreahavetended to have high levels sector (seetable 2.1), domestic comf centration in their manufacturing petition has usually been vigorous. The Japanesc government has proceeded-on the assumption that competition among fewer, more evenlymatched firms is preferableto having one large firm competing with many smaller rivals,a principle that is well-recognizedin athletic
- -competitions
Table2.1 Concentration RtoinManufacturing

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Contest-basedcompeution included dear well-enforced rules, and prizes forwinners.Table2.2 brieflydescribessome of the contestsorga6 The simplestand most widey used were nized by HPmE governments.
~~~~~~
93
C -RCLE R RA
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Y'Oi'3m2 Running a Contest, Rewais;,Ruies, n

. JT-H-lE,ECONOTC CONASTS.IT
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Contestsin NortheastAsian.economics have succeeded pardy becauserthe prerquisits were right. 1.:Preferentialaccess~to -d .credit .and-Ibrdgn excchange: . *
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7 'caconomicpertormance,primarilawull arrl&hi' base,however,these :-centere coh: montns ies-. land somchmes rcontestis,anddiir-role-mthe economy resmble chl7-" understoodd:mpcrauve to ,expor; Referees,he gov-ren,sprc gaes officials-wh&hbave design'ed ~andsprie ti.- .O:ganiihg conrc s ists a more pccaned way to . ,ihetonresrs t5m -have:been gFnerally comperciuandfir., run! ;a e:,oomv Esez-fi*i; than,el:'i.i r r:i W . , -jt a .' ."' . been - economy .L rC nng.on ssz-talre, justas nA same time, ;parcipation has nortbeen ,; -b'f , p s r r:,Complcate, anatoq. c at prce cd rrtosit out'a, contest g. ! Thul IC ffi.l1iezi dobeeni phdinr igo.; In some inpunished nave not etunga-hcxiuo pAovA KaA~ieana-p ayingfid tnAy-fied, L both'vk. . .-srancessuchas Hondasshifr toHau-; l easc., i-fa ie -fi; s;-l--vm *i*o -*e-toau 1 ut7laeyp"' and-u&ec"oplay game,:e-. 6ioniobile' maniffctrang .at a time whenzfJapines .p ugb pgarta a well-mrri :^Bu--a-wdll-run.contesr, .: .
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~~~~~irms with confirmed export orders. For many small and medium-scale
p-
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entrprises, export creditswere their only accesstO the fbral financialS :sector - .- (Levy 1993).Monitoringperfomiance wassimple; firms were re-i;quired to show evidence of export orders to receive credi
In Koreaand Taiwan,China, exportcontestsweremore elaborate. access to fids, but firms char ex-s Nor onlydid exportprojects er easier such had an easiertimegettingfiure loans.Because portedsuccessfilly dil creditwasfungibleand creditgenerally wastight, firmssometimes nonexportinvestments. its to higher-yielding vertedexportfinancing
'.4-
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~~~~~~~~~~~~~~~~~~~~~~~~~~~~~P U B Lil-C. '2
exports became a performancecriterion for projects that were not directly aimed at serving the export market. In these cases monitoring problems were greater, since both export perfomnanceatid the related projects needed to be monitored. A second type of contest used the power of government to grant licenses.Table 2.2 shows two of these contests,based on Japaneseexperience. In the first, the Bank of Japan created a contest in which commercial banks competed to provide financial servicesin line with governmentpolicy-for exampic,by opening rural branches-in hopes of winning highly sought-afterurban branch licenses.The contest also gave banks a strong incentive to comply with technicallynonbinding
Table 2.2 Examples of Contests

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PUBLIC
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economies of scale or leaming permitted industries to cxpandexport market sharcs. Our final example is that of the coordination of investments in Korea under the Ha drive. This is the most complex example we have of a contest, one that combined licensing of capacity, access to credit, and protection against competing imports with both physical and economic targets fbr performance. Its economic success is still not clearly established, and many observers have judged it a failure, but it illustrates very well the use of contests. At the heart of the HCI drive was the goal of changing industrial structure toward more capital- and knowledge-intensive industries through coordinating public and private investments. Large private companies, the "chaebol," bid on individual, large-scale investments-fior example, electronics, shipbuilding, and machinery-for which thev '2ceived acdusive licenses combined with generous access to credit. The rewards consisted of quasi-rents due to import restrictions and restrictions on entry, access to credit in a highly credit-constrained system, and government support during business cycle downturns. These incentives have been the source of disastrous economicperformance in other economuies.The check on poor perfornance in Korea wasthe result of rwo performance-based rules. Fi-st, government estabIished a timetable for the attainment of international competitiveness in eachindustrial sector Firms that failed to maintain the pace of cost recductionsin line with the international norms faced both political and economic sanctions (Kim and Leipziger 1993). Second, because access to credit, even at early nonexporting stages of the development of HCI investments, was linked to the export performance of other products produced by the chaebol, efforts to maintain export Competitiveness across a wide range of products were encouraged. Mhe Rules of the Came: Exports as a Yanistici Contests are only as beneficial as their rules. If perfbrnance criteria channel effort into unproductive activities, there will bt little benefit to the economy.8 If rewards are unrelated to effort, contests will not increase compe'tiion. There is one common thrrad among all of the contests outlined above. Exports, and especially manufactured, nontraditional exports, were the yardstick ainst which the success of other allocation decisions-for example, credit allocation, domestic content requirements, and industrial licensinwere judged. Accordingly, there was a high degree of competiion among finns, in spite of the &fctthat in certain domains and '97
rttC
LVRcE
The export performancerule at certain times they acted cooperatively. was broadly shared among HPAE governmentsand is almost unique to the East Asian economies.Chapter 3 illustrateshow each of the HPAEs
used shifting combinations of fundamental policies and selective interventions to maintain the pro-export orientation. Box 2.3 describes how some HPAESused apparent constraints on their ability to export to create export contests to new markets. Using exports as a performance yardstick generated substantial economic benefits. A firm's success in the export market is a good indicator of economic efficiency-a much better indicator, in faict,than success in a domestic market. Export markets are likely to be much more compethiivethan domestic markets. Even if the firm's success is based on finding a niche in a foreign market, its contribution to the domestic economy is still as large as if it had succeeded by developing new production processes or othenvise boosting efficiency9
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There are, of course,other advantagesassociatedwith exports.In the processof entering international markets, firms learn a great deal and nor only about the particularmarkets they are entering.There are spillovers related both to mnarketing know-how and to producrion knowhow,topics to which we shall return in chapter 6. For instance,success in the production of intermediategoods requiresproducing to standards that are typically higher than those tat prevail within developing economies.The contacts made in the processof exports may also be of valuewhen the firm decides to enter related markets. It will know to
whom to turn to acquire advanced technology.
successin exportingmay be a better While from a socialperspective, indicatorof whethera firm meritsadditionalfuindsthan successin selling domestically, banks have (in the absenceof govemrnment prodding) typicallypreferred domesticlending to foreignlending and for a simplereason (Stiglitz 1993b). Banls are likely to be less informed concerning externalmarketsthan they are concerninginternalmarkets,and from the banks perspective, there isgreaterrisk associated with lendingfor exportorientedprojectsthanwith lending for productsfor the domesticmarket. HPAEgovernmentswere also lessheavy-handedthan some others that haveattempted selectiveinterventions.Though they made mistakesof judgment, they generallydid not forcedecisionson otherswho werewilling to risk their own capital (The creationof the MitsubishiAutomobile Company in) 965, rejectng m's gtidance ro refrainfrom enteringthe production of automobiles,is a casein point.) Thisisone ofthe strengths of decentralizeddecisionmalcing it providesinsuranceagainstmistaken
views being given too much dominance. Running the Gamen TheRoleof Referees.Referees are also fundamental to
contests. Someone must enforce the rules, administer the rewards,and discourage cheating. If one group of participants in a contest captures it and turns it to their advantage, they will reap rewards without the
necessary effort. If some participants feel that others are excessively
favored,they will refuseto abide by the rules. In the contestsdescribedaboveithe refereesvaried.For exporccredit, the contest was largelyself-enforcing. Banks had the incentiveto moni-tor exportperformance, sinceexecution of the export orderwas essential to repayment Banking supervisorsand customs authorities could also .-,use their coercivepower to enforcethe rules. In the case of banldng in Japan, the supervisory authoritiesof the Bank ofJapan were responsible for running the con Tlheofficials of mmwere the arbitersof indus-
.99
RAC LBE
duringtheHCIdriveboththepolitical inJapan,and in Korea trialpolicy performance. monitored administration and theeconomic leadership The. Liits and CoustaintsofCootests canbe effiecively usedto promore whethercontests Whatdetermines growth? Thereappearto be two important betterallocation and fitster and the institubehavior benefits of coordinated the relative elements compeiitive tional costs of implementingnonmarket,contest-bared discipline. Wherethe benefits of coordinated behavior arenot great-for example,in small,highlyopen economics with goodentrepreneurial skills of inof coordination goodssectors-the benefits and smallnontraded vestment decisionsor sharingof informationare likelyto be small. for marketsto be infiormation Internationalprices conveysufficient This mayexplain returnswillcoincideand socialand private efficient, havenot foundit worthsuchasHongKongand Singapore whyHPAEs while to run contestsand establishthe types of highly structured foundin Japan councils) (deliberative mechanisms information-sharing
and Korea,despite the high quality of their bureaucracies.
Evenin caseswherecoordinadion benefitsare potentially large-in or interdependent investmentsnontraded goods, externalities, coordination performance-based maynot be ableto enforce govermnents fiom coordinated Despitebenefits China,is an example. rules.Taiwan, aslarge asin Korea,and the behavior that werepresumably potentially in ofthe types employed contests service, ofa high-quality-civil presence Japanand Koreawere not used.This may have been due to Taiwan, industrial structure. With a largenumberofsmalland China's, different relatively small firms,in contrastto Japansand Korea's medium-scale costsofattempting groups,the institutional numberofmajorindustrial Instead, wereprohibitive. all but the simplestactivities to coordinate Taiwan, China,addressed the coordinatonproblemthroughpublicinvestment in large,indivisible industries. for the export contest-r The absence of effective conrests-except Malaysia,and Thailand,can Indonesia, the Southeast Asianeconomies, alsobe interpreted asa caseof highinstitutional costs.Civilservices in theseeconomies are norwellinsulated fiompoliticalor economic interaceconomic then,that effirtsto coordinare ferenceIt isnot surprising, t-vity tirough selective interventions have been lesssucssfL The
*100-
contests cithcr bave had poorly defined rules or have bcen bijacked by -their pardicipants. These nwofactors may also explain why the reliance on contest-based economy. Box 2.4 doc- :competition may change over time in the samne urnents the changing nature of industrial potigr in Japan, from selective tOfunctional incentives and fiom extensive reliance on contests during the rapid growth period tOmarket-based competiuon in the 1990s. In -large measure this is due to perceptions among poliyrnakers that the large benefits from coordination characteristic of the rapid grwth pe.-
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riod had diminished as-the economy grew and became more complex, and that the insttutional costs of administering contes had increased as power shifted from government admininstmraors to enterprises. Simnilar concerns appear to be driving recent changes in Korean industrial polices (Km and Leipziger 1993).
The searc hfrpolicyexplanations forEast AsiA succss hasnotbeen completey successfulL Each of the broad views of the relationship between public policy and rapid growth-neoassical, revisionist,and markcet-friendlyadds important elements to our undcrstandingl but none fuiily captures the compleity of public poiicy and rapid growth in
the Hfl'AE. We have proposed using a fuinctional approach to under-
standing the relationship between policies and gowth. In this vieew policies contribute to t atteauunt oh of tv hree centml Sanctions:acinulation, allocation, and produc growth-neocl. Markcr-orienited poicies, the fundamentas, were widely used by al the HPAEs and formed the basisfor their rapidh growth. More interventonist policieshave the potenti to contribute to growth in caseswohrec the addresseconomic coordination problems,but to succeed they must combinethe benefits of cooperation with competitivedisciplineby creatingcontests. Effectiveimplementationof contestsdepended on two sets of&fictors - almost unique to the northern HPAEs. The first is the competence,insulation, and relativelackof corruptibilityof the public administrationsin Japan and Korea.The historicaloriginsof theseeconomies'high-quality economicadministrations and the mcchanisms that they used to maincain
quality and limit political influence and corruption are the subject
of chapter 4. The second is the pragmatism and flexibilityof governments in the high-perfonning East Asian economies where contests
were tried and abandoned or continued dependig on their results.We .examine this flexibilityin policy formulation in two importnt areas, macroeconomic management and promotion of export, in the next
chapteL
102
PUBLIC. PO'LICyA
Notes
1. Forgoodexamples,seeBalam(1982) Bhgwvati (1978), Krueger(1978),and Litle, Scitovsky, and ScoEr (1970). 2. Moreover,some of the measures presenord,such as those of Itoh and Kiyono(1988) for Japan, are probably minimumestmates insofaras theircalculations of efieclve ratesof protection(Em's) arebasedon triffdata, not on estimatesof nominallevelsof protectionderivedfrom comparisonsofdomestc and international prias. On Korea,see PadcandWcstphal (1986)andtherefrencrscitedthercin. On Taiwan, China,see Wadc (1990). On Japan, see Itoh and Klyono(1988).Wade doesnot presentor dceestimates of effeciveratesof protectionin Taiwan,China,for the period afer 1969, while the other two presentevidenceon ERPS forjapan and Korea Conversely, Wadedoesoffercarefrfly documented qualittivc evidence ofthe extentofselective intervention.Despite the frequent use of Taiwan, China,as a modd of limitedintervention, thercareno estimatesof whichwe are awareof effectrive ratesof protection or dome resource costfor the periodafter1970. 3. See Yamawaki(1988) on the steel industry, Mutoh (1988) on cars, Yamnazawa (1988) on textiles,Yonezawa (1988) on shipbuilding, and Tanaka (1988) on aluminum refining. 4. A formal expositionof this concept is containedin R%gand Peuri(1993).
5.Popular discussions of the successofJapan and severl other economiesof East Asiahavestressedthe cooperanve relations between government and business, betweenworkersand cmployers,and among businesses. This phenomenon is sometimes rerred to as 'Japan, Inc." or "Malaysia,Inc," conveyingan impressionof a single-mindeddirecrionto economicactivity,promoting the collectiveinuerescs of the economy.Clearly,dtis popular imge caggeractes. Like all governments, governments in EastAsialack the control t cnforcea common set of goals.
6. The list is by no meansexhaustive,nIordoes it indude examples of failed contests, of which there are many. 7. See, for example,Kim and Leipziger(1993) for a dicussion of the instiutional features of the Ha drive and an evaluationof the successof the program. 8. Amsden (1989) in a seminal workloudines the nature of perfiormance critera used in Japan and Korea to disciplineinterventionistpolicies. 9. Again,this is perhaps not quite accurate;there may be spillovcrsfrom Iarning how to produce some commodity morecheaply.
103
M4acroeconomnic StabIlt
an ort
ACROECONOMIC STABILiTYAND RAPID Ex-
port growth were two key elements in scarning the virmous cirdes of high rates of accumulation, ficent allocation, and strong p roductivity growth thiat formed the basisfor EastAsia's suiccess. Governments achieved macroeconomic stabilityby adheringto orthodox policyprescriptions-in particular, by holding budget deficits to levels that could -be prudently fin2nced.They achievedrapid export growth through an export pusha combination of orchodox,market-orientedmechanisms,mianylinked to Macconomic stabilitye and omplementarypro-exportincentives.' Policy initatives in these two areas sharedtwo features that furtier illustrate the framework outlined in chapter 2: respect for certain findamentals-for example,fiscalpridence and avoidanceof exchange rate overvaluation;and quick and flexibleresponsesto changing economic circumstances.Policiesto achievemacroeconomicstability and rapid export growth differedover time and acrosseconomlies, partly because governmentswere responding to a changingeconomic environment and paryld because they wcre seeing efficient policy packgens thdrugh trial and error. We define macroeconomicstability to mean that inflation was kept under control, inti eal and external debt remained manageable, and macroeconomic crists tat emerged were resolved quiddy, usuaiy within a year or two. Short recessionsand policyadjustments to macroeconomuc stress somtimces sq the private scector.But these weare
transidonalperiods to new episodes of rapid growth, quite unlike the yeamof recessionandiuncertainty that have plagued.many other develran Africaand Latin America. Opig coonomes,particularlyin Sub-Saha
1105
Export push isa more complex phenomenon than macoeconomic stbility and the variety of policies used is greater. Mechanisms range from broad, export-friendly measuressuch as avoiding an appreciated exchange rate, which are esmployedin all the HPAEs,to government-mn export contests, which have been used primarilyin Japan, the Republic of Korea, and Taiwan, China. Universal export incentives, such as tax breaks and credir guarantees for all exporters, have been the main instruments in Hong Kong Indonesia, Malaysia. Singapore, and Thailand. Despite this diversity of approach, as a group the HPAES are unique among developing countries in the attention they havc devoted to export promotion and the success they have achieved. The second half of this chapter reviews the evolution of export-push policies in each of the HPAEs.
Pragmatic Orthodoxy in Macroeconomic Management

ry"IHE SHPA WERE MORE SUCCESSFUL THAN MOST OTHER DE-
veloping economies in keeping public deficits within the limits -. the economy could absorb; as a result, ,hey were better able to restrain inflation and manage both internal and external debL Low inflation and manageable debt in turn facilitated realistic exchange rates and the avoidance of the appreciation that elsewhereundermined export performance. When the macroeconomy did go awry, usually due to eaternal shocks, govermments quiddy implernented orthodox solutions, reducing the fiscal deficit and, when necessary,devaluaring the currencyIn contrast, many other developing economies have been less successful in keeping deficits within bounds and have therefore had more trouble managing inflation, debt, and exchange rates. As a result, policymakers in these econonmieshave often had less room to maneuver when confionted with a macroeconomic shock; perhaps pardy because of this, their response has often been hesitant and ineffecrive The HPAEs macroeconomic management superior is reflected in less severe imbalances and generally lower variance in key indicators, including teal exchange rates, ral interest rates, and inflation. To be sure, macroeconomic conditions varywidely among the HPAEs. Malaysia and Singapore have long-run inflation rates comparable to Switzerland7s,at below 4 percent, while inflation in Indonesia and Korea xo6
MACROEC'ON
exceedsthe South Asian averageof around 8 percent. Singaporehas confiscal deficit peaked at sistendy avoided fiscal deficits,while Malaysia's 18 percent of GDP in 1982. Hong Kong,Singapore,and Taiwan, China, -do not borrow abroad, while Korea was the worlds fourth biggest -debtorin 1980 and Indonesia'sforeign debt tripled during the 1980s. Exchangerate regimeshave varied from rigidlyfixedto managed floats. Arnid the diversiy, however,are some common themes. While some governmentshave run substantialdeficits,none has financeda deficitin a manner that destabilizedthe economy.The level of the deficit that is affordable,and hence nor destabilizing,is specificto eacheconomy.It is generallylarger the faster the rate of growth and the larger the pool of privatesavings(both at home and abroad)relativeto privateinvestment. have perforned better than many In both these dimensions, the HPAEs counterparts during the past thirty years. of their developing-economy Becauseof this, while some economieshave had higher inflation than others, none has had to endure the very highi,debilitating inflation that has troubled other developingeconomies. The HPABs chose a varieryof macoeconomic policy paths becauseof different economic conditions and preferences. All lay within the bounds of prudent stabiliy, and wheneverthe macroeconomyappeared to be in danger of movingout of control, swift action was taken to restore stability.This was true even when the source of macroeconomic
instability was policies intended to promote growth in the real economy.
For example,the heavyand chemicalindustriesdrive in Korea,to which we shall return below,was modifiedwhen its adverseimpact on the key indicators of macoeconomic stability,inflation, and the real exchange rate became excessive. In the following section we discuss how low deficits enabled the successful Asian economiesto keep key macroeconomicindicators relainvelystable, and we contrast their performance with the macroeconomic instabiliy that plagues many other developing economies. that illustte thevariey Wethen rum brieflyto four HPAEcase smudies of rapid and effectiveresponsesto macroeconomicshocks.
Adhering to Macroonomic Fundameuias

In contast with many other developing economies, where boom-
and-bust cycles have
cauised wild swings in macroeconomic
indicators,
the HPAES have been remarkably successul in creatng and sustaining 107
macroeconomic stabiliy. This has been a potent encouragement for private savings, investment, exports, and growth, since the private sector could count on relatively constant prices and interest rates. Here we consider the HPAE's successfiulmanagement of four macroeconomic findarnentals budger deficits. inflation, external debt, and exchange rates. The HPAES' budget deficitsare not Budget Deficits Manageable. Keepi.g dramatically better as a group than other developing economies'. But there are two distinctive things about the HPAEs. First, dtey almost always kept the deficit within the limits that could be financed without macroeconomic destabilization. Second, these limits were higher than in other developing economics because of the beneficial feedback fiom other good policies. International experience suggests that the macoeconomic consequences of pubLicscaor deficits depend on how they are financed. 2 Excessive monetary financing of deficits leads to inflation; heavy govermnent domestic borrowing drives up interest rates and crowds out private borrwing; large external financing of the deficit leads to debt kept each type of financing within bounds, avoiding aises The -PAFEs the corresponding macroeconomic disease. The means for restraining deficit financing have varied widely. Some governments established institutional watchdogs, such as the currency board in Singapore. Others took rule-based appmaches. such as Indonesias balanced budget law and Thailand's exchange rate management framework, which undl the early 1980s resembled a gold standard. Sill others reed on the discretion of economic policymakers, as evidenced by the macroeconomic adjustment process in Korea and Malaysia. Table 3.1 shows consolidated public sector deficits for the 1980s fbr three HPAEs for which there are good data compared with a sample of OECDand developing econornies. As a percentage of GDP,Korea's budget deficits were below even the OECD average. This helps explain why Korea was able to keep inflation, extrnal borrowing and interest rates within bounds. Malaysia and Thailand are more complicated. Thaieconomies in lands budget deficits were about average for devdopi the 1980s, while Malaysiaiswere substantally bigger than average. Both ran bigger budget deficits than such troubled economies as Argentina, Brazil, Mexico, and the Philippines. Unlike these and other economies that encountered difficulties, however, Malaysia and Thailand successfully financed their deficits.This was possible for the foilowing reasons: io08
MACROE.ON-O,
Table 3.1 Consolidated Public Sector Deficits, Selected East Asian and Other Economies
.
Eir * .,~ ~
def20tcii pcet 0>;0vj6wP dkevelpngncotrnries 'age: -. : -gi ^. ofDP~ D,a9r '980-88; .( (I ehi 4stefx) ~~~~O ., -.
.
-Averag
pliRaikmo
ng
4O
Korea,Rep.of ;Mn.Iaysia
.*
1^89
10980' 5,8023
;u0
034-
.$Thai
-nd e
'
Auemge~~~
-via g. OECDeronomnies - : -- Oderieconomi&
6.39,
2.82 :.
~~ Az~~cndna
.BIUI Yhilippines
.
~~9.62:4.02-
~~~~~z.4.30
-and S
i
Hcbbdl (lirrhcomi-g).
Sewtcasticr1y
Rdgc
:* Frst, dierewasfeedbackfrom higbgrowh. Sincegrowthwashigher in Malaysia and Thailand than in less successfil economies, a higher budget deficit could be financed. Becausehigh growth increases the demand for financial assets, Malaysiaand Thailand were able to absorbhigher levelsof monetary financingwithout a rapid risein inflation.Moreover,their rapid GDPgrowth raisedthe levelof sustainabledomesticand external borrowin (an economy can borrow more for a given debt to GDP ratio when GDP is rising rapidly). In contrast, many Latin American economiesfell into a vicious cycleof low growth and unsustainabledeficis a Second, there was fredbackfrom bigbfinancial savings.Savings rates were high in Malaysiaand Thailand, and much of this savingswent into the domesticfinancialsystem(asopposed to realassets or capital flight as in Latin America) due to the pro-savings financialpoliciesdescribedin chapter 5. This firther increasedthe demand fir money and other domestic financial assets, making increaseddomestic financing of the deficit possiblewithout resortng to inflationary financing. In Malaysia, the government's
Provident Fund mobilizeddomesuc savingsfor the goverrment's

use in noninflationary financing of the deficit
109
~~~~~~~LE
- _~~~~~rIR C L E-
* Third, therewere low init debt ratios. In Thailand,the initial debt to GDPwas very low, which meant that exterlevetof external
when needed. nal financingwas available burscs have avoided the inflation-inducing Becauseof this, the HPAEs that afflict other developingeconomies.Figure 3.1 of money aceation and Thailand showsmoney creationasa ratio to GDP in Korea,Malaysia, and in three unstablecomparators-Argentina, Mexico,and Zairc. The contrast is striking while money creation has been relativelyconstant each of the comparatorsexperiencedtwo episodesof among the HPAEs, rapid money creation when fiscal balancesdeterioratedor external financing dried up. The impact on inflation has been equallydramatic. Unlike many Latin American to LowInflation. Moderate maintaining the HPAEskept inflation from spinning out of control. Table economies, 3.2 shows the low inflation in Malaysia,Singapore,Thailand, and Taiwan, China. Indonesia and Korea have higher inflation but sdll far belowLatin America. Jnternationalexperiencesuggestsinflationbelow during their rapid 20 percent, a levelnot breachedby any of the FPAEs growth periods, can be maintained for long periods without generating and Fischer 1993). Low inflamacroeconomicinstability (Domrnbusch tuon is a corollaryof fiscalprudence: East Asian governmentsnever had to rely heavily on the inflationt becauseteir deficitswerewithin financeablelimits. Asian governmentshave made fornal commitments to . .Several i. . r East low inflation that constrained their options fr acivism. Historically, most important of these was the commitment to a fixed exdhange rate; however,aU but Hong Kong have since abandoned this mechnism. Other self-imposed constraints on fiscal policies and borrowing
Rates Table 32 Inflation

-
. Aveiag;'
*Eco nonre
tt96iAOi
,.- HPAt. Hong

l &z^4J,
75
1'
.ong
.;
8.8
1^2.2 Athe $3
tjQA Korei~iRe~of -I i ,
r
M-%
-;
--.. 6 > :;.

lie-............. :. -
.A
~
2005l|wzX, ^ . * i s .>^7^ -1.1
induding balancedbudget lawsand variousinstitutional checks,remain in place and have generaly contributed to fiscaldisciplineand low infladion.(We discussrthesein chapter 4.) In general, HPAE govenments been >^;have strong enough to alter public spending and foreign borrow~ .; ing asneeded,althoughin Thailandthishasbeena continuous struggle (Warr and Nadhiprabha 1993). Reasons fbr the commitment to low inflation vary widely but are In Indonesia rooted in the recenteconomichistoryof each of the HPAEs. and Taiwan, China (and to a lesserextent Korea), aversionto inflation
- - -: MiK&
i
no.
__*>'1120Z:
ld^y^ l
economic spiralstiat accompanied grewout-of traumatic inflationary

of colonial-era and Singapore,the success and politcal crises.In Malaysia fiscalconservatsm seemsto have helped shape postcolonialpolicies.In
0.$g11i;ES
MACRQ ECON~
;:.~~~~~~~~~~~~~I I: asa Percentage Figure 3.1 Revenues from Money Creation ofGDP.Examples from East Asia and Other Selected Economies
(Percent)
4 4
12 -
iMalayhia
-a
:: .. 10
:
IIa-
~~~~~Thafland
Rep.of Komea
-I
1970 8 2 190 12-
1972 22
1974
194
1976 1976
1978
198
2982
1984
1986
988
1378f-
1980
of G'
-
198.2-s de -j,
M2fy1984
1986
N Reene ie
ZaireM Arge.tnna
iw moe c:ato o t o
Ji a pecng GD--
afined asroo
oaIl
10 -
6-uce World^ Ban dat a.
--
-2_
__
--
fro de
;
ansfrgincrase goenmn
1972 1974 1976 1978
spending.#
1980 1982
A
is"4
,
1986
1970
Nofte. Rev:nucs from moncy crmcaon as a pucrcntagep of GDP is ds fi ned as ra2do of nominal
nge in hirgu-powerdmony monominalGDP. O
iwcff Weridl S Bankc damc
v dependence. In HongKong,
: Thailand,the traclition of responsible fiscal policies datesfrm t:he niine: teenthcentury, whien a strosng currency helpedthffe kingdomretainifts incoloniial rWfie has
insffJated the
government
; from demandsfor-increased govemmrent spending.- . 0 One result.of low tO moderatei&fltion'rates pardicula-rly welco'me tO
:businessis stable real interest rates.Figure3.2 shows real interest rates in
V
.- .
-: -
~~~~~~~~~~ ::-
; 4 S 'MIRACLE;
Ghana,and withArgentina, and Thailand,compared Korea,Malaysia, is rcmarktble. In the East thecontrast Aswith moneycreation, Mexico. keptrealinterest policies financial and flexible lowinflation Asiancases, of the combination For the comparators, rateswithina narrowrange. inflation wasdeadly. withhighand unstable interest ratecontrols nominal
gyrations in realinterst rates createdsevereuncertaintyfor investorsm wild East Asia from Examples Rates Intemst 3.2 Real Figure Economies Selected and Other
RealInterestrate (percent)
20 ~-
-70 SO-80._R.~~~
J I
1974
j
i I * C -
Rep.ofKorea Malandu: Malaysia. ,~~~1~
1970
1972
197E
1978
1980
296
1984
2988
20-
40
o4 -A-.
-30
-70 "-80
-1
!-
'-
+_
'
Argentina
Ghana
-- . '
-.
400
400
19-70 1972 1974 1976
!_ i7[7
197
_
i982 1 1984
_]
_=
2S80
1986
Nte. Realintercstratesaredefinedas diedepositrate deflatedby the consumerpuce index. WorldBankdata. &-wuree: . 11-2., --.
MACROECQ
-M
Keeptmg Extenal Debt under ControL Of the sevendeveloping HPAES,
only
Indonesia,Korea,Malaysia, and Thailand havepublic or publiclyguaranteedforeigndebt. The governments of the others-Hong Kong,Singapore,and Taiwan,China-have not borrowedabroad. None of the four with foreign debt has faced a aisis, in the sense of having to rescheduledebt, but sharp incrases in debt have led to rapid adjustment. In some economies duringsome periods-for example,Koreain .1980-85, Malaysia in 198248, and Indonesiasince 1987--debt-GNP ratios have been quite high comparedwith other indebted economies (seetable 3.3). As with fiscaldeficits,however, fivorablefeedback from other policiesenabledthe HPAE debtors to sustain higherexternaldebt to GDP han othereconomies.High levelsof exportsmeant that foreign exchange wasreadilyavailable to service the foreigndebt. Similarly, high growthimpliedthat retrs on borrowedcapitalweresufficientto pay
the interest.
Korea'ssuccessfulhandling of a very high foreign debt illustrates thesetrends.Beginning in the early1970s,Koreaborrowed heavilyto finance privatesectorinvestmentand build up foreignexchange reserves. By 1984Korea's foreigndebt was fourth largest in the world;by 1985 it equaledmore than halfits GNP.Yetbecauseof its high export-GNP rauio and rapid overallgrowth,Koreaneverlost creditwordliness. From 1986 the govermment pursued an actve debr-reducton policr, drawing on Table 3.3 Intional
4g-."
lndebtedness
,xen .- Ra,. ofor Pea pt
--
;t
-~S '
>Akioftvnal deb to
WStFrnom'rgo
199 d
Pk
U' -:9
HPE
x0
POW
hdonesia
qv478r
690
s66A
-455 2
1384 54
~~MaI~jysxa ~865
47
,:
- *,
'A Dc';-.
*
A..4.
-`3408'
-,'."-' *
47"'' '''0
390 T98joCr'.;
177
;f;
r4+44;-;-t' 7:2 0h te;nme * ~~-.-is~,t-
4:
-
r.
-'!r-sA
38
..
-.
026B0
tx
-1762II
"3
AaNt 1VRAC
burgeoning international reservesgenerated by exports to make payments aheadof schedule; by 1990the debrtCNPratiowas down-to14 percent (In contrast, when Mexicofaced scvereproblemswith its creditorsin 1982, it had a much /owerdebtto GNP ratio than Koreain 1984 but a much higherdebt to export ratio.)
Keeping theExchangeRatein Une. The HPAEs avoided the severe appreci-
ation that besetSub-SaharanAfricaand Latin America(seecable 3.4). In contrast to such economies as Bolivia and Ghana, the East Asian economies did not cling to a given nominal exchangerare (or inadequare rare of nominal depreciation)in the faceof continuing inflation but depreciated when necessary, someumes quite sharply. Fiscalprudence preventedthe cxcessive demand pressuresthat appreciatedthe real exchangerate in such economies as C6te d'Ivoire and Nigeria. The evolutionof exchangerate regimesin the HPAES has been broadly similar.Hong Kong, Malaysia,and Singaporepegged their curencies to the Britishpound during the Breon Woods period, then floatedthem in 1973 or 1974.The Taiwan,China, doUlar waspegged to the U.S.dol-
Table3.4 AverageAppriation Index,1976-85

.-
. f.
.Ecoonomy ..
: H
Kong
*Indonesia. Koreo,Rep. of
Indx ;t : f(highier vau means. . mare app recr
Pe;rcent -.- aamgerankr>:
( O: si.an10 most..e
ap.-p. at0a&O
.r.s
98 1
Malaysia
Singapore-
~~~88
87;
25 41 1 I-
Oce - .
e-co ;;Slidiend "nomiei-s
Bolivia
,- ' "' ' ''' 0 ' ''
11 4' ,
'-
,, ,-
~~
~~~~~~0;
...
.8 D-
90
4a
--
..-
.2- J--";
MACRORC
: .* -:
larfrom 1960 to 1973, then appredated twice,and wasfloated in 1979. Thailand had the longestfixedrate regimc the baht was fixedto the dollar during 1954-84, with a singlesmall devaluationin 1981. In 1984 the baht wasdevaluedand floatedas part of an adjustment program. Indonesiafixedthe rupiahto the U.S. dollar from 1971 to 1978. Because inflationwas higher in Indonesia than the United Staes, the rupiah appredated vis-a-visthe dollar, necessitatingmnajor devaluationsin 1978 (51 percent), 1983 (38 percent),and 1986 (45 percent),afterwhich Indonesiashiftedto a managedfloar.Korea,too, triedto tie its currencyto i-the dollar but resortedto four major devaluations between 1961and the start of a managedflnat in 1980. Most moved from long-term fixed rate regimes, to fixed-butadjustablerate regimeswith occasional steep devaluations,to managed floating rate regimes.Hong Kong, the single exception,reintroduceda fixed linked) rate regime in 1983 in the face of fierce speculation againstthe currencyprompted by politicaluncertainty.Under the managed floating regines that began in the early 1980s, policymakersno longrer set rates but attempt to influencethem at the margin, generally to movein parallelrothe U.S.dollar Becausethe United Stateshas been the region'smajor export market, maintaining a stable and at times slighdyundervalued exchangerate vis-a-visthe U.S. dollar has assisted exporters. The HPAES'successat maintaining stablcexchangerates isapparent in figure3.3, which contraststhe remarkablestabilityof real exchangerates since 1970 in Korea,Malaysia,and Thailand with rhe severeexhnge rate instabilityin Argentina, Peru, and Sri Lanka.Argentinarepeatedly attempted to use the exchangerate as a nominalanchor againsthigh inflation (fr example, in 1973-74 and 1980-81). But failure to keep other macroeconomicfundamentalsin line led to the collapseof the real exchangerate and sharp real devaluations.In contrast, the East Asian economies'pragmatic macroecononic management eambledthem to avoidswingsof the real exchangerate, evenin the faceof major external shocks (seebox 3.1).
Responding Quickly to Macroeconomic Shocks -The HPAEs rapid responseto macroeconomic shocks has been greatly
. dflitated by two characreristics First, by limiting distortions and

tighdtysupervsingbanks, governmentsreduced the spilloverfrom the "5
Fiupre 33 Exmples of RealExchange Rate variabiryy in East Asia andOtherSelected Economies

Realexchange rate (percent)
300 25D 0200
Rep oKorea-
SD- -
__
I__
I_
I___
__I.,
__
0 1970
I'
1972
1974
1976
1978
I980
1982
1984
1986
1988
300-
------mo 1 t
_
300--
--
-- Arg ntarM e-i.o
Tr.
Z.
MO 100 -
~ ~~
10
-5-
1
: I , I
I !
1 i i !
i t ,
I
. ,
i
o
1970
1972
1974
1976
1978
1980
2982
1984
1986
i988
rce: I980=100 cal depreciaton is down. I.. Inder of ral xchange Sot t:World Bankdam.
real sector into the financialsector that in other economiesexacerbated labor and capital markets enabled the rcal fiscalwoes. Second, flexdble sector to react quiddy to governmentinitiatives,seting off new growth cyclestha easedthe recessionary impaa of stabilizationmeasures.Thus the HPAEs recoveredquickly from rnacroeconomnic shocks.Box 3.2 describestwo more typicaldevelopingeconomies,Cc-e d'Ivoireand MexWia
ROECNO: MACRAC
gik"I!xL~R
-I
.~~~~~~~~~~~~~~A
J5tc zur
&q i"-,
'-#-
c 7
'
?YvsK:r~~
dafiii "
k g'%
yx;rvn
m;
rm'n
dXc~~~~~6aecord4icsi.&acrh. o-n' uq`c1ie.aRAsianiconj x1B

*1 ~~~~~~~~ :t10
t
aia
hcdo
bbiisl'btt`~i~
"' 1"t.>-iJ
4
r*T.
.;
K>e,;efiile(nu
-;-* tgl g$>
>0
t
b
*t>
io*eeldvomgm
t-;gTl,
Uroole'Eithti
'a,d
*
jt, wini-omm CZ>-F'
b&AkfrAhe
cnsxilngwod4sing
thinaUe.Weinri
or
is a
mn
.;
n boxa3&
ath-: anca frgr ttSF
.m4e for caes

-lci
_
. variety of -i to.ea -,=- j*fd l- E' Nh, ; + < *&e.mtvt'w>.ttiS.................-i> uya succdi, athe HPAESinrsonde in whidi rheismdy4bun&m ihakd&Rod&M-> -13eeoiOmlecs ,^fto action in rs,'l;lponsewr; uhshcsanc-v fMaulettaocltaket'imEely that <6_. f $X ,,3ii'-g\;-,..)-sVl,<w;-;='i--*,te>;t,r<,., =tr 2,; j,
*
*_
sjeoomamr
t'F"'vhe awer"'ou
'.-s
-wlWtora--
-..
term.asOft2dcbrnzoi.EhcEastArsiaccn
voabe .,as cfa-vscin ohocsf dvlo96u-t.aggl
wstas mi*>>icshavebeoinaica
unfaexa--
to tak toiml ac5tidoninepos to ico,din flled

sods:Indonesia, maCrOe:oneomic hva rge nIobsrvr Somxe
i-tand s uc shockl
-Bld-ow
we
*su
Thand.. Siengapoenloand rather Asia has bee +lucky7 Ea'noooS>ast ta ore,h,
vorale sthose ficing othernadevl,topingzeonomis.Below e exam-4 $ to aaieyo n ou ae in whc th HPE respode sucesll Kra,Singi;Dapore,andThailand. Indonesiai,snc shomcks: macroeconomic
0 %-"7J 2.eex14f-;RS,.-~*S.-4,~-tk;k.te-fSKe-t.w,WNit..hej
''-'~~~~~~~~-.'i'-:a~~~~~~n~;'
:1
~ ~~ ~~ ~
~ .
~
_V
~0'
~
*.
..
~ ~~ _t-j
..
,,,',PO
, : t
4
--
:fifl
_~
..........................................
no
fd
O-MalwAfl&q8w
d4x,O
Aursou1s4
ipA
ntoJran ; -o errcostlsXnomy<naewdroDalln ': *mrC&jp.
;DeB
XanonianadiLiebanksav-w1rkt1iaru&oPmnsm;amapcemad trto .4l~~a
^n~~~~~t
5tf
XR2SOZSFU.uas=g
~~~~~
to itls'l 1986 Inonsi *fuced From 1982c Indonesias. Pries hi.s Oil : > w>W~~~~~~~~~ein;iug decli%ni;ngi traecuedrmriyb ters oqf rarpily worsenuing - tMcreaeq-puD^ltMndgwith av remarkabl r esponde.di _ 1983,4> jgovernment, thej! Strtn in t t~~~~~~~~rcs DinanF-d vsucesuladjustmenstpro2gDram.Idealuedthe Uestlrsrlvs~~omplrehelnsie .. . an cur exedtus 1986>= in 198 awntd .~~~~~~~~~~il oDmff teachieveen . remmentSemMewolskomeffmeasurem *-. . -~~~~~~~n "8~~~~~~~~~E
SS
>erStalfizaonx DastalpriXeoa.Srng .~~~~~~~~~Ddnn adarLsIndonesa. OF aalcs inilntacil90 rom.ut1982
minl
by recedln ollow
faed
bthe i fosqrom 98tillPustated

lreOspondkled.u with a.eaml
to 196,Iadronosi
othes orthaocomng). The exces of fo ;Littlean calculoytaEnViamSoaetion

OIhened t eue
n18,tegvranenTaa-nit
poDjeC robinssnaett)eltSmitocapiml-intcnsive
~~~~~~~~~iprso goos adnnactoservices
frormtab texots f*i:3ls overannon-ol

urn account deficit
.~ ~
~~
;
~~~~~1
ca'lto
(fo
Li'
anc
otes
foromn)
xeso
--
192no scdvices F ove si ~~~~~~~~~importsof lslpiaiyb td rapidlyw~~~~~~~9orsligtrso

rosSarigi 93 hegvrmn
A96 exportsi facedfi
elnn
epoddw8
MACROECO
15 percent of GDPi 44 to 7 percent in 1988.This shiftof 8 percent OfGDP measuresthe extentby whichabsorptionhad to be reduced-the ects--eof increased principalrepaymentsof long-termdebt, higher interest payments,and reducedincome from oil and gas imports. This massive resource shift, also associatedwith trade liberalization,was inflation. brought about withoutincreased *-.~ - Adjustment M was not painless.Growth initiallyfell due to lower ex-- : port incomes and a tight 1983 budget; by 1985 the economy had - slipped into a recession, with only 1 percent growth. Evenso the government pushed ahead with the adjustmentprocess, which actuallyacpaid off in celeratedin 1986. In the later half of the 1980s,perseverance a boom of manufacturedexportsthat pushed the exportgrowth rate to 25 percent a year for the period 1985-91. Since then Indonesia has chalkedup averageannualgrowthof about 7.1 percent. Respodimgto M economic Crisis inKorea. In 1979, Koreaencountered a varietyofproblems that threatened to undercut the 1970s'impressive gro wthu Risingoil pricesbattered Korea'stermns of trade, the world recessiondampenedexporcdemand, and high interestrates boosted debt servicecosts. Koreawas not unique in these troubles,of course; these outsideof werethe samewoesthat led to debt cises in many economnies
East Asia.
Koreahad plenty of specificproblemsbesides.Realappreciationdurrate regine had made exportslesscoming the 1974-79 fixedexchange the rice crop had filed, and the assassination of PresidentPark petitive, * ~-Chung-Hee had exacerbatedpolitical uncertainty (Coffins and Park 1989). Koreahad a few structuraladvantages,however Unlike economies thatquidyfel into debt crises,Koreawas not running largeandgrowing budget deficits.And while privatesavingshad dropped due to decdining output and incomes, investment remained high. More
important, Korea responded quicldy to its troubles with an aggressive
standby credits.The January 1980 stabilizaton packagebackedby UmF rate regime,devalued the won by governmentended the fixedexchangre 17 percent, and dghtened monetaryand fiscalpolicy Things got worse beforethry got better In 1980, output fell 5 perCentr, inHfation soaredto more than 25 percent, and the currentaccount deficitapproached9 percentof GDP.The strong medicinewaspardy responsible for the economys worsning symptoms: the devaluation spurred inflation, while tighter aggregatedemand polcies excerbated
:i9g
~~~~~the drop in output. Even so, and despite politicaloutraiesoverKords risingforeigndebt,it continued foreignborrowingthroughout the cri-
sis, thus maintaninghigh investmentlevels. 'Within two years,the medicinehad begun to rake the desiredeffect. * ~~In 1982inflationdroppedto 7 percentand in 1983 to 3.4 percent.The :!current account defict fei to 2 percent of rot in 1983. Overall, the
gov:edr nes proumpt and effectiveresponseto a potential crisis

stresngthened the conomy,preparingit for rapid growthin the 1980s. Mjusting to n in Sho i Thailand. Thaland onlypartaly adlustedto the first oil shock and in the late 1970s engagedin a mild privateand
publicspending boom then Th mcmeh secondoilshockand the risein worldinterest rates.By 1980-81,thet cornlidatedpublicsectordeficit
was 7 percent of GDP,nearlyhalf of which-wasthe deficitof nonfinan-
dal publicenterprises. Thecurrentaccountdeficitwasalsoabout7 perctentBecauseforeignbo rro ing had been moderate-the debt-GDP radto wasonly35 percent in 1982-Thailand wasnot &cing a dbt crnsis and continuedto borrow. Evenso, the new government thatrook wover in 1980 perceived that macroeconomic adjustment was needed. Monetry policy options were lifmitedbythe fixed xchange rateandthe relatively opencapital marke. The government therfci retookthealternative path,fiscl contraction, movig gradualybut consistenty dudrg
the next several yearsto cut expendituresand boost revenues Policymakers steeplycur deficits of the nonfinancialpublic enter-
prises,then gradualyreduced the centralgovernment defici. As a rtsuit, the consolidated govemrnent deficitdecined from 8 percentof GDP in 198142 to 1.6 percentin 1986-87,whenadjustment was essentiallycomplete.Meanwhile,steepertaxrates and toughercolection efTorts boostedcepntal gavernent ax revenue f'rom13 percent of GD? in 1982 to 16 percentin 1988.The amdjustment process was facilitated by a 1984 devaluation. Thai gradualismwas possiblebecauseforeign borowing had been mode:ra and the economy did not yet fatce a crsis.Butgrdualismwas not h-esitancnconservative fiscalpolices were consistentand weresustained into the late 1980samid an exporct and foreigninvestmentboom. Sin 19878Tailand has becen accumulatingfoeign excamnge rewerosu fan eficlpiiswreosset hesanqconev ~~~~ecnomy serves,and the governm has ent rcgularlyrecordeda fiscalsurplus. ThaCocing Policy Failwes h Snpor. Singaporeescapedthe 1980-81 world recession wathsecacely adip in its robust growth.But in 1985the encountereda sudden and severerecessiongrowthfel hom -economy
;- . : -
--
120.
MACKtE~9
in 1984 to 41.6 percentin 1985. Reasonsfor thi~s unusual .83 perce-nt: episode included governmentencouragementof high wages between 1979 and 1981, which was intended to speed the decline of laborby erodingcompetitiveness, and the intensiveproduction but backfired exchangerare. apprecation of the Singaporedollar'strade-'weighted These were eamcerbated by a sharp declinein public investmentL due to completion of severalmajor projects.Privateinvestthe simultaneous -: N ment, whichhad been declining gradually for several years,alsodropped in 1985, apparentlybecauseof flling externaldemnand resultingfrom
Singaprs decining comperitiveness
Recognizingthe problems,the government devisedan integrated policypackagethat reversedthe high wagepolicyto restoreSingapore's competitivenes and stimulated domestic demand. The govermecnt also cut the emnployers compulsorycontribution to the Central ProvW dent Fund from 25 percent of wagesto 10 percent, reducedcorporate taxes,and introduced accelerateddepredation.Income taxeswere cut andtdevelopmentexpenditure was boostedby 21Iperrcent. Thesepolicy repnses and a fortuitousdepred'ationin the Singaporedollar,due to the globaldepredation of the U.S. dollar,contributedto a rapid recoto 2 percent,and by 1987it had reached My-c In 1986growth recovered 9.5 percent, a levelmaintainedthrough 1990.
HowMacreconic StabiriyContnb-- to Gmowth
that all of theseseveneconomies havehad It cannot be a coincidence exceptionally high growthbyworld standards,and all havehad unusual successmanagingtheir maa.oeconomnics over the long run. Al but Inth CenrMProvi cmpulsoy th contibutio emploers' tO . alsocut donesiaand Koreahave also been long-termlow-inflationeconomies, while Indoncsia and Koreafal into the moderatelylow-inflationategoesvLowor modate inflationfor lbong periods providesa fivorable growth. envirorinmentfor Thaere are four main reasons why high inflationis likelyto be adverse Forgrowth. and why rhe conservatve policaes followedin the HPAs are likelyto have been favorable for growth. Fsrl economiesthat are not fuly adjustedto a givenrate ofinflationusuallysufferfromrelative price distortionspcaused byrinflation Nominal interm rates are often conaolled, and hence real interest rates become negativeand volatle; depreciatons of the exchangerate lag behind inflation, so that rel appreciatonsand exche rate variability rsult. As wc satw, the grelinGompeiitiveneSS domestic and sumulated demand. The governmenr
7---7Pen
MAL
terestrateand the real exchange ratewereunusually stablein most HPAEs, compared withotherdeveloping economies, whichmeantthat alloat guidingresource thesecrucialrelative pricesweremoree&fctive
cation(a topic to whichwe shallreturn in chapter6). Second,realtax collections laginflation,because collections arebased on nominalincomesof an earlieryear(the Tanzicffect),andpublic utility pricesare not raisedin line with inflation.For both reasonsthe fiscal may be reduced. problemis intensifiedby inflation,and publicsavings high havebeenan importantcomponentof the unusually Publicsavings levelsof total savings in the HPAEs,comparedwith other low- and middle-income economies (seechapter5). Third, high inflation is inevitablyunstble. There is uncertainty aboutfutureratesofinflation,and thisboth reduces the efficiency of investmentand discourage it. If the inflationrate were high and stable, therewould,in theory,be no problemon thisaccount.But in realitythe higher the inflation,the morelikelyare measures to reduceit. Thesein turn have a contractonary impact on privateinvestmentin the short run. Finally, highand variable inflationimposes substantial institutional scarcemanDuringperiodsof pricevolatility, costsin manyeconomies. agerialresources in the economy are drawninto financialas opposedto real sector management, aswas the casein Latin America in the 1980s. Howirportant to growthis maaoeconomic stbility?Cross-economy, growth studiesgenerally find that higherinflationreduces econometric is not robustfor small changes;an (Fischer 1993).But the relationship economywith a slightlylower-than-average inflationrare for a longer perod doesnot necessarily havea somewhat highergrowthrate.For example,Thailand'slong-termgrowth rate is well belowthat of Korea, eventhoughKoreisaverage inflationrate has beenhigheLFurthermow, thereare manyeconomies that have,at varioustimes,had lowinflation rates and low growth.The most importantcaseis that of India.There with high growth.The most are alsocasesof high inflationassociated importantexampleis Brazil from 1968to 1980.Morerecenty,Turke/s 5.4 percent,whileits inflation growthratefrom 1981 to 1990averaged rate averaged 46 percent (ittle and others,forthcoming). Lowto modcrateinflationmay be a necessary conditionfor growth,but it dearly is not sufficent. Relatively cautiousfiscaland fbreignborrwing policiesmeant that seriousdebt crises were avoided,which reducedthe stopgo pattern of crisis and response that characterized manydeveloping cconomies in the
In
MACROACCjj_~.
in Korea and notably 1980s. Asnotedabove,therehavebeenproblems, and, even Malaysia, but theyweredealt with swiftly. The Indonesian were more gradualbut also effective. Avoiding more, Thai reactions
was crises and the need for reschedulingmeant that creditworthiness maintained, and it was easierto borrow in the shorc term and to avoid in invesmenL Suddenreductionsin aggregate very deep cuts, especially
by debt crises weremajorcauses demandand in investment compelled

of the sharp declines in growth rates in many of the heavily indebted Americaand elsewhere. economiesof Latin Although macroeconomicstabilityand prompt responsesto macrosuccess, these economicshockswere not the whole story of the HPAES' factors created a basis firomwhich policiesintended to affect the real economy-the supply side-could be launched in an environmentof stable realinterest and exchangerates.We now tum to the most broadly shared of thesesupplyside policy initiatives:creatingan export push.
Creating anExport Push

GOVERMENTS OF THE HPAEs HAVE ENCOURAGED
exports by fostering a supportive macroeconomicclimateand
by providing suitable microeconomic incentives. Macroeconomic stability helped exports by easing the liberaization of restraints on tade and by facilitating realistic and, in some cases, rates.We discussthese issuesbelow.Few generalundervaluedexchange izations can be made about microeconomicincentives,however,since
these economies differed in the degree and selectivity of promotion, and
each economypassedthrough severalstages.Because of tis and because ecport promotion has played such an important role in the East Asian mirade, we condude this chapter with a survey of the evolution of export-push polices in all seven developingHPAEs(these arc summarizedin table 3.5). Appendix 3.1 givcs brief policy histories of each economyin the fiormof timelines.
Macmecononic Stability Facilitated omre Open Economies
The successof the HPAES rests pardy on what they have done and partly on what they have not done. One thing theyhave not done is to
n3
IRA~~~~CLUE
Table3.5 Phases in HPAETmade Regimes

.~Nad&z anlimad 'War and construeguidcddevclpmcnc, do'a,1950-O0 194846' Mket-led developmet .150-70 Land reformn anid reconstruction, Natural-resouirceae prs
~~~~~~~
~~~~~~1949-.521900
Impori-substinicing industrialirzatiLon-, 1953-57

J
AF:K~~~~~~~~~~~Eport promotion
1958-72
-
ZTilting.twr
promotion. tSelectiv6inter:vendion>2andirnPortssubst-~ Omlandcommoitydioi4hii:heavy 2nd -boomIn,974-81 cciakuwe
.
~ incur 73 1967 tiC .;;J*-Export
Fvoring import sb Indi'srial. con-solida- sio 197180: no stontut7-o5 growth,1973-080
* AdjstmntEto aex-
~~Functional
abdlbcraizaon, 1809 shodci` ~ ~ ~ ~ 85~ ~
.-
.':
~~~~~~~~~~~~icntvs
~~~~~~~Refborm ad epr
-1980-
Derc~~~u1adon:and oriU.nrarion,T * outward d

..
Hihtecnlgn Adjw~~~mciz-andh- moeniztion, 19iiod-ors cAIimno,

-
present
A_
,11986-9 CMLEMUOn,
present.
impose general import restrictions to redress balance of payments deficits. Hong Kong, MaIayrsi-a, Singapore, Thailand. and Taiwan, China, had no cause to-imposesuch restrictions,since their current account balancesneve-rfaced serious long-term deficits. ndonesa and Korea. with more troubled current:accounts, might have imposed restrictions but dlidnor. The benefit of avoiding import restrictosi iely understood. Such measuresstrve enterprisesof imported inputs and are particularly hard on exporters,who tend to depend heaviy on i.mportedmaterials
124
MACRO-EC;~~
and capitalgoods. But easingimport restrictions without accommiodating maacrconomic or exchangerate policycan womsen current account problems,as consumersand firms buy imported goods not previously available. The trade regimesof the eight H-PAEs havedifferedwidely,but each has gradually liberalizedwithout incurring a serious current account deficit. Often trade liberalization has been part of a policypackage chat included devaluation(usuallyto cushion the blow to import -substitution industries), exchangerate unification, fiscal reform, and foreign aid or concessionalloanisto offset a tempomarily deteriorating current account. The dose link betweensuccessfuil macroeconomic policiesand trade liberalizationcan be seen in the experiences of Indonesia, Korea,and Taiwan,China. Taiwan,China, took its firstbigstep toward trade liberalizationin 1958 with a policy packagechatincluded a 25 percent devaluation,a unifiedexchangerate, exportincentives,and the widespread remnoval of quantitative import restrictions.In Korea,devaluationsand tradeliberalization havegone hand in hand, beginningwith a dtrastkc devaluationin 1961 (Collinsand Park 1989). Indonesiabegantrade liberalization in the late 1960s, together with the stabilizationefforts chat marked the start of the Suharto era. The new government abolished comprehensiveimport licensingand in 1970 united and devaluedthe exchangerate. After an inward-lookingperiod in the mid.-1970s,trade liberalizationresumed in the 1980s and has since proceedecd together with an export boom.
Exchange RatesandExports
As Wehaveseen,several HiPAE governmentrs used exchangerate policies to off-set the adverseimpact of trade liberalizations on producersof import substitutes.A few went beyondthis objctive, however,and used * deliberatelyundervalued exchangerates to assistexporters.In theseinstinces, exchangerate policy and the fiscaland monetary tools to carry it out becamea part of an overal export-pushstrteg Taiwan, China, avis the most notable exampleof this, but Koreaand Indonesiaalsodelibecrately undrvalued their currenciesto boost exports.We brieflydiscuss aglthree belowo The very large current surplusesthat Taiwan,China, ran in the 1980s, especally from 1984 to 1987 (when the surpluses
125
CL E
with an etraordinary peak of 20 peraveraged16 percent of GDP, cent in 1986), resultedfrom governmenteffortsto managethe exchange rates What would have happened if the New Taiwan, Exports to appreciatemorerapidly? China, dollar had been allowed reducedexportgrowthwould would havebecomelesscompetitive, effect,and this in rum could have probablyhavehad a deflationary Alternatively-and more realistically-thc potenreducedsavings. tial deflationaryeffectwould have been offset by increasedpublic expenditure,leading to a budget deficir. * Koreaused exchangerate protection from 1986 to 1989 when it ran a current account surplus (which peaked at 8 percent of GDP in 1988). A desire to protect the export industrieswas certainlya rate policy,but tie main concernwas to fictor in Korean exdcange reducethe debt ratio and build up reservesto avoid repeatingthe closebrush with a foreigndebt crisisin 1984-85. laelyas anm The Indonesiandevaluationof 1978 can be classificd ticipatoryexchangerate protection.No immediatebalanceof payments problem existed, as the adverseeffect of the previousreal appreciationof the rupiah on non-oil exports had been offset by the rise in the quantity and value of oil and natural gas exporcs. Rather, the aim of devaluationwas to encouragenon-oil exports and slow import growth. By 1982, when the balanceof payments was had sharplydeteriorated,the wisdomof the 1978 devaluation clear. One can see a fairlyclear relationshipbetweendevaluationsand export growth in the 1980s.Taiwan,China's,real exchangerate relativeto the United Statesdepreciatedsharplyfrom 1980 to 1985 (the period of generaldollar appreciation),and the result can be dearly scen in an export boomto the United States.The Koreanreal exchangerate waskept during the period of the fairlystble by numerous nominal devaluations first great Koreanexport boom, 1963-72. The effectson exportsof real devaluation from 1982 to 1988 can also be seen very dearly. The Malaysianreal exchangerate steadilydepreciatedfrom 1987 to 1990, and this must have been one factor in rapid export growth-. The effectsof Thailand's real devaluationin 1984-88 on export growthwerequite dramatic,eventhough therewerealsoexternalfiators of capitl fiom Japan explainingexportgrowth, notably the availability From 1986 to and Taiwan, China, for developingexport indlustries. 1989 the dollarvalueof exportsrose 12 percent.All three of Indonesims
126
MAC ROE CO NO M ICr
devaluations had dear effects on exporcs of manufiactures, and this was particularly trueof the 1986devaluation. From 1986to 1988the volIume of exportsof manufactures rose80 percent(froma Fairly lowbase), and growthcontinuedright through 1990.
We now turn to our surveyof the evolutionof aporc-push strategies
in the sevendeveloping HPAEs. 'Korea Pushes Exports andIndustrial *

X
Korea's development has passedthroughthreesmges and is currently in the midst of a fourth Unlikeseveral of the largereconomies in East Asia,which evolved from protectionist,inward-looking trade regimes
toward relatively open economies, Koreadid not have a sufficiendylarge
::
domestic population to contemplate a strategy odtcr thanexport-led development. Its performance may be described as forcedgrowdt,because
it did not stem from exploitationof natural resources,an influxof labor, flowsof speculative capital,or the adoptionof new meansof produc-
tion.Rather,growthresultedfrom a systematic programof importing

raw materialsand intermediate goodsfor processing and exportwith addedvalue. War, P oanstrclion, andLand Refonn (1956O-01. Koreahad a relaively well-developed infrascructreat the end of WorldWarII, but the partitioning of the peninsulaby U.S. and Sovietforcesseveredeconomic linksbetweenthe heavilyMidustrial north and agricultural south. The war tooka heavytoll,taking1.5 millionlivesand destroying two-thirds of the south'sindustrial capaciy.With a poor naturalresource baseand 'oneofthe world'shighestpopulation densities, thesouthwasalmostentirelydependenton U.S.aidafterthe war Forallits devastation, thewar mayhavehelpedto prepare Koreafor an industrialtakeoffbyloosening a rigidsocialstructure,openingthe wayfor fundamentalchangesin oudook. Whiledevelopmenr effortsin tie 1950sinduded several false srans, progress wasmadein reconstruction, includingthe restoration of
transportaton and communication networks. The government also
a land reformprogramthat had stalledbeforethe war. completed Export Takeoff 1961-73). UnderPresidentPark,aggressive promotion of exports was combined with-classicimport protection at home. Koreanpolicyakers nmainLiained dose control over trade, exchange, and - 1financialpolicy, as wel as aspeccsof industrial decisionmaking. In contrastto othercontrolled economies, theyusedtheseinstruments to pur127,
L~~~~~~A4
41
,.
C,
E-
sue the primary objectiveof export growth. The trade regimewasbiased of exports as a whole but essentiallyneutral with respectto dte in fiavor
composition of exports.
Even so, the first instruments of export promotion were highly discretionary.Exporters were supported with multiple exchangerates, direct cash payments(seetable 3.6), permissionto retain foreign exchange earningsto import restrictedcommodities,and permissionto borrowin foreign currcncies.This system not only avoided hampering exporters with restrictionson capital and intermediate inputs for their own use, exchange rates determined by but it also gave access to he firavomble scarcity rents in heavily protected domestic markets. Even as discreincentives were gradually replaced by more automatic instruments, exporters received significant exemptions from import controls.
tionary
for Imports andExports, Table 3.6 Effective Exchange Rates Republic of Korea
' ' ' '' ' ' S' '''' ^ '#ren'ccs due to: '"~ '
-
-~~' '
Ecnge-
; 4 f-,--' -,"-, Yen
~d6r tcashX
p'remiums phs:
of2&i<E&YZY.5. suGbsud
. wE 1.79 97
:.ax ax a n.' ':D'treet ji. materb-- - '.' u a equwa.. inSurceMt) (percent)
-1958
1959 .19 0 -1961 1.962
`19638
'0
10.7173 7 1964 114 '~~

-225
~~29: 21
23 29 .5K
19
.4
... 196., ,1970
118
.44
44 .-. :
33
3:
148
:.~~~~~~~~~16
113
-69 ;
,-
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xz8
MACROECON
Tariff exemptions were given to indirect as well as direct exporters, and generous wastage allowances on imported intermediates allowed some resale (table 3.6). These enabled exporters to avoid distortions from protection and in some cases to benefit from the protection of the domestic marker. Support for exports was also channeled through rhe stare-controlled banking system. Objectves were implemented through bank loans explicitly earmarked. by the government for particular activities or industries, lent passively by banks at preferential interest rates. Following explicit government directives, banks increasingly used export performance as the criterion of creditworthiness. Heavy and Chemical Indostries Drive 11973-791. The heavy and chemical industries (HCI)drive was a major policy shift, away from the neutral incentives of the takeoffperiod to a commitment by govremment to use all its levers to steer resources into specific sectors to rapidly alter the industrial structure. Special legislation singled out six strategic industriessteel, petrochemicals, nonferrous metals, shipbuilding, electronics, and machinery-to receivesupport, induding tax incentives, detailed engineering, subsidized public services, and preferential financing. Thcegovernment chose the fir dutee sectors to enhance self-sufficiency in industrial raw materials, while the latter three were meant to be groomed inro technology-intensive export industries Unlike other governments thac have attempted to build a heavy-industry sector, Korea was at least partly successful. One reason is that the government made dear fiom the outset that these industries were expected to become internationally competitive. As a result, projects tended to be forward-looking--only current technology was imported, and U.SI-trained. Korean scientists and enginaeerswere recruited. (See box 33.) However, interventions were so pervasive that botdenecks emerged, largscale debts were incurred, and labor-intensive industries were starved of credit. When the second oil shock hit, inflation was already high, and the exchange rate had apprecated; capacity utiliation in the :HC: seccor was low, and exports were faltering. The government switchled course. FunctionlIncentives and Liberalization (1980-90J. Support for strategic industries was curmiled and abmpdy reversed. The currency was devalued, and credit allocation policies switched, with a termination of large-scale preferences to the HcI sector. The five-year economic plan 129
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MACRO: EcoNP.
of Export Push inTaiwan, China TheEvolition of fivestagesin Development policyin Taiwan, China,has consisted but changing comprehensive has implemented which the government poliqcpackages. Throughout,low inflationand macroeconomic stabilityhavebeen a foundationfor growth-enhancing policyinitiatives, and sincethe late 1950s-export growthhasalso beena fundamental goal.
LandReform andReconstruction (1949-52). When the Taiwanese authorities took over in 1949, one of their first initiatives was an ambitious
land reform program. The program fosteredsocialand politicalstability

and increased agricultural production. Greater agricultural output pro-
videdraw materialsfor exports and earned foreign exchangeto fund imequipment, and industrial raw marerials.These in ports of machinery, rapid development turn helpedto make possiblesubsequent cxport-led Impat-Substitg Industializaoun(1953-571.During the second stage, the government attempted to developindustry as the basefor economic self-sufficiencyThe government invested heavily in infrastructure, exbuilt by the Japanese;U.S. panding transportation and power necworks aiidwas an important sourceoffiriance,funding 49 percent of public inquantitative restrictions and high vestment in infiastructure. Excensive ta-riff ratesshielded domestic consumergoods from foreign competition. To take advantageof abundant labor, the government subsidizedsome light industries,particularlytextiles.Consumer goods industries such as textiles,apparel, wood andlearher products, and bicyclesdevelopedvery rapidly. By the end of the 1950s, industrial production had doubled. over time. By stimthe costs ofimporc substitution increased -'However,
ulating the import of capital and intermediate goods while penalizing
exports, imporc substitution contributed to a growing trade deficit, financedlargely by U.S. aid. As the small domestic marketbecamesaturated, overallgrowth declined, fiom 9 percent in the early 1950s to 6.5
percent in the mid-1 950s.
Expot Prmotion 11958-72). Anticipating the termination of U.S. aid
2and hence a need to obtain foreign exchange,the govermnent shifted to a policy of outward orientation and export promotion. Staring in 1958 it adopted a seriesof measuresaimed at promoting exports and foreign mnvestment. Amultiple exchangerate systemwas replacedwith a unitary rate, and appreciation was avoided. Tariffs and import controls were -gradually reduced, especially for inputs to export. In addition, the Bank of Taiwan, China, offered low-interestloans to exporters.The govern-
131'
R~
~~TWL
promisinginInstitute to idendifjy ment alsohired the StanfordResearch dustries for export promotion and development. On the basis of Taiwan, Chinas, comparative advantage in low-cost labor and existing technical capabilities, the institure chose plastics, synthetic fibers, and electronic components. Other indusrries subsequently promoted induded apparel, consumer eectronics, homc appliances, watches, and docks. Direct foreign investment(Dn) playeda catalyticrole during this period and replaced U.S. aid as the main source of foreign capitl. Although DFI was only 6 percent of gross capitalformation in the 1960s, nearly 80 percent of it went into manufaacuring.More important, DFI facilitatedtechnologyand skill transfers,leading to much improvement of industries. in quality and the diversification The impact of these measures was dramatic. Exports, which had grown less than 12 percent annuallyberween 1953-62, grew 28 percert a year between 1963-72, rising from 123 million to almost 3 billion dollars. The transition firm import substitution to export promotion dewasthe most important policy changein Taiwan, China's,economic v-elopment.It shifted the economy from a relativelydosed to an open economic system and exposedit to the forcesof international competition and technological change. (1973-80). As hic 1970s and NewExportGrowth IndusirialConsoidation
threatened the contunuation progressed,intemal and externalchallenges of export-led growth. The rapid manufacuring increasesof the 1960s strained transportaton, electric, and communications systems.The island suflrd profound extemal setbacks. More important, Taiwan, China's, light manufacuring industries faced new competition from lower-wageproducers abroad.As foreign investorsrushed to the newly opened mainland Chinese market; international confidence in Taiwan, Chin;:s, economydedined. The 1973-74 oil crisis had dramatc lepercussionsfor the Taiwaneseeconomy. RealGNP grew only 1.2 percent in 1974and inflation climbed tO 47 percent, while exports declinedin real terms by about 7 percent. Beginning in 1973, the govenment chose a more self-relianrdevelopment strategy based on industrial consolidation and renewed export growth. Once again, it mrnedto foreign expertsand commissionedthe U.S.managementfirm ofArthur D. Litde to find solutons to the eco.nomiccrsis. Basedon Taiwan, China's,economic needs and capabilities,the Americans recommendedheavy investuents in infiasrmrure, industrial upgrading and secondaryimport substitution.A government
132
MACRO'ECO
plan incorporating the recommendations focused on development of capital-intensive,heavy, and petrochemicalindustries to increase production of raw materialsand intermediatesfor the use of export industries.Thle governmentalso launched ten major public sector projects,at a total cost of 8 bilion dollars, to rcvitaize the economy and remove bottlenecks to economic growth. These included highways, milroads, airports, and construction of nuclear power plants..
High Technology and Moderunihaon 11981-I. As it entered its fourth
decade, Taiwan, China, confionted a challengingdomestic and internacional environmenc.The spectaculargrowth of the 1960s and early 1970s sputtered to just below 7 percent in the late 1970sX Taiwan, ChinaTs, continued inrcgration into the world economy revealedstructural weaknesses,particularly the financial system'sinability to match the increasingdemands of induscialization and external trade. Externally, Taiwan, Chinais, persistent trade surpluses with major trading partmes led to growing protectionism. In the later half of the 1980s, Taiwads exports faced an additonal loss of competitiveness due to the appreciadon of the Taiwan, China, dollar and rapidly rising wages. Manufacuing wages rose, undercumrngTaiwan, China's; advantage, and local firms moved production overseas. As in other first-generation East Asian NiEs,Taiwan, China, manufacturerswere squeezedbetween lower-wage NIEsin traditional, labor-intensivemanufacturing on the one hand, and high-technologyproducts from industrial economies on the other. Once again, the governmentmoved to rescrure the economy. After extensiveconsultations with domestic and foreign advisers;, the government decided to focus on high-technology industries: information, biotechnology, electro-optics, machinery and precisioninstruents, and environmental technolo&rindustries. Theshift to ahigh-technologyeconomy has necessiated the close coordinaton of industrial, financial, science and technology, and human resources policies. In 1984, the government revised laws to provide tax incentivesfor manufacturers who allocatea percentageof their revenuesto researchand developmenr (R&D). Incentiveswere given to industry to diversifyr and improve production techniques.The government encouraged the establishment of
venture-capital firms and revised university curricula to stengthen sci-
-nce, mathematics,engineering, and computer education. It began to recruit rechnicalmanpowerfrom abroad by offeringcompetitivesalaries to forner Taiwan, China, residentsliving overseas.
'33
~1R'A CLE
In addition, in 1985 the government launchedfourteen major infrastructure projects, including expansionof the energy,telecommnunications, and transportation networksand developmentof water resources and national parks. The government'sdevelopmentplan for 1991-96 callsfor 330 billion dollarsin public sectorprojects.To support theseeffbrcs,the governmenthas adopted an overallstrategy of economic liberalization and internationalization, including the lifting of foreigi exchangecontrols. a few observations While it is too earlyto assessthese policiesfillly, are possible.A growing number of small, high-technologyfirms proproducts. For duce incrcasinglysophisticatedand higher-value-added most firns, however,the transition to hi-tech industrieshas been difficult. On one hand, the rapid rate of technologicalchange and rising protectionism in industrial economies make it increasinglydifficult to obtain advancedtechnology. On the other, the small-scalestructurc of industry is not conduciveto the costlyinvestmentsin R&D and skillstraining needed to shift toward high technology.As a result, most Taiwan, China, manufacturers are still assembling imported high-tech components.
tD Manufacturd Exporus Malaysia'sShift knm Resource-Based
continued afer independence,Malaysia During the firsttwentyyears the essentiallyfree market trade and industrial policiesof the colonial to promote mral develaldtough it intervened extensively govemrnment, While the governopment and providesocialand physicalinfrastruacure. ment protected import-competng industies, protection wasgenerally less strong than in other developingeconomies.Government was re-
strainedfiom heavily biasing incentives against agriculture by the economic and political importance of
theplantation
and mining sector In
1957, Malaysi's exports of tin anctnatural rubber accountedfor a thiid of GDP(Bruton and others 1993). Import Subsitution [1950-701. The objectiveof Malaysia's limited imporc substitution was the same as that in odter developingeconomies: reducingimportsof consumer goods and increasingprocessingof natural resourcesto create industial employmentopportunities. The government did not promote individual sectors, and effective rates of
protection were very low, averaging 7 percent, compared with a range of 25 percent to 92 percent in other economies at similar levels of income.3
134
MAC ROE CO
Nevertheless,between 1960 and 1980 import substitution combined with domestic demand expansion accounted for virtually all of Maoutput (Salich,Yeah,and Meyanathan laysia's growth of manuFacuring 1993). Combining Export Promotion and Import Substituion (197145).Malaysia's 1969 ethnic conflictstriggereda reexaminationof developmencpolicy The New Economic Policy(NEP) launched in 1971 had many dimensionsintended to promote growth with equity. In trade policy,the govemmnentbegan more acive promotion of natural resource exports, particularlyrubber, timber, palm oil, and petroleium,and light manuparticularlytextiles, footwear,and garmens During factured exports, the 1970s, export-promotioneffortswere designed to complement the modest import-substitution regime inherited from the 1960s. Major NEP export incentives induded taxableincome deductions linked to export performance and domestic input content, tax allowances for export-related promotional expenses,and accelerated depreciation for finmsexpormngmore than 20 percent of their output. Credit policies promored exports through guaranteesand automatic rediscountingof exporcfinancing at low interest rates. Export-processingzones, fiee trade zones,and licensed manufacturing warehouses that permitted duty-free import of materials to be assembledor processedfor export were crucial to the successfill combination of import substitution and export promotion. Foreign investment, particularlyfrom Japan and elsewherein NorcheastAsia,poured in. By 1980, about 70 percent of manufacturedexports originatedin the export-processingzones, primarily from foreign-owned firms. As the economy has developed,the proportion of exports from the zones dedined to about 40 percent in 1989. (1986).A combination of terms of trade Adjustment andLiberalzation shocks and fiscal imbalances (describedabove) prompted the govcrnment to move in 1986 away from state-ledindustrialization.Promotion ofprivateminvestment acrossa broad rangeof sectorswas combinedwith macroeconomicadjustment and continued effortsto increasemanufac4 Tax incentivesfor exporterswere increasedand imports tured exports. were liberalized.As a result, the averageeffectiveprotection to induscry declined from 31 percent in 1979-80 (an internal World Bank report) to 17 percent in 1987 (C. Edwards 1990). At the same time, tariff reductions and changes in export incentivesincreasedthe variation in cffectiveprotecCton acrosssectors. [135
-ALCL I
Indonesia Tries It Both Ways and Opts forExport Push

Indonesian trade policies have swung from protectionism to openness.The current open phase has gone fiurtherthan any earlier efforts
and obtained the most impressive results. Nationalism aud Guided Development (1948-66E Followingindependence
in 1948, economic policy was shaped by a strong sense of nationalism flavoredwith anticolonial and anti-Chinesesentiment. DLespire several early attempts at liberalization,the policy regime became increasingly inward oriented and interventionist.A pervasive and complexregimeof import and investment licensesfostereda new group of Indonesianimporters and traderswho earned substantialrents and becamea powerful lobby for trade restrictions.Followinga centralizationof politicalpower a populist platform of 'Guided in 1958, PresidentSukarno expounded Democracyand Guided Economy,"and the economy entered a period of more direct state control of production and trade. Dutch enterprises were nationalized, and stare enterprises took over all aspects of the economy-including the recendy emergedimport monopolies. Growing mismanagement resulted in chaotic economic conditions.. Inlation acceleratedto 1,000 percent by 1965. Exports and foreign exchange reservesdwindled, and debt serviceexceededforeign exdcange earnings.Economic growchstagnated. By 1965per capita income was 15 percenr lower than in 1958. Widespreadsocial unrest and violence ser the stagefor a change in leadership. OitwardOriented New Order Goverment (1967-731.The new government of PresidentSuharto moved quiddy to restoremacroeconomicstability and adopted a moreivorable stancetowarddomestic and foreignprivate investmentSomenationalizedenterprises werereturned t previousowners,and a newForeignInvesament Lawthat provideda thirty-year guaranree of nonnationalization was enacted.The exchangerate was adjusted throughlargedevaluations. In 1970,the governent established the mclianismfor a market-driven unifiedexchange rate and abolishedcontrolson capitalmovements. Sweeping changes wereintroducedin the tradeand incentiveregimes,ildg the abolitionofiport licensingthough litde
change was made to tariffi. As a result, non-oil exports increased at an
annual rate of nearly 26 percent from 1967 to 1973, comparedwith annual increases of barely2 percentduring theprevioussevenyears. OilandCommodt Boom(1974813. Indonesiabenefitedfrom the sudden surgesin c-i prices in the 1970s, and the boom in primary commodity
x36
MACROECOO
prices. The surge in revenue gave the govenment an opportunity to intensifr development effort but it also posed the problem of how to protect the competitveness of the non-oil economy from the adverse consequences of oil-windfiil spending. While Indonesia was relatively successful in moderating exchange rate appreciation, the appreciation that did occur increased pressures to protect domestic industry from
imports.
Compared with many oil exporters, Indonesia used its enhanced resources well. Daring the 1970s, about 40 percent of the government budget went to infrastructure for the economy. The government also placed strong emphasis on improving the availability of education, health services, and family planning. As a result of these physical and social investments, Indonesia was able to make extremly rapid progress during the 1970s in reducing poverty and improving social conditions. Economic growth averaged dose to 8 percent through the 1970s and early 1980s, as a result ofstrong expansion of public and private investment- Non-oil activities reinained buoyant, especialy agriculture and manufacturing. The government maintained good macrocoonomic managerment and, following a debt crisis with the state oil firm Pertamma in the miid-1970s, a conservative foreign borrowing straregy, By 1980, the current account of the balance of payments was in surplus, and debt service payments were less than 13 percent of exports Despite these achievements, the trade and investment regime became increasingly state dominated and inward oriented. Fluzh with cash from oil and commodities the goveme nt invested heavily in such capitaland resource-intensive sectrs as oil refining, liquid natural gas, chemicaL, pulp and paper, fertilizer, cemenc, and steeL As the states role in the cconomy grew, the govemment tightened regulations on foreign and domestic private investment Meanwhile, gradual appreciation of the exchange rate eroded the competitiveness of non-oil exports, and pressure from domestc interests caused the trade regime to become more protectionist and variable. AdMjusuenttExtenal Shocks(1982-85. The high-cost nature of the industrial scaor and die end of the oil boom sparked a debate and reassessmentof industrial strategy in the early 1980s. The govermnment initiated a broadly based adjustment program designed to maintain balance of payments and fiscal stability while reducing the economy's dependence on oil revenue. As with previous macroeconomic imbalances, the government responded with a combination of fiscal, monetary, and
'37
rs>I&A1 .
M I RAC L E
RatOs Figum3.4 Effective

... Import-:X Impoflb 2sminvestment
Tramnston
exchange rare policy adjustments. It also initiated comprehensive financial and tax reforms, and made major improvements in customs, ports, and shipping. As we discuss elsewhere in this chapter, the macroeconomic measures successfiuly restored financial stability. The current account deficit dedined, and inflation was brought to below 5 percent, from 7.6 percent in 1982. But trade and industrial policies gradually became even,more inward oriented and subject to government intervention. In addition, the adjustment resulted in slower growth of output and incomes, reduced public and private investment, low rates of capacity utilization, and the emergence of financial problems among industrial enterprises. Moreover, although textiles and plywood both emerged as important exports during this period, overall manufacturing growth slowed in the face of weak non-oil exports and weak domestic demand. By 1985, a plethora of decrees had brought a wide range of products under different forms of import control. Overall, the production regime favored import substitution rlatidve to exports. As a result, domestic resources were drawn into relatively inefficient capital-intensive activities supplying the domestic marker- This disadvantaged the more labor-. intensive, efficient downstream producers and reduced export growth. In 1986, the economy sufOrietaton(1986P--. Derigflation andOutward fered further shocks, as declining oil and commodity prices led to a steep dererioration in the terns of trade and a jump in the debt-service matio. This time, however, in addition to successful efforrsto restore macmeconomic stability, the goverrnent launched a program of broad trade and regulatory reforms that opened the way for a decisive shlfif o export promotion. Exporc-oriented deregulation has gathered momentum since 1986-8 7, culmninatingin a series of major reforms in trde policy, licensing and transport regulatons. The first step toward trade reforrn bad actualy been taken in 1985 with steep tariff curs. In 1986, pushed forward by extrnal shocks, the _ l
Iprocess gathered momentum. Between May and Ocaober, tde govern1 1--+,i
:Exportpush-dI
-- 20 40 o - 6o so 100
Effatve rtedf potectJon
(percent)
* Mlaysia
ment announced a package of exporc incentives, a major devaluation, and the first of several programs to simplify imprt and export procedures. Major exporters were given unresticted, duty-free accessto im-
31Indonesia Thabnd and Mcyanadmn -cSalieb, Xcah.

Yeah and Mcpnathan
porcs (see figure-3.4). Later the government deregulareddomestic and

foreign private investment, and for the first time permirted the private
sector to invest in power, telecommunications, ports, and roads. It also
-mcr 507zSo&k,
(1993); Bbarracharyaand Pangx

Brinmbc (1993).
(1992w);
firher deregulatedthe financialsector
138
'M ACRO E
'CON
The economyrespondedrapidlyas manufacturing output, exports, and investmentall increased. Growthaccelerated from 1988onward as a resurgencein domestic demand accompaniedthe continued growthof non-oil exports. Plywoodand textilesremainedthe largest manufacturedexport items,but other manu&cturedexportssuch ats shoes,apparel,and electronics beganto growveryrapidly.Foreigninvestmentprojectsapprovedby the govcrnmentincreasedtenfold between 1986 and 1991, to more than $8 billion, and domestic investmcntroseby a similarproportion,to $30 billion.Perhapsmorc important,70 percentof the foreigninvesrment approvedwasexport oriented,comparedwith 38 percentin 1986.Since1986, GDPgrowth has averaged9.3 percent annually,the highestsustainedgrowthrate sinceindependence. Indonesia continuesto encounter occasional difficulties. In 1990and 1991,the economyexperienced an importsurgeand deceleradon of export growthdue to increased aggregate demand promptedby a prior easingof monetarypolicies.This led to a wideningcurrent account deficit and a surge in foreign borrowing. As with previousmacroeconomiccdistortions, the government respondedby tighteningmonetarypolicy and curbing borrowing. Meanwhile, the obvious successof
export-pushpolicies can be expectedto generatemomentum for firTher
export-oriented reflrm. If this is the case,future swings towardprotectionism,should they occur,are likelyto be lesspronouncedand less damaging than thoseof the past. Thailand's Shift fom Resource-Based Exports to Manufacturing LikcIndonesia and Malaysia, Thailandhistorically exportedprimary and agricultural productsderivedfrom its rich naturalresources. Early rent associated tradepoliciesemphasized taxationof the resource-based with theproductionof theseexportable commodities. Tradewasheavily
controlled.Rice exports, Thailand'smajor commodity export, werecon-
trolledby a statemarketing monopoly, exporttaxeson othercommoditieswereheavy, and a multipleexchange rateregimediscouraged export producton (Jitsuchon1991).
Exports 11955-70). In 1955 the exchangerate was Natural-Reso.rce-Based
unified,and the state marketingmonopolyon rice exportswas abolished. Although thesepolicyreforms encouraged natural-resource-based anrd agricultural exports,Thailandmaintainedsubstantial import pro'.39
ffl ,, ]\ ,,
.RWCLE
tection for specificindustries.As late as the mid-1960s,however,overall levels of effectiveprotection to industry were modest by developingeconomy standards. This was especiallynotable in consumer goods manufacruring,where nominal tariffs were in the range of 25-30 percent ad valorem.Tariffson machinery and intermediateinputs were in the range of 15-20 percent. following (1971401. In the 1970sThailamd, FavoiingImportSubsfition the import-substitution strategies favored by many other developing economics, raised tarifli on consumer goods to a rangc of 30-55 percent. Capital and intermediate goods continued to enter at low duty rates, leading to an increasein the effectiveprotection to valueadded in protection import-substitutingindustriesand to dedines in the eff-ective to agricultureand traditional exports (figure3.4). The biasagainstagricultural and export production increased. Textiles,pharmaceuticals, and automobile assembly were particularly favored. At times, vehide importswere banned, which resulredin limitlessprotection for domesticmanuficurers But therewasa quid pro quo. Domestic content requirementswere establishedto promote upstream suppliersofcomponentsand parts. Thesenontariffbarriersto competing producton costsin the assembly importsof componentsand parts raised sectorwhile subsidizingthe produce- of inputs. Consumers were in effect taxedto promote an intermediategoods sector. R-aion andExport IncentWes (19804.As was noted in our discussionof macroecononic polic, the second oil shock exposedweaknesses in the Thai economythat werethe resultof the import-substitutionpoliciesof the 1970s. In 1981 Thailand's trade poliqc shifted explicitlyin the direction of export promotion. Remainingexport taxeswere reduced, and as describedabove, the exchange rate was devaluedand subsequently moved to a managed floaL The government also began reducing protection of local industries and making tariff lower and more uniform. The maximnum duty rate was reducedfiom 100 to 60 percent, and the averagerate was reduced.The tariffreductionswerealrnostimmediately offser, however,by the government's decision to impose a tariff surchargeto raise revenue for macroeconomicstabization objectves. Effective prntection remained high into dte mid-1980s at 52 percent of value added, higher thaL other EastAsian economiessuch as Korea(28 percent) and Malaysia(23 percent). During theseearly stagesof the export-pushperiod, the govemment Board of Investment (BOI)played an important role in promoting cx140
M
. .~~~~~~~~~~~~~~~~~~~~~~~~.
ACROECO?rw1
port growth. The BOI,which had been established in 1960 to supervise the applicationof investmentincentives,had long been a tool for implementing the import-substimtionstrategy.One of its keyroles was to distribute (and often increase)the incentivesfor firms operating in protected domestic market niches through waiversof tariflis,import sur5 charges,and occasionally bans on competingimports. The shift to export promotion brought a differentrole to the BOI.A major study of the exporc-promotionsystemwas carried out under a uNDP-World Bank technical assistance project. The study recommended radicalreformsin the wayin which the BOIdid business.It advocated using moreautomatic,sectorailybased incentives (in contrast to - the firm-specificdiscretionalincentivesof the past two decades) and shiftingthe targetof incentivesto labor-intensive, export-oriented,geographicallydispersedactivities.In 1983 the BOIannounced new promo* tional criteria that f&vored, among other objectives,exports and labor intensity.Box 3.4 describesthe impact of this shift on direct tariff investment. Other incentivesfor exportersinduded tax exemptionsand rebates,reductions in electricitytariffs,automartic accessto credit, marketing assistance,and promotion of tracing companies.The government also stramined customs procedures and abolished unnecessaty 6 regtuationsto expediteexport shipments. Automatic and concessionary credit was another major elementin the export-push strategy.The Bank of Thailand had taditionally extended refinancingflaciiities(RFFs), through the commercialbanks, to key economic sectors.7 These RFFs were mostly used to rediscount cx* port billsof largeexportershandling traditionalproducs As part of the export incenuvespackage,the Bank of Thailand revisedits rediscount irules to focus more explicidyon small, nontraditionalexportersand on other productive activities. Many of the export-pushincentiveswerespecifically designedto offset remaining distortionsfrom Thailand's import-substitutionera. Tax rebates, duty-freeimports, and export-processing zones correced partiallyfor existingdistortions.In this sense,Thailand'sexperienceis similar to that of the northeastem HPABs; the initial surge of export promotion tookplace in the context ofa domesticmarket that remained modctey protected from the rigors of foreign competiton. Thailand has recentlybegun a more broadly based liberalizationof imports. In -1990tarifs on capitl goodswerereduced,and in 1991largereductions werc made in tariffson automobilesand computers.
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E
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ofa gowing volume ofThat
foei Oirect ilVtmetpl n
ex-
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- u - ~~~~~ - ~~~ - The -outcome of these pol~~~~~~~~~~~~~~iy alaacB 96*
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MACR0O
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of Man.factnriug, Thailand :0 0Table'3.7 v3: Distribution ;n.uMtA (Percentage of grossdomesticproduct)

Senor' ,97. '1986
C R1O36
Hev inutis3.9
42.6:
High-skilllabor-intensive idusre Traditional light inutis19.2 * . Total. mTab 3 e Banko ofTi2n

aflTiland
9.7
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11.1 201
100
.
3. .13.3 .23.'3
100
Push The Elementsof a Successful Export These summariesof the evolution of export push revealthe plethora of policiesconsistentwith exportpromotion. (China'srecentpoliciesfa.to axvoring manufactured exportsare outlined in box 3.5.) AssistaLnce ports varied over rime and across economiesand induded p..ferential .financing,promotion stubsidies,tax incentives,subsidized inf1auctLre, and foreign investment incentives.Moreover,at any given time and in any particular economy,the magnitude of the incentivesvaried favored nontraditional exports, acrossactivities.Some governments exportshEven so, there some favoredparticular types of manufacmured commonalitiesamongtheseponlCis.Each contributed to aresignificant one or moreof the four elements of a successfl export pushi accss for exporters to imports at world prices;accessfor exporters to lon- and short-term financing-,goverment sistancnin penetrating markets; and flexibilityin policy implementation. :
at Worm Pricer When imports are restricted or rtaed, Accessto Iviports exporters are: disadvantaged vis--vis exporters from other cono e npntrin bonmd aed in aitn p sorts-tewrld prinacer who do not face similarly expensive imports. To combine import protection with export promotion, these ill effctcs must be mitigated. HPAE governments, have found myriadeways to grant exporters access to ir-portsatworldipories free trade zones, exppot-processing zones, nd
0 ovrnen:shn
exemptions from tiffs. However, the warehouses, luty drawbacks, or img epotesapssst foud yia wystogan higher thelevel of irmport-substitution protecton, the greatcerthe level
wof adminisrative
for exporters. Perha
cormiptenc
because of these difficulties and the dedining
needed to cseate countrvailing imcentves
benefits of import-substitution protection in successful export-oriented economies, each of these economies has gradually liberalized its trade
'-43
_5 -tCL~CE
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all governments recognized the difficulty Mabrket Penebaiom. NearLy expoers Fce in crackingfbreignmarkersbut againchosevariousmeans to encourageexportersto overcomethese hurdles. Somedirectlysubsidized export activity (direct income tax incentives),some subsidized marker penectration(through exporter associations),some subsidized small and medium-sizeexporters to offier their difficultiesin marker penetration, and some promoted the creation of international trading companies. fleibfit. Pragnatism and a commitment to resultsmark the HPAE governments'approachto exportpolicy:Policyflexibility provedimportant becausehitting the right strategyis not easy, fir three reasons.The right strategydepends on the circumstances.It changesas the economy is not necessarchanges.And it is not alwaysobvious.Making mistakes ily bad, as long as the mistakesare reversed.The dassicexampleof policy flexibility is Koreals reversal of the HCI drive. After a large commitment to promoting heavyand chemicalindustries4the Korean government neverthelesschanged course when circumscances changed and the policy threatened exports.But Koreawas not unique in this regard. In each of the lPA.Es, policiesevolvedoverrime and oftenrequired major revLsions. In chapter 1 we showedthe impact oftheHAEs' export-pushsategy on the rapid growth of manufacturedexports. Another outcome of the export push can be seen in their changing compositionof exports (see figure 3.5).With the exceptionof Indonesia (whoseexporcsof refined petroleumproducts are induded under chemicals)all of the HPAEsdramaticallyincreasedthe share of exportsin machineryand equipment at the expenseof such traditional manufiacmres as food products and texexports in total manufacturd extiles. In 1991 the share of rnachinery ports for the developing HPAEs was about double that for other developingeconomies. This shift clearlyshowsthe responseof exporters to changing market opportunities, rising labor force skills,increasing technoogical capabiliy, and changing comparativecosts. What is surprising,however,is the extent to which textiles and ap parel remainedimportant exportsin the faceof shiftingcomparativeadvantage.As late as 1991 most of the developingHPAEs had shares of textdlesin manufacured exports which cxceeded the averagefor other developingeconomies, suggestingthat thesesectorsretainedsubstantial cost competitivenessdespite rapid capicaldeepening and rising real wages(a phenomonon to which we shall return in chapter 6).
:-45
IE~~~~~~~~~~~
MA CR- O
The successful East Asian economies have had much greater macroeconomicstabilityand much more rapid exportgrowththan most other developingeconomies.They achievedmacroeconomicstability by adhering to macroeconomicfundamentals-particularly by keeping fiscal deficitswithin the linmits of prudent financing-and by rapidlyand effectively correcting major macroeconomic imbalancesthat emerged. They achieved rapid export growth by fostering a favorableenvironment through macroeconomic stabilityand by applyingon a trial-anderror basis a vast array of market interventions and microeconomic incentives. In contrast to the many lesssuccessfiul economiesthat have clung to filled policies,the HPAEs have pragmaticallychosen and assessed policies accordingto their impact on macroeconomicstability and export growth. They have adapted policiesas necessary, kept those that worked, and dropped those that failed or outlivedtheir usefilness 'Why did the EastAsian economieschoosemacroeconomic stability and exporrsas their policy yardsticks? And why have they been more succsfil than other economiesin selecting,implementng, and alterto these questions ing policiesas necessary to attain thesegoals?We mrn of politicaleconomyin the next chapter.
3-47
R'A CLE
Appendix 3.1 Economic and Ploflitcal rimermes

Indonesia
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Notes
1. Bradfordis among the first to categorizea combination of functionaland sclectiveinterventionsthat resultin the effectiveexchangerare for exports exceedingthat for imports as an export push. By this definition the SoutheastAsian NiEs would not qtalifl (Bradford1986, 1990). We we dse term somewhatmore broadlyro indude sustained movementtoward parity of incentivesbetweenexport and import substitutes,combinedwith institutional supporr for exporters. 2. The analysisin this section draws on Easterly and Vchmidt-Hebbel (Ibrthcoming. The data on consolidated public deficits,as wellas the resr of the data in this section except where otherwise indicated, are from the same source. Consolidated public deficits, though less widely availablethan central government deficits, are a much more reliable indicator of fiscal management becausetheyindude operating deficitsof public enterprises that have played a critical role in some macroeconomic cases. 3. Although the mean level of effectiveprotecrion was low, varianceamong sectorswashigh. 4. The Promotion of InvestmentsAct of 1986 provided incentivesfor investmentsin agriculture,industry. and tourism. 5. The BOi's policies of selectiveinterventionto promore firmsand specificsectorsare discussedmore fullyin chapter 6. was the es6. Onc impormtn exampleof these efforts tablishmentof export-processing zones (Ens) and bonded warehouses. Drawingon Korea'sand Taiwan,China's, ecxperience,Thailand used the EPs to streamlinetemporary admissionof inputs for exportersin the zones. The zones also offeredlower-cost elecrricity, frcedomof immigration for managers and technicians, and. common-facility bonded warehousesto reduce customs and storagecosts for enterpriseslocatedin the zonc. In general theseincentivesalso favoredlargeand often foreign-owned firms. 7. A firmwishingto obtain accessto the schemeissued a promissorynote, which was discoLntedby its commercial bank and firther rectiscountedby the central bank both at subsidizedinterest rates.
.56
R 4
An Institution
Basis
forShared Grot
N EACHH-PAE EXCEPTJAPAN,NEW LEADERS PACEDAN URGENT
need to establish.their plitical viability before the economic takeoff.The Republicof Koreawas threatened by invasionfr-om the North; Taiwan, China, fr-omChina; and Thailand, from Viet Nam andt Cambodia. In Indonesia, Malaysia,Singapore, and Thailand, leaders faced formidablecommnunist threats. In * addition,leadersin Indonesia, Korea,and Taiwan,China, having taken power, neededtto prove their ability to govern.Leadersin Malaysiaand Singaporehad to contend with ethnic diversityand attendant questions of political representation. Even in Japan, where the competition was less immediate, leadershad to earn public confidenceafter the debacle of World War [I. In all casesthen, leadersdesperatelyneeded to answer *a basicquestion:why should they lead and not others? Whateverstrategythe leadersof theHPAE governmentsselectedto answer the basicchallengeof legitimnacy, they included apindpoIe ofsbazred growth.The leaders hoped chat rapid, widely shared improvements in economicwelfarewould bring legtimacyOf course, feiw political leadersanywherewould reject, on principle, either the desirabilityof gwrowh or that the benefitsof growth should be 1 shared. 'What distinguished the HPAEe' leadershp was thecextent to which,they.adoptedtspecificinstitutional mechanismns tailored to these goals, and that workced. In this chapter we brieflyreviewthe history of the adoption of an explicitcommitmnent to sharedgrowth. We then dis* cuss the main institutional mechanismsadopted to achievethis goal and how they were areated and mainmainedh * Wealth-sharing programs designed to indude non-elites in eco~~nomiuc growth
'157
4~~~~~~
~C
KlA CLE
* A cadre of economic technocrats insulated from narrow political pressures o InsEirutionsand mechanisms to share information and win the support of businesselites.
Legitimacy through Shared Growth Achieving
T
tHE
PRINCIPLE OF SHARED GROVfH ASSUMED DIFFERENT forns in each HPAE It was most explicitin Malaysia.In response
to racialriots in 1969, three dominant parties,each representing a major ethnic group, widened their coalition to indude other parties under a nationalfiront.The coalition'sgoal was to share wealthmore equitaMlywithout stifling growh The coalition'ssolution was the New EconomicPolicy(NEP), an attempt to improve the lot of the Bumiputera, the largestbut poorest ehinic group. The coalition'sown early descriprion of the NEP is quite explicir: The NEP has as its overriding objective the promotion of national through the two pronged strategyoF.(i) eradicatingpovertyby unnity raising the income levelsand increasing employrnentopportunities
for all Malaysians, irrespective of race and (ii) accelerating the process
of restrucruringMalaysiansocietyto correcteconomic imbalance,so as to reduceand eventuallyeliminate the identificationof race with economic function.... The effortsto attain theseobjectives were, in -turn, to be undertaken in the contextof rapid structural change and expansion of the economyso as to ensure that no particular group experiencesany loss or feelsany sense of deprivation. [Salleh,Yeah,and Meyanathan 1993] The principle of shared growth is also explicit in Indo- .esia,where President Suharto advocates "economic democracr. For example,in 1990 President Suharto himself strongly endorsed research results of the Indonesian Economists Association stressing the importance of sharing the benefits of growth. 'I hope that IsEfsfindings on the system of EconomiicDemocracyreceivesas m.uchpublic exposure as possible and that all levelsof society become involvedin the discussionof this vital issue. This will enable us to reach national consensus as we strive forward toward the full implementation of Economic Democ:
58
::-
-:
AN..:INsTn'
racy" (isEa 1990). Economic democracyadvocates reliance on the free
market to stimulate growth. But it also explicitly acknowledgesthe market system's inadequaciesin distribution and actively seeks to redress them. In Taiwan, Cbina, commitment to shared growth grew out of the Taiwanese authorities' searching analysis of their failure in mainland China The leaders' five-point diagnosis included three equity issues: agricultural tenants had rebelled against exploitation while the party continued to identify with the landlords; labor unions had run out of control; and governmentwas beholden to vested interests(Wade1990). These realizations,combined with pressure from the United States to undertake social and economic restructuring, led the Kuomintang to adopt shared growth as the formula for its rule in Taiwan,China. Unlike the Taiwaneseauthorities, Korea'spost-World War II leadership lackeda synchronizedviewofgrowth and distribution. Evenso, the sequence of policies it pursued, and the flattening of wealth resulting fiom the Korean War effectively produced egalitariangrowth. Pardy by accident and pardy by trial and error, the leadership graduallyadopted the principle of shared growth. In both postwar Japan and post-independence Singapore, growth with equity was the leaders' primary concern. In Japan, the war's destruction of landed wealth actually helped the leadership to implement its redistributivegoals.In Singaporelack of a significantrural sectorand the absence of a landlord elite also made pursuing equity goals easier. But neither set of leaders was complacent; both adopted effectiveconsultativearrangementsbetween labor,government, and business.' Chapter 1 presents evidencethat the leadersof the HPAEshave been unusually successfudin achieving shared growrh. Growth-rate and income-distribution performancemeasuresshow that the HPAEs significantly outperformed other low- and middle-income economies.How did they do this? If adopting the principles were sufficient, certainly achievementwouid be widespread.The answermust partiallylie in the insttutions and mechanismsand in how they worked. To win the support of non-elites, the leadersof the I4PAEs introduced mechanismsthat drasticallyincreasedoppormtnitues to share the benefits of growth. These mechanismsvaried from economyto economy but included education (in all the HPAEs); land reform (in Japan, Korea, and Taiwan, China); support for small and medium-size industries (Hong Kong,Japan, Korea,and Taiwan, China); and governmentprovisionof '159
suchbasicamenitiesas housingand publichealthservices (HongKong

and Singapore).Nearly all HPAEgovernmentswalked a delicate line regarding labor by limiting the power of unions and intervening to check labor radicalism, while at the same time encouraging a cooperative dimate in which labor was rewarded for increases in producriviy. These wealth-sharing measures have differed from the typical redistributdve approach of most developing economies. Instead of granting direct income transfes or subsidizing specfic commodities (for exampIe, food or fuel), HPAE leaders have favored mechanisms that increase opportunities for upward mobiity. The frequent result is that indivliduals and families, provided the opportnity and convinced that efforts will be rewarded, srudy more, work harder, and save more.
Universal Education
Education is arguably the most important of these wealth-sharing, opportunity-creating mechanisms. The provision ofuniversal primary education and wide access to secondary and higher education contributed substantially to opportunities for upward mobility. This mobiity in turn mirigated the feeling of non-elites that society is unjust and made them more accepting of the market-orientedpolicies needed to foster growth. In Korea, for example, the government invested heavily in the expansion of education at the primary and secondary levels soon afier the wan In rhe mid-I 960s, Park Chung Hee's export-promotion drive boosted demand for educated labor, providJingjobs for the first crop of graduates to benefit from the postwar education push.
Equitable Land Holding andLand Refonn

Theory and empirical evidencesuggest that widespread ownership of
land not only improves equity but also improves land prodlccrMry (Berry and Cline 1979). All the lPA.Es with subsEantial agrarian sectors have widespread land holding, resulting from either taditional ownership patterns (Indonesia and Thailand) or land reform (Japan, Korea, and Taiwan, China). In Malaysia, corporate-owned plantations have dominated agriculture since the colonial era. But with a relatively small dpopulaton and ample land, it has avoided equity problems common-to other developing economies with highly unequal land distributions. Hong Kong and Singapore have almost no agricultural seroc.
x6o
AN
Koreaand Taiwan, China, began land reform under broadly simnilar circumstances.In both cases,authoritarian governments&cing a communist threat were dependent on the assistanceof the United States, whose advisersurged them to adopt more egalitarianland holding. In Taiwan, China, rhe government seized land from the landlords, compensating them with shares in state enterprises.It then sold d-ieland to the tillersat fitvorable credit termsand fivorableprices.The government then helpcd the tillersupgradeproduction for domesticand export markets. The program worked, economicallyand politically.Land reform helpedTaiwan,China, achieveone of the world'smost equitableincome distributions (Kuo 1976). Political stability benefited in two ways. NewlyIandedfarmers,focused on boostingproduction, had little interest in radical activities.Former landlords, as new shareholdersin state enterprises,had a vestedinterest in the successof the Taiwaneseauthoriies economic program. In Korea, land reform occurred in two stages.The first, initiated by U.S. forcesin 1947, distributed the land confiscatedfrom the Japanese at the end of Wurid War II to the tillersand put a ceiling on rents of other land. The second, begun in 1950 and completed after the Korean War, was undertaken by the Korean governmentafter a lengthy debate in the legislatum The government took over landlord properties, paid the latter nominal compensation, and distributed the land to 900,000 renants, effectively eliminatng tenancy.
Euuterpises Small and Medium-Size AreBeautiful

Just as numeroussmall land holdings improvedequityand efficiency, the HP'AEs benefited fiom a profusion of small and medium-size enterprises (SMEs). The large number of SMEsgenerally reflected market forces rather than government intervention. But several of these economiessupported SMEs with preferentialcreditsand specificsupport services.Rapid growth of labor-intensivemanufacturing in these firms absorbed large numbers of workers, reducing unemployment and attracting rural labor As firms shifted to more sophistcated production, efficiengrrose and workers'real incomes increased. Support for SMEshas been most explicit and successfulin Taiwan, China. As shown in table 4.1, SMEscomprise at least 90 percent of enr-erpnsesin each secor. Not surprisingly,the SMEs also dominate the export sector, producing about 60 percent of the total value of exports r16i
- g,sji~~srA
I IACCL E
China inTaiwan, Businesses andMedium-Size Table4.1 SmaUl

--. - ,.-; ;e
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Smell --.
Number0
medim--e
-i
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Percentageof
: a -ni vi - rts
livstock,forestry Âgri culur, fishing, ..Mning and:quarlying . MItanu-;ting gm a r. . .: 1t.. ;Ee c,gis,nd , -. Constructon Commerces: Tmansporr,-srorngc,and ommunimcations services surancerel estatebusiness Funancc,.i servic .69,550 social, andpersonal --. :.Comxruunit$, Total -';
nTai Stmrn China(1992b). 0
3,256
3,171
-
97.39
-1,390-157,965,
.
.1,360 155,263
8628,419
489,864 36,897 30,534
818,061=- :':
168.
.
97.84; 98.29:. 90.32
26,456 475,106.96.99 35,818 28263 69,229..

-794,834 0 . . --
93.09.
97.08-; 92.56: ; 99.54
,97.16 -- : - ,: :
(see tabIe 4.2). Other HPAEs have also encouraged small and mediumsize industries. Japan has direaed enormous financial resources toward dcveloping small and medium-size enterprises. Public financial instirutions have allocated an average of 10 percent of lending toward SMES. During the rapid growth period of the 1950s, as much as 30 percent of their total lending for fixed investments went to SMEs.The various government-supported direcred-credit programs have proven particularly helpful during times of transition and rapid change (Itoh and Urama1993). Although there are mixed evaluations of the success of these programs, one thing is dear. The SMEsector has become an important cornerstone of Japan's economy. In 1989, SMEsaccounted for about 52 percent of both manuficturing value added and sales, and their share of employment in various manufacturing subsectors
Businesses in Taiwaan, China Table4.2 TheExport Value of SmaliandMedium-Size
(millons of U.S. dogrs)

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ranged from a low of 41 percent in transport machinery to a high of 100 percent in silverware. Korean developmenthas been largelydriven by the expansionof conglomerates,the so-calledchacbols But beginningin the early 1980s,the
SME
2 SMES'share in total manufacturing sector began to grow rapidly.
employment rose from 37.6 percenr in 1976 to 51.2 percent in 1988; while at the same time the SME sharein mnanufacturing value added rose from 23.7 percent to 34.9 percent (Kim and Nugent 1993). Korea establishedan extensivesupport system for SMEs. And, as in Japan, financial support systems, such as export financing and credit guaree
programs. have becn d-iemost imporcant.
Housing: Successfully Targting Low-lncome Households

Two HPAEs, Hong Kong and Singapore, intervened heavily in housimg markers to win the support and cooperation of non-elites. By proriding low-cost housing for the majority of residents, both programs have helped to decrease inequality and minimize social unrest, thus prothe long-term stability attractive to investors. Moreover, the masviding< sive construction effort created lobs when both economies faced higb unmemploymenrtsubsequendy, the wide availability of low-cost housing for workers helped to hold down wage demands, subsidizing laborintensive manufacturing. In Hong Kong, which has generally followed a laissez-faire approach to the economy, mass housing programs were a iesponse to a massive influx of refiigees and migrants from China. The rapid increase in Hong Kong's population from 600,000 in 1945 to 2.4 million in 1950 spawned slum areas, high unemploymenr, and poverry. These led to social disturbances, which culminated in riots in 1967. To difflasethe tension and improve living conditions of the general public, in 1972 the govemment launched a Thst- track public housing program that has since expanded to include the construction of entre new towns outsidc the city propet By 1987, more than 40 percent of the population lived in public housing. Like Hong Kong, Singapore experienced a dramatic influx of mi-grants in the late 1950s and early 1960s and faced similarproblems. Its expulsion fiom the Malayan Federation made matters worse. The govermuent responded by creating the Housing Development Board (HDB) in 1960 to provide public housing to low-income f2milies. As these
-63
-FIAA
CL E
needs weremet, the HDB has turned to developmentof middle-income public housing and self-sufficientnew towns similar to those in Hong Kong. Today 80 percent of the population lives in public housing, and more than 90 percent of the familiesin public housing own their units. While successin Hong Kong and Singaporehas been aided by small territoriesand populations, the experienceof Indonesia suggeststhat public housing carefully targeted coward low-income groups may have benefitsin larger economies as wel (seebox 4.1).
The Labor Trade-Off: Cooperative Unions Geta Bigger Slice

and Taiwan,China (and to a lesserextent In Japan, Korea,Singapore, restrucured the laborsectorto suppressradicalacMalaysia), governments
-.
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1c64
AN IN4S-TQ -*
tradestability. Governments abolished tivityin an effirt to ensurepolitical basedlaborunionsand pushedthe creationofcompany-or enterprse-based unions. Managementand company union representatives were then repoliies. quiredto joindyformulateand implementwork-related Labor movementsin Indonesia and Thailand, whilenot subjected to systematicrestructuring, were nonetheless routinely suppressed at the first sign of radicalism, primarily becauseof the governments' fear of communism. In Hong Kong, conversely,union radicalism has been held in check by a steadysupply of new laborfrom China and by the influence of Beijing, which has encouraged moderation in the unions under its Hong Kong umbrella organization. Governments in severalAsian NIEs, particularly in Malaysia and Singapore, have modeled their systems of labor relations after Japan, where labor radicalismwas quickly suppressedafter World War It and labor-management consultations were gradually institutionalized. In Japan, these consultationshave led workers to expect that adjustments in their wageswill correspondto trends in the national economydespite the unions' lack of politicalweight. 'Labor has been compensatedfor its decreasedpolitical role through wage policies tied to increasesin productivity" (Johnson 1982, p. 151). Like the governmentin posrwarJapan, the governmentin Singapore sharply lirmited union autonomy soon after independencedue to fears of
political instability Lacking natural resources following the separation from Malaysia,Singaporecourted foreign investment in labor-intensive
manufacuring by suppressing independent unions and assuring investors industrial peace. To meet workers' rising expectations, the governmnent in 1969 instructed the National Trade Union Congress (NrUC), the officially recognized labor umbrella organizaton, to suggest new directions for the union movement. The NTUC,which is in effect a branch of the ruling People's Action Parry (PAP),made two recorimmendations:govemment, management, and labor should work together to avoid antagonistic wage negotations; and workers should organize into cooperatives with a stake in the economy. To firrher cooperation, the NTUCestablished the trpartite National Wages Council (Nwc). Each year, the NWCreviews wage and economic trends before advising the government on wage adjustment guidelines. Although recommendations are officially nonbinding, the govemment usualy endorses them wholesale, and business and labor use them as wage settlement benchmarks. The NWCseffectivenesswas evident during
I65
, 1, ,t77;tS>ri
C LE
the 1985-86 recession,when it persuadedlabor to accept wage cuts of about 12 percent. The rAP alsoreorganizedthe NTUcitself,transforming it from a negotiatingagent to a providerof goodsand services. The NTUC has since establisheda number of worker cooperatives, rangingfrom dhe FairpriceSupermarketCooperative,with more than 240,000 members, to the Comfort Taxi Service,with 5,500 members(seebox 4.2).
i-ONQO5tTHEE1R. FIRCOOPE
ATVESORAGANIZD*.BYSINGAPORE'S K byOf&r( ..... fridhbYii t ari
LW. ,>NtwOACoA't bf.lrodany, a

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Other economieshave forestalled developmentof largeand politically powerfulunions with less formal arrangements.In Taiwan, China, for example,closemanagemcnt-laborcontact in small and medium-sizeenterprisesreducedworkers'interest in union representation(seetable 4.3). Moreover, the emphasison labor-intensivemanufacturing generated rapid increasesin the demand for labor. Consequendy,as figure4.1 illustrates, from 1952 to 1979, inflation-adjustedbasic wages increased more than sixfold in manufacturing and more than fourfold in agriculture. The total increasein compensation has actually been higher, since basic wages are supplemented twice annually with profit-sharing bonuses.
Technocracy the Economic Insulating
politicallegitimacyrequiressharing but it also requiresgrowth. We now discussHPAEinstitutional traitsthat have been critical to achieving both thesegoals.Foremostamong them is technocraticinsulationthe ability of economic technocratsto formulate and implementpolicies formulated nationalgoalswith a minimum of with politicaUly in kceeping lobbyingfor specialfivors fiom politiciansand interest groups.Without i, technocratsin the high-perforningAsian economieswould have been unable to introduce and sustain rational economic policies,and some viralwealth-sharingmechanismswould have been neutralizedsoon after their inception, as was land reform in the Philippines (seebox 4.3). Activit byScaleof Businessin Taiwan,China 4.3 LaborUnion Table
(pnenetz
IMPLEMENTING
SHARED GROWTH TO SOLVE THE PROBLEM OF
,p-
*-3,--es
No . 4
.-. .;
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Norrenponre ,a 008 015 0 37 T' ..

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Government, Annual
& '980-84
167
Wags 1952-79 ofReal 4.1 Index Figure

o;#{~~~~~~~ ii.
-
(IndEx: 1952;100) Percent :.: l~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
'
~~~~~~~~~~Murnsfacturln
.::
0~~~~~~~~~~
300
Fue41Inv of RelWgsI927
400 -
glAtr
200-
p1952
1955
1955
1M1964
1967
1970
1973
1976
1979
SPrcent, Kuo, and Ranis (198 1, p.2).
Direct
Mechanisms
insulaton
Hong Kong offers the cearest case of insulation, since the colonial government, which has been stronglycommitted to free marker forces,
tomaintain ofprivateinterests support needior dependon thepolitical

diminish as democratic instipower But insulaion does not necessarily
in authoritariansocieties tutions proliferar. Indeed, the technocracy be utterlywithout insulation, while those in some democraciesare -may insulatedfromoutsidepressures. heavily
not only the economictechnocracy In Japan, insulation chacacterizes
draft laws in Japanesebureaucrats but nearly the entire bureaucracy. ofthe rulingliberal Democrawith the policycommittees consultation the diet (parliament)merely tic Partyand privatesector representatives; has the bureaucracy hasprepared.Because whatthe bureaucracy ratifies fromindividualactors independentpower,it can oftenignorepressure in the privatesector. Moreover,rhe bureaucracycan achievepolicy goals
through administrative guidance-nonbinding recommendations.
and with generousincentives-suchaslicenses ale enforced Guidelines

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foreign exchange allocations-and the implicit threat to withhold them from companies that refuseto cooperate. One of the distinct featuresof the b'ueleary processin all the HPAEs
is the primacy given to the bureaucracy over the legislature in drafting laws. Though the.legislature must approve the laws, the bureaucracy studies, analyzes, and drafts the bills. It has considerable control over the agenda and can use this to minimize political pressure. IThejapanesebureaucracy is further protecred fiom political pressure by the Natonal Personnel Authority, an independent body that sets the bureaucray's pay scales and promotdon policies, administers civil service exams, and makes most appointments. Japan's prime minister names only his ministers and, except in a few caes, one of the two vice-nunisters in each ministry; the National PersonnelAuthority is responsiblefor the resrt3 As in Japan, the bureaucracy in Korea has a long tradition of independent policymaking. This was boosted in 1961, when army General Park Chung Hee seized power and reorganized the govemment to promote rapid development. He createa a powerful Economic Planning Board that has had broad budgetary authoriry. Acdministraive control over the banking system has given the bureaucracy strong leverage over big business, which relies on government-backed financing to fund rapid expansion.4 The partnership has generaly been uneven, with the bureaucracy dominating the relationship. Whe few of the HPAEs have such thoroughly insulated bureaucracies as Japan and Korea, each boasts at least a small, ideologically consistent technocratic core that answers directly to the top leaders and therefore has some independence from the legislature and other sources of political pressure. Indonesia and Thailand, where bureaucratic traditions more dosely resemble thse in other developing economies, are instructive on this score.
Inflation Control and Debt Management in Thailand andlIndonesia

For historical reasons, Thailand and Indonesia have been proroundly concerned with low inflation and debt management. Thailand is unique in Southeast Asia for being the only economy in that region not to have been colonized, in fact one of the few in the.developing world. One reason for this remarkable alchievement was the openness of the Thai Kingdom to trade with foreigners. Another was the monarchy's concern with avoiding indebtedness to foreigners. And a third, 170-
IN.r:a.n.s-ANNm.
and perhaps the most important, was the establishment of a bureaucracy in 1892 that enabled the monarchy to centralizepolitical control over the kingdom'smany regions.Historically,then, the bureaucracyin Thailand has alwayshad a powerful influence over public administration and policymaking.But it was-not until 1957, when Gcncral Sarit took over the reins of government, chat bureaucratic reforms were introduced to address macroeconomic imbalances.Since then, keeping inflation low and efficientdy managing debt have been among the government's key concerns. These same issueshave been extremelyimportant to the Indonesian governmentsince President Suharto took power in 1967. The previous Guided Dem'ocracyregime of President Sukano had let goverrnent spending run out of control, leadingto annual inflation rates of 1,000 percenic and other seriouseconomic problems induding a rapidly deteriorating infratructure. Suharto'sNew Order govemment ascendedto power with an explicit conmitment to fight inflation and develop infratructure, particularlyin the rural areas.This led to passageof a balanced budget law and to financial controlsthat addressedinfrastructure d development. To achieve the rwinobjectivesof low inflation and prudent debt management, both governments created mechanisms tO insulate their -: .economic redcnocracies.In Thailand, the government'sBudget Bureau has tight control of the budget drafting process and has maintained a stable exchangerate and low inflation. To draft the budget, the Budget Bureau consultswith the National Economic and Social Development Board about proposed public investmentsand with the Finance Ministryabout expectedrevenues.It then deternines together with the Central Bank how much deficit financingthe economycan toleratewithout t increasing inflation. Having detcrniined aggregateallowable expenditure, it calculateshow much each government agency may spend and :forwards a broad outline of proposed expendituresto the cabinet. The cabinet may propose changesto the outline before forwardingit to a parliamentary budget committee for evaluation. But since neither the cabinet nor the committee receivesbudget details, the bureau'sproposals usually survivewith few alterations.After approval by the commnittee, the budget outline is submitted to the endiic parliament fior routine passage. Throughout, the bureau draws support from budgetary laws that -'-'lUriiit the governmentdeficit to a small percentageof the year'stotal ex-
'7'
V MRCLE ,
penditures and that cap the percentage of the budget that can be spent servcing the foreign public debt (the current cap is 13 percent). Parliamentary rules offer a fiirther unusual guarantee against runaway deficit spending nonrninisrerial membe of parliament on the budget commuitte may propose-only minimial changes and in any event may nor revise the budget upward. The results have been impressive (see figure 4.2). Except for the diruptions caused by the 1972 and 1979 oil shocks, the annual inflation rate has been dlose to 5 percent. Few. developing eoinoies can lay dlaim to such an achievemet and even more adwinced HPA.Rs such as Hong, Kon-gand Korea have had higher rates. This demonstrates how a small technocratc core, insulated from politics, can set a positive tone for an entire economy. In Indonesia, too, technocrats keep a tight rein on the budget. Under Suharto, a balanced budget has been the cornerstone of government 6inancial policy: In 1967, the legislature approve-da law limiting expendiares to domestic. revenues plus foreign assistnce. Since then, he finance ministry has institutionalized a review that requires each ministry to justify prposed expenditures on a line-by-line bAsis. In addispend ~ing nminisr of priaet onIh ugtc
Iemer
Figure4.2 Thailand Consumer Price Index (percentage change from previous year)
Percentagchange
30 --
20--
10 -i'
k.ii---If
4j
1955 1958 1961 1964 1867 1970
1973 1976
1979 1952 1955585
&unr Innualtional MoneratyFund da.el
r72
S~~~~~~~~~~~~~~~~~~~~~~
ST
dion, parliamentary rules restrict the legislature'sdiscussion of thebudget to broad policy issues.Armed with thesc instruments, the finance ministry has establisheda macroeconomic environment favorable to growth. Inflation has dropped since the 1960s and has generally remained low and stable (seefigure4.3).
Indirect lusulation Mechanisns

SomeHPAEshaveenhanced bureaucraticinsulationindiiecdyand generally inadvertently. For example,wealth-sharingmechanismsreducethe potential gain to interestgroups of intervening in policymaking and implementation,sincesomeshareof the firuits of growthhas alreadybeen assuled. In addition, when wealth-sharingmechanisms reducethe size of oroductionunits, aswithland reformand support for smalland mediumsize industries, the marginalcost of organizing and lobbying increases. 'Withthe benefitsof lobbyingdown,and the costsup, interestgroups tend to be more willingto leavethe policyprocessto the technocrats. Reozganizationof labor from industrywide unions into company unions, along with labor federationprovisionof goods and services, has Figure 4.3 Indoneia Consumer Pnce Index
(perentage changefim previous year)
Percentage change 0
f
*.
-'-N-
30
--
rv-20 -~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
; I
~~~~~~~~~~~I 1 j
0~~~~~~~ ~
~~~~~~ f
~01970
-5 0 40
1972 l- :n eItional
1974
1976
197t1
"SO
1982
lS84
1986
.
1.98S
_
1990
_ '.
h Monc4y Fund daa
-17_
197, 197 0 ;our.neranaa
2.97 197 29: =8 Mocx Fun darn00. ,
196 ;8
819
.98
similarly reduced the marginal benefit and increased the marginal cost of collectiveaction. Thus, in contrasr with wokers in many other developing economies, workers in the HPAEs arc more lihklyto refrain from work stOppages and other disruptions and fiom lobbying the government for mandated wage increases. Because employers faced fewer demands fiom labor they, too, have had less incentive to press demands on the reclnocracy. Of course a powerfil bureaucracy insulated fiom external pressure can also be dangerous. Indeed, the description ofjapan's bureaucracyan independent force that controls generous incentives and issues vague guidelines-is nor unlike that of bureaucracies in ocher economies that engage in corruption and malfeasance on a vast scale. In Japan, itselE some ministries are perceived to be captured by the interests they regulate. These ministries enjoy less power and prestige than those that resist politicization. 5 Even well-intentioned bureaucrats may become counterproductive or lose sight of the goals they are supposed to pursue if bureaucratic insulation means that they are not held accountable for their decisions. How have the HPAEskept insulated bureaucracies honest and responsive to legitimate private concerns? The next two scctions address these perennial problems of bureaucracr. honesty and responsiveness.
Service Building a Reputable Civnl

While insulation of the techmocracymay be necessary,it is hardly sufficient-in the long term. To sustain growth, a bureaucracy must have the competence to formulatEeffectivepolicies and the integrity coiimplement them fairly.The more policymakers attempt to fine tune the economy, the greater the need for competence and honesry. Among the HwAEs, Hong Kong, Japan, Korea, Singapore, and Taiwan, China, have been successfiLlin building relatively competent and honest bureaucraaes. The Southeast Asian NiEs,Indonesia, Malaysia, and Thailand, have gradually introduced measures to upgrade theirs, with Malaysia in the forefront of the process, but they still clearly lag behind more industrialized economies. Despite the stress on culture in much popular writng about the Asian miracle, the most successflil bureaucracies have not relied on culture alone. HPAE bureaucracies have employed numero us mechanisms to increase the appeal of a public service career, thereby heightening competition and improving the pool of a1 plicants. The overall principles of these mechanisms, readily applicable to any sociecy are:
'74 -
ANN I NSTUT
* Recrauitmentand promotion must be merit based and highly
competuve. * Total compensation, induding pay, perks, and prestige, must be competitivewith the private sector. * Those who makc it to the top should be amply rewardecd Merit-Based Recnuibnent and Pmmotion. Recruitment in Japan revolves around highly competitivecmil serviceexaminationsadministered each year by the National PersonneIAuthority. For the higher-levelexams, the rate'of successhas been less than 8 percent. Indeed, in 1980 the averagerate of successwas 2.7 percent (Kim 1988). Promotion within the bureaucracyis basedon a combination of seniorityand a host of performnance indicators that dif&r across the ministries. Becausethe number of personnel in the bureaucracyis fixed by law, compention for promotion can be intense (seePempel 1984)!' Korea also relies on exams and performancebut has supplemented thcsefilkersby,,recruitingheavilyamongacademics with advanceddegrees. (Box 4A describesthe turnaronundin the Korean civil service in the 1960s.)This has resultedin a prolifcrationof researchinstiutes associated with ministries. Since die Economic PlamningBoard established the Korea Development lnstiute in 1971, most other ministries have followed SUiL Most institute researchershave a PhD., many from a respectedforeignuniversity(im and Leipziger 1993). LikeKorea,Taiwan, in primarilyto offsetweaknesses China, recruits heavilyfrom academnia, the civilserviceexamsystem.Academicsare recruitedfrom major universities,usuallyfor fixedperiods rangingfrom three to sixyears. acion In Malaysia,civilserviceexam resultsaresubjectto affirnmative guidelinesmeant to increasethe number of Malaysin gaovement. Becausethis reducesthe pool of eligibleapplicants,it probably hinders development of the bureaucracy Incentie-BasedCompensation. In bureaucracies, as in nearly everything else,you get whar you pay for. Table 4.4 suggs that relativepay is significandy berter in the Four Tigers than in other economies. Relative pay in Mvialaysia and Thailand is about the same as the averagefor other low- and middle-in&me econo-mies but is brillsignEficantly higher than -in the Philippines,which is widely perceivedto have one of the weakest bureaucraciesin SoutheastAsia.In general, the more fa-vorably the total public sector compensation package comparesto compensation in the private sector,the better the quality of the bureaucramcy
'175
....
~~~~~~~~~~~~~~~~~~~~~~~~~~~ 'e.:.
2
~~~~~~~~~~~~~~~~~,
L~~~
tyJQ.y~i*S
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Wotsurp'sne4ingapre,uowhidii 'widely'
bCS 'fie
;1 tNrnsnorecdRBErmwt oinon 1 an ontlybaejmlayofacputHministercvdiningapordranws d:o

alsomke^6 a, dcieatem; Pcrsnne
JapanF.t anfiS Korca

sector I
effor*;t >Jto<>
match
annuay
the
p rivate
sur
thepulic sectorwforsentry-level,m_id-l
Japn,oteNationaul
icAuthmForityHo
posi_-io
dif-
Koreabascsldsaelwrthan
bu W-pine aflownrs hlp
salnre.otarein lare pivaslrbed copnis to narrowr th;e

; *iffcen-
of salary plus* bonuss in thlet pvteo seaorzan sahlary plus hatltowne in S$22, 100to S$7,2 ;3iF (aou US$i3,812'l_e9 to US$1,390) s whl .. a n
Japan ndKreaalo ak dliert effort tomathte privaste s seconn Jeapan th@e Nationalt Per,.sonnel kAu*thoit annuallyS*,-,{F.4 surves thu dso o mpanis toderin :job pay rates$ (Kimo1988 p.) In Koea bs p;saries arcloer than saares in large pr,;iFitvate cmpaies.x gin's mtost compentsan uaprihtabreacracyb pmays itasn iburacr ofi salar plus te riae sector amnd alrypls a llowncsin b7estT thly onuss basensalayoaflmister iSngorerang
Tain
acon
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in totasr nly compnsatione appear to biel smlerie

otcmern
tOhane
t
in most
pgtbracaqspy
ueurt
1NSTwt:ANWpNS
Table 4.4 ICP Estimates of PerCapita GDP andRaftio of Public to Private Sector Salaries, 1992
(penent)
HPA&; &ononq/regran ,.f.4i. -a),

';f - i ; *; apo* r;
-
A n4:b
Seir leve
'Mddee
B~A
_B-A 1150 -
;Ennyluas 107-'. 7. .
GDPpacai
114.
920
:Korea, Re.. of
;
-.
;65.2
,':o*.;
98.
60.3 33
0 :--2i7.50 .:
8 .
X
Ta aM China
0LMa1-aysia
Thailand.
0
40 47.G.6-; 0 f; .
i277
8 .3 63.5343 -; 33.6 . 25.0
822
65.8
83.6 60.0
-
-710
7,954
-5001 5oo
9 4418.0 232
.-43.0
325
- .Philipie
A-
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;Tind-anToa,
4 . ,3
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63.5
-
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007 3 7.1
8,51 ;0
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2 SnbSsjz70Afia ~~ tmgu; ;~aLua
2416
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2. i~
24
35
2
-
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11.2=, -'
'.
2
! ;.
122r-
;wCili
-LEsciae a.
toth UN4. Ineraoa ComparZion Pr e. ,. reth to i- ernational indude alloaneos and boiisetDtarnibrpriarteseor comnpmsdoui ae ased
'
in asurveyof
impranis with 500or more;-
lAor
smalrilab, on
average compdranontn
iconomige u
te
(o
public sector. In other HPEs public sector base salaries are consistendy lower than :-their privare sector counterparts (table 4.4).7 W7hile figures were not availablefor Indonesia, anecdotal evidence suggests tat te private-: :tpublic wage gap tre is the largestamong HIAEs. A stdent graduating from an Idonesian university can expectto earn t o to four times as much in the private sector as in a government job. Nor surprisingly, c Som frsle the technocratic core, Indonesias bureaucracy is perhaps the least sell regarded among HPAES. In economies where public sector wages are at least decent, prestige, job:seciny, c cll -=AE-s. and other advantages of public employment will persuade cas reare amn H
se y, and other 2civa --
oDf pu -
plymn
wil : peruad
-::
r~~~~~~~~
V ItALE
some talented individualsto forgo higher earningsin the privatesector. The trick for governments is to hit on a combination that will attact competent individualsto the ci-vil service. Prestige is of course partly a function of culture; thus East Asian cultures that regard dvii servants highy have an advantage in building bureaucracies. Confurcian thought, with its venerationofscholars and precivi service examns, remainsa powoccupationwith written tests,especially erful force in Hong Kong,Japan, Korea,Singapore,and Taiwan, China. Not surprisingy,thesesocieties have producedstrongbureaucraces. But bureaucracy building need not be culturallyconstrained. Meritbased screening with economic incentives to attract a large pool of applicantscan produce high status for civilservants in any society.Provided that the exams are sufficientlycompetitive,individualswho pass rare. Thus passin the examn or winning a comthem will be relat-ively petitive divi servicepromotion becomessimilar to being inducted into is special. 'While a hail of fame; it signalsthe public that an indLividual the value of prestigecannot normallybe quantified, the monetary value accordedto some Thai royal decorations,describedin box 4.5, suggests can be very high indeed. that the value of such pre-stige
job security can also offsetslightly lowerpay.In most
HPAE bureau-
cracies, dismissa is unlikely unless the bureaucrat commits a serious mistake. Security of tenure translates into lower income variability, to accept a lower which in turn providesincentivesfor public-employees salary.Furthermore,in many economiesa public employeecan look forward to a retirementpension, a benefit not normallyavailablein the private sector exceptin large corporations. bureaucracy AClear Pathtothe Top. A final requirementfor a successfuil is a well-defined, competitivecareerpath with a substantialprizefor those
who make itto the top. In Japan and some other
beyond the pay; perks, and prestige to indude
E*AEs,
retrement comes
The
bureaucrataresubstantial,extending early,and the rewardsto a successfUl

a golden parchute.
Japanese have a specialword for it- amakuckr4 which means "descet from Heaven"' and connotesa lucrativejob in a public or private corpora-. election to politicaloffice.Similar practicesexis in tion or occasionally Korea,Malaysia, Singapore, and Taiwan,China, in differingdegrees. which whisks bureaucrats Unlikthe much-criticizedrevolving-door, fiom the pubfic sector to the privatesector and back in other economides again, descent from Heaven is a one-way tp. Moreover, rethringbureaucrats in Japan do not choose their sinecuresbut are assignedthem 178
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,~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
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B The Iu1e.f
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179
i;RA ACLE
service, dismissal brings disgrace on the entire family; hence family members have an incentiveto discouragecorrupt activities.This mechanism appears to be especiallycffectivein Korea, where tradition has placed a high premium on goveniment service. Strictly enforced dismissalpolicies also help reduce graft. In Singapore, large or small corruption is pcnalizcd by expulsion from the civil service and withdrawal of one's pension. In addition, distissed public employees are unwelcome in the private sector. Under such circumstances, the cost of engagingin comrpt acts becomes nearlyprohibitive. Other economies in the region have governmentanticorruption squads that focuson enforcementand ptnishment As Japan and Singapore in the early 1990s illustrate, rich economies have an advantagein building honest and competent bureaucrades that further the creation of wealth. For example, economies with higler per capita GDPcan afford to pay bureaucrats better and to fund the high-qualinr education that results in a better pool of applicants. The challenge for developing economies is to concentrate availabie resources where the can most effectively replicate the advantages of the industrial economies. This is nor to say that corruption and bribery do not occur in ithose HPAEs with reputable bureaucracies. These social evils exist in Japan, Korea, and Taiwan, China, and even in Singapore. The critical point is that they have occurred less frequently and in smaller magnitudes than in other lowand middle-income economies. Indeed, most of dteHPAEs scored significantly better than other newly industrializing economies in survey rankings of the prevalence of improper practices and special interest group lobbying contained in the 1992 World Competitiveness Report (World Economic Forum 1992).
Developing Better Business-Govemment Relations

Whereas most other low- and middle-income economieshave only
recently turnedto the private sector to stimulate growth, the HPAEshave
done so for many years 1 often decades.They have done this by providing a legal and regulatory enviro=nent for private invesment, by creat-
ing support systems for SmEs,and by establishingcooperativerelations with big businessand in some caseslabor. Compared with other developing Mmlh Legal and ReguLaztoy Envirounet. economies,the HPAMEs have been more successfulin creatinga legal and
-80
- t;-
~~~~~ 4N.l
~~~~~~AN
regulatory environment conducive to privatesectordevelopment. Based on selectedcriceria or fourteennewlyindustrializing economies in the 1992 WorlzCompetitiws Report, in whichlowerscores indicate a better environment,the HPAES had an averageoverall score of 32.3 (with a standarddeviationof 18.4) comparedwith an averageof 56.9 (with a standarddeviation of 13.3)for the odtereconomies.8
EncouragingSrall andMedinm-Size Enterpriss Small and medium-size en-
texprises generally havedifficulty geridng creditto finance capital improve-ments, obtain better technology,and break into markets, particularly export markets.Hence, a nontrivial SMEsector cannot be established without external assistance. Studies indicate that the northern-tier HPAEsJapan, Korea, and Taiwan, China-lhcv been able to develop relaively effecdve financial supporc programs (Itoh and Urata 1993; Kim and Nugmt 1993; Wade 1990). largdy because of weak institutional capabiities, Indonesia has not had much successwith itS support progams(Berry and Levy 1993); however, the private banking system appears to have been hdpf3i irndeveloping some sNEs. Both Malaysia and Th h atiV V support prograams but not much is known about their effectiveness.
Wooing BigBusiness
communication and cooperadon between die private and public sectors, whereby rentsharing rules can be made transparent and whereby each participant can be assured of a share of rents. These art, in effect, an institutionalized form of wealth sharing aimed primarily at winning the support and cooperation of business elites.
fciitate
HE HIGH-PERFORMING ASIAN ECONOMIES TEND TO HAVE
fbrmal instiutions that
East Asia'sDeliberation Councils

Japans efforts to establish such institutions are the most widely recognized and have been the most thorough. Since the beginning of the postwar period, the Japanese government and private industry have en-gaged in serious policy deliberations though deliberation councilsoftwo ype The first is organized along functional or thematic lines, such as pollution or finance; the second is organized according to industry, fr
: 8ii
exaple-, automobiles or chemicals. Government ministries establish
the councils,which are generally associated with. a specific buLreau within the establishingministry Each councl providesa forum for governmentofficial and represtentatives from the private sector-business, labor, consumers,academia, and the press-to discusspolicy and marker trends and gencrallyto acchange information. Consensus is encouraged. Figure 4.4 shows the processof formulating a policy ac the Ministry of Trade and Industry.
MITI
officials first invite interested parties to a series of hearings, the re-
sults of which are forwarded ro a Mm research group. The research group prepares a report for the approprate deliberativecouncil, where
policy negotiations may take place. On the basis of feedback from the
council, the group revises the report and releases it to the public to acplain the objectives of the new policy. Final approval by the diet is usually routinc. Without consensus from the relevant deliberative council, however,a MITmpolicy stands little chance of success.9
Figre 4A Indusial Wsion FonnuationProcess

Conductsurver
compile data
r|
MMjuniorstaff
study group
- Learned individuals
- Interested parties - Overseas erployees - Local rpresentadves
Hearing
Prepare draft
- oUers
>
Research group (Subcommittee)
(Outside lcturers) Otdelcue;
.~~~~~~~~~~~~~~
{eedbacM
(Briefings. subcomnittees' reports)
-|Deliberativecouncil
Publec r
-
Ationr
Public Aions
(Report) ----
-*
Explanatorymngs
Lectures
-Others S&urn-. Ono (1992).

: X . ' . -~~~~~
In Korea, from the mid-1960s to the early 1980s, goverment and private sector relationswere also dloseand cooperative,although some in the p'rivatesector argue that goverment was coostrong handed and 10 Goverment and businessleadersmet oftn and regularly dictatorial. although less formdlly than in Japan. Government solicitedbusinesses' views and included them as a criticalpolicy component.
Until the early1980s,the most imporgnt communication channels

were monthly rexport-promoton meetings, at which the president of
Korea himself presided overdiscussions berween the economic ministers andictop business leaders. Businessmen expressed theirviews about marets,regulations, and potential plans.The president: theninstructed specific ministers to attend to each important issue;at the nt meetng,
mnUnisters dlivered a progress reporton theirassigned tasks. Thesemeetings weresupplerm ented bygoverment-initiateddis-of siongroupsinvolving companymanagersi middbe-level government of-ficials, and expertsor scholars.As in Japan, there were basicaluy two
types: fumnctional (for example, taxation) and sectoral (usuallyfocused
on a particular industry).In both, bureaucrats invitedincerested partes and cxperts topresenttheirviews. The focus wason information gath- eren bureaucrats madethe finaldecision. E vernmsonoicitied oin-cor poate al viewpoints in policies. 'WithKoreais gradualdemocratization sincethe raid-1980s, irlations betweengoverinmetand business have becomemore distant and the meetingslessfprequent. Recently, however, as the conomy hasslowed, thereis a growingconsensus that monthlymeetings shouldresume. 'Similarconsultative mechnisms appearto be evolving in Malaysia.
From independenceuntil 1970, the governmentfocused on infrastructueand generallyLeft the privatesectorto fimction freely.From 1972 t'o
1985,as the goverment responded to the racialdrots-of 1969wichthe NewvEcovrnomic Polncyd relationsbetweengovenmentand bness tendedto be contentous,in partbecause of the requirement that aslenterpriseshave at least 30 percent Malayparticipation.Since 1986 business-government relations havegradualyimprOved, culminating in 1991indhe New Development Policy(ND), whichhas strucka more Ne balance cn betweengrowthand distributon.For example, uner
cvenalac
beCe
rwhaddsrbnn
o xml, underthe
NEP, all firmswith morethan M$250,000(US$104,167) capitlization -wererequiredto complywith ethnidcy-based shareholding rgulations.
Under the NDP, the cut-Offpoint ha been raised to M$2.5 milion (US$1.04 rmillion).
183
The NDP specifically seeks to emulate Japan's government-business

S~~~~~~~~~~~cni
consultative mechanisms, a determinat-ion reflected in PrimecMinister taiv Bin stmcFu I Mahathir Mohamad's 'Look East Policy." Formal consultations began in 199 1, when the government invited capt-ainsof industry to discuss the national budget with finance officials in a much publicized
budget dialogue. In thessame year Mahathir aeaaed the pinnace of the
conulttiv stuctre,
the Malaysian Business Council, which'i chaired
bycth pruie minister and includes more than sixty members from industry, labor, and govermennt. Thailand has been slower to develop consultative mechanisms. In 1983; the govenmmentestablished the National Joint Pubfic and Private Consulkative Committe (NJPPCC)with the prime munister as chairman and the head of the plnning agency as searetary general. Othmer members are top government officials, particularly from the economic agenaies, and nine private sector represenmives dmawn from the Thai Chamber of Commerce, the Association of Thai Industries, and the Thai BankersAssociation. Provincial consultative comrnitees have been established to supplement the NJPPCC (Samudavanija 1992, p. 26). Views about the effectveness of the committee differ widely. Public-private consultation is most cxplicit in Singapore. The private sector paricipates in policymaking in many ways. For example, private citizens serve as directors on government statutory boards and as members ofad hoc government advisoy commirtees. In both capacities, they review policies and programs and make recommendations for official considemraion.In addirion, the government regularly invites chambers of commerce, trade associations, and professional societies to subniit their views on specific issues (Chia 1992, p- 11). The Singapore ents efforts to manage dhe economy are most. fully apparent in the National Wages Council, which indudes rp-resentatives fiom govenmen; business, and labor Becauseof this tripartite structumr, the Nwc fulfills several coordination funcuons, simultaneously fiurthering the govenment's guidance of business and of labor, as wel as business-laborcooperation. Having rejected more typicaldenocratic ifrms as too adversaial, the PAPhas also etablished a wide variety of citizenassociatiorLs to provide channels of communicanon with the government Formal mechanisms for business-government interface are almost entirely lackingin Taiwan, China. Instead, coordination is handled tirough large public entrrise that provide basic inputs to manu cturers and through enterprise owned by the Khomintang the dominant political
184
AN
.~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~-
NST
----- ---
1 Indeed, public enterprises,broadlydefined, account for a larger parry.share of GDP in Taiwan,China, than in Koreaor even India, where cenrualplanning plays a key role. These public, quasi-public, and partyowned firmsgivethe governmenta high degreeof control overlarge-scale sensitiveinvestmentsand a means to influencethe generally smallerfirms that oomprisethe privatesector.Over the years,the largerole of the public sector has become lessobvious, as some parry and govemment firms weresold to cooperative private interests. Coordination is also facilitated
by middle- and lower-level officials of the Industrial Development Board, who make routine, infornal visits to thousands of small and medium-size enterprises within their jurisdictions. Like Taiwan, China, Indonesia lacks the formal government-business coordinating links of other HPABs; this may be pardy explained by the
weaknessof its bureaucracy.Coordination appearsto be handled by in2 Little fbrmal networkslinking senior officialswith major enterprises.' is known about thesenetworks,but theyappear to have produced a high degree of cooperation in the economy. In contrast to the deliberation councils,where rulesare more transparent, thesenetworksare more susceptible to captLre by participants and to corruption. Deliberation councils natually reflectthe history and culture of the societyin which they operate Evenso, the experiencein the HPA:Es suggeststhat their applicabilityis not limited, as some analystsmay suggest, to the Conf&ciancultures of Northeast Asia. Becausethe operation of deliberation councils has been so importanr in winning the support of business elites, we now look in greater derail at the operation of these councils in two very differenteconomies,Japan and Malaysia. Japan's Councils: e Foreunnes The concept of deliberation councils in Japan is most closely associatedwith Mm. Because of m1Im's role in developing and implementing the economys industrial policy, the public-private consultativeprocess was most dearly manifested in the councils attached to it. Government-businesscollaboration has long been a hallmark of the Japanese economy. The zaibauu-Japan's large corporate holding groups-were dosely linked with the military-bureaucraticcomplex of the 1920s and 1930sand were a key element in building the economy's industrial and military base. At that time, the influence of big business matched and sometimesexceededthat of the bureaucracy. The U.S. occupation forces, ideniliing the zabatiu as a keyelement in the build-up ofJapan7s wartime machiney tried to limit their power,
185
= - .
QSI.YMiI R-A CL
in part by conferring more power on the politically independent bu-
reaucracy. Ironically,this not only strengthenedthe bureaucracyparticularly MITT,which became the center of developmcnt policy
formulation-but also faciliraced the resurrection of industrialholding this timearoundbanks(theso-called kid'mu system). groups,organized Thesenew groupsbecamcthe main. players in the government-initiated
consultation procss.
The principal instrument of the bureauicracyin managing this
process hasbeenadministrative guidance, the useof threatsand rewards to induceprivatc partiesto follow or implement measures suggested by the bureaucracy. Administrative guidancedoesnot depend on any law or regulation. Rather,it employs eidter threatsof adverse consequences
should a private party refuseto conform to a 'suggestion or recominen-
dation"or, alternatively, rewardsdhatcan be grantedshould the party concede,I MITEis wellkcnown for havingemployed this withgreatskill.
Until the mid-1960s, administrativeguidancewas a powerfil4 tool for
Mm bureaucrats. Mm had firmcontrolovertheallocation of foreign exchangeand overimportationthroughthe Foreign Exchange and Trade Control Law.But intermational pressure,combinedwith the need to maintin an export-based economy, led the government to gradually liberalize the rade and investment regime.The processbeganin the mid1960sand continuedtill 1979,whenthe Foreign Exchange and Control Lawwasdismandedand the Foreign CapitalIav liberalized. Of course this meantthatMmT waslosing keycomponents of administraive guidance. By the late 1970s,guidancehad taken a distinctiely different form-mergers of industies spicedwith financialsupport from the government-and coercion declined.
experience with and Korea.Malaysia's Ealaysia'sCouncls: mnulalingJapan public-private cooperation through ddiberation councils has paricular relevancefor developing econqomies. UnlikeJapan or Korea, Malaysia is a multiechnicsociety,and unlike Singaporeit has a eladvely large population and land area.Thus Malaysiais in many waysmore tpical ofa devloping economy than are te high-perfomiing economies of Nordteast Asia. When the Malaysian govermment introduced foirmal public-private cooperation in 1983, it embodied-the concept in the slogan "Malaysia Inc.,' an overt attempt m emulate Japan Inc., partcularly the dose relarionship between Japanesecministries (especially )and big business. In Malaysia, officials have applied this concept to their quest for growth with equiit, a particularly important goal in a multiethnic so6ey-I86 :.;
AN
INS'
* .
Before 1983, Malaysia had some consultative panels within minmainlywith istries that dealtwithspecialized issues and wereconcerned cutting red tape. Many had litde privatesector participation; those that did, however,produced concreceresults. Since then, more deliberation councils have been formed,dealing with broader and more complicated issues (the budget and trade,for instance). One of the most ambitious, the MalaysianBusinessCouncil, which was formed in 1991, resembles Koreashighly successful Export Promotion Council. Although it is too earlyto know how effectivethesenew councilswill be, thev would be hamstrung without an efficient and rcpurable civil servicebureaucracy. The government recognizesthis and is trying to increase the bureaucracy'sefficiency,eliminate corruption, and educate civilservants on the value of cooperatingwith the privatesector.
Why Deberaton Councils Assist Growth

From an economicstandpoint, deliberatve councilsfacilitate information transmission-They enable the bureaucracy to gadter infbrrnation about world markets, technology trends, and the impact of regulationsdomesticallyand abroad, synthesizethe information into an action plan, and communicate the plan back to the private sector. Selfinterested behavioris more or less constrained by the repeatednature of the collaboration.This in part helps establishcredibility-private sector participants believe cheating and reneging are less likely. Politically, these councils serve as proto-democratic institutions, providing direct channels for big business,labor, and academnia to the seat of power.Finally,becausethe rules that governan industry are effectively esablished - rwithin the council, everymember is assuredthat the rules canolt be altered arbitrarily.With dear rules established,memberscan concentare on market competiton and not worry about others tring to curry special &ivors from the government.In effecr,their share of industryprofits is determined more through competition than through rent-seeking.In this sense, a deliberation council can be viewed as a wealth-sharing mechanism.
: . T . -. ,
Studies of the successfulAsian economies have fiequently emphasizedthe authoritarian nature of their leadership.Leadersof these soCd-
are eties described as benevolent dict;ators who,incontrast

0
to
mostother-
1-
0 X H -:-:
- - :.
I~~~~~~~~
- - -
~~~~CL E
dictators, uscd their authority to musde businessmen,workers,and bu-
pursuit of development.This chapter ofreaucratsinto a single-mLinded fers a different interpretation. Leaders need the active cooperation of their peoplc to stimulate and sustain growth. Heavy-handedtreatment might subjugatethe ruled, but it would also increasethe perceivedrisk
of exprpriation, driving away capital. Lack of capital would slow
growth, in turn driving awayskilled workers and entrepreneurs.Thus, even authoritarian leaders cannot rely on coercion alone Rather,all leadersneed a strategy that will induce people to participatewillinglyin have to growth. Whether by designor accident, the leadersof the HPAEs various degreesdevisedmechanisms thar effectivelydeliverthe promise of shared growth. Although policiesto promote growth are generallywell known, they tend to be eitherdifficulrto initiate and/or to sustainovertime. Growth makes those at the top of the economic pyramid uncertainabout the fiuntre of their wealth. It introduces changesthat are likely to open avenues for fellow elitesand new competitors to contest control of their enomic fiefdoms Elitegroups therefore generallyfind it in their interest to try and maintain the status quo unless theyare assuredthat they will benefit from rapid growth. Furthermore, the initial stages of growth Hence, evenif often requirethat the generalpopulation make sacrifices. growh can be initiated it may be interrupted by socialand political unres; unless its fruits are shard by the non-elites.
The taskof initiating and susmininggrowth thus presents a very difficult coordination problem. Lcadersmust persuadeeliregroups roshare the growth dividend.They must demonstrate to non-elites thar part of
the dividend will indeed accrue to them. Governments must create
acedible means to persuade everyonethat their plans are nor all rhetoric.
all establishedmechanisms that operaThe governmentsin the HPAEs rionalizedte princple of shared growth. The NE in Malaysia,deliberation councils in Japan, public housing in Hong Kong and Singapore, and small enterprise promotion in Korea and Taiwan, China-all helped to demonstate the realityof shared growth. Finally,govemmentsmust foster the conditions in which the bureaucracy, or at leasta dedicatedtechnocraticcore,can designand implement effectivepolicies.To varing degrees,and with a varietyof mechanisms, the HPAEshave performed these tasksunusually welLIn the next two
chapters, we
examine the
policies:and instruments that
HrAE
govern-
ments used in their effort to rialize the promise of shared growth.
I88 ;
Notes
1. For example,the National WagesCouncil in Singapore has helped coordinatewageriseswith increasingproductivity. In Japan, the establishment of the Japan Produtctivity Center helpedi institutionalize labormanagement consutrations. 2. In fact, the smE. sectordeclinedonly when the HCI push wasinitiated in the mid-1970s. 3. In those cases where the prime minister appoints both vice ministers, he is constrained by custom to appoint a career bureaucratfrom the ministryto the post of admninistrative vic minister. 4. The debt-equityratio has beeninordinatelyhigh in Korea. Official statisticsindicate that this is in the range 310-80, although the 'true' figuresare said to be lower, at about 160-80 (Wade 1990). Nevertheless,this is still high comparedwith the ratio in the United Statesand the where the rangeis50-90. United Kcingdom, 5. Okimoto (1989) ranks the power and prestigeof ministries as the inverse. of their degree of policicization. * The heavilypoliticizedconstructionministryrankslowest and the relativelynonpolicicized Mmu the highest. * 6. Senioritybearsheavilyon promotion decisions.It is 8. The criteriaselectedare (a) the transpare-ncy of the government,(b) the effectiveness of antitrust laws,(c) the in the adsecurityof propertyandtperson, (d) the faimirss ministration of justice, (e) the extent of improper practices in the public sector, and (1) the extent to whiich The lobbying influences government decisionnmaking. rankinigs for eachcriterion arebased on responsesof business executives stationed in each of the economiesin the A Borda survey to questionspertaining to the criteri-on. scorewas computed for each country by summingup its rankingsfor eachof the criteria.The overallrank score for a group of economiesis the avenage of their Borda scores. 9. Industrialassociationshavebeen important participanesin the consultativeprocess.In many cases,theseassociations are empowered by law to represent their sectors.T'hus,the businesscommunity has strong representationin a council.
that, onceone hassuccessfulfly hurdledthe diEfassumed

cult entrance exams,she or he is capableof doing (effiand eff-ectively) what is askedi of her or him. This is * ciendly not -to say that performance does not count. The pyramidlikestructure of the bureaucr-acy guaranteessome c ok oehrt * greeofcmeiin A neigds ensure that its membersprosper.. Who becomesa buor ultimatelythe (adminisreau chief,a director-general, trative) vice minister is a source of intense competition amongthe classesin a ministry"(Johnson 1982, p. 62).
..
10. Though dhe channels of communicationare still operational,the democratizationof the polity has led to somechillingof relations.The country is currentlyundergoingrapidpoliticalchange that has affectedthe businessgovemment:interface. There is a recognition in many quarters, including business,fir the need to reestablish good relations but under a new form of collaboration. That form is likelyto reflecta more evenbalancebetween the tWOSCectr.
large I11. It is alsowidelyknown that the relativelyfeiw private businesses havedloselinks to the party. somemidsizc 12. In fuct,inte'rviews revealedthat even. firms haveestablishedrelationsof this type.
13.Johnson (1982) givesan interestingexample:"The city of Musashinoin the suburbs of Tokyo issueda policy statemnent sayving that housing contractorswhobuilt large or helping to buy 7. Finance-relatedagenciesin Thailand, for examnple, projectshad to cooperatein provicding land on which to build elemnentary schools.Whena. conthe Bank of Thailand and the BudgetBureau, havetheir own personneland recruitmenit programs.There, salaries tracor ignoredthes guidelines,die city cappedthe water are said to be about 30 percent higher across the boardt and sewagelines he had built for the project with conthan in the rest of the public sector. crete. The contractortook die cityto court, but the court upheld the city" (p. 266).
189
w~R
Strategies for Rapid Accumulation

CCUMULATION OF PRODUCrIVE ASSETS IS THE
foundation of economic growth. It is therefore noE surprising that, as shown in chapter 1, the highperforming Asian economies (HPAEs) accumulated both physical and human capital much more rapidly and consistently than other economies and that accumulation accounts for a large portion of their superior performance. More interesting is the question of how the HPAEs were able to achieve these rapid rates of accumulation and, in particular, to what extent policies were responsible. This chapter examines the HPAEs'superior performance in three accumulation-related areas: human capital accumulation, financial savings, and investnent. For each area, explananions fill into three broad categories: - Conditions that were not the direct result-of accumulation policy : Policy fundamentals: areas in which nearly all governmenrs intervene, but in which HPAE governments acted more effectively i ActivisE policies: selective interventions underraken in some HPAEs to increase accumulation. Rapid economic growth and the attendant changes in economic structure not directly related to accumulation policies were important factors in increasing all dtree forms of accumuladion. For example, the HPAEs' rapid sLift from high birth rates to low birth rates increased the resources per child potcntially available for education at home and in rhe dassroorn. At the same time, the rapid deceleration of population growth increased household saving, in turn creating resources for investment. :n addition, the HPAES performed well in selectng and implementing . .. fuindamental economic policies related to accumulation. Every governgover9 ry econon fundam.nml
:~~~~~~~~~~~~~~~~~~~~~~~~~~g
spent their money more wisely, emphasizing universal primnaryand, later, secondary' education. Similarly, every governmen tcries to control inflation and secure property rights, and most regulate banking institutions to protect savers against default, all of which encourage savings and investment. The HPAEsdidt these things better than the rest. Moreover, as the HPAFsdeveloped, their government:s strengthened the legal and regulatory firameworks fir bond andt security markets to facilitace investment. Besides fostering Favor 0 ble general condidions and getting policy fundamenrals right, some HPABs have deliberately intervened in marker to solve specific coordlination problems related to accumulation. These interventions aimecdat boosting savings and investment rates are the most controversial of the HPAEs accumulation policies. Generally, interventions have been more comrmonand more successful in the three northern HPAEs-Japan, the Republic of Korea, and Taiwan, China-al of which have strong govermnnmetl institutions. With some notmble exceptions, attempts to replicate such efforts among Southeast Asian newly industriaiigeconomieishave not been successful. Atrthe outset we must acknowledge a fundamental methodological diffickty. Since we know the HnPAFs bad rapid accumulation (and to some extent were chosen as a group on that basis), we also knoyw,even before examining their policies, that they wer not inconsistent with aantdfut rapid accumulation. l The fwikecorg challenge is to separate aig policies.that n netet were neuh tral or perhaps negative but not sufficiently negative to hinder accumulation significantly from those policies that actually faLcilitatedrapid accumulation. We do thtis,noting that our findings are based on antalytic and empirical judgmecnts rather tha-n derived from statistical models.
HPAEs
ment spends on education, but the
Explaining East Asia's Hi'gh Human Capital Fonnation

XCEPTr FOR IN THAE AND, THE QUANTITYOF BASIC EDUCATION
192.-
provided to boys and girls of school aehas been consistently the HPAEs tha in economiies with similar levels of income. After having achieved universal primary schooling, thereby eliminating the gap between boys and girls at the primary level a decade or .mren searle than most, the HPAEs expanded secondary educaer rapidly
iEtiigierin
STRATEGIES
FOR RAIMDACPIDA
tion and were particularly effcctivein reducing gender gaps at that
level.
What accounts for this extraordinary performance?We focus first on three enabling factors; high income growth, early demographic transidions, and more equal income distributions. Each of these greatly increasedthe resourcesavailablefor education. We then shift focus to two policy variables: the overall budgemry commitment to education and the distribution of the education budget. We seek to show that the allocation of public resourcesto primary and secondary education was the major determining factor in East Asias successfuleducationalstrategies.
Rapid Economic Growth

Rapid economic growth is the first factor that accounts fbr East Asia's extraorlinary quanrity of education. For example, during the decade 1965-75, CDP growth averaged6.7 percent in Malaysiaand 4.1 percent in Argentina. This implies that over the decade a conscantshare of GDP allocated to education would have doubledthe resourcesavailablefor education in Malaysia,while in Argentina they would have increasedby less than half Rapid growth also crearesjobs, increasesreal wages,and raises the rate of return on labor forceskills, thereby increasingthe deo mand for education (Ing, Anderson, and Wang 1993). Thus, rapid growth operates on both the supply side of the market for educational services,by increasing the potendal resourcesavailablefor education, and on the demand side. The risingreal wagesthar area product of rapidgwdicould have a dampening effect on educational opportunities, if the relativewages of teachers rise. Fortunately,rapid accumulationof hurnan capitalfacilitates subsequent educationalexpansionby increasingthe potential supply of eachers,thereby reducing the premium teacherscommand.' The wages of educated workers,includingteachers,tend to rise at a slowerrate than averagewages.Therefore, the impact of risingwages on the cost of edu2 For example, per pupil cation and hence on enrollments is weakened. operatng costs at the primary level average roughly 13 percent of per capita GNP in Indonesia and Malaysiabut more than double that, 29 percent, in Sub-SaharanAfrica. In Indonesiaand Malaysiathe annual earnings of primary teachers are roughly 2.4 times per capita GNP. In Sub-SaharanAfrica, however,where human capital is relativelyscarce,
that ratio is much higherA-The pattern is similar at the secondary leveL. 'I93
--- RAC_LE
Declining Popubtion Growth EastAsiapreceded otherdeveloping regions in moving throughthe demographic uansition,and the education sectorwasa majorbeneficiary.
One important outcomeofa deceleration of the rate of populationgrowth
is a deline in the rateofgrowth of theschool-age population. Duringthe 1980s,the growthrareof the population age6-11 yearswasverylowin EastAsia-so low that the absolute numberof schoolchildren in Korea, Singapore, and Thailandactually declined-but wasphenomenally high in Sub-Saharan Africa. Asa result, from1965to 1989theshare of thepopulation up to 14yearsoldin Singapore fellfrom44 to 24 percent, whilein Kenya it rosefrom47 to 51 percent. Similar contrastareevidentbetween otherHPAESandSub-Saharan African economies (seetable5.1). When the school-age populationis growingrapidly, as in Kenyaor Pakistan, risingexpendirures on basiceducationareneededjust to keep enrollmentratesconstant.With declining or slowly growingschool-age populatons,however, similarincreases in expenditures can go for more schooling or betterquality. Alternatively, expenditures asa proportion of GDP can be cut while current standards are maintained (see table A5.1, in appendixA5.1).
Table5.1 Sizeand Growth of School-Age Populabon
of tota pp .,
(rnl
*.FIPA&E2.1:
ong-Ko
-- f-.-rcaRPf -
402
-i'o n
1:
i
0
-0,.,3'
p"t.of."
'
143r4o-
'4
'
- _- 37
'.4-4
iio:' 26--r:'0.7.
'
0.2
d'
1 Banglaesh.X'
... 1~~~~~~~~~~~~~~~~~~~6 a :,..:a'
' ' ..
'C: '.47
'-.'43
.
.
''., 2 9' . ...... 0
T-
'
47s51_3 igrn.~~~~~~ 46 ~~. ~~~~~~

,
4
r! 7 t
9~11
120 -
* I94
Brazl ; t,
35
' "1-
'194.
STRATEGIES
FOR. R-A:P-D`
Accordingly, declining,stagnant, or slowlygrowing school-agepopulations have allowedsubstantial increasesin per pupil expenditure in all of the HPAEs. Table 5.2 shows the magnitudc of the savingson expenditure on basiceducation in East Asiadue to the decline in the proportion 5 Consider the most striking of the population of schoolage. example:if the share of the school-agepopulation in 1988 were as large in Koreaas in Kenya,the Korean govemment would have had to spcnd 5.6 percent
Table 5.2 Percentage of CNP Allocated to Education Saved Due to Lower Fertility Rates
t
f _
;\;
X~'.on
Expendtre
:Economyp- :.-;
basic eduation: --ere a prcenage -a = :of GNP: . fi!ny'
dne torowthm;s#e rhuol-aepopnltdon tower an. Mcio

P
#t
X.n
Ho,gKon' 1975 - 7 t180-1

,
2.0
1.7 4.2 2.8
l9-;
12
1.5 4. :4.8
w ..
1.0
L 38 8 1.
1.0
2 3 3.9
;1975 . . 98849 1 . .*w;~~~~~~~~ -..
- -;
1975 1988-89:
13 28
0~~ 6 . 3. 16 ; .21
~~~ 04
~~. 0420 %8 :14
1980-81 ~~~4:4 11 ;1988-8 4.40 * ''J1975

"_J ''i
5
0 4'0 04
08
','
0
20
:ijS"
<
t'' ''05i '!
'.'
-9 8
268 ofcul
lan o. [Cur
0.3
'
08
aof )
4t,'-,'^ .iNnc'
on basic ed
an an asapccara2e
'
Fr.
, .
percencddference ErAsiznan4orhcrccononucs inscihoolWsg popadi) z s S * q ;~~r between ;2,-,;j:u;f t *, , 1;-th.iii 'n2u',_ -+ ,L{'; (cxpcn mme on on .a;p ied ;oFGN)an c Cai =a f addal itht would havte been rqe h p gw e m rp s. A 0C-d . . - t - r. LTvuuut1accoarcstuiooup. 4 %Th%isanndImrrofd1Saviui Thris ra ndxue n asic dlihearo,usso(iouy",brn"~
':95
.~~~~~~~~C
of GNP on education instead of the 2.8 percent actuallyspent to achiieve
ratessaved rates. Thissuggests that lowerfcrtility Korea's highenrollment school-age populahad Pakistan's Korea2.8 percentof GNP.Conversely, of Pakistan lowKoreanrate, thegovcrnment tiongrownat the relatively ratesby as muchas 50 percent. enrollment couldhaveincreased
Equality inDistributon ofIncome

The moreequalan economy's distributionof income,thehigherpriof more maryand secondary enrollments tend to be. In a crosa-section negsignificant thereis a strongand statistically than eightyeconomies, ativecorrelation between basiceducationenrollmentratesand the level of incomeinequality, asmeasured by the Ginicoefficient (Clarke1992). can havean equalizing imAs we discussbelow, educational expansion
pact, so the causality in this relationship could run from enrollment
thereare a variety of rearatcsto the distributionof income.However, in chapter 1, which we docurment sons why low income inequaliry, to highenrollmentratesin might havebeen a third factorco:ntributing
East Asia.
the incomeofthe poorest20 percent incomeequality, Due to greater of the population in EastAsianeconomies is higherthan in economies (seetableA5.4,at incomebut greaterinequality with the sameaverage of budgetary constraints(and capital the end of the chapter).Because marketimperfections that preclude their borrowing to investin educaare unableto investin theirchildreneven non), verypoor households whenthe returnsarehigh:the pressing need to subsistcrowds out highThis is lesslikelyto occurin EastAsiabecausethe return investments. level. incomesof thepoor tend to be furtherabovesubsistence Measuresof the income elasticityof the enrollmentraio derived fiom cross-economy educationexpenditure equations are0.31 and 0.43 that in levels(Schultz1988).This implies at the primaryand secondary of lowerinequality effect on schoolenrollments EastAsiathe positive canbe quitelarge.Forexample, givenan incomeelasticity of basiceduof 0.40, if the distributionof income wasasequalin cationenrollments Brazil asin Malaysia, enrollments amongpoorBrazilian children would of dethe incomeelasticity be roughly33 percent higher.Moreover, mand for basicschoolingamongpoor families is likelyto be substantiallyhigherthan average and mayexceed1.0.In this case,enrollments' childrenwouldbe 80 percenthigher. . . . amongpoorBrazilian
-96.- -
STRATEGIES
FORR-R
Coordination Probems that Hinder HumanCapitalFomation are higher the higher Numerous studiesshow thata person'scarnings their human capital,as measuredby their education and 'iealthstatus.As shown in chapter 1, the same is true for nadons; we know that investto economicgrowth. But ments in education contribute significandty justifiespublic provicionof education. neither of thesepoints necessarily Indeed, if the privatereturns art as high zs socialreturns on theseinvestments, individualsand householdsare likelyto make adequate (from an economywidepoint of view) investmentsin human capitalon their own. However,two kinds of problems generatea gap betweenprivate and sowhich-if not countered by governmentaction-will result cialretumrns,
in
fnilies investing less in their children's education than is in society's
interesLFirst, theremay be filures in the capitalmarket and in informaabove, that reduceparents ability or interest in investing. tion, discussed which imply Second, educationalinvestmentshave positiveexternalities, 6 that familiesthar invest in education are not the sole beneficiaries. The difficulty of borrowing to send children to school affectsthe poor especiallyCreditors cannot easilystake a fuitureclaim on embodied human capital (as they can for other types of collateral).Evenpoor &milieswho might be willingto borrow,becauseschoolinghas high priratcreturns, usually cannot The poor are also likelyto be less awareof fixture returnson education-and thereforeinvest less in their children's schooling than would make sense even from a strictly private point of view.7 These market faulres in principle suggescmaking loans available and improving information about future retuns. A simpler, and more common, alternative is for government to reduce the direct costs of schooling by making public schooling availableand free. The second classof marker failure-externalities-has more immediate implicationsfor what type and levelof schooling the government should subsidizeand for whit groups.There are severalsourcesof externalities.An educated person may increasenot only her household'sincome but also the income of other households, because her ideas and
innovations spill over to others. Similarly,education may have social benefits not directly compensatedmonetarily,for example, a reducton in the spreadof contagious diseases.In these and other cases,coordinanon probleiims ast, and governments acting on society's behalf have reason to choose a higher level of education than families acting alone. I97
. -- MIRAC
LE
onInveshnent Figure5.1 Returns in Education byLevel (Latest Year)

Ratreof rtuwm(percent)
:Primary
Pri_
---
c- ndia1
--
I-i
SondarJ
Kr
Policy responses generally consist of making schooling availableand free and in some economies compulsory.The differencebetweensocial and private returns from educauton is probably higher at tle primary and secondarylevels than at the university level (see figu 5.1). Many positive spilloverscome from literacyacquired at lowerlevelsof schoolfhing, while the retu:s from training at the universitylevel are almost
fuly ! captured by te higher i income of university graduates. Vocational training also havc high social payoffs, if it improves worker productivity not only for the trainee but also for her co-workers. More importantly, evidence suggests that vocational training is most
Hi4her X
*;
05 ID 2may L 0~~~' 5 10 15- 20 25 30 3!i SocIal return U Pilvato Social retrns N Nvaf mt
Soww Pswchaopoulos (1993).
cost-effective if trainees have a solid baseof primary and secondaryeducation. All of this argues for universalprimary arid broadly based secondary education as a means to improve economic efficiency and income distribution.
Table5.3 Public Expend4tnre on Education as a Percentage of GNP

;E con>msrnyI +. if
Policies that PromotedHumanCapitalFormation
-1960 196.i 9
5 .-
f Higher shares of national income devoted to education cannot
fiuly
oegg :~5
Kong2.8 2.0 p.oE Korc ]46 -2.8 34 '.97~ pV W

J.'x',tfg>R;
explain the larger accumulation ofhuman capitl in the HwAES.In both ;1960 and 1989, public expenditure on education as a percenrage of GNP
;:,--Smngipoin ?g1ayi
T
was not much higher in EastAsia than elsewhere(seetable 5.3). In 1960 the share was 2.2 percent for all developingeconomies,2.4 percent for
Sub-Saharan Africa, and 2.5 percent for East Askia During the three
z lndocs
*;*ZAvctnX ;.sc ,.1
23.", 2z3
2i.5{
-*~~~~~~~'
'.3]9.2.
0.9
Si
;
decadesthat followed, the governmentsof East Asia markedlyincreased

;.
share nthe of national output they invested in formal educaion, but so

governments ' '_t_AX'l in *'ii;i other developing regions. In 1989 the in Sub
ovr
nts- ogVIg f! Eas.............t2T-J
;;rg sa 1;9
PakfisraaV$1'I -- ttdc4cs:oPcdr
\
;
q
r
SaharanAfrica, 4.1 percent, was higher than the East Asian share, 3.7
-l
.-- J 26{bSs
;t
percent, which barely exceeded the averge share for al developing

8 economies,3.6 percent
E fl
; -6 '
-
.7.'.
3.1S'St;
41/
wer initial conditions, for example the colonial legarcy,decisive.

\
9'n
5|;
>Nor
Et
4
*
V's e Korea did have much hier W
enrollment mtes in 1950
thn
most
d0Zn~
oFcDnms' j^['.''Lli{,.rM<developing
econom
,ies subsequent increases in primary and seconday
wa1
-ourc esdaral
;' Ni
enrollmnent rtates account for Koreas present wide lead in enrollments over other middle-income economies. A comparison of lndonesia, a success story, and Pakistan, a laggard, is also illustative. In 1987 In.- donesia had achieved universal primary cnrollmcnt and a 48 percent
secondary enrollment rate. By contrast, Pakistan's enrolment rates were
0- - ~
-. Q: .98
--E f g .. ...
t>
52 percent at the primary level and 19 percent at the secondarylevel. What proportionof thesegapsis due to initialconditions? At the pri-
-..
-.
STRATEGIES
FOR
RID7ArCCU-M4
mary level,Indonesia increasedits enrollmenr rate by nearly 80 percent-
age points since 1950, while Pakistan managed an increase of only 34 percentagepoints, implyingthat inost of the current gap is explainedby the pace of increaserather than initial conditions. For secondaryschooling, Pakistan'senrollment rate in 1950 wasactuallyhigher than Indonesias; all ofde current gap is explainedby the rates of increaseduring the past thit-seven years Prmawy andSecoudary Education. The allocation of public expenditure between-basic and higher education is the major public policy factor that accounts fbr East Asias extraordinary performancewith regard to the quantiry of basiceducation provided. The share of public expenditure on educationallocated to basic education has been consistently higher in EastAsia than clsewherm: Koreaand Venezuela provide an extreme examplethat nicelyillustrs the point. Table 5A indicaresthat in 1985 Venezuela allocated 43 percent of its education budget to higher education;,by conwzst,in the same year Koreaallocatedonly 10 percencof its budget to higher education. Public expenditureon education as a percentage of GNP was actuallyhigher in Venezuela(4.3) than
Table 5.4 Allocation of Education Budgets,1985
f~~~~Pbi 'K> . r;j6Z.et.t Pub&-, Peretge

.
of Percenag
-
s -- g.
-*
~~~~~~~~~*
; r ' ; - on
~-
eoncain as
,
sit ;- educanon
; L;;te>ni8s. on'! .- .t
- '
cn. cio*
* t--Indones23:
... i
--.
--
..
..
Mn . ,9; iKoeaRepo 0 1vIalay~~~~~ia 79
72..
*W-
2-~.
",
'
.0
10.3,
0f
14.6~
749
;E~ A:LdcaoonzyGW Singapore 5.0

'F.
.4. ..
o 32,N-
Siid,cinollnt bsc ducanon i:980. . 30.7: . 4

-
-'~~~~~~~I" 7 t L' a6E

't
e-3
;E-310 .2' a9d4.3itwfl95.46,iiuhatrthe

.8.
per
, eniag eu4oi .Taln .t3.ofthe .

-1 '-
buidgealarcmbic?Iuconwns_81 2..10
St .adalu`p* e
P-d
m 9S48; and80,
'I -:
~tini985-8 ..-
dc: ng
it
--
-c-
Mg(* W5Ofli
. t.-
.,Lltf
-atv.Sosc
Qu-.
'99.
in Korea (3.0). After subtracting the share going to higher education, however,public expenditur availablefor basiceducation as a percentage of GNPwas considerablyhigher in Korea (2.5) than in Venezuela (1.3). Box 5.1 shows how Indonesia'semphasis on primary education, contrasted with Bolivia'srelative negIlectof primary schooling, is reflected in rural educationalopportunities. The share of public funds allocated to tertiary education in East Asia has tended to be low, averagingroughly 15 percent during the past three 9 In Latin Americadie share has been roughly 24 percent.'0 In decades. South Asia, the share is dose to the Latin American leveL This had been the case in Sub-Saharan. Africa as well, but in recentyears the share has dedinedrto East Asian levels. By givingpriorityto expandingthe primaryand secondarybasesof dhe educatoa pyramid, East Asian governments have stimulated the demand for highereducation,while relyingto a largeextent on the private sectorto satisfyr that demand. Eni all developingregionsthe probabilityof going to universityis miarkedlyhigher for secondaryschool graduates from high- thianfrom low-incomefamirnls. Typically, in low-and middleincome economiesgovernmentsubsidiesof universityeducation are nor relatedto need, implyingthat they benefit fimilieswi 'hrelatively high incomesthat could aflordto pay feescloserto the actual costof schooling. At the same time, in many economies,Braziland Kenya being notable examples, low public funding of secondary education results in poorly qualified children fr-omlow-income backgrounds being forced into the private sector or entirelyout of the education system. Because of the higher conce-ntrationon basic education in East Asia, public finds for education are more likely to benefit children of low-income famnilies who might otherwise have difficultyremaining in schooL Vocational Twining.Human resources and the trainingr to upgrade them have been important to the HI'Ans successfulexport drives,despite the high degree of labor intensity in their manufactured exports. Highlevelskills are essential for such manufacturing-relatedaaiviries as mnanagement and entrepreneurship, information -technology, finance, markceting, accounting, and law.Moreover,adaptive innovationson the shop floor, which are responsiblefor a major share of productivity in. manufacruring, demand both higher- and lower-levelskills. But while vocational taining is widlreonzda imotant such traing is rarelycost-efficientwhen providedin the school systems.Firmsprefer to do their own trairnin pardy becausemany skillsare firm-spedific..
-200
STRATEGIES
FO.R. k-Ai
Us N
-Wl Ed n :p quesm--lSZ
31
Mud gg
0
. 0
ou
to
.,H,
citi0ii"bf-
PC-= Pff
-5-i -r. n. ZOM ulca'don- ud et,' 00 pq*" 90 r w=ntpmbamrucauonz,-,F-,,"j,,. C uc2uoq diiii2b M-ffiki6 0,-percmrp -,-PFF 2=enta o Bft a c;-,MC:rcmamclcri,,-,, CUOn. arsozaLs= R -'zcu -m y,'one in
C
propoipomp Y, $61
j'an jopPrO 7 o non,
ZhQ?
:ax "ea .11;2pcm ):PM
gr
m 's,
1987' ;",O
Li
liEfic,ar-kniv C=O caiiNwduj

&-Co
iham P C
zm owcvcr
Lti SCIOLOO
201
Few studies have been made of training in the HPAESor ocher developing economies, in part because of the difficulty of defining tamining. One lage survey of 48,00 0 manufliLccring firms in Taiwan, China, conduded chat firm-level trining rised productvity by encouraging the efficient use of technolog (Aw and Tan 1993). The study also found chat returns from training were higher in industries with well-educaced workers in an environment of rapid technological change. Another Taiwan, China, study with a smaller survey sample and stricter definition
of training found that only 24 percent of Sins provided trining and only 7 percent of technicians receivedit. As would be expected, training was positivelyaffectedby the levelof technologyand negativelyafficted
by labor turnover and high opportunity costs of training (San 1990).
Other studies in the HPAaEs have reached similar conclusions.Enterprise and preemployment training have produced social rates of reTur of 20 percent in Maaysia. In-plant taining for welders in Korean shipbuilding had a socal rate of return of 28 percent, higber than in nonfirm. training institutions (Middlecton and others, forthcoming).
and powerfulingrediOn-the-job ntrainig was an tremely systemainc (onishni 1989). entb in the rapid growth ofjapanese companieas" In some instances,govern-mnt effortsto pomote taining have gone awry According to one study, Koreis 1974 SpecialLaw for Vocational
Training, which required firms to provide six months' training in am
proved schemes, discouraged firm-level training; firms considered the period too long and opted to pay a fine instead (Kim 1987; van Adams 1989). More narrowgovernmentefforts to forecastoccupationdemand or providetnained workersto fillanticipated jobs have also generallynot been successfil.
One exception is Singapore's use of training to promote the inforna-
ton technology sector. Singapore has achieved world leadership in servicesthrugh a concerted program thar involved information-related and engineeringsoftware educationalinsintitons (specializngin business
training), training subsidies to schools and office workers, computeriza-
don of the dvil service,and establishmentof TxadeNer, an interatonal

infornation network (Hon 1992). This successillustrates the importnce ability to foresee a major trend and coordinate compleof a govenmmenes At the same dime, businesses must stand menary privare invesctnents. rreadyto take advantage of the comprehensive support that the gvern-
ptovides.Other East Asian economieshave had imilar,if lessspec-. nment

tacular, successesin telecommunications (Mody and others 1992). zoz
STRATEGIES
FOR
RAP
Has training been more effective or widespread among the HPAEs than other developing economies? The evidence is too limited for a dear conclusion. However, ir is dear chat retunms from training are augmented by emnomic growth and consequent job creation and are therefore higher in the HPAEs. Moreover, the HPAES' extensive participation in international markets aided the success of their training pmgrams. Intremational competition encourages finls to train workers and increases the number of skill-intensive jobs, thereby ensuring that new skills do nor erode. Training, then, appears to function like many other aspects of development in East Asia. It contributes to rapid, susained growth but does not, in imselfmake such growth possible. Why East Asia's EnducationalPoicies Wirked Ln most of the ecorarnies of East Asia, public investments in educatdon were not only larger than elsewhere in absolute rerms-they were also betten They responded more appropriately to coordination filures in the market for education. Emphasis on universal, high-quality primaryeducation had importantpayoffs both for economic efficiency and for equiy. The excess demand for secondary and tertiarv education, generated by rapid ateainment of universal primary education, was met largey by a combination of expansion ofa public secondary system with mentocratic entrance requirements and a self-financed private system. This stands in stark contrast to many other low- and middle-income economies, which have stressed public subsidies to university education.
Explaining EastAsia'sHigh SavingsRates : -
A5
S IS THE CASEWITH EAST ASIA'S RAPID
HUMAN CAPITAL
formation, the region's high savings rates are in part an outcome of rapid growth and rapid demographic transitions. Government policy also encouraged (and sometmes compelled) increased savings through a variety of means. The most basic of these was the maintenance of macroeconomic stabiliry. In addition, the HPAEs have addressed savings-related coordinaion problems with numerous measures designed specifically to boost savings rates. Thcse range from policy fundamentals (such as rguatory supevision of bnks, winch 203
0j
IRACLE
addressan absence of depositinsurancemarkers), to targetedinterventions (suchas restrictions on consumercreditand forcedsavings plans). Growth and Demographics: TheEffectonSavings Manypopulareffortsto explain the EasrAsianmiracle haveinvoked culturalfactors to explainhighsavings ratesand usedthose highsavings
rates to explain high rates of investment and growth. Neither element of such explanationshas receivedmuch empiricalsupport. Indeed, studies
of the income-savings relationship in a broadcrosssectionofeconomies indicatethat whileincomeand savings growthare highlycorrelated, incomesoften haverisenbefbresavings ratesratherthan after,suggesting that growth drivessavingsrather than the other way around. Recent econometric studiessupportthe idea that rapid incomegrowthboosts savings rates as households acquireresources fister than they increase consumption(Carroll,Weil, and Summers 1993). According to this
view, East Asia'shigh savingsrates since the 1960s are partily an out-
comeof high growthratesratherthan a cause. relationship We haveattemptedour own testsof the savings-growth for the HPAEs (described in greaterdetailin aDpendix 5.1 and its correspondingtableA5.2).Incomegrowthhas beena remarkably goodpredictorof increased savings rates in Indonesia, Japan, Korea,Thailand, and Taiwan, China, but savingshas not been a good predictor of growth.Resultsare mixedfor Hong Kongand Malaysia, and causation might run eitherway.In Singapore incomechanges were not a significant fctor in the speccacular rise in savingsrates in the 1970s and the viewthat demographic fiactors and, to a lesser 1980s,consistentwith proFund, a forcedsavings of the CentralProvident extent, the policies gramn, determinedthe rise(Monetary Authorityof Singapore 1991). Rapid changes in rhe size and age composition of households may
have cont-ributed to risingsavings rates for many of the same reasons
that rapiddemographic transitions fostered human capitalformation: as birth ratesfell,the dependency ratio-that is, the ratioof non-woringto working-agepeople-decreased. Theories of savingsbased agepeople on the life cycle of increasing then decreasing income relativeto consumption predict that societieswith a high proportion of prime-age
workers willsavemorethan thosewith higherproportionsof youngor old people(Andoand Modigliani 1963;Modigliani1970).Of course, the benefitoffilling bir ratesevntually will be reversed asthe popu204
STRATEGIES
FOR
At
lation agesand the old age dependencyratio rises,an effect seen in studies of European economies and Japan (see Blumenthal 1970; Horioka 1990). For the HPAES other than Japan, there is litle evidence of the relationship between demographic changes and household savings. The Singapore study mentioned above showed that most of the increased savingsrate fiom 19 to 46 percent betwi.:n 1970 to 1989 was attributable to dedining dependency ratios (MonetaryAuthority of Singapore 1991). In Taiwan, China, where household savingsrates are generally very high, households headed by prime-ageworkers tend to save more, possibly reflectingin part preparation for old age. (Bursavingsin older households are also remarkablyhigh and stable, contrary to the view of the life cyde savingshypothesis [Deaton and Paxon 1992].) Demo,raphic factors may also interact with corpwt"c behaviorto increasesavings. In Japan the tradition of employees working beyond retirement age at reduced wages appears to contribute significantlyto higher savings rates (Horioka 1990). Policy Fundamentals andHigh Saings Rates In addition to benefitingfrom higher growth and demographicshifts conducive to savings, East Asian governments selected, ofien through tial and error, a broad spectum of policies rhat encouraged savings. Two fundamentalsthat facilitated high levelsof savingswere the management of macroeconomic policy and the making of budgetary choices. The Role ofReal Interest Rates.Foremost amongmacroeconomic fmndamentals was the effort to control inflation discussedin chapter 3. Because high inflation rates also tend to be volatile, real interest rates are often negativeand unpredictable, discouragng domestic financial savings. Moreover,since unanticipared high inflation erxdes the ral value offinancial assets,volatilityof inflation ,increases the riskassociatedwitth holding,them. Conversely,low to moderate inflation, partculady astable rates, encourages financial savings.Thus the HPAEs' generally superior record at avoiding long-term fiscaldeficitsand restaiing inflation gavepeople the-confidenceto save (Neal 1990). Table 5.5 documents average real interest rats in the uAEscompared with other low- and middle-incomeeconomies.Real interest rares on depositsin the HPAEs were either positiveor nildly negative.In con2.05
MC LE
Table 5.5 Average Real Intkeres Rates onDeposits, Selected Economies

*. .
r~~~~~~~~~~~~~~nwiu&wrd
MJPA& AIcegtsx
'
~~~~~~1973-2.
1973-90 1
', .
-tJ
* Tan.Iiq,~~~~~d * MmhI& Taiwan C. ThIml
AS3
19,7-91 94-3
1177-got
~~~~~~~2.43
.8 4.4197
177
.2.47
i
7*
'-
-.
Naqj.dab NcpI
~~~~1976-92
.
117449
~-3.6
04
.'3
55
M-ils
1791443$3'.4
1935-91
~~~~~J314 ~~~~
94.9
Un4m7
3976-9'
~~~~~~~~~~LA9 Ism,
EWF
-.
-.
~~~~~~1976-9
-63m-
Taft, 1
At.tqc
. ,
~~~1976-1-5
-~~~~~~~~~~~521
83 334~~19
Am.-
'.
144
I . -: :I!-: ;w
-243
-. 21033j 9
'*aIa~~~~~~~~17
uas
mAi
12793-q
Zsra ore
1Sgonsshw -5an ecnmc*it1agIeadertso ae er 1. 13.1 intercst

109
average
prciinTASseS
an
G2aeret 2o6~~~~~~~~~~-l
nZaba.Ra
ra4e
weeas'
3
evlOS
3
as
STRATEGIES
FOR
'AlI'
measuredby the standard deviation) in other low- and middle-income . economies than in the HPAEs. While the standard deviation was 3.5 in the HPAEs, dose to the OECD economies at 2.8, on averageit was 40 in Latin America, 14 in Sub-SaharanAfrica, and 6 in South Asia. Malaysia and Singaporehave maintained the most consistendypositiveand stable real interest rates on deposits, paralleling interest race trends in the --.. United States.Japan maintained negative,but highly stable, real interest raceson depositsuntil 1983 and has had verylow btutstablepositivereal miterest rates since that time. Korea, especiallyIndonesia, and Taiwan, China, have had much greater volatility of real interest rates than the :otherHPi-Esbut stl substantially less than in many other low- and -middle-incomeeconomies. Several studies have documented the positive association between real interest rates and the growth of savingsdeposits and broad money aggregates(Fry 1988; Lanyi and Saracoglu 1983; Gelb 1989). This is especialy evident for changesfrom highly negativeto positive real rates of interest. For example, when Taiwan, China, raised real interest rates on bank deposits from a negative300 percent in 1949 to about 8.5 percent in 1953, the ratio of time and savingsdepositsto money stock rose from 2 to 34 percent in three years (Chiu 1992). Indonesia and Korea -achieved similarly dramatic increasesin financial savings after stabilizing inflation and shifting from negatve to positive real interest rates. More recendy, Argentina, Chile, Mexico, and Pakistan have done the
same.
TheRole ofPubicSavings One direct way that any government can addressthe concen that aggregatesavingsare too low is to generate public sector savings through a combination of tax and expenditure policies. Although in theory forward-lookingprivate saversshould increaseconsumption (and reduce savings)to match any increase in public savings (becausetheir future obligationsare reduced),in practice householdsare facedwith liquidity constraints and are not able to act on expectaions. Thus total savingsmay risewith an increasein public savings(Summers 1985). Empirical evidenceshows that governmentsavingsdoes not fuly crowd out private savings. Furdtermore, the method of raising public savings matter.s:on average,increasing public savings via reduced expenditures is more effectivethan raising taxation. For a sample of thirteen developing economies, a transitory increase of a dollar in public
savings, miadethrough a cut in expenditures,reducesprivate savingsby

only 1-50 cenrs. If the dollar increase in public saving is achieved -207
UI4MXLCLE
through a current period tax increas, private savingsdedlinesby 48-65 cents (Corbo and Schmidt-Hebbcl 1991). Most HPAEs have maintained high public savings compared with througi. -ombination of tax other low-and middle-incomececonomies policy and expenditure restraint. The extent to waich HPAE governments have restrainedcurrent expendituresrelativeto other developing and industrial economies is shown in figure 5.2. which gives average between 1970 and 1988 for public consumption as a percentageof GDP a sample of 111 economies. Indonesia, Japan, Korea, Singapore, and Thailand are in the bottom third of the distribution of all economiesin terms of the share of public consumption, with public consumption shares below 15 percent of GDP. Malaysiaand Taiwan, China, are ecxceptions, faling in the middle of the distribution. In Malaysiathe high levelsof public consumption reflectedthe explicit redistribucionalobjectivesof the New Economic Policy As a group, the avcrage share of public consumption in the HPAEsis below both the OECD economies and all other regional groupingsof low- and middle-incomeeconomies. In contrast to the situation in most developing economies, in the HPAEs,rates of public and private savingshave been high and growing. For example,Singapore'spublic savingsrosefrom 5.5 percent of GDP in 197480 to 18.5 percent in 1981-90, and private savings rose from 22.6 to 24 percent. Malaysia'spublic savingsincreasedfrom an average 3.2 percent of GDP in 1961-80 to 10.3 percent in 1981-90, while its private savingsincreasedslightly.Th2iland'spublic savingswas high in the 1980s (87-15percentof GDP), but declined as a proportion of GDP in the mid-1980s, when the privaresavingsrate rose dramatically (see table 5.6). While in some other economies (for example,Pakistan, Zimbabwe, and Venezuela)public savingswas relativelyhigh and accounted for a major part of national savings, generally public savings in low- and middle-income economies was substantially lower than in the HPAEs and had decdined.For example, public savingsin the Philippines dedined from an averageof 10.4 percent of GDP in 1980-83 to 1.4 percent in 1984-87, leadingto much lower national savings rates. Both public and private savingsdcdined in the mid-l 980s in Argentina and Chile. Brazilspublic savingsdropped from 8.3 percent of GDP in 1980 Some Sub-Saharan African to 3.2 percent for the period 1983-85.11 economies (for example, Ghana) had negative public savings m the
1980s, offseting increases in private savings.
208
STRATEGIES
FOR RAI3D
Figure5.2 Averag PublicConsumption asa Percentage of GDP
-~~~~~~~~~~~~~~~~~~~-
I
Taiwan, Ch Ina
Singapore
Rep.of Korea
EHPAEs
Oethe eownomies
o,10
.Soe
20
30
40
Average public contsumptlon (percentage of GDP)

_, orldB2nk6 --
209
!&4iIRfACLE
Table 5.6 Public andPrivate Savings of HPAEs

andOther Selected Developing Economies
(pereL'ntage of CGP)
u-blesaings
;
i4o6
J-apa, ,*
')0 955-70 z |
-19714=0
0 ;
'
0 17.2t^6.2
4.6
f.;::
'2011
0f:
i . R:|?8 ~~191480 6
-198190.
3 .2;X 12 103
187'; 15
191i
*. .
Singapore .
1981-90'b 4;---o 1980-B5
*
..
1-ft .-14.3
8.6.
3. . -- >;i24.0 ;:'
I83
-j198
14
Oird deSpigeconemi
-. -Argendna~S.Kw'lii -- ;--.1980-85* .....
. ,t''-'.'' s_ -' _
. 5
I4.2
-19804871,
1980-8. :: 985647 : j-
235
1980-84 3.9 7. 7.
7.9
06
2~~~~~~1.6 1364
06
*'~~~~ 1980-84~~
-~~~
1985~~~~-187 Csti Rica198-8
*19858
P'ia9i5-8704
161
61",
,.,
'Philippines~~~~~~~~~~~~~~~~~~J i.o,9.O I9 .4-. ,.

.s '.--'-,0.;;'--. 1690
1.
97'.=-'
.2IO: ~~
'1503
STPTRATEGIESFORJLAiPPD&
Coorditon Problems thatHinder Savings Savrings are afficted by severaltypes. of coordinationproblemsinducedbyfeatures of financial markets. Below, webriefly describe eachof thesecoordination problems and the policyresponses of HPAEgovern* --ments+The rangeofthe HPAES' policrresponses to theses-rual or incipmarker fhiluresrange fiom standard remediesthat the HPAEs may ... haveimplemented better, such as the prudential regulationof banks, to
-ient
more acavLst interventions, such as-limitng competition or regulating tinerest rare spreads. Abse--.,nf Deposit-Insurance People will only deposit funds with a
bank or other financialinstitution if they are reasonablyconfidenrthat '.the insirution will retrn the. funds as promised. In theory, private -firs.or eVenthe banks themselvescould.sell insuranceto depositors, in practice,theydo nor (Thesepoints are discussedat greater length in . 'Stigiz -1993a) T.he reasons are straightforward. Assuming a pae firm-didLofferdeposit insurance, depositors have no more reason to tru:st.an insurer than they do the bank: either or both could faiL Indeed,-afirm that insured severalbanks would risk nearly simultaneous lossesduring a general economic downturn or-a bank run. The risk of such lossesm-akesaprivare insurers promise to deliver.even-more suspec than.the banks. Thus, withour government effors to guarantee that banks will be. able to honor their liabilities,potential depositors .would rend-tosaveless and keep a higherproportion of theirsavings in nonfinancial assets.. Governmentshave. a second-motivationfor insuring deposits.Fman.ial.hlures. of banks have a strong negative-excernality;when some bank fail, depositors lose confidence even in. sound. financial institudons, as the history of bank runs attests-Govemrnments therefore ty to preventrovertbank 6ailures-, fiequendy acting explicitlyor implicidy as the-insurer oflascresorr through the central bank. :High rnsacti.CostsPrivate banks seek large-deposits and those tharare relatvely inexpensive to sevice theg therefore compete for the de-
pits of -corporations andtaffluenturban -dwellers and.make lite or-no efforrro attact ithe savings-ofworkers, poor people,_ andLresidents-of snulLi owna andshe: countyside In.addition,-banks may-rcfiisesuch ;marg inall po eposits by settng minimumin deposit lewlsThe:pracceaise.the transactons costs forsmall saversancdiscour-age themfruomn aking,financial saving. | , t. 0 ;g , . . . . .~ ~ ~ ~ ~ ~ ~~111
I`-
LE
andInsufficient Savings.Some economists have also suggested Isolaton that individualsacting on their own and their flimilysbehalf may save lessthan would be desirablefrom the point of view of societyas a whole. This is becausethey fail to consider the impact of their savingsdecisions on others. If savings decisions could be coordinated, each individual would savemore and aggregatesavingswould rise (Dasgupra,Marglin, and Sen 1972). In such circumstancessocial returns on savingsexceed private retums, and there may be a role for government efliortsto increasesavings.
Policies that Promoted Savings

Governmentresponsesto these coordinationproblems arevaried.All governmentstake stepsto alleviatethe lackof deposit insurance markets and to promore stble financial institutions. These generally indude prudential regulation of savingsinstitutions and protection of depositors from bank defaults. In general, the developing HPAEs have performed these fundamentals better than many other developing to economies.East Asian governmentshave artached great inmportance maintaining saver' confidence in financial institutions. Often their policieshave gone beyond prudential rgulations to include protectng banks fiom competition to increasethe financialstrength of banking in1 2 Sometimes this has been done at the expenseof long-nm stitutions. efficiency. When necessary, all EPAR govenments have bailed out troubled financial institutions through financial and managenent assistanceor mergers with stronger banks (seetableA5.5, at the end of the chapter). This isnot to saythat the iEns have not experiencedbanking crises. Indeed, some financial instability is probably unavoidable in economies that are expanding as rapidly as those in East Asia Nonetheless, the crisesthat have occurred,for exanpie,in the wake of the 1980s' real estate speculation boom in Hong Kongi Japan, Korea, Malaysia, and Thailand, havegenerallybeen brief and modest, particularlyin comparison with the protracted and disruptivebanking crisesin Bolivia,Chile, Ghana, the Philippines,and Turkey during the same period. of Central banks and departments toProaneBank Solvency. Regu;llions appearto have been generallymoresuccessfulin su'financein the HPAEs pervising commercal banks, which have reported a rdatively low proportion of nonperforming loans in thcir portfolios. There are some
2.17
STRATEGIES
FOR RAPI
major exceptions:Indonesia in the late 1980s,Koreain the early 1980s, however,nonand MalaysiasBank Bumiputera in the 1970s. Generally, than in many performingloans have been lessof a problem in the HPAEs developingeconomics.For example, one study of twelveLatin American economiesfound that nonperformingloans accountedfor nearly 14 percent of total loans in 1987, while the proportion of bad loans surpassed 20 percent in Argentina, Honduras, Uruguay, and Venezuela (Morris.ndothers 1990). In Pakistan,requiredprovisionsfor bad debts constituted 14 percent of tota pordolios in 1989 (an internal World Bank report). In Sub-Saharan Africa, many banks have failed, and 25-40 percent of bank portfolios have had to be written off. While macroeconomicinstabilityand low growthare partly responsiblefor this poor performance,inadequateprudentialregulationalsocontributed. The more effectiveprudential regulationof East Asian banks is apparent in the easewith which most of them adopted the international capital adequacyrequirementsset by the Bank for International Settlements (Bis) to ensurethat banks do not takeon inappropriatelevelsof risks.Hong Kong,Japan, and Singaporebegan to stengthen prudential reguation in the 1970s, and Malaysia,Thailand, and Taiwan, China, oi-llowed suit in the 198Os. All IPAEs have since adopred the BIScapital adequacyreo'4 rements. Indonesia,the last to do so,has had some difficulty achieving BIS capital requirement levels because it introduced 13 proper prudential regulationsrather late. standar4 By conast, in Lain Americaonly Ecuador adheredto BEIS iwile Colombiawas in the processof adoptng the standards(Morrisand others 1990). Moreover, some Latin American economies have not established minimum capitalrequirements for new banks. In Sub-Saharan Africa,thenet worthpositions ofbanldngstyerms siarplydeteriorated in the
1980s,and adopting BIS standards wold entail subsantial rcapialization.
Most East Asianeconomiescontinue to rclyon dose contact between supervisorsand banks to encourageprudence. This routine, often daily interactonenablesregulators personally to assess the riskinessof a bankA portfblio.This pragmaticapproachis evident in their attitude toward collateral requir~ments& To reduce the risk of borrowerdefaults,regulators -encuragedbanks to requiresubstantialcollateral. But becausethe collatera. was usually real estate, banks became increasinglyexposed in the 4 Face with potenial insolven-1980s to the risk of assetprice declines. -ies due to heavy real estate lending, regulatorsin Hong Kong, Japan, Thailand, and Taiwan,China, have limitedthe use of real estate as collat2.13
LE
eral and sought to reduce loan concentration by limiting lending to related parties.Enforcemnenr has been difficult,however, becausecompanies are doselyheldland dlisdosure rulesare geCnerally weak.Moreoverinm severl economies,notablyIndonesia,Japan, and Thaiad, banks and firms rend to have inrerlikng ownership. Many East Asian financial systems appear to be moving to ara mixed system of enfbrce-menr, in which the highly structured exposure rules that characterizeinternational supervision are backed by traditional moral suasion in which bank regulators use their control of branch licensing,rediscounts,and other regulationsas leverage to ensure cooperation.The Bank of Japan, for example, has used constant interaction between city bankcs and the supervisory authorities, coupledwith its tight control of branch licensingi to encourage prudent behavior. Malaysia's bank supervisorsoperate in a similar flhshion. Coping witfDistessed Financial Iustitutioas. In spite of generaly good pmudentialregulation, there have been financial crises in Eas Asia brought about by a mix of macroeconomicshocks,insufficientprudential regulation,and seculative lending (seetable A5.5, at the endtof thechapter). However,goverrnmentsrapid and effTctivc responsehas been able to maintain confidenceby acting as implicit insurerwithout excessivefiscalcosts. Rapid growth and spiraling real estate priceshave often tempted financial instittions into property and sometimesstock speculation. This has happened repeatedly in Hong Kong (in 1965, 1982, and 1986), but it has also been a problem in Malaysia,Thailandt,and, most recently, Japan. By the late 1980s, financial institutions in each of these economies were facing diffliclties, as nonperformning loans rose due -to the economaic downturn. Korea encounteredsimilardifficultiesbut for somewhatdifkirenrreasons, among them the heavyindebtednessof firmns that had been beneficiariesof government-directedcredit. 'When exenldemand fell in the 1980s, many firms had large excesscapacityand poor -debtservice capability.Among them were gvrmecnt priority projects in shipping; overseasconstruction, texties, and machinery.Becausethe firms were highly leverged, they werefinanciallyvulnerableto changesin demandt and interest rates. 'When fnnildistres has occurred, HPAEgovernmentshave come to the rescue_ Table A5.5 describesthe originsof and responsesto some of the significantbanking crisesin the HPAEs. Whil only KoreaandtTabWn, China, have estOablished explit deposit isurance (both in the
2-4
STRATEGIES
FOR RiAPVT
early1980s),they and other HPAEs have for decadesimplicitlyinsured to preventbank failures. deposits by steppingin whenever necessary In some cases, especially in Japan,strongerbankswerepressed to take overbanks in financialtrouble.When mergershave been impractical, EastAsiangovernments haveservedas lenderof last resort.OnlyHong Kongand Thailandhave liquidated insolventfinancialinstitutions.Yet iecauseof rougherprudentialsupervision and better econornic growth, the costsof bank rescuesin East Asiahave been lower than in many othereconomies. During the 1980sthe estimatedfiscalcost of bailouts in the HPAEs was 0.5-1 percentof GDP,comparedwith 2.3 percent in the United States,2.5 percentin Turkey, 3 percent in the Philippines, and 26 percentin Chile.
Puntein ofBanksfrom Compedfioo. Nearlyallgovernments regulatethe
acation of new financialinstitutionsand the entryof foreignfinancial are solventand willremain institutionsto try to ensurethar newcomers havegonefiirrher,limiting comso. But manyEast Asiangovernments petition and protecting existingbanks both fiom foreign banks and from new domesticcompetitors. With the notableexceptions of Hong the openingofnew fiKong,Indonesia, and Singaporewhichwelcome nancialinsritutionsprovidedthey meet capializationand other regulatory requirements,most HPAEs have had rigid restricions on entry. When expansion has been pennitted,it has mostlybeen through the licensingof new branchesof exsting banks.Despitelimitson enny, rhe bankingsectorsin the HPAEs areno moreconcentrated than in otier developingeconomies or OECD economies(seetableA5.6, at the end of differlitde in structure the chapter).This means that bankingsysrems among economies, although the onrgins of their relatively high internationaldegreeof concentration maydiffer,as we shalldiscussbelow. Why were entry restrictionsusedrather than high net worth stanEntry restrictionsgivegoverndards to encourageprudent behavior? the behaviorof banksthan mentsa morediscretio,-. y tool to influence net worth requiremnentr ' tovernmentsmayexercise discretionin deciding whichbanksshouldexand (throughmore branches)and when. Bankshave an incentive to respondto govenments' actions lest they forgothe additionalprofitsfrom asset growth.Net worth requirements do not providegoveriments this avenue of influence. Have these restrictions on compentioncontributedto increased financial savings? The answeris ambiguous.Larger, more profitable bankshavemoreto loseand so a greater incentive to maintaintheirrep.. . . . . .~~~~~~~~~~~~~~~~~~1
utations by prudent lendling. Moreover, restricting competition mncreasesprofits, and higher profits increasethe financialstrengthiof the banking system (provided banks do not distribute profits to shareholders).These effcts would raisesaverconfidenceand hence increase savings. Yet,in most economnies regulatorshave arguedthat the financial sectoes tendency toward concentration is so great that govermnments must interveneto maintain competitionwithin the banldngsector,preventing monopolistic practices that squeezedlients, reduce efficiency and innovation,and hence, lowersavings.' or Therefore,whethe-rcontrolling competition results in &avorablc unfaivorable outcomesfor savingsdepe-nds on whetherthe increasedsolThe evidenceamong develvency comes at the expenseof efficiency. oped economiessupports the view that financial systems with fewer, larger banks outperform systems with many smaler banks (Vitrs econoes financialmarketsare domi1991). But in many developening natal by a few large,veq inefficientbanks whose size is bad less on limits economiesof scalethn on restrictionsof bank licensesand othecr on comp'etinon. The impact of limited competiton on banking efficiengcvres acrosseconomiesin East Asia.Japanes commercalbanks, for example, of the presare regardedas efficient,despite enty restictions, sure of competition among existing banks (Sakaklbaraand others 1982). Thee is no dominant commercialbank in JapanyThe top five ban are roughly equal mn size,and they accunt for about 40 percent of total commercialbank assets(seetable A5.6). In comparisonto large German banks, Japanese banks tend to have lower lending margins (spreads),although smal German banks have lower spreadsthan small Japanese banks. The Japanese banks also have lower lending margins tha equivalentbankcsin the United States but approximatelyequal rates of return on cquity (Ueda 1992). Gross nterest miarginsas wellas net operating costs (as a percentageOf total aSSetS)ofbanks in KoreaI, Malaysia, and Thailand werein line with oECDeconomiesand substantialy lower than othecrdevelopig economics notably Liberiof Sri Lanka, and Turkeys and selectedeconomies in Latin America (Hanson Be p rtn cot(as of prcetg tt t)of - = ner ~~~~~~~~~~~~~~~~~spo studiesof the bankingsystemin Indoneand Rocha 1986). Conversely, pracbtces (nsia and Koreafind that protecion has led to lessianovautve ternal World Bank reports). Thus the evidencedoes not condusivelysuprt the efficacy opl acesto imitentry.CWhere ted,encies toward large nancial institutions z16.
STRATEGIES
FOR
are strong, govrnment
cfforcs to limit entry will mainly reduce efficiency especially true of Mstrctions in some
and lowerinnovation. This is
economies on foreignbanks,which tend to be the leadersin innovation. Regilalg Spreads. Exceptfor Hong Kong and Singapore, ali HPAEs haveat timessimultaneously regulateddepositand lendingratesand consequendy the spreadsof financialinstitutions.If spreadsare controlled, bankswillearn limitedrentsdespice protectionfromcompetiion. In genaal, lendingspreadsof the HPABs have been comparableto many OECD economies and lowerthan most other devdopingeconomies, indicaung that controlson intermediation magins were generally effcidve.Figure 5.3showsthat avage terestspread of dte iHPAEs (about 3 percent) is lower than aveg spreads in other developing regions, whichrangefrom 4.0 to neary 10 percet. Maren in Indonesia,Thailand, and Taiwan, China,wereabout3-4 pcent in the 1980s.Thesemargi ar comparable to those in the United States (2 percent) and Japan (3 prcenr). In Koreaand Malaysia they weregenerally igher at about 4.5 percent (see tableA5.7,at the end ofthe chapter).Thus, whilerestricingcompetition grenerated some rentsfor banks,a combinationofcompettion among incumbents,regulationof spreads,and evenntalliberalization of entry reFwue 5.3 Spreads in Financiallnternediatioi, 1979-89
P-cntge pentspread
I r
14~~~~~~~~~~~~~
' ---
-,
fl---l
---
-/-
. \. - 0,
. '
, ,-m'-.
~~
~~~~~~~~~~i
I
1-
.-
0~~
;(t,~ . K
~
2-
1 1-'
1979
1930
1981
1982
1983
1984
1985
1986
1987
2988
1989
a. Indudes countnres in Sub-Saharan Africa and Nonh AfricL S:ournranamdonal MoncrccyFund dan.
2;7
..- A GL EL
widtthose stricdions madebanksin East Asiarlaivelyefficient compared in otherlow-and middle-income economies. banks spreads are not always binding,however, because Regulated balthem by charging feesor requiringcompensating can circumvent chargedcompensating ances.Banksin Japan and Korea,for example, weresufficient to balances. Thereis someevidence that thesepractices inin Japan (Ueda 1992).Intermediation circumvent the regulations hasbeenhigherthanthesimpledifcomeofcommercial banksin Korea ference betweenlendingand depositrates.In contrast,regulations on dcpositand lendingraceshavebeen bindingin the state-owned com-China. In Thailand,commermercial banksof Indonesia and Taiwan, cial bank lendingratestended to bunch aroundthe ceilingrate, and dueto a drop slighdy afterthe mid-1980s interestratespreads increased in deposit ratesand the relatively unchanged lending rateceilings (aninternalWorldBankreport). prudential suSaiugs lnsoboansIn additionto effective Creatng Postal pervision and regulation of entryand spreads, all of whichencouraged savings by ensuringstablebanks,Japan, Korea,Malaysia, Singapore, and Taiwan,China,established government-run postalsavings systems
to attract small savers.Postalsavings systemsoffrecdsmallsaversgreater security and lower action costs than the private sector and were
therefore particularly effectivc in attracting to the formalfinancial sector the savings of low-income and mralhouseholds Japanestablished the region's firstpostal savin progamin 1875, with the explicit goalof fostering savings of rual dwelersand people withlow were in thecities and towns. Undlthen,suchpeople to moderate incomes ssten, whichlacked ruralnetworks effectively exduded fromthe financial highminimum balances or smalldepositors byrequiring anddiscouraged paying verylowinterest races on small deposits. TheJapanese government andmade savingamong low-income households heavily promoted postal the interest income on small postal savin deposits taxfree. Similar institutions with thesamesavings mobilization goals wereestablishedin Korea,Malaysia, Singapore,and Taiwan,China. Like Japan,both Koreaand Taiwan,China,havegrantedtx- exemptstatus to the interestincomefrompostalsavings during longperiods.In Taiwan,China,postalsavings offices accountfor aboura thirdof allfinancialinstitutionoffices,and the postalsavingsservice haslongerbusiness In Malaysia institutions (Shea, fbrchconiing). hoursthanotherfinancial for a large prohavealsoaccounted wherepostalsavings andSingapore,
,.. :.... .:
STRATEGIES
FOR. RAPD
portion of domestic deposits,the governments separated management of the savingssystemfrom the post officein the early 1970s,when the proportionof postal savingsin total savingsdedined, cvidendybecause postal employees were not enthusiasticpromotersof savings.Even so, the savingssystem continued to utilize the post officesas a deposittaking branch network. Postalsavingssystemscan be an effective way of mobilizinghousehold savings,provided that governmentstake care thar the cost of administerng the systemsdoes nor outstrip the benefits.Geneally postal savings systemspiggyback on the mail-delivery infrastrucumre, thus minining overhead and fixedcosts. In the earlyyears in Japan, the system often operated out of the houses of wealthylandownersthat were alreadyservingas postalbranches.As postalsavingsexpandedand the administrative burden rose, posta officals demanded wage increases. Overall,however, the postal systemscost of acceptingdepositshas been much lessthan that of the privatebanks (Mukai 1981). ForedSavins Besidesthe above measures, some HPAEs have tried to compelsavingsthroughseveralmeasures, includingmandatory pension schemesand restictons on consumptionand borrowingfor consumption. Becausethese measures consttute more active interventions in markers,their efficacy, even in East Asia,is open to question. Restrictons on consumer choices, induding the basic consumption-savings decision, have welfare costs. Moreover, similar efforts in other economies have been spectacularfailures.Examplesindude the Widespreaddeprivationand massivewaste associated with forced savingsin the now-defunctcommand economies. Three economiesin East Asia,Japan, Malaysia and Singapore,have well-developed, mandatorypensionplans The impact of these plans on aggregatesavings depends on the degreeto whichthey subsdtuteforvoluntary savings.Evidenceof the impact of pension funds in Japan and Singapore, the only two economieswherethe issuehas been studied, is incondusive.One studyof savingsin Japan found pensionfundshad no significant impacton tocalsavings,althoughthey did channelhousehold savingsinto financialasset therebycontributingto financialdeepening (Delde 1988). Anoher found a small negativeeffc (Nogui 1985). This SU that the Japanesepension fund squeezedout a portion of volunary savings Conversely, there is evidencethat SingaporesCenal Provident Fund boostedaggregate savings by about4 percentof GDPduring-the 1970s and 1980s(MonetaryAuthority of Singapore 1991).
.219
jILA~~~CLE
durables, constmer aedit to purase housing, Thelackofconsumer savings household increased items mayhaveinduced andotherconsumer
in Japan,Korea,and TaiBankregulators in somcEastAsianeconomies. purchases. for consumerdurables wan, China, rsriaetd credit available
in Japan that the rapidincrasein savings evidence offers Maki(1993) dumables, consumer by theneedto acquire WarII wasdriven afterWorld China. As in Korea and Taiwan, thesamepatternexisted and he shows savinacased, dumbles for consumcr andthedemand incomes household for demand Oncetheexcess roscrapidly. of income ingsas a proportion andevendeclined. smbilized savings rates wasmem dumbles consumer
Savings? PordesIncreased Have

savings? ar increasing aimed in theHPAEs werepolicies Howeffective account for fundamentals and goodpolicy growth conditions Favorable Maoeconomicstasavings performance. superior mostof East Asias
institutions of financial bilitycombinedwithsolidprudenrialregulation weresecureand retainedtheir in which savings createdan environment value.Limitsto competitionamong banks and the willinpess of govhad costs-reduced enments to rescuefinancialinstitutionsin trouble
were in thelatter-but these costs case andfiscal in theformer efficiency in savings for bytheincrease beencompensated andmayhave moderate hadthe virtue Postal savings in banks. confidence bypublic engendered Govfor smallsavers. instruments and accessible of beingbothsecure and China,aswel asMalaysia and Taiwan, in Japan,Korea, ernments tappinga nontradiefficiently, theseinstimtions operated Singapore, tive coss lowadminisa at rdatively savings of financial tionalsource morethantheywould consumersto save Have measurethatrequired is ambiguous. wvelfare? Theanswer economic voluntarily increased have inJapan rates tempoarily savings credit raised on consumer Restictions through penbut at a cost in termsof consumerwdfar Forcedsavings savingratesin in increasing havenot beena majorficaor sionschemes arean imporbutpublicsavings perhaps in Singapore, Eassia, except Tojusr insavings. of highaggregare source tantand complementary savings deasions,social returnson the incread trening in households'
must exceed the privatcoppomruitycos detenined by the rate savings
iftotal ficforexample, be thecase, Thiswould on investment. ofreturn of component and a significant growthwerepositive tor productivity orof scale economies ofdynamic either asa onsquence growth, overall
220
STRATEGIES
FOR RAPD X
i.*
cxtnalities associatedwith investment.The social return also must acceedthe private returnto jusfyr interveningin households'savingsdecisions. In Japan (during its rapid growth period), Korea, and Taiwan, China, there is cvidencethat economywide productivitygrowthhas been positiveand rates of return to capitalhave been good. In Singapore,however,evidencesuggeststhat aggregae total fctor productivitygrowth is negativeand rates of return to capitalare low (Young1992). Singapore may havecompelledits consumersto savetoo much.
Rates Asia's High Investment Explaining East
their unusuallyhigh rates of privateinvestment.Privateinvestaveragedabout 7 percentagepoints of GDP ment in the IIPAEs higher than other low- and middle-incomeeconomies (seechapter 1). As with East Asia'shigh rates of human capital formation and savings, invsment has been fosteredby macroeconomicstabilityand rapid economic growth. Growth,savings,and investmentinteracted in a viruous cirde as high investment initiallyspured growth, which resultedin increasedsavingsto support continued high rates of invesnnent. In additon, two general conditions have been particularly important to nvesntmen. Thes-secu property rights and complementarypublic invesrnenr in infrastructure-are key elements of the market-friendly institutional environmentdiscussedin chapter 4. Securityof property rights is so obviousthat it might easilybe overlooked. Where foreign or domestic private investors fear completeor
partial expropriation of their investments, private investment initative
JNE OF THE MOST REMARKABLE ASPECTS OF THE HPAEs IS
is naturally reduced. Thus secureproperty rights embodied in the legal framework were a key to high investment rates. In addition, formaland informal mechanisms leading to enforcement of contracts were an important contributing factor.
Data also suggest that the developing HPAE governments have done a
better job providinginfrructure
themselves and, at times, creatingthe
conditions for the private sector tO provide it. Limited econometric evi-
dence suggeststhat these investnents, at least in the casesof Korea'and Tiwan, China, generate very high rates of return (an intemal World :Bankreport). Easterlyand Rebelo (1993) present cross-econonlyesti. .~~~~~~~~~~~~~~~~~~~~~~~~~~~~~22
CLE
for economic has a high payoff matesthat infrastucture investment complenenaryto private havc bccnhighly growth. Theseinvestments manu&cauring activities. in export-oriented investment, especially for development of infrastructural someindication 5.7shows Table
and selectedlow- and middle-incomeeconomies. the developingHPAES Evenifwe set aside urbanizedHong Kong and Singapore,the HPAEs'per capita electricity generating capacity is equal to or exceeds that of from 1975 to economiesat similarlevelsof per capit incomc. Similarly, 1985 the five developing HPAEswith nontrivial mral sectors increased telephone servicemuch faster than other economies with roughly the same population per phone in 1975. For example,in Malaysiathe numwhile Brazil,Mauriber of telephones per person roughly quadmrpled,
Years of infrastructure,Selected Table5.7 Direct Provision
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STRATEGIES
FORRK R.A%W
tius, and Peru had smallergains. Al though increasesin infiastructure are clearlycorrelated with income growth, recenteconometric evidence suggestscausality may run from infrastructure spending to growth (Easterlyand Rebelo1993; Canning and Nry 1993). CoordinationPmrblems that Hinder Inrestment Beyondestablishingivorablegeneralconditionsfor investment,most HPAE governmentshave employeda varietyof policiesdesignedspecificaly to address coordination problems that may hinder investment. These problemsare derivedfiom shortcomingsin markets for information and in marketsfor sharing risk both types of problems exist in all economies,but the problemsand the consequencestend to be worse in informadeveloping economies.For example,such developing-economy don problems as poor accounting standaris and a dearth of merchant banks and other institutions to monitor corporate performancemean that bond and equity marketsare often weak or entirelyabsen.' 7 Similarly, while market mechanisms for sharing risk are limited in all in developingand industial economiesoften cannot economies-firms buy insurancefor the most seriousrisks they face-the consequencesare more severein developingeconomiesin whichlower wealthlevelsmake households and firms more vulnerable.Furthermore, the transformadons inherent in development,such asthe creationofnew firms and new heighten uncertainty. industriesand the absorptionof new technologies, HPAEresponses to theseproblemscan be Polciesto PmouteInmeshment as theseeconomieshave magrouped into three broad categoriesFLrst, theiratrteion to the creation tured,policynmakers havegraduallyincreased and improvenentof bond and equitymarkets.Hownrer,whilethesemarimportant roe they werenot generay a ketsare playingan increasingly economicmkeoffi. key factorin mobizing investmentduring the HPAEs Second, many Hwss created developmentbanks to ease constraintsin long-terncapitalmarkets,as wel as specializdinstitutionsto providefinancig to agriculmre and small-and medium-size enterprises. These cforts-appear, on balance,mt havebeen moresucccssfi4 in the HPAEs than in otherdeveloping economies, for reasons we shal exploreFmally, HPAE governments have encourged investmentwitha wide arrayof other mechanismsdesignedto inacase the atrcdveness of privateinvestment.. The remainder of this chapter describesspecificpolicies in each of
these thiee categories-supporc for bond and equity markers, establish223
ment of decvelopment banks,and mechanismsto increasetheattraativeness of privateinvestment-and attempts to evaluatewhethereachwas effective in increasinginvestment.Wedevoteparticularattention to the third category, whiichincludesseveral policiesthat involve a high degree of interventionin markets.At the simplestlevel,many HPALE boosted corporations'retainedearningsby adopting low corporatetaxes.So'me alsoreducedthe cost of investmentby adjustingtax,tariff,and exchanige rate policiesto hold downthe relative priceof capitalgoods.Several govermecnts, particularly japan, Korea,and Taiwan,China, triedto reduce risk for investorsby shoulderingsome of it themselves or spreading it acrossother firms.The northern-tierFIPAE-s also stanldout for their effortsto increase domesticinvestmentby restrictingcapitalflows,Finally, several HPAEs, againparticularly the northiern tier but alsoMalaysia, subsidizedinvestmentfinancingbyslightlysuppressing the interestrateson savingsdepo'sits and corporateborrowing.This last mechanism,which we term mild financialrepression, playsa k-eyrolein capitalallocaidon, the subjectof the next chapter. Bend amd EqLit Markets, Developed after theTakeoff. Despitethe phenomenalgrowthofAsianco:poatons, bond and equitymarketshaveplayed a relativelysmall role in Asian finance. As table 5.8 shows,bonds on average between1970and 1990accounted for lessthan 10 percentof the net financing of corporations for the fiveHPAEs forwhichdataexist This is higherthan the shareof bond finanding-in the oECD economies, however Ironically, pofides that contributed tco some of the HPAEs successin developingother financialmarket institutionsmay have been inimical to the earlydevelopmentof a corporatebond market.In Japan, for example,the long-ternm creditbanks govermnment-protected monopolyon the issueof long-ternm debenturesdiscouraged the development of bondi 8 markets.' TeTa governmentcreatedthe samemonopolyfor its private long-termcredit banks.In addition,tb"~ lackof governmentsecurities in most HPAEs, a direct outgrowth of their successat minimizing fiscaldeficits,has deprivedembryonicbond marketsof the most widely utilize-d risk-freebenchmarkrate. This has impededcorporatebondtismsues,sincemarketsfind it difficultto determinesimultaneously the riskfree, rate and the risk premiumassociated wiiAa specific corporatebond. In response,Hong Konghas issuedbonds,re.-n though the government did not need the financing,to establisha risk-fleebenchmarkfor the corpomte bond market. Malaysiaand Sina ar now considering followingsuint.
.22.4
STRATEGIES
FOWIRAP-r"DA&
-table5.8.NetFinancing Soumes ofNonfinancial Corporations in East Asia andSelected Other Developing Economies
I~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
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been
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changing- as the Asian-economiecs mature. Asian corporations with their headquarters in Japan, Korea, Taiwan, China, and othe-r I?PAE aeincreasinglyissuing.corporate bonds, drawing on the 'strength -of reputations and accessto international financial mrartheir worldwvide 9 ks'1 Recognizing-the value -of a healthy bondmarket, Japan has corporate bonds. SimilarlyThai*eased lalws thar discriminared agamnst land, a.nd-rec'endy. Indonesia. hav strengthened rating and reg ulatory agendes, -while-Hong ,Kong has refornictl its regulatory-structures.: rating-agency.Thus,_ whlile. Malaysiahas introduced acrotebond
.
'corporatebonds
have -notibeen? imnportant -in Asia'stakeoff,:theyr are
<lkl o play arnincreasing role in its:.financial-fiicure~.

25'
.~~~~~~~~~~~~~~~I
The story for equity markets is broadlysimilar to that for bonds: development has tended to follow rather than lead the HPABs economic are similar to other economies. Indeed, recent takeoff.In this, the HPAES evidenceshows thar equity markets do not play a dominant role in capital formation in either developing or industrial economies (Stiglitz 1993a). Even so, as the East Asian economies have matred, govemments have moved with varying degrees of success to promote their growth by streamlining listing procedures and strengthening safguards against fraud. In Hong Kong, for example, the govemment pushed the 1986 merger of four competing exchangesinto the unified Hong Kong Stock Exchange, and it has since gradually strengthened discosure requirements and antriaud safeguards. Korea has prodded firms toward the equity market by limiting bank lending. Since 1987, Indonesia has liberalized restrictions on share issues and allowed foreign-owned joint ventures to operate secur;'ies firms. Even so, before the remarkable bull market of the late 1980s, Asian stock markets played a relativelyminor role in the mobilization of capitalexcept in Korea and Taiwan, China, where issues of shares accounted for more than 10 percent of net financing. Since 1985, new share issues have increased, and the proportion of external financing from equity has nisen steeply. Recent policies to support the development of equity and bond markets have been largely successfUl. The growth of stock marker capitalization in the HrAEs was very rapid in the 1980s, altiough the volatility of stock prices in response to speculative pressures and capital inflows may have reduced their value in signaling efficient investments.20 However, the Asian stockmarket boom is a relatively recent phlenomenon, and its timing-beginning long after most HPAEs'economic takeof3swere well under way-suggests that it is a result rather than a cause of East Asia's rapid growth. Devopmnt Banks. East Asian governments created a wide range of fi-: nancial institutions to fill perceived gaps in the types of credit provided by private entities (see table A5.8, at the end of the chapter). Thcy3addressed the need for long-term credit for industry by creating development banks. Most have also aeated specialized institutions that provide credit to agriculture and small firms. -Industrial development banks have been substantial. long-term leders in Indonesia, Japan, Korea, and Taiwan, China, but not in the In Japan, the development banks-the public Japan Deother HPAEs.
:226
STRATEGIES
FORP RAPDCG
'
velopment Bank ODB) and the private Industrial Bank of Japanaccounted for about two-thirds of loans outsmnding for equipment investment in the 1950sand about half in the early 1960s. Their share in total lending to industry was small, however,and has dedinedLAt its lent. Sartpeak in 1953, theJDBaccounted for 18 percent ofnewfimnds ing in the mid-1950s, job lending fell to 1-6 percent of new lending; the rest was accounted for by private banks (Kawaura 1991).21 The Korean Development Bank made an averageof a third of all loans and guarantees in the 1970s, and the development bank of Taiwan, China, the Bank ofCoimunications, holds about half of the assetsof the banking-system. Conversely, Malaysias development financial institutions
accounted for 2.9 percent of the assetsof the financialsysremin 1980s. Thailand's industrial developmentbank hasonly 1 percent of dteassets of the financialsystem. Hong Kong has no development bank Many other developingeconomies have also attempted to remedy the perceived failurein long-term capital markets. Nearly all have been unsuccessful in creating development banks. Development banks in
South Asia, Latin America, and SubSaharan Africa are beset with low
repayment rates; a representativesample of eighteen industrial development banks in developingeconomies had on averagenearly 50 percent of the value of their loans in arrears (World Bank 1989c). The most commonlycited causesof developmentbank flilureshave been political to finance bad projectsand the poor incentivesfor and capabilpressiure to screen and monitor projects. ity oFfinancialinstimutions Development banks have performed much better in the HPAEs, especially those banks in the northern tier economies concentrating on industrial finance.2 Fmancial performance has been adequate to good, and the capacity to evaluateand monitor projects has at least in Japan created spillovers for the resr of the formal financial.systen (JDB/JERI 1993).23Successfildevelopment banks in East Asia have applied commercial criteria in selecting and monitoring projects and firms, even - bwihin the constraints set by government prioriiy activities. Development banks in Japan and Singapore,for example, must select projects
that-will repay, since the banks are expected to repay with interest the
-funds thy obtain from the government Taiwan, China, introduced another mechanism when in the early 1960s it required borrowersreceivfrom the U.S. Agency for International Development to put ing fumds -upmathing funds and made lending to a nonperformer a criminal offensei imposed on:the loan Officer.
227
Most Eaist Asian governmnents have devisedmeans to contain wilful politicalinterferencein devlopment banks. Japan, Korea,and Taiwan, China, have appointed seniorofficials from ministriesoffinance as chairmen, so they may withstand pressure from other parts of government Others have controlledthe tyes of lending.Thailand simply disallowed its developmentbank froam lending to stateenterprises.The high pro&cssionalismand institutional identificat-ion of sraflj which is charactristic of successfuldevelopmentbanks, is a positive&actor as well.
Policies tolacrease the Attractiveness ofInvetmnt

Besidies fostering a dimate conducive to investment, encouraging bond andiequity markets and, in some instances,establishingdevelopment banks, each of the HL'AEs responded to coordination problems that hinder investment with a variety of mechanisms to make private investment more attractive. Like most other governments that have tried to increaseprivate investment,the HPAEs embodied many of these pro-investment policies in their tax codes. These codes varied across economies and over time, both in their specificintentand in the degree of succe-ss, but have nearly alwaysaimed broadly to encourage invest-' ment. Becausetax codes are often central to the quait-y of the investment climate, this section begins with a brief survey of tax policy in each of t-hewpAEs. We conclude the section, and the chapter,with a discussion of foiurhighly specificmechanisms usedtin some of the HrWAEs. to encourageinvestment. low relativeprices for capitalgoods, risk slaring, controls on capital outflows,and mild financial re-pression. Tax Policies, to Encorage Investment The HPAES have employed a widle variety of tax policies to increase investmnentby raising the retained earnings of companies. On one extremne, Koreca and Taiwani,China, used complex tax codes not only to favor investment but also to direct the pattern of their industrial development. On th: other extreme, Hong Kong has maintained a simple and largely neutral tax structure with lo croaetax rates. Other tax policy regimes fll inx between.. Singapore uses taes to promote industrialization and to attain social objectives.Indonesia and Malaysiahave relied heavily on oil revenues andt so until recently have paid little a-ttention to other aspects of tax policy. Like Korea and Taiwan, China, Thailand has tried to use tax policy to provide investment incentives; however,weak administrative cap.abilites mean such efforts have been distortionsxy rather thin
2oi.
STRATEGIES
FOR
RA
helpful. Box 5.2 further explores these issuesfor Korea, Malaysia, ant Thailand. Below we review briefly the investment-relatedaspects of the tax structr in each of the developing HPAEs.
* In Taiwan, China, income taxes generate only a small share of revenue because of extensive exemptions. Income from dividends and interest were tax-exempt until 1981, as were capital gains until 1989. Corporate tax incentives have also been extensive. Research and development expendituresare exduded from the tax base. New industries receive a five-year tax holiday, and industry generally is offered accelerated depreciation of investments. Industries that the government deems strategic receive additional special tax credits (Tanzi and Shome 1992). * Korea was the first HPAE to estblish a value-added tax (VAr).The vAT in Korea provided revenue to support incentives for investors in indusry, particularlyexporters Tax incentives induded credits, accelerated deprecKorea has ation, and special exemptions. In contrast with the other HPAEs, continuously fine-tuned itStax policy to promote industrial development. From 1953 to 1986, there have been nine major tax reforms. * The most distinctive feature of Hong Kong's tax policy is its low rate strucmre and the low level of revenue it generates. The maximum personal income tax rate is about 15 percent, while oorporate income taxes are 17.5 percent. Hong Kong uses low taxes to attract investments in contrast to the mix of high tax rates and high tax incentives offered in Korea and Taiwan, China. * Singapore's tax regime is as interventionist as those in Korea and Taiwan, China, but focuses special incentives on foreign investors and on promoting savings. (Contributions to the Central Provident Fund are tax-exempt for both employers and employees.) Malaysia has the highest level of taxation. Its tax-GD? ratio averaged 21.45 percent in 1979-88 but fcil steadily during the period because oil revenues declined without compensating increases in non-oil revenucs, and the government continued to expand tax incentives to sustain its industriilization drive. The resulting high deficit and emergng constraints on spending have focused attention on the need for systematic tax reforms. * Since the 1970s Indonesia has relied heavily on revenue from petroleum andgas, and did not until the early 1980s use tax policyforspecific incentive objectives. In 1985 in response to dwindling oil revenues, it embarked on a comprehensive reform that unified personal and corporate-income taxes, introduced value-added and urban real estate taxes,
229
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STRATEGIES
FOIR-
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Did the Hr-s'
investment-friendly tax olicics spur -growth? Tax poli-
a trnsfer of income from taxpayer in general to des involve fiscalsacriflice, hii depends investors. The assessmentofwhether these polices were successf
on similar considerations to those applying to pubc or forced savings, If the increased investments were absorbed effidiently, as ir appears thcy were
itrislikelythatrthey raised ag*in mostroftherHrAEswitha2ctvisttax polldies~ gregate welfare But the administrative burden associated withi a compliCared tax incntitructure Kon such as K-oreas or Singapore's has hi,h social
costs itself The success of ocher economies in East Asia, such as Hong
with very low but unifrm. tame on corporate incomes, suggests that:
the major gains accrue from leaving mrtaiedearings with corporationss ceand pionolvng fivestment i equipmmen,rather than from attempting to tfine-mneincentive strucurecsto private investors through the tax system.
7231
Low Relative Pties forCapital Goods. Unlikemostrocher low-and middleincome economies,the H-iPAEs wereable to hold down the relativeprices of invertment goods, especiallyequipment, during the 1980s (Bhiartacharya and Page 1993). Figure 5.4 shows the relativeprice of investment of goods (ratio of the investmentdeflator to the GDPdeflator)for forty economies for whi'ch consistent real private investment data are ava-ilable. F-orthe group as a whole, the price of investment goods increasedabout 15 percent fasterthan all otlicr goodsduring the 1980s,in part because devaluationsincreasedthe domestic price ofinmportedand import-intensiveinvestment goods. The HPA.Esarc different in severalways. First, the relativepriceof'mnvestment goods remained lower than in other developing :i~~~~~~~~~~~~~~~~~~~~ I economiues throughout the global economicexpansionof the 1970s and the adjustment period in the 1980s. Second, the relative priceof investme'nt goods declined during the early stages of adjustment frm 1980 to 1984-a period when they were rising in most other developing economies-and only began to rise in'1985, when the HiPAEeconomies letog od rtoo h necetdfao oteGrttso)fo werewell on the way to recovery. By 1989, relative between HPAES fr hih onisenrrel riat prices iarsten dt0ar -foerecnoie and ocher economies were again aligned. Thus in these economies de-. h middle-ncmconcs rieo te netmn od-n 104lbe awoe NowLM eafe oregopa ices fo=aia od lowniems and Figure 5.4 Investment Deflator/GDP Defator
ta~~~~~~~~Suceay PeTrandPand Index1970 _
120 -
Mad93).a (1992)
hwv
daieprc
f net
- ;:
middler-ievlopin than . vestme.t godsreaie lower ir~~~~~~~~~~~~ource Pout-an th lbleooi Madaassa(I 92xaso
122
economnies
fe17sand eaiv rc f neimn
e.peidi2h328sScnd
232~~~~~~~~~1
STRATEGIES
FOR
RAPI
cdiningreal prices of investment goods smoothed the impact of adjustment on investment.2 4 Rising investment goods prices affect the relationship between investment effort and investment outcomes. As the relative price of investment goods rises (over dime or across economies), more nominal investment expenditure is needed to achieve the same volume of physical investment. For the HPAES and the economies of the non-HPAEsample, investment efftortand outcomes coincided quite dosely during the 1970s when the relative price of investment goods was essendiallysimilar. During the 1980s, the rising relative price of investment goods in non-HIPAEs was reflected in an increasing divergence between investment effort and outcomes. By 1989 the difference was nearly 3 percentage points of GDP?By contrast, in the HPAES, investment outcomes exceeded investment effort (for both public and private investment) for the entire period 197089.25 Tax, marif,and exchange rate policies that kepc the relative price of investment goods in the HPAEsbelow that for other low- and middle-income economies undoubtedly contributed to growth. Snce the same volume of nominal investment bought more real capital goods in these economies, output was increased and returns on nominal inves=nenrs were higher.
Bounding Risksto Piate Iiwestwm Some HPAE govemrnments, primarily in
the northern tier, have attempted to increaseinvestment by lowering the uncertainty associated with real investment, implicitly or explicitly sharing risks with the private sector. Risk-sharing mechanisms have come in many forms-recession cartels in Japan, firm and bank workouts in Korea, financial repression to recapitalize firms in Malaysia. signaling prorities and policy intentions through the direaed-aedicsystems of Japan, Korea, and Taiwan, China, and credit guarantees to small and medium-size enterprises in Korea and Taiwan, Chinat Those that were effective all exiibited a common feature firms benefiting from shared risk were monitored for performance. In this way governments mitigated the problem that has plagued many public sector attempts to share risks with rhe private sector in other low- and middle-income economies: reducing the risk of fihilureto the private sector reduces the incentive to avoid failure. This can lead to a political dynamic in which gains are private but losses are socialized. An importnt feature ofjapanese industrial policywas the creation of recession carrels and the use of other forms of adjustment assistance in dedining industries. Japanese andimonopoly law has been consistendy
233
: :: g C -:
0
A CLX
_EEFLE V-~~LE
lenientin allowving the organization of cartelsunder the administaive guidance of Mm to ease the exit of firms from dedining industries.
These cartelswere especiallycommon during the rapid growth period when they were used to ease the adjustment problems of dedining industries. The cartel allowsfirms to share losses.They may also be eligible for subsidizedloans to upgrade technologyor restructureoperadons. In ths way, bankruptcy or massivelayoffs by one enterprise may be avoided (Ito 1992). Japaneseadjustment assistancc has been especially prominent in mining, textiles,shipbuilding,and aluminum. In generalit has succecdedin avoiding the abrupt dislocationsthat often characcerize firm fiailures in market economies, but this orderly decline has been purchased at the cost of inaeased prices to consumers and lower reurums to investorsin firms that would have survived.Moreover,the cartelsprovidean incentive for firms to overinvestin capacityduring good times,since they will be protected during downns and their adjustnent assistancewill be
related to their existing capacity.
Performancecriteriaplay an important role, even in declining industries. Interacton among firms and between firms and MITIare a means to prevent free riding and to monitor performance.Thus the organization of an industial adjustnent assistanceprogram in Japan conforms to the model of contests presented in chapter 2 and suggests that economies without similarlywell-developedinstitutional capacitymay wish to avoid the commitments to orderly exit policies. troubled priority most frequentlyin Japanand Korea, In some HPAEs, projects have been bailed out by the govemrnment. Often, the financial cost of the bailout was large. In Japan the govenment took over some with financingdecdining industries,such as in coal minlossesassociated ing. When govenmuent-supported heavyand chemnical industry projects in Korea experiencedsevereexcesscapacity and financial diffidultiesin the 1980s, the governmenz provided seventy-eightdistressedfirms with new, subsidizedloans (totaling abour 16 percent of commercial bank loans)and rescheduledoutstanding ones. The govrncmentalsoprovided banks, whose nonperformingloans rose substantiallyand whose profits dedined (partly becauselending rates werecut), with subsidizedcredit from the Central Bank and allowedthem entry into attractiveareasof financial services.In Indonesia, the govemment bought 35 percent of the
equity of a large ement plantwhen it becamefinanciallytroubledwhile operating only at 50 percent capacity (Kunio 1988).
234
STRATEGIES
FOR RAPI
Dcvcdopmenr bank lendingmay also confrr implicit insurance.It fiequendy signals areas of government commitment, providing an additional measure of comfort to private investors and banks JDB/JERI 1993). These commitments may extnd to efforts to ease adjustment problems in promoted sectors. With government inducement, the Industrial Bank of Japan has led syndications for firms in distress and forced their restructuring&substituting for liquidation or external cakeovers. In the 1980s Koreaextended cheap development bank loans to firms that were nor meeting their debt obligations. Has bounding risk contributed to growth?Bounding risk by the private sector was apparently successfulor at least not a fitilurein Japan, Korea,and Taiwan, China, but this is almost unique compared with the experience of other economies, developing or industrial. Risk sharing generates moral hazard problems, which Japan, Korea, and Taiwan, fostering insitutions to monitor China, attempted to contain dtrough priority projects. One consequenceof shared risks was shared monitoring by the private and public sectors. Severalinstiutions, induding development banks, private financial institutions, firms, and various ministries in the governmenr,often had stakesin the implementation of the project. The government's role as monitor of firms was important. For example, Korea'sfinancial policies promoted high leverage,which made firms vulnerable to loan rol over decisions of financial insttutions. Since the government was able to influence which loans were rolled over, it was able to use them as a lever for elicitingcompliance from firms (Sakong 1993). Similar monitoring was rarelyoresent in the Southeast Asian HPAEs, with the consequence that attempts to bound risk there were not successful.
Restrictng capital outflows is one of the Coerals on CapitalOufflows.
more controversialmechanisms employed by the HPAEs to increasedomestic investment.Japan, Korea,and Taiwan, China, all employedsuch restrictions during the formativeperiods of their rapid growth. In each case the rationale was straightforward:if people were prohibited from sending capital abroad, they would saveand invest at home. In addition
the capital controls made repressing interest rates on deposits possible,
since savers were denied higher-yielding assets abroad. Although all

three economies have since liberalized controls on capital flows to vary-
ing degrees,the existenceof restrictionsat a time when these economies were achievinghigh and risingsavingsrates challengesthe premise that free and open financialmarkets are alwaysbest for growtk
235
f -a.;;..
5Y
WVhat impact, then, do capital export restrictions have on accumuldadion?The obvious fuilure of such restrictions in economicesprone to capit-alflight suggests that capital is too fluiidto be retained wvhendomestic conditions are inimical to savings and investmenc. Therefore the simplest explanation for the seemningsuccess of these restrictions in Northeast Aiistathecnmsoffered returns adequate to retain capita even without restrictions. Converely, for reasons we discussed in chapter 4, these particular governments have been unusually successful in eliciting the cooperation of economic elites, t-he very groups and individuals who might otherwise shiip capital offihore. Thus, for certain periods in these dthre economies, government restricdions on outward capital flows may have contributed marginally to domesnc accumulation, if only by raising the risk and therefore the cost of sending capital abroad. If so, such restrictons; which have the potential disadvantage of driving otherwise legitimatc ecoonomnic activity underground or even provoking capital flight, would rank among the comparatively risky interventions that are likely to prove successfujlonly in economies that have able bureaucracies and have already established the fundamentals of growth. Moreover, as the trend toward capital account liberalzation in Japan, Korea, and Taiwan, China, suggests, retrctions are probably useful orl4 for a lImited dimc: as economnies grow, becoming more sophisticated andi more dloselylinked to international markets, restrictions on capital exports inhibit efficiencyand must be dismantled. In aniy event, the success of the more open BPAEsundermines any suggestion that capital flow restrictions are somehow necessary for savings and growti. Hong Kong, Malaysia, andlSingapore have all achieved
high and risingsavingsrates whilepermitidngand-in the caseof the gional financial hubs, Hong Kong and Singapore-even encouraging free flowsof capital. Indonesia attempted to control its capital account
from independence until the early 1970s but due to the very open nature of its capital marker chose to shift to a gradual policy of libemliza-
don. Finaluy,Thailand has retained format restricdions on capital movements,but the economyin peractice exhibitsa high degee of opnnes (an internal World Bank report). Thus, although capital account
restrictionsmay have playeda positivcrole in the early growth of some HPA:s, conomuesthat have never imposed rthemor have since liberalized appcar to have little to gain by imposing them.
East Asia'slesson about capital account restrnctionsmay in fact be

how to get rid of them rather thanhow to impose them. Both Japan and
1Z36
STRATEGIES
FOR R
Taiwan, China, weresuccessfulin liberalizingtheir capitalaccounts very graduallythroughout the 1970s and 1980s, adjusting the pace as necessary to maintain macroeconomic stability and minimize interest rate and exchangerate volarility.Indonesia'scapital marker liberalization is described in box 5.3. But while gradual deregulation may be best for economies in which bureaucrats can craft economic policy with relativelylittle interference,sudden deregulationmay be the only deregulation possible in economies where governments are less insulated and there is strong resistance to reforn. In such cases policymakersmust weigh the dangers of sudden liberalizationagainst the risk that gradual reform may be derailedalrogether. Moderate Repression ofInteiest Rates.The finalmechanismwe discussthe repressionof interest rates on corporate borrowing-is perhaps the most controversial. Financial repressionis often used to describe the situation when interest rates are at negativereal levels.A more precise definition, the one we use here, is govermnent intervention to hold interest rates below market-clearing levels, Of course, in many developing economies with capitaI account restrictions, managed exchange rates, and undevelopedcapitaland money markets, it isdifficult to determine a market-clearinginterest rate. In the absence of such rates, HPAEgovernments tended to use international interest rates, such as the London interbank offired rate, as guides for the opporunity cost of domestic savings. Given dosed capiral accounts or high transactions costs in moring funds abroad, they have sometimes had the latitude to maintain deposit rates below marker-dcearing levels without provoking capital flight or significant disintermediarion into the informal markets, where higher real rates prevaiL Economic theory and empirical evidence agree that if a government holds real interest rates on deposits too low for too long people will have little or no incentive to accumulate financial assets, financat savings will fall, and econonic growth will be adversely affected. Fmancial repression usually occurs when inflation runs ahead of adjustrnents in govermmentregulated nominal intcrest rates. This type of financial repression has often resulted in severely negative real interest rates, for example, in Argentina between 1972 and 1985, in Indonesia between 1973 and 1980, and in the Philippines between 1970 and 1985. Cross-economy regression analyses supporc a positive association between real interest rates and the rate of growth of economic output; that is, large negative real interest rates result in lower growth (Gelb 1989).
237
AR CL
e dn d&rgdl ~
$
nhgh9
L4i
meore,s
guhuS
rs
R
/
k4
U2
flV.w%
~oi'nrArf
1"
.a
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iJ*&V
T heHofNavust assessme suggests'rle'op 5 fnanr n sfrgsures to
beresoom s codnsitn se fzinanchial Hoevr,83acile elctdco&nomic naecitlrsea.
time or notherheldrntcrestirtes4below HacShaeveinog used ancmia nnthels
makt-dZaringlcv and
hl de-nia
citen asgrea repression
rsourcessfto finnc the bdgvlpento liiberatepolic fovrtime tosecurentl greoevriaca economicsscos resourcesntoselectedsaig:dcthAin branksanr afterany extenal bepenssedion,selectd peraniodsrepusually pression hasca so on to treAsansemresucles?oadete iigidsra shockte markeostclaringlEeveSmwhil finterestl raespbelow time orfanotherahel find pigrtso aggregateintmtand n hHancial. achitevighgdn nonetUyhaels banksgancoimeodpositinofordsavns diaidltheoAsianleconomiesrowes
23-8
STRArEGIE
=t~~~~~~~~~~~~~NT
. t =~~~~~~~~~~~~~~~~~~~~t
RAIDXO R0
37
S T~~~~~~~~~~~~~~~ RAE ;7;;
SF
X. 2
-; . .
nr+ridd rd4 -uMffiedylwn .iis
a4the'interestr
iid it
has r:Fa
pmasewoduc-s andservces'inuluhdprvate b
mrgina e ipnvacerafinnci 12
*r
s-
s - rpn 9SiytoiBhves overrnment hogusane o ser,Un Cld
mchiaseher
aatet
* - -ment.by reducUingborrowig
ie
t ODW.nm_xc0xnVcbUarQto.%cn n the cc, .' t ;:l t3.es.
oRnted,thes
y.$0
r poirsii bostp
subidy -:
cij
2
-
d &MCM-.-~~~~~~~~~~~~~~~~~~~~. iid
ulbCC& -:cooiesinmthreeaimpom.nvhent
dshedrefeeshiond
wasmo
notcrtoet
ubkflt&7Q
rElativdy moderate arldw

in pen;istndy
sh
-lir`dexcepions
di
. .... . -
real.n interestrat
i3rprsso
tablea5.5 In
Iit
as.
ae
of euryn
in a enon h&gbvn merntnenrghn
non
ieod
A.....
- fiom .to firsns househol inreases the oolorate!profitabljusvof invest

; . --.g
a
,J
::: ofth
flfiC0
duringn
'qiymru
to2E'eooctaefprosbpo
- -FandiadorpressincinthuHAEghs s iffered froimlatStin ro.swd o nthernasrxcs from ousehlds o frms inceaesth crprates proitbiit1o iinvest-.trq
the euityoffins, nablig thm toinvet inriskierprojetsnd bo Uo ings is,'more sufficiently low and t corporate sector has a highe financethese to projec.' Thi ma hvepadyofe te marginal eanes
.~~.+*~a.-,.. -~ off' -.. mareooi
i4owe
=--
an
was
no
urintede
conseque *1-ai
N.
-of
idingfirns. anatrnatived toa tequt fiainngesrt (Sdlasiity of993a)ldsav Fginancufiadpendyion ind the HopAESeseo diardfo has thathin mostgothe penois inythre nporthan th ways.hoFirstao,thedereenofrepressayincrwase ~~ ~ aregav1 oeate ansmnd, wirtha ewrsore,t-lied fcdeptiontrs,tio retcsultid ino peusistenlydnegtoeirealinterestmes (see tablrae 5.5).tbiSecyofnd,estwe
_ -X ..-
havte showninychapktedri3g rheprsion wasonderctakenoifa penvironmentpro oFmnancninic rpestainintye

ecoomis
HandEws nohes unintened rmta conmseqecofhe

W27S.rlrt, i thee mpotan he legee f rpresio3Wa
L E .
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C
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;':~~~~~~~~~~~a
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FQ15g"fim%1,,.,-1B
.~~~~~~~~R~p
~ unosyxyi}neetrtSadvabnod ~ xb~
pl,o in,rainrasne.-dig
I.;-i
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os
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et r >Et s:
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-
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~~~~~~contos.ce
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ponsdw7e.cmpabl
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mxtl!oruenv sann= : f^we*,a ts^

i
i
cuuenw,te
.f~~~~~~~~~~~~~~~~~~~~~~
~~ ~~ ~~ ~ ~
r.4 }
~ oovr>navnolX ~ ~ ~
-
oryaetd::-.. -v>l-t-)
dA
aculii4tz1-
z:pRrC=sOn,,wo
wt1E -;Si -;;f4
~ - ~ ~~~~~~~~~r -icmiemltGsaco
2
cosraire-mti=ur.a: 1uuNvdeLAtsts@
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-
I B;be>vE;uldshor-rem;tfinancrqprn=svsitrmalsmm4ia;UkI, : . ; I g ;,=
~ ~ ~~ ~ ~ .4 ,fF ,4 l- = J oSaN t:' _fi< .

itrFt..4->><stxts,t<i/gt;
,,>,'gsSw4'St;t
' r St-, , *-;
0 t
,-; ~
-tU
b pem6d a '<l-'4' '^
2* s- e r., Xs >
t ,,
~~,r-J;.>a)>iJ--.i
=tr2aonnPnrllgno-vnvscLitg.de6tea v sr-eecv4ec,.ak-o
~S- t',S:-Ji :
; ;
-vat.FSeracser. } "~~~~~~s vereLstri
<S:t' n
- *t i :
r
0',''~~~~~~~~~~~~~~. 'V
: .
E > *-5s-^st2 Srsge Sg.^=^, wer s> .w--\*1.tPGK> fNtf<!
9WillhOtilL9tlt'iOiEiittCrClltOnnpis-:SIi
_.I
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Of.ii.rAdilICDO:4Wai&
&1
u bzmatH.fRftAS;sf-he;Ho S-,R,;wiftW:2.S'sruXs .{2;;7t>iv1X;742-r it^.=x 4.*l -. -r-9. Pj . f.mE~~~~~~~~~~~~~~~~~-m S.7;1vt ; "Proodx tssXadMeneeRnf>Bcue.i zn-<S'6Stae>-en
-O
mof-
~~~~~~~~~~~~~~~~~~a.-::'
A.,~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
':
. | - r -
: 0 :
'
e~~~rapifinfancial stuleding rate
Av sp=,d, wercpaed
indtwirdl ehansth on
bankt
eguatossquee that s resuts rorld ations).
foth pId into
dcepoit.
Svrate
rhatidie to borrw
depositorsla 8).e' ' .
;.~.
. - 0 f' -7-'
.0
households)
';--
1, ' '
'' ;:
.- '
- '
'-. . ers,
Nonethesltni finiandial
WSuring repression
tleatlo
in
raest mess
racsae dmanct
posauedo frae
efetos'ofmow:ayic SevAeralc d-':
.-
~~~~~~~~~~~~~~~~tde o.- ~ ~ ~ ~ .~ ~ -f0 .. ~ ~ ~ -~ ~ ~ ~ ~ 0 ~ ~ ~ ~~eav

, j z X ,, thsaye,
-. 'X S X" .
with geneitie.
hav
arue
~ ~ ~~~m
fo grwt (Wrl
tha
thrd
th at : reslt 1989:
pes
is infiin Fr 198.
and :on !'paricuarl
has
cosqu-e . :--
Bank
e.msancs.-stngin2da.r
*,~ -' ~~ ~
~ ~~~~~~~~~~~hs 0,' '
-:f 'earesutin ,''in' ne''4rtv ..
:0:,-':
:.:
e,'-t'o
mod--,-
STRATEGIES
FOR
P.A P,r.
Evn widhoutfinancial repression, banks do not allocateloansto the highest bidders. Since biddersfor credit offrer promisesrater than payment, banks must evaluate the bidders and decide which promises are most likelyto be kept. Since rationing alreadytakesplace in financialsystems, the additional impact of moderate financial repressioncan be relatively small. Indeed, credit rationing may actually be good for growth, if the mechanismused to selectborrowersgeneratesincentivesto perform. For -emmple, Japan, Korea,and Taiwan,China, allocatedsubsidizedcredit on the basisof past performance,usuallywith exportsas the criterionof success.Since the valueof subsidizedcapitalwas high, firms perceivedhigh marginal returns from greater effort and competed accordingly. We explore this finction of credit allocationin detail in chapter 6. Did moderate financial repression hinder growth? We address this question by examining the relationships between income growth, real interest rates, and inflation using two statisticalmethods and two data sets:a sampleof nineteen economiesthat includesa subserwith positive real interest rates, and time-seriesdata for Korea and Taiwan, China. (Details are in appendix 5.2). In the nineteen-economiessample, inflaton rates are far more important in explaininggrowti than real interest rates. i the subset of economieswith positivereal interest rates, the inwrtestrate is statisticallyinsignificantand actually has a negativeeffect on gowth when inflation is included. Similar tescscan be made using time-seriesdata for Korea and Taiwan, China We use the differenceberweenthe curb rate and the institutional interest rate as a measure of financial repression.Its coefficient is statisticallyinsignificant.In Korea, inflation and the curb market rate (our proxy for the equilibrium interest rare)significantlyexplainincome growth. In Taiwan, China, none of the variablesis significandy related to trhe growth rate. While these testsare not condcusive, they support the view that moderate fnancial repression did not necessarily hinder growth in Korea and Taiwan, China.
Which were the factors that contributed most to the HPAEs7 extraordinary record of accumulation over the past thirty years?Judgments are difficult,given our incomplete understanding of the costs and benefits of all the policies used. But on balancethe common elementsacross the eight emnomies tend to favor the importance of doing the finda-mentals well-encouraging stable and predictablemacroeconomicenvi., . = , . .~~~~~~~~~~~~~~~~~4
.~~~~~~~~~~dr
'.
ronments,universalprimary (and later secondary)education,sound and solventfinancialinsctations, secureproperty rights and complementarypublicinvestments in infrastructure, and lowrelative pricesof investmentgoods. Effortsto improvethe institutionalframework for capitalmarketdevelopment camelater in the processand werenot responsible fbr takeoff. In some cases well-functioning development bankswerea positivebut not a determining factor. Moreselective interventions-forcedsavings, taxpolicies to promote (sometimes very specific) investnents, sharing risk, restrictingcapital outflow,and repressing interestrates also appearto have succeeded in some HPAEs, especiallyJapan, Korea, Singapore, and Taiwan, China But
the potential costs of these more selectve interventions if misapplied
can be veryhighin termsof consumer welfare, and stronginstitutional capability is necessary. Theywouldnot havesucceeded withoutthe important monitoringand disciplinary rolesperformedby the banksand public institurions of these economies. Where other East Asian economieshave lacked this capability-in Indonesia,Malaysia, and Thailand-ef%orsat selective interventions to promoterapidaccumulation havebeen generally unsuccessful.
Appendix 5.1: Granger Causality Tests for Savings Rates andGrowth Rates
EXISTENCE OF A REIATIONSHIP BETWEEN VARlABLES
proves neither the existenceof causalitynor the direction of in-
fluence.Granger-type testsareofienusedto test forcausality betweentwo variables, in this casethe growthrate of realcD per capita i) and the grosssaving rate (s).Testsweredone for regression result
fir the eight East Asian economiesand the United States. Vectorauto-
regressions wereperformed on equations5.1 and 5.2:

(5.1)
g=X
k-I
g',- +
k-
s,+,i
(5.2)
s=
k-I
S*-k +
k-I
gr-
242
STRATEGIES
FORItAI
'.
Then F-restswere performed to see whether the laggedsavingsrates are jointly significant (equation 5.1) and whether the laggedgrowth rates arejointly significant(equation 5.2). Up to fiveyears of lagged rates are included. The results show a causal relationshipfrom ODP growth rates to savingsrates for most East Asian economies (seetable AS.1). The Granger definition exploits time-seriesrelationships to identify causality.By this definition, g causess if the prediction of the current by usingpast valuesofgt. Thus, gcauses s if value of s (s) isstrengthened 2 c2a(s 1 IA,) < cr (rsA%-gt) where A, = {A*ik<t- 1I denotes the information set that includes Ak for all past k up to and including t-1, and a2
(st
1A) is the variance of s,about the best predictorby A-,.
To deflinecausalityin a time-seriesmodel involvingtwo variables,we make two simplifjing assumptions. First, that the set A, indudes s, and g only, and not a third variable.Second, that tansformations 7Tand T exist, such that ST Tss,and G,= Tg, are a pair of linear, covariancesmtionarydine series,and that S,and G6 preservethe causalityrelationship of s,andg,. Ordinary or seasonaldifferencingisan exampleof such :ransfonnations. Causalitycan be defined by using severalrepresentationsof the timeseriesmodel for the independent and dependent variables.The autoreTable A5.1 Public Expenditure perStudent on Primary andSecondary Education (US. dolirs)
-~ ______ -.
1975:18
28 Primac y - ;C
,cmy
-i
-' Seconday
-.
Hog'Y 'co ra,Rep.of-' 1 'aaysi=5.

PT
1923.-3 90
180.5
32
'
8.15581
147
512
3898
-8340O
810.2* 352.5
,;j 09699
572.5 314.7 ~~~~~~~193'3.

.176 1881
a 0j
t0xnanana -67i i49

t~ e
2 9
~~2. I 778.0.' 1r2 ~~ 'Brazil

4
76.9 175
7
1~~~~~~~~~79.1-' 15.4-22. 30.9 312
~~~~ 9
'
~~~~~~~~27 62.3 3.
`6
.
India53 Mexicot.
_-'3
713 566
~~~~~~~~5038
1210 10.
,..,
~23&
.
.
875'
)3
fl wwevtAunat.wl
c tea,
'UNFUd--.
ta.
' '.
243
*~~~~~~~
~~~~~~~ ~
Table A5.2 Tests of Bivariate Granger Causality between theReal *2 S; S Per Capit GOP Growth Rate and theGmoss Savings Rate
Si
0
~~~~Sig
SBal
;-i -,*-tX
~~~~~~~~~~~~~~~~~~~~~~~~~~~
t
.m
1S
.Si
jas
S -8 3;.KS. .
MSN NS~~~~S
.
Zg ,;t-fI.. . .. g
~~~~~~~~~~~~~~~~~~~~~~
S,
'
Kqq,-S--
..
N'S MS'
, -~.
-Si
Mdapua1-
Si
Ng~~~~~~~a
.
S .i -41rs NS
MS
Mg~~~~~~S
.~~~~~~~S
.~~~~~~~ .2
,
-,
KS 11
MS '
16 ,~ ~~~~Si
115_ ; ;. PM-
3
4
S la
In.i
-S
Si
K~~~~~~~~~~Si,
Ti wuyo-u "S
- '
~~~ ~
~ :
~
.-
~
,,-
~2
-
'
MS
md &"
:7
~~~ ~
244~~~~~~~~~~
~ -~ -;~ ~ ~ ~
luhLgO8
''
KS
gX
STRATEGIES
FO
EGERAYIF
gressiverepresentationwas selectedfbr this study. In this representation : and by Granger'sdefinition,ifg doesnot causes,, laggedvaluesofgcannor add to the predictiveaccuracyof sp,givenpast valuesof s. Using the autoregressrve representations, s. can be regressedon its own past values and on past valuesofgto restwhetherg, causess, byresting whether the of the laggedvaluesofgare significandydifferentfiom zero coefficients (Granger 1969). The resultsindicatethat past valuesofgare a verygood - predictor of s, but that the reverseis not true (seetable A5.2).
ontheRelationship Note 5.2:Technical Appendix andGrowth between interestRates
P;
(5.3)
monetary
= REVIOUS STUDIES, NOTABLY BY FRY (1984, 1988) AiND GELB
(1989), have tested the relationshipbetweenreal interest rates (R)

(G) using the foilowing equation:
and the rate of GDP growti
-IRu+ G= consrant +
also indude rates following in 1973. Both positve a shift variable to account for structual the breakdowvn of the Bretton Fry- and Gedb apply ordinary dine-sries significant Woods least
Gelb's equations changes in growth system
squares (OLS) estimation ship between economic But equation between stitutional whereas plored
to pooled cross-economy and statistcally Fr,
data Both relation-
studies show a consistendy
growth and the real rate of interest it fahils to disinguish (the difor in5.3, system repression
5.3 has major shortcomings.
small and large degrees of financial rate). moderate High negative real interest
ference between the equilibrium .ff&ets on the economy fects that are not captred system repression, Second, financial terest rates. Other putting
rate of interest and the controlled
rates have severe negative or positive efcan be ex-
and may have driven the results of equation repression may have benign by the equation. economies These difirences
financial
by spliming the sample in two according with negatve
to degree of financial real rates of interest
in one group and those with positive real rares in another regression is not the only reason for high negative ineconomic problems can afifct interest rates as well. in the sample with high negative interest rates also
Many ofthe economies
245
had high and often volatileinflationrates (Murdock and Srigiirz1993). Introducing inflaton to the equation,this correctsfor the rce of inflation in analyzingwhetherfinancialrepressionhas a negativeeffectr on growth: (5.4) constant fPi,R+ J32 1NF :.+
Third, investment opportuities also aff*ect real interest races. A &ll in the real instimutional rate of interest does not mean a changein financial repressionif the equilibrium rate falls equivalentlybecauseof lackof investmenitopportunities. This study, thercfore,introduces better proxies for the degree of financial repressionin the single economy regressions: the differencebetween the curb marker rates and the banking system's interest rates. (These are available fMr Korea and Taiwan, China, but:not fMr the other'high-performingAsian economiies.) Fourth, OLSestimiates couldtbe biasedwhen the regressors are correlated with the error term, as in equation 5.3.If an economyexperiences a sudden increasein productivity, for example,the demnand for creditwill rise,and inflation islikelyto tu'rn out to be lower than expected-Both effects will result in a higher-than-expected real interest rate. Thus, twostage least square estimation (2sLS) is used in this study. (In the event, the results for OLSand 2SLS suggest thar the condlusionsin this study would not have been substantially changedhad oLs estimatesbeen used.) Using pooled clint-seriesdata for twenty economnies, this studlyestimated equation 5.3 applying a two-stage least squarcs estimation to both thLe complete sampleand to the subsampleofeconomies with positive average rates of interest. Avenage GNP growth rates were used as proxies for the growth rate, an1dreal lending races (from the International Financial Statistics'database) as proxies for real interest rates. T'he 25L estimation induded the previousyear'sinterest rate as the instrumental variablefor the real interest rate~, a year variableto account for any sectoral trend, and two measuresof an index of relativeincome because standard growth models predict that poorer ecoonomies have higher equiibriumngrowth rates. All regressionsindlude dummy variablesfor each economy. Table A5.3 reports the resultsfor the imact of the real interest rare. and the inflationrate on the GNPgrowth rare. FoIhCsml of twenty economnies the real interest ratechasastatisticallysignificantand positive impact on growth (equation 5.3).But when inflation is induded (eiqua donA),the cefficient of the real ineetrare is no longer statistically significant,while the negativecoefficienton the rate of inflation is. For 246
STRATEGIES
FOR,
AS.3 ParameterEstmatesfor Interest RatesandGrowth Table

,
'; aJrnsr&-vru.'
Rea hien ~~.L. rw&ratr'rate

,.. .;.
A,
'T,
tuft* nn.. .
,F-
Rea *cur *b.,, =

interest rnf
~~~ rat
.
'Whole
sample(2S):.
-.
- -'.'-'
P1=2 92
; ;7s Ekiuado .Rn 1.
- ..
; 0.148
<tLLUL LAJIA 5
-000;; 1
AX
-.
0.277
-.
f
Subsamplcof&os o-i;
_ C5
tri-ot
>tT-.>g . .
, ;
Equaiontl
'
-0-:
'
i Equaon& 2
Equarioni).. 0.391~~~0. ;'w-. 0.059 Eqarin3 -- . A389 C~1;perat lewd.,'

Ieastst regesons were
. .;:-;frA. >: < -
x0
-~-::~;0363u-
0 438a
Icr............,;><,.
M6 Ea WattTrto-sSt ae
-~
estimated
on
* -
hmp b
of w-
i
on
2;
suhsampl.ofcaniameoLswason otlie
..-
the nm
.
:l '
:-
-: -
swarcw&iBank dima
;:. f!:.y*:............... ,.. ...... , .. -
r..
the subsample of economies with positive real interest rates, the coefficdent of the
realinterest
rate is not statistially
significant cxcept when
inflation is induded. Then the coefficient of the real interest rate is sig.nficat and ngative, suggestingthat lower real interest rates may have had a positive impact on growth. The coefficient on inflation remains negtive and significanL
'Table A5.3 also reports estimares of a time-series analysis of the relationship of interest rates, inflaton, and growth in Korea. A third equa-
includesthe,realcurb rate as a proxy for the equilibriuminterest race.For equation5.3, the coefficientofthe real interest rate is positive, 'large, and statisticallyhighly significant. When the realcurb rate is intion
dudced, the real interest rate is no longer significant, but the real curb rate is. When the infladoti variableis added, the eal curb rate rerains
highly significant,but the real interest rate and the inflation rare do not. 'When the same tests are perfonned on time-series infboration for Taihave wan, China (not reported in tale A5.3), the esdmatedcoefficients the samesignand similarmanitudes as those for Korea,but the standard significant. isstatistically errorsaremuch largerand none of ti coeffiacnts
747
fI.
F--ACLE=
- Table AIA
GNPper
IcomeDo Rzobution shareof.

iib omm 2
arof:
:top20.
pferentof
tope
Ec--fonomy,;- .f(perytr) -t
; :pon~f;= =2 1: I96590 Ysrr
:: - -.. cap
of
pertof
hovsseholds
botm20
eholkoouse hold
: .HogIong-'Indonesia)
9AEV-Japa
6.;62 1980' 4.50 0>i1976' 4.r i1~ ; 1969`

f
.-
5.4A --6.6
Korea,R ep.of
71
7.9 *0-XX1979.. ' 8.7 1976.- '5.7 5.1. 995. .I - 00---
-47.049.4-' 41.0
8.7 74
;375 453
6.1; .51.2 ' 35.0 :49.8R
5.2 431 7.95

-16.03 E11.1 91982683 9 6.-. -3.68: 8.89 14.6 8.7 3i3
4Maaysia"'
= R -
tq. -gapo 6.5: Taiwan, China.

Thailandh * :
.0' . 1973:3.5 . .0;198T'0.:4G6
1976
, -
4.4
1975-76 5.6
*.
f.OzhtAid
*-0
PhilPEippines000: 1.i3
19e g70-71 - 03.7
.;53.9
: 6
-5.6.5
f51985 ;.- --0 -l985b5 -;; .48.0' ;

...
Brad!....
-. taiRica ..
3.. 3
1972
2.0
;.
*
1983' 2.47 626 26.0. 1.4 .:. '1;:-971. 3;3'.......... 54.8 4} :t. ~~~~~~~~~-.; . 54 8c 8--S ......;:--1 -16.61.511986" ~..3 33 -
-Mco p~.
-I{
.
2.8 0.2 - - ^: -:- - -- .

- '_!. -10
00
1977 2.9 1I72 ;L198546w 44< 0 1970 -.T
57.7--0. i-9 :5139

-:.
19.9 2.11 179
V&elzuea
3.0 .-
;.:-54.0 . .- .................... {;
7197'
0~~~~~~~~~~~0
;76 50
0010 5
rt
Boiswana. i --^ =' -- :i -4- 19856 --`2'.: Cbce'Ivi-re 05 198- ;8-T 50

Gh-.na
',-.
527
-14-.
19s8j9'
dia
1-9
'19645 -9 6.7'
1975-76 7 .:
.
48
49:4
7.2
, 0 -. .
. -
- n s04..
314.... -.
a.-~ ~
1 ''i ''
'
~ ~
; .
~
i"'
~
'.
~
q
~~~t'.nerprcznmoc
' '-a~ ' . r '-,:
-..
-s.-u r'|
:
bou'e.i"k.c'p.ndz'ut. '~.D .o
.-
--- 248---:-
STRATEGIES
FOR RA:PtDiW
TableA5S5Natuire, Causes, and Resolufion of BankingSystem Crises

Naturnfnere.
.:'Enfisrj
T-TnnHon na
::s
Causes
.
Nature ofbiot
or re
..-- Ninedeposi:-aing c. .
-1982-83
-
(a) rg exposurc toreal estateiled e lending f-raud

and mismanagement. * andw wak prudential
t*
Thegovement rem
liquidated troubled DTCs.
reg-
ulatoryandaudiuing system and
regation.
g;or&., inhteiiga
Hihinternational
m or:. 1rg* itrst t- res
1{o4 Kong, 1;8-86 : ::
Eight banks, includinga maJor -international ankwere in. 'fnancial difficultie .

[7stwi
large-exposureto real The gormentookoverthe estatelendingand spillover lagebankcandintrduced ne effers fiom 1983crii in cludingtopexecusince che banks o-;ccL- -sewn&de t-v from tceJargeieo rn'
..
.' ;..---
DTCs
-
aSsubsidiaries.
nrial me.
ban.kThose no: taken ovcr
b.
....
--
- ,
: -
--;- :-.
tr
by thgovernrmenrreaivedcrdt from toher com rcialnk

(a) Excive
1 --- realestatelending,cornprisi about 90 pcentofthe bid loansof d
Japan.
ACenini
; -l991 11;
Bank repor has esrti
Encourage
rnergerioFweaker
...-
mated the sizeof problun loans of the top 21 banks o be. betwc 3.5-4.8 _ percentof
bki systrem:ase,.S. .n
'
banksb with hthier ones, r o b provide.tO
and a
epdeclinein
-
ofaount.to'be wrte ten off2sabout 1 1-5 percent banking systema.
ral esae prices Ina-ecjuare -nc were: .s;rale to

P-
ban-sNo-~
lon to be
transu
r exposuredititugh Ins to nonbanic
t dalinstidon,and ---
dthecosto,
..
4,
'
de&eoftbsie among commercia bank.;
- ;.
7
-a-lureof
4.
'1985-88
88.rins:
~~~cooperatie ini8cuec
-k;ng (a) Preoinant causesaThe goverinrrescud -24 ru n speculationi, isletcooperatives and con-~ n`32(if35o) r. : d sldar In addituo;n4! (o38) bnsstOCks iic npM'.Te eta
and4 (of = 47) i' Iedfe naiicecompa
one deposit-
-.
,.gee' nieterealsoiinacial disOXi
(b) Deterioration rtemsia,
,ic
Bank
l
s b
i
, r '~~~I ' -' '.
iiit of
:i'
..
-d,
1'
.i44~~~.;'C~~ijrr.
M i"
i..,u..
.n7.'
.. .butOO~~ ~ .1C ~
SI"' ':ononur
n.r-'$20
s,.
4..h,4.to
,.-
J8'4r y0'"C-:
.. Z L'ooeratLVeS
ae
,L'
.luo trbek~ .
'S44.
opt
-
(&4kivirnnre -. ',-4
X . .4 - ,- ' .
~~~
OUr1Uust:-&rnpan _S n
~~.. .-...
-J,
,,..
Z9
249
LE
TableASS (coawiaWed)
Economy
ThailandL-1983-87
NantresJiitttn.iI
Thegovernment'st ofbout of 50 financecompanies w..as estiinatedtUS$190 milion or 0.48percent ofGNP.
0 .X
C
(a) Fraudand_speculation on real,estare and exch agerae c--ansac ons. () EHigh concenaon unscuredinsider loans.
Aauee
fbaib ut
- -
-*--
Five 0 ,commercialbanks accounting for 24 percent ofcommercia bank assct were in
- 0f:-; ---ii -
t 3 u;9 ; - - ; -
45 .an
of
-
-t soldthmto ncwmvsots
ands tinvestors i n o banks) It bouiht someshares ofrou-
The governmentliqtuidaed 24 financecompanis and-meriged another 9, andthe Centra-: Bank cookoverthe other 17 :
financial-difficulties in
-.
(c Hit
te -
bledbank ksocaeda-Ioarid
'
--
*a 000 1 - '' . t9B6-;87 < <' >> g5 0t, 0 0"~
" - - inestrae
~-
- 0- - 0- -; -:0~; .-Mat-uri-y
.6
of
to_ provid emnergec loans to rubd -TheRind would be finlanced by contribui-: tions frdmn commercial-banks.Trobe -m-00-orriom t mowwcre'
Gl' ;;' :- 'fChide,' X 7';EntLrc mortgage bankingsys0 X -1976 te0 - was - - insolvent.n
-' -
Matitymismatchesof .Troubled assetsand liabilitiesas liqudat ~~~~~~~~~~~~~interestrates wosc andi
* *: -
~~~~~~~~~~~~inadequate Capital ~~~~~~~~~~~~~requirements-,.

.
-Chile,Severn!financialinsdiutons (or -a) Severe. r i ' :.':198b-83. :-; t: :iabout 60pcrcentofrhefinan-, ,'1981driasi c ase - .0ni'sln .-.. ;.:al 1porolio) m nterest rts,adX w insolvencii-n1988;ceniral decline i terms of-
-5banlholdingsofbadconcrpe
G
n1981. thegoverrncmnt bqu dat ed:8insticunon&sIn:1983:it rook ovceS(liquida*ng-3nd rccapitzng5).n The:Ceir
trade dueto:ihecol-.
coppero
Bank also reqs-ec

tesd raie
e rate.-,
cost
est
&iiloutrct dat -was US$6bil(
lion, or 26.2 percent of GDP.r

7 . . .0 !, _,'
schemetomee-rcgnkabik
p ' ltoadsupervisowo and r2Mpaniisider and speculative lendling interest rate sub er4utpwp o ea nc
,.-,,
0,
~~~~~~~~~C ofthe banking
'''t -. ,';30>-.Maa
'Ghana
Thlicnetwot
-1988
*
system wax ,-lose negativsiat

*c&rof restructuriii as 7 US-$300 millionornealy 6
-.Hug foreinecag
andahppor-,
--
'rionirononiperfrrnng2ans o (a) Collapse1in hepic;of -Government5
1hr
ng
heavylosses.~ ~
~ oi. ipuin ~A enig
wie oOamoans. resieur n,' capta Encourage drpe:and o
'~tew.
. -. . .
'
L....
...... I.
.-
_'50
STRATEGIES
FOR RAPI
Economy -1-; Eco ov . ;
~~Nature offlwwal
cause: (a).Inrcrascsin oil prices
Naftre ofLalikt or rescue Insolvent isttutions weas
dt-ress .~*-PhiUippinas,---- :. Amongsmaller finanacalinsti--
i- 5;- :1981-87
-.
wituuons, comprising7.6 percent
o- deposit money bank assets,w 182 iilai In a In,a~~~~~~~~ddizio erment intcrvened in thc two largestp bli f
'
private banks, accountingF
.Ilb)
more than two thirds i of the. asset. s .-.ofde|itnolney ban.
off by ie deposit insurance deterioration'i he an cc corporatio. tenms oftradc. -banks. Th 2 publicbankswere. High concentration oforestu-c-tr: in 1986, and their. lending to relate par, adporios wcr put und raa tienes and inadequate : epate agencyunder over
nd international interesi rats, coupled with
liquidated and depositorspaid
j .--i4, r-
-- ;;:-.By-1986, centl b:.lcassis--e.- :;: -- -- :-.tance to financial nstirudons am9-:outto 19.1 bmiion pesos ; . E .!. y:. Sor 3 percent-ofGDP.i
piud al rigon mMnaeent. Five private and--:suevso, . bak reaie under......... direct.. c tral-banlk !ene'X ~~6-.~ supervision;:
t;meat
i;Turkey.-
- .'.198245-8 5
-' '-:',.
:-
Afinancialcrsis Aeruptedwith: ~Inadequate prudential

the
collapsc
ofsal brokers, =
-adfeba weres dara
Thegovernment recapitalizedthe--a banuks an'd isisted onthe-ir op-opucrurt, erriaires
'-
superision.----
5. .-.- 8-
:- ~
re+ xc=ured. .> ,Uwe Strs .

'Of
.-
*
.(a)Predominat &wewa
rea esat pru
on its prudential regulaons.

'
appodirel 4,500
175 liqudated. n -:ofanks'aserand .21982-87. bank, spcltv A meried1,575 'andfi eriarporen~ b1~! upcr ;N ; E >- -'-troubl in 1987.tec en 1982 - loans:;; - and1988, e ou 424banks
-'1.
Simia approach tora oth in S&Lgoemn-e FedraDeoi Isrc-).

themers'nd.rnew'ana2ei-
banks(a d od
nce :Corporation l riquidated~

x!srctn&-
~~~~~-:.M' fiwxra.ouc'acdequateat
sp
X i57s9-89;
;
Sincel9i epe ~ ( ~ ~ ~ ~~"rceve Berien 1 D988, about 1,5O6 ..f :-'.:(ofES,147) S&Jwre 2 l 98Ireiducedrhev ~~ aluc -;ur;;IeC&porons.ised al crisis uptea wid-n T :i
S&Ls)
.-
4>
. i
~~ ~~
-!;4 -.
Q f, . .
'. ''
i
. _
1989 w over60 _-~0 -- (o ne 1~ fift oif~ ~ were solvent -'.Toed
mcesineetrob 'to poo7r-q,ueprtc~ alr ecerpaid t depostors,.
er
liaosoS
.
-- A.
r. noe
...e0
L a
acquiredw
.
- ' 'D?.
..
4..~.,
of
~~~~~ (~~~~~~iarioi1987.sB KiCwewn198 (19)lindz ,~ i: _lrg ,b=., 6

.VV~'p
-
(96;Seg(18A9)Sii&ae CO'.rbn
~~~~ inic vi aennas supervision; let
costs'OLcLa.ofA.Lupec,rtsoFGN t 1 ~~~~~~~~~~~~~~~~~~~~ !ei2 ge ioanC.Q'I otspJ additionlg' up
~il~jii15o
,
~S'
ibi-i,sl9
'
4A '
'f* _
'
__
,_
.A.,
-:'
~US-$13 bilion
r22
(b Dergultion ofS
,s, -t rb -7 >'thertJ5Ss of
,,
.4-0
'
'
S&._ .- to le_h ' -
~~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~
* g f
~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~
Table A5.6Comparison ofBa nkingSystem ConcetainRto

mi
&rp
_.e
.'
,.
Tnw
.;g
ka
ses
-tuSI Hmlshnet Indaish lapi ' KcrsRep.J d qi _ ln
E 75 2 41 77.7
-.
~~~193
28-54 15 94
59
40 50 56 6
690.10
37
.2
1.-
0,0.1959 .00
2: 60
'51 61 7.
D IO P 0i-.,
: >;
~~~~~~~~~~~~~hil.,nd . 359f8 9 56 Pidais ~~~~19116-U

-
66
40
72 4
t, O.26
CLOW)
hipln
3986-U
t<N-x-~~~~~~~~~~Dhlds) CA"ac '.19156-111-
tips-Y;an
74w 20..
(UGh
U.f:t
90
0.50
52
X=atbr i
l O s-u
;
,
g
.
! .9! i
5.
6CM.
0040
.Camdz, Pane *. .
-
2989 1989 1359U

-
' ~50
5~~~4 .43
6 69,
41
431a
-
LU
as
993
.r
S'ahgznbnd
.. ,
~~~ ~~ .C. ~
~ ~ ~ ~ ~ ~
~~~1383 .. ~~4enua1abJc
-
71
:2
. tlkHcdnMiI main&Inedbna~iuIl.,w Sahi
,.M.Ifbbrh
mAh6hIfl6&lkj
d k=ni htl
.~~~~~~~~~~~~~~~~&cw
DdU n(Ihhkaa& higuhie Saif wn(5
cineanmtflrKd ktmdinfrask~.~ah.k indah SmwcnSm d Iph.Pn ISbehbrasO tnzh,S),, baptvv I [naMti cm(x9kzphw,JnJ wi 3,nishll
klptn
3
u~~~~~~~~~~~Ti,;
.-
76
*~~~~ ..
~~~ ~
;
W..~~~~~~~~~~~~~~~~~~~~~~~~ cs~~~~~~~~~~~~~~I
-.-
~~~~~~
.20.
3.8
67X,
4:02
~ ~ ~ ~ ~ ~ ~ ~ ~ .91 r ~ ~ ~ ~
Iy
**
.7
-.
- -
FOR0 RA,_ STRAT~~~~~~~~~~~~~~~~~~EGIES s F ST1_s;RAT ~~~~~~~~~~*
:!i
HPAErs Selected Banks, of Commercial RateSpreads -.TableA5.7 Interest

tS @ S ;.^r > ;= s -i < z . r = ~~~~~~~~~~~~~~~~~~~~~~~~~~~~.. ........ P > la .; s;] s r _ps
i ;J1980
*',i-i#t.. -3, 21. .. -; ; '1;'; , '; '......... l'-' '....................
09' I--1 r199 Silg9O8|e

0 1' r a ,s; _L _N
S @ 03e2 -7.0 -- 0S
to
. r ."5
;~~~~~~~~~~~~~~~
X .. @V
i or:ptnsn<SiXpn:-il-cl tclHai-ners
6
ac:
L&enm&at ~ 'calS' tMposrnt'ctsaresweaswond;El}i

-1aitltwo
s4 i
. .;r4,4
;;
:/_~~~~~~~~~2
4
x,,ua,o.lpoxasedr lGo e s.v
- . X .e.
>nfre.
.l
fl,c.,.
<,>3.g,c<anddwoslE.!
kV'N we;ostffnsfrIhln,&-
-tasta;6OrM-.7;Ft..f
.- ,-~~~~~~~~~~
tiluo,,.ii.rn=ii
-::~~geed
.te
-r7- 4 . .- -.
:-
. -IR_AL E5
EE
Table A5.8 Outimes of Major Policy Implem on inancing Institutions

-Aals a
-~~~~~~~
(Af it I
..
-.
-. .
< . ;.
U..e
.0,--;0Dl
nnii7.5pantna..d
-
Bath(
-PtN009 '
De
0rWSM7mIlm, (
M3 manC4 - (GO~~~~~mt) %nr .

;
--
bafowa nd. Acwith bath.
Pksci.fwpa&M.y-
;f0Q00Q.--
.4n
~tirl;.u;
LnU1S
, fterstssX n1ef
MO
UmmlUll 23
Fw* %
'1135~~~~~~~~~~~~~~~~~~~~~~~~~ii
-u
wi4
17a= l,
.*, raEd
**
*t
Ewe uneur
Das.
'-
hAS?bik
we-'
5, p=^
'
nrlmam4ea
Iaaswmi-aawha-uda h-
t2 * tss9,~lnsgTe 05, C
lat l
,x
,
b;;-l -l,e A, t ;r .-{lwace

.-
h -
iicrs)
n . n- ,--s
.
inpesmu,
e mmdmmBan Mas.s-~
(US$3 LEADe 38) H - 351 ,Wtau

,
r6'w -S>
'f,
'MWkm~ ;
,.
ra
rtu7
'tn
-m'. ''
-to
DcbuaP.aceD,adepeet. BakefMaLquh r"T"'ad
(US$54
821sata
W"
i-:)k
.huu !
haEraw$
hp
0;..
beta-1usdm b*r
.................. ;
M s'.-
15*41=
~ ~~ ~
~~~~mylwdncg
pre:,:
iu
Saa,Dwqscfa
(383fpm f6ai,na
Ouse
aena,iacpehfehtd
cMa&aashqm
na
.' "~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~w
(U
. -
-'ps, 1
1.!
F.
..
:w
aucef,u
DZI~hhy
_~
~~ ~~ ~~ ~~ ~~ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~i.anuctl&nl
...
254
-. .. ; , .
. .~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
.e
ST RATE GI ES
FORRWD
notAum
bnal.pnwant nkdkdw Phllpphim (inw) .
56Na'.".mnouvkt aayTciamr
-17MpcLIpa:Dad.xemowwt
UISI
WUDNW
Caa,g--st
salmawn4 younfixwmldtus Hai,

3
Ealcmwmaai ma
25dluftolankga.safaw,
*. .
Ml~~~~~~~~~~~~~naCr)
-. .
fhlsi5p).Amam 1ka(vn$
'ra'.
Cia... lwx.~
~~~~~~~~~~~~~~~~~~~~~~agmriaa ftfiwm. Fwre io

. . .
taandeatnamI &Wtuat.,.
L U.Jm..
...
flakdC.ma,wdcttaaa. .. I
-. -
Psunatatd
..
~~~~~Damu-lag rumtht ptwmsnt.
M.&Sns-toharm
spn
Indian]
Capstans: Jlbadand
Rime.
~~~~~21.1 raiKonbAixtaIwna ~(USSLIS ils.)
hAlfpnaee
Ova.sbmmPt-gbaii.ouwbg fa pnaar'AaSlak
- -isllh-
s.leantam line. fiwrdxsA aee nmt& nxd.dbamd mAman
Back fhcAgcdswc (MAO
~45JW KWon
0(W)
54 pm--
Drpsu
(W1i5tPSmaxlonwund-
PiLbSzaa aghhinAxn
G Na'orSbn Haaxid2781 .easmatn
snaenntw
ix ai
t 13tmx
aotnaan
=it
dndaif.d,136
(n
bnvarFan&nsn lelmnaina Rantm (199011. nc.Ceainul lash ripen Exap nImpaMllk a Japa bmtlwa kandblnkLTuixwaLnz h Eaptut-ap Bank f,V bases mixs dhcDdJchi Kangac Dank. lad. Malayt, teat] banksa.iaa.Dn fllnAadRps 33Twhfpa.Ca ai u.uo Iqi Bthtapnbahndoknet Japa Cntlnmmod Kot.spaeqtaa(nip am TDank 52ldr. w mi lee N.re hl~C"lbakum T a
Novtes
1. See chapter 6 below for a mor'ederaileddiscussion of the relationship between educational expansion, the * growth of labor demand, and the educationalstructure of wages. * 2. From aross-economny school expenditureequations esinared by Schultz (1988), the elasticityof enrollments with respect to the relativeprice of teachers is -0.80 and -0.70 at -theprimary and secondarylevels. 3. Of courseGNP per capitais much higher in EastAsia than in Sub-SabaranAfrica.Becauseof the bias that results from using exchangerates rather than measuresof purchasingpower parity, we do nor attempt to weigh the effect on costsof higher GNP per capita against the effect of lower teachers wagesrelativeto GNP~per capita. 4. the relationshipbetweenthe abundance ofthumnan capital and reachierpay is not firm. In Korea,~where
CRACL E
human capital is most abundant, the earningsof primary teachersare roughly 5 times per capitaGNP.However,because pupil-rcacherratios are higher in Korea, operating costsasa perccntageofper capitaGNPare, at 16.5percent, not much higher than in Indonesia and Malaysia,suggestingan important role for policy both in determining teachers' vage and in controlling costs. Sec Tan and Mingat (1992), pp. 28-34.
1O;Given the smaller size of the basiceducation age cohort in East Asia than in Latin Amcrica (see bdow in underestimatesthe gap between chetext), this difFerence the nworegionsin the strength of dte public sectors commitment to basiceducation. 11. Howevcr,since the mid-1980s, public savingsin Argentina, Brazil, Chile, Colombia, Costa Rica (since 1983), and Mcxico (in 1987) have incrcasedin response to fiscaladjusrments,leadingnationalsavingsto rise (an intcrnal World Bank report). 12. In Japan, by managingexcesscompetition, industrial policymay havealso assistedir the stabilityof financialinstiutions. Japan's recession cartels,fir example,may have avoided large and systematic bankruptcies,which surely helpedthe solvencyof financialinstitutions. 13. The danger of casing intcrest ratesand entry controis without simultancously strengthening prudential regulationsand capital adequacy requirementshas been evidenrin Indonesia, where low capital requirementsfor entry and poor enforcementof prudential regulationsled to mounting concern about insolvenrbanks. 14. In severaleconomies, the risk was aggravatedby the banks' tendency to speculatein securities.TableA5.4 shows that the major source of financial disruptions in Hong Kong,Malaysia,Thailand, and, recently,Japan was real estateand securitiesspeculation.
5. Implicit in the calculationsis the assumption that

expenditureper pupil would remain the same even if the growth of the school-agepopulation was faster. 6. There may also be problemson the supplyside-inadequatecapital marketsor entrepreneuri deficiencesthat limit the private provision of educational services, Psacharopoulos,Jimenez, and Tan (1986) present estiSee mnates of private and social retrns from education. Behrmn Psacharopoulos (1993)for morerecenrestimares. (1993) citesthe manycritcisms of hese estates, indudingtheir failurcto acoountforabiityand forqualiy ofCeducation. Neither he nor others, however, question the existence of some gap betweenprivateand socialreturns. 7. In fact, it is difficultto distinguishcmpiricallyb-i of nor being able to borrowand the eftween the e1*lrEs fectsof poor inbrmnationon the demand for schooling8. Governmentexpenditureon education,exprssed as a percentageof GrNP,was used as an explanatoryvariable
in a cross-economy regreSSionin which expected years of
15. Stiglirz(1993a) notes that in economiesin which governments do nor take an active pro-competitive stance,there are a limited number of firmsin the banking sector.Furthermore, evenwhen there are a large number of banls, e&ctive competirion (if viewedfrom the perspectiveof the receiverof the financialservice)is likelyto 9. In Koreaand Taiwan, China, the share of public exbe limited,This is becauseinformationpertinent to a sinpenduimre on education allocatedto higher education has gle borrower is specialized,and each of tie major categories of loans represents a diffcrent product markerk increasedduring the lastdecadeor so for two reasons.On the one hand; universal and near universal enrollmrient There are differencesin the kind of infbrmation that is rateshavebeen achievedat the primaryand siondary levneeded across product categoriesand few economies of scope across the categories. Patterns of specialization - , respeccively. On the other hand, the increasehas been consistenrwith the shift in the strucrure of production among financialinstiturionsconfirm this view. - and exports to more technologicallysophisticated and skill-intensiveproducts, and die consequent increasein 16. Data on quality are extremelylimited,but availthe demand for engineersand other skilledworkers. able measurements suggest that infiastructure in the an aggreschoolingof the school-agecohort (essentially gateof enrollment rates) is the independentvariable.For a sample of fifteenAsian and Latin Americaneconomies, the expenditure variablewas insignificant.See Tan and Mingat (1992). -256
STRATEGIES
FOR
R_
may be of better quality than in other developing economies.Table 5.7 shows the percentageof roads that -arepaved in a largeselectionof low- and middle-income economies.
HPAEs
enterprisesin Indonesiaand Malaysiahave reported difficulies becauseof a growingvolume of arrears. 23. For example,in the 1950s and 1960s, the ratio of and bad loans to rotal assets of JDB was lower write-offs 1993). The Dethan private commercialbanks ODaIJERI velopment Bank of Singapore has evolvcd inro Singapore's largest private commercial bank, largely on the basis of its excellent financial performance (Gordon 1983). Yaron(1992)suggeststhat traditional financialindicators may not be the best indicator of peformance of developmentbanks,since they havebeen establishedwith developmentobjectives.Hc mcasuresinstead the degree of depcndence of developmcnt banks on subsidiesfrom the government. With some exceptions (for example, Malaysia'sBank Bumiputera,Indonesia's Bapindo), the HPAEs'developmentbanks are self-reliant. 24. There is remarkable umiformity in the pattern of investmenroutcomesexceedinginvestmenteffortsamong the fiveHPAEs in the sample.Malaysiais perhaps the least representativcin the sensethat during the 1970s(and up the real to 1982) the nominal investmentshare cxceeded investmentshare. All five economies, however, had real investmenr shares that exceeded the nominal share between 1982and 1985. Korea continued to show a declining relative price of investment goods throughout the 1980s, while Thailand had a major increase in relative capital goodspricesin 1988-89. 25. De Long and Summers (1991) obtain a similarresult for the relativeprice of equipment (to the GDP deflator). They predict the realequipment price for the sample of sixty-twoeconomiesas a function of relative1980 GDP per worker. Of the six HPAEs in-their sample (Singapore and Taiwan, China, are excluded), Indonesia and Malaysia lie dose to but above their predicted values; Hong Kong. Japan, Korea, ancdThailand are all significantly belowtheir predictedvalues.Real equipmentprices are unusuallylow in theseeconomies.
17. There is a large literature not only documenting the relativeunimportance of equirymarketsas a sourceof financebut also explainingwhy this isso, both in termsof the evidenceconcerningthe negativeeffectof share issucs on share price and in theoretical terms. See Stiglicz (1993a). 18. Long-term credit banks, but not city banks,issued coupon debenturcsof arnaturityof fiveyears,and this has to the segmentation of short- and long-term been centrml finance (Packer1992). 19. Korea's bond market has been expanding more than other East Asian economies,except for Japan. But most of these bonds arc government guaranteed. Firms have begun to issue bonds, because governmenc has begun to control the debt-equiy ratios of largecorporations (an internal World Bank report). Many of the corporate bond issues may be simply a form of bank financing that carriesa government guarantec. 20. This is known as the price discoveryfinction of stock markets. 21. More substantial long-term lending to industry has been carriedout by other developmentbanks (for example, Eximbank, the Small BusinessFinance Corporanon, and private long-term credit banks). economicswith 22. While the experince offEastAsian developmentbankshas been generallypositive,there also have been failed development banks. In Japan (Reconstruction FinanceBank in 1952) and Thailand(Industrial Bank in 1959), insolventdevelopmentbankswere closed. Development banks lending to srnall and medium-size
-.
.~~~~~~~~~~~~~~~~~~5
0;
R 6
Using Resources Efficiendy: on Marketsand Exports Relyiing E

T IS APPARENT THAT THE HIGH-PERFORMING ASIAN
economies were unusually successhflin strategies to achieve rapid accumulation. But high levelsof physicaland human capital formation are not a guarantee of economic success,as the modem economic history of the former Soviet Union and Eastem Europe sadly attests. Resources, once accumulated, need to be allocated to high-yielding actirities. This chapter first considers the strategies, explicit and implicir, that the HPAEs used to achieve efficient allocation inte areas: the labor market, the capital market; and international trade. It then turns to industrial policy-deliberate, governmentwas an sponsored interventions to alter industrial structurewhich and asks whether important feature of public policy in some HpAES, these efforts have resulted in superior economic performance. Finally, the chapter considers the role ofmanufacured exports in promoting the demand for skilled labor and the acquisition and mastery of bestpractice technology.
EastAsia'sEfficientResourceUse Explaining
0 t|HE
absorbed unprecedented rates of growth of physical and human capitai for thirty years. As we showed in chapter 1, all of the had total factor productivity growdt that exceeded that of more HPAEs than 70 percent of developing economies between 1960 and 1989, and the Republic of Korea, Hong Kong, Malaysia. and Taisome-japan, -wan, China-had among the highest rates of TFPgrowth in the world
259
HIGH-PERFORMING ASIANECONOMES HAVEEFFICIENTLY
_EE
[+
~C LE
This means that fictors, once accumulated in the HPAES, contributed much more to output growth than would be predicted on the basis of the average performance of a broad sample of economies, both developing and industrial. -How have the East Asian economies succeeded in using resources efficiently? Good fundamentalsagain tell much of the story. Price distordions, while present, were limited, and markets were allowed to work HPAE governments have relied primarily on market mechanisms to guide allocative decisions in both labor and capital markets. Labor markets in the HPAEs have been remarkably flee of the interventions that restrict labor mobility and create small, high-wage elites in other developing regions. Whle capital markets have been frequently controlled, resrictions on deposit and lending raceshave generally distorted markets less than in most other low- and middle-income economies (as we demonstrated in chapter 5). Government efforts to direct credit have generally been undertaken within the framework of moderate interest rare subsidies, and financal institutions have been given the final decision on the creditworthiness of investment projects. This has meant that loans supplied through directed credit have been monitored and generally have been repaid. The relative prices of capital and labor have broadly reflccred their relative scarcities. The HPAEs have also used the international economy more effectvely than many other low- and middle-income economies. Each of the HPAEs, except Hong Kong, went through an early phase of protection of impo rt-subsituting industries. But these policies were later modified by reductions in import controls and tariffs, combined with strong incentives to export (see chapter 3). This opened up much of the modem economy to international compeiition and introduced world prices as performance standards, not only for exports but also for tie intermediatc and capital goods used in export production. As a result, domestic prices for traded goods in the HPAEs are more doseJy aligned with international prices than in many other developing economies. Apart from these findamnentals, however, most IIPAEsseletvely intervened in financial markets and used a combination of policies to promote thc development of specific industries. Most HPAEShalve directed credit to priority sectors and sometimes to specific firms. Where these programs have been effectivein -allocating resources to high-yielding investrnents-for example, automatic credit for exporters-irt was because allocation rules were performance-based, and borrowers were ac:26
USING
REESOURCiS
tivelymonitored; in short, effectivecontestswere created. These condi-tions have been more-common in the three northern HPAEs that have strong governmental institutions. * 0 Indonesia, Japan, Korea, Malaysia, Singapore,and Taiwan, China, have tried to use targeted industrial.policy to promote the development of specificknowledge-and capital-intensive industries.We test the relationship between industrial policy and productivity-basedcatching up and conclude that industrial policy has generally nor been successfulin changing industrial structure or raising productivity, What, then, has contributed to the iPAEs' apparendy superior performance in adopting and mastering international best-practicetechnologies?We argue that the combination of compedtive discipline and well-firictioning factor markets with a pro-exportorientation-the export-push strategywas responsiblefor their supeemployed by all eight of these econormies rior productivity performance. Manufacturet exports acceleratedthe acquisition and mastery of international best-practice technologiesin highly imperfsc international technology markets. Hih and rising levels of htiman capital in the
especialy the superior educationd atminment and cognitive skl HPAES,
of the industrial labor force, helped to ensure that these new processes Thus export orientaand equipment were used and adapted effectively. tion and high human capitl formed a virtuous circle;exports raisedthe raisedthe retuns from exporting. returns from education,and educationi
UsUsng the Market Labor Markets in East Asia

5
xT
rILE
HUMAN CAPITAL ACCUMULATION MAY BE A NECES-
condition for sustained rapid growth of output and wages,it certainly is not a suffiaent condition. The Philippines, the republicsof the former SovietUnion, and Sri Lanka arepromithat have had high school-enrollmentrates nent examples of economies but low rates of growth of per capita income and of wages. Utilizing humnancapital in activitiesthat yield high returns on the prior investment in education and training is as unportantto growdhas the accumulation of human capitaL
We have fiequently looked to coordination turilures in markets to
understand why public policy might be used,to help markets function

-;
0 ~~~~~~~~~~~ -
,'','
e!'kCLE
better.In the case of labor markets,however, coordinationfailuresare

limited, and information, although not perfectly symmetric between
workers and employers, is betterthan in capitalmarkets.'Extenalities, aswe showedin the previouschapter,primarily alTce investmentdecisionsin humancapital,not interactions in the labormarker.Thus, there is a presumption tiat, ifleftto themselves, labormarkets wouldperform theircoordinating (allocative) rolequitewell. Twoconditionsmust be fulfilledfor a growingsupply of educated laborto be utilizedin high-retumactivities. First, rheremust be rapid growthoflabordemandrelative to supply and, in particular, of demand forskilled labor.Second,thelabormarketmustperform well.It must be efficient, flexible4 and responsive to changing conditions so asto ensure thatworkers are employed in jobsin whichtheirskillsaremost productively utilized. If thesetwoconditions arenot filfilled,thereis a riskthat rapideducatonalexpansion may resultin labor marketproblemsdtat erodethe benefits of human capitml accumulation and havea seriously
adverseimpact on the growth of output and wages.
In ourassessment of whyhuman capitalin FastAsiaappearsto have beenefficiendy utilized and whychanges in labormarketoutcomes have beenso fuvorable, we focuson twofacors:the dynamicsoflaborsupply We alsoexaminethe interand demandand labormarketperformance. actionsbetweenthesetwo factors.Then we consider whetherthereare
any common denominators in thaepolicies of East Asian governments that have contributed to the efficientutilizationof human capital.
Labor Supply and Demand in the HPAEs Shiftsin theaggregate supplyand demandfor laborin EastAsiacomparedwith otherdeveloping regions haveledto morerapidlyrisingreal wages(seefigure6.1).East Asia's morerapid rate of increase of wages, following an initialperiodduring whichwages did nor increase, .is the reslt ofslower growthof supplyand morerapidgrowthof demandfor 2 labor. Fora givenrate of growthoflabordemand,the slowerthe rateof
increaseof labor supply,the bigger the increasein wageslikelyto result
from competitive pressures in the labor market. One measureof the dampening influence oflaborforcegrowthon the rareof increase ofreal wages wasobtainedfor a crosssectionof twenty-two economies in the 1970s; a 1 percentincrease in laborforcegrowthresultedin a 1 percent declinein realwagegrowth(Gregory and Lal 1977).
z6z
USING
RESO5 RC
Figure 6.1 Increase hi RealEarnings

Japan Rep. of Komea
;-
[
__
l 0 I
.
Tawan,nChina HongKong| Singapore Indonesia
7=
-Z
.
}
Thailand
- -
}
1SrO.:It
Latin Amneuca and Certhean FSubSahIranAbica d980-90 -'At
mi
0 1
1
I
-t
2 3 4 5 6 7 8 Increase Inrealeamings (p'e.nt)
10
11
Nwc ldIdoc for Taiw2n,Chin= 1979 = 100. Other Asiancconomicsarr Bangladcsh, India. Pakistan,and the Philppines. SouwreWorld Bankdacvi Taiwan, China, National Stistcs.
Labor Force Growth. During their period of industrializarion in the nineteenth century, the populations of the currendy high-income economies grew, on average, ar an annual race of only 0.8 percent.3 Today, the population of Sub-Saharan Africa is growing at roughly four times ca rate; the populations of Latin America and South Asia are growing at romughly three times that race. Only in East Asia have populaton growth rares, and the share of the population less than fourteen ycars old, declined to levels 4 approaciing those that prevailed in the high-income cconomies. We have already seen how the early denographic transition in East Asia markedly reduced the rate of growth of the school-age population to levels well below those in other developing regions, thereby easing the financial burden of maintaining education enrollment rates. The early demographic transition also reduced, with a lag, the rate of growth of new entrants into the East Asian labor force. The annual rate of labor force growth during the 1980s was 2.6 percent in Sub-Saharan Africa and Latin America and 2.2 percent in Soudt Asia. In East Asia the rate was 1.8 percent (see table 6.1). The labor force growth rare in Singapore is only 0.8 percent, about the same as that experienced by the highincome economies in the nineteenth century. In Sub-Saharan Africa the rate of labor force growth continues to increase. In Est Asia, despite increases in the particpation rates of women, labor force growt rates have been declining much faster than in Latin America or South Asia.
263
RACL E
Table 6.1 Labor ForceGrowth Rates

Ecenomy,vfonegjn.
J--.90-85
1985-2000
H; , s;Indonesia: . -~ -; Rep.of.
t'rKc,
Malaysia
.. Sinore
2.5 -2.4 2.7 2.9 1.9
Thailand
thAsria L4 in Am6icai ST--S m2ranAfr. .
-; bhea-n
:
2.52.2 2.8
2.3
.-
1.8 2.2 1.-9 2:6 0.8 1.7 0-
2.2 2.6
2.6:.
S are WorldBank(1987b).
Growth ofLabor Demand. Not only has the growth of labor supply been slowerin East Asia than in other developingregions, but the growth of labor demand has been faster. For the period 1960-90, the rates of growth of wage employment in manu&cruring construction, and services have tended to be substantiallyhigher in East Asia than in SubSaharan Africa, Laiin America, or South Asia. This is not because gowth of employment has been unusuallyslow esewher Widt the exception of the 1980s, during which output and employment stgnared because of the macroeconomicadjustments made necessaryby debtserviceproblems, the pace of industrial sector employment growth in Sub-SaharanAfrica, Latin Arnerica,and South Asiawas more than double the pace in the currentlyhigh-income economies during the perod 1880-1900 (see table A6.4, at the end of the chapter). Rather, the interregional differcnce reflects the unusually rapid growth of employment in East Asia. Even as it has been growing rapidly, labor demand in East Asia has become increasingly skill-intensive.As a share of wage employment, white collar and technical employment increased steadily during the. 1970s and the 1980s;in Korea,for example,it rosefrom 29 percent in 1980 co36 percent in 1990, and in Taiwan, China, from 32 to 40 percent during the same period (seetable 6.2). The pace of change in the
occupational structure of employment is lower in other developing regions. The change in the occupational composition of labor demand in the HPAEs reflected increases in the abundance of educated labor, and consequent declines in its relative price, as well as changes in compara-
264
USING
RESO-UE
Table6.2 Professional andTechnical, Administrative andManagerial, Clerical, andSalesOccupations as a Percentage of TotalEmployment e

i
Kora,JRp of
-
Shngapore
Tariano Chbina
1980 29.0: .1981; 292 0 S-; 198200: f - . 30.6: 0 : 1983

-1984 1 l985*. :-1986. - 1987 2
-1 98 8:. . . : ,1l989~0 0
;1990_
42
-42.8 . *;: -;-44.2
31.8
32.7 33.1 33.1 33.7 34.2 34.3; 35.1
37.2 X
30.8 .-- 0 -
32.1 32
34.3ta;; -
45.6
-
34.3.3 34.1
34.6
36.2
379
-
46.5 - |--.46.5 46.247.0

.-X
46.1
- 35A4 ~> V - -? -
-t-46.8
60.0
38.5 39.8
-
* /
r'-_Notvanilablc;
aToml employment forHoneKongindudes Linmployed whohavepreviously bald K Iidudes serviceworke Somiwfe::ields : (1993).
-X
tive advantage. East Asian exporters shifted into more technologically sophisticated, skill-intensive goods as rapidly rising wages of unskilled labor eroded international competitiveness in labor-intensive manufactured goods. What accounts for the extraordinary pace at which labor demand, a-nd in particular the demand for skilld labor, has expanded in East Asia? Since the demand for labor is derived from the demand for output, the explanation must be sought, in the first instance, in those factors that contributed to East Asia'srapid output growth: high rates of savings and investment and high rates of return on investment B at it is also important to consider the extent to which the path ofgrowth of output has been more labor demanding in East Asia than in other developing regions. As we shall see, the dynamism of agriculture and export-push stratcgies contributed to rapid increases in the demand for labor and to rising skill-intensity of labor demand.
Letting Markets Woric Public Policy in the Labor Mardt

The term "labor market?' generally refers to the complex of interactions between employees and employers. The labor market thus bears the responsibility for melding the changing needs of the economys pro265
iR_ACLCE
skillsand preferences of laborforce with the changing ductiveapparatus participants(Berryand Sabot 1981).In the courseof economicdeveltraining, educational, opment,workers-most of whom are following and vocationalpaths differentfrom precedinggenerations-tend to shift toward more dynamicsectors,from self-employmenr to wage5 flexoccupations.An efficient, and towardhigher-skilled employment, labor market allowsrapid matchingof skills to ible, and responsive needs, improvingresourceallocationacrossfirms and industriesand thereby contributingto growth. Whilein most developing economies, labormarkets havetendedto unctionratherwell,wherethey havenot, the costshaveat timesbeen high.7
In East Asia, more than elsewhere,governmentsresistedthe temptation to intervene in the labor market to counter outcomesunpalatable
where wages below in the shortrun or to particulargroups(forexample, or the emtheyoughtto be, educatedunemployment, workers believed
ployment of educated workersin lower-leveloccupations).A relatively
by allowof laborwasachieved in the allocation high levelof efficiency by the interaction to be determined largely ing wagesand employment ratherthan by of thosesupplyingand those demandinglaborservices, or unionpressure publicsectorleadership, legislation, government Markets Perform? How WePl DidEast Asian Labor in the demand for In EastAsia,wageswerepulled up by increases elsewhere there was a greatertendencyfor wagesto be labor,whereas Earningsgrowthwas determinedmore by the pushed up artificially. growthof the economy as a whole hn bygrowthin anyparticularsector (Fields1992).In economies with highlysegmented labormarkets, the opposite is the case. the price of laborin Labor Markets. Bynot allowing East Asia's Flexible somesectors to risewellabove what workers couldearnelsewhere in the laborelite. avoidedthe creationof a high-wage economy, most HiPAEs for Taiwan, China,of a remarkably inteFor example, thereis evidence grated labor market; there is no significantcorrelationbetweenthe Manuand the growthofoutputwithinsectors. growthrateof earnings &acuring wagesfor unskilled laborare only20 percenthigherthan agriwhere labor Lulturalwages.By contrast, in Colombiaand Jamaica, markers are highlysegmented, workers with the sameievel -ofskillearn wagesthat exceedagricultmral wagesby 150 percent nonagricultural 266
USING
-R
(Fields 1992). Still larger intersecroralwage gaps have becn observedin East Sub-Saharan Africa (Ranis 1992). Another noable feature of the -structure of wages in East Asia, as illustrated by Korea and Taiwan, China, is the modest size of the gap betweenskilledand unskilledwages in the nonagriculturil sector (see figure 6.2; also see Ranis 1992). The small gap did not result from minimum wagelegislationpushing up unskilledwages.Rather the growthof demandfor unskilledlabor, in combination with marked increasesin the abundance of educated workers, compressedthe occupationalstructure of wages. One benefit of the compressedwage structure in the HPAEswas that it reduced the incentive for educated workers to conduct a lcngthy search for a relativelyhigh-wagejob, and thereby remain unemployed, rather than fill a job slot at a loweroccupational level.Conversely, a segmented labor market may provide an incentive to workers in low-income employment, and to the unemployed,to lobbythe governmentto provide more high-wagejobs than justified by the derived demand for 8 Thus, the share of the public sector in the increasein total wage labor. employment in recent decadesis a crude indicator of the magnitude of 9 As public sector surplus labor, and hence labor market segmentation. table 6.3 shows, in all the Sub-SaharanAfrcan, Latin American, and South Asian economies for which data were available,employment in the public sector grew more rapidly than wage employment in the privatesector. The median share of the public sector in the increasein total 0 employment was between71 and 87 percent.' With the exception of Malaysia, the experience of tl-e East Asian - economies is markedly different. Omitting Malaysia, the share of the public sector in the increase in total wage employment in those Et Asian economiesfor which data were available was lessthan half the medi-anshare for other developingeconomies.The limited growth ofpublic employment in these East Asian economies is evidence that public surplus employment has been kept in check and stronger evidencethat the scope Sorlobbyingfor make-workjobs has been limited. The need to maintain international compeitiveness helped to limit growth of V public employment becauseimporters who purchased intermediate inputs from public enterprises lobbied for low prices. Moreover,governmentsstrivingfor macroeconomicstabilitystricdylimited the sizeof the public enterprise deficitsthat they would finance. In-Malaysiathe share of the public sectorin the increasein tota wage employment is as high as in other developingregions. The increasein 267
1Figum 6.2 Industrial Wage Gaps

-~~~~~~~~~~~~~~~~~~~~~~~~~~~~t ' . ' Wage a Taiwan,Ch._a earings (thouK;mds of 1955 NTS) Meanmonthly '
..
~~~~~~~~~~~~~~
:~2~
....
T-
to-I
-l
rea walp
O.
IF=
F4
--
~~~~~~0.5-
| I
'
]I
I .
UnakflledlIndustulal realwags4
0.0
1953
!
1955
X t
l9S7
f
1959
1
1961
11~~~~~~~~~~-MeradusLnduilrsalwags
1963 1965 2967 1969 2.971
Wags gap, Rep. of Korea Moan monthly eamings (thousands of 1975 won) 40
10
_________
I
1965 1967 1969
V
1971
*I
-.-
Unskilld
odustrialreal wa
Average Industrbl reawuge
1963
1973
1975
1977
1979
Sounrs: Kuo (1983); Taiwan. China (various years, 1988); Korea (1978); Kim (1990).
26-:
USING-RESOUIRCE
Table 6.3 Cmwth of Wage Emnployme.t inthePublic andPrivate Sectors, Selected DeveloPing Economies
__ __ __ __ __ _ __ __ __
p b tsector In inrase p/otl wageemplyment
&onorny/~on Peno LnAmerica aznd C"bantbe:

* '
Public 1.4 :6
.
rkwre 00.
,
Toal 0.3
2.
:
-
CostaRica Panama *':, Peru Trinidad` Venezuela Middle ase and Notnfipc Egjp ,
.
~~~19733 1~~973-43. :1963-82 ~~~~1970-44

*
92
45
28353
061.4 12 34
~7.3
6.61-
,.,18
:1970-84 ;1967-82 1~~966-76f

tA
,195
'.
~~~~~51
23-.
-c
37 .
27 103
n*nj.I
Gh~~~~ina
,Keny Tanzania
LZambia
~~196048-734
196381
-5.93-4. 64.2.
~~~196246.
-1966-080
K
6.1' 7.2
--3.8' -r0943
. 1.619
67
India
SnI nka
?
~~~197183"
.
.~~~~~~1960-80 42213.2 8.0
7 09393
~~Thailand
I'
Taiwan,China
'
.:
-196.5-85 ~~~~ 1963-83
6.
23.~~~~~~~~~~~~~~~~~~1
65501 6
..
33,
Unwciglired.mC"ean"
bl'emlyetwsntarsostolbyninud
by2.la0or
mar2-
publennat0.
ahr,pbic employmentEwswns aresons
tolbyn nue
bynlaborcma-
ployment opporrtunities for the historicallydisadvantagedethnic Malay Majority. The Bumriputera program can be seen as an aggressive aflirmatiye action policythat resulted in considerablepublic surplus labor (Freeman 1992). In contrast to many gvrmnts in similar circumstances, however, when the macroeconozmc costsof public employmentbegan 'to mount theMalasian government, manifesting the adaptability that sewedgovernmnents so well -throughout the region,changeddirection.Why Were Eas Asian Labor Markts More Niedble? Rapidgrowthwasake -fcror in making wagesmore flexiblein the HPAEs. Workersaregenerally more willingto accept flexibilityof wagesaround a rapidly rising trend bc&ause downward adjuLstment implies a:slowerrate oinrease rte than an absolu:te declinein reai earnuings, (Shiah and Mathur -1992).This 2.69
is manifested in wage-setting practi ces that tie compenation to enterprise performnance, another example of how the extraordinary hibor marker dynainics in Eas Asia contributed to superior labor marker perforrnance. But some HPAE governiA.."ts also intervened in labor markets, primanily for political reasons, to suppress the activities of industry- or economywide unions and to ensure that wage bargains were set at the enterprise level. We have suggested chat the rapid growth of wages contributed to the explanation of why, in contrast to odchr regions, wages were not maintained above market-dclaring levels in E-astAsia. An alternative, or perhaps complementary explanation is that governments, in collaboration with employer repressed laibor markets. Wage-seuingpractices One manifestation of the link between rapid growth and wage flexibility is the apparent willigness of workers, espediaily in the northeastern economies of Asia, to accept wage structures that include a substantial element of-performance-based bonuses. This' practice links compensation to enterprise, rather than wholly individua perfbrm2nce. It is comnmon for current cash compensation to have two comnponents-a base wage and a bonus (Shah and Mathur 1992). To the extent th at "special cash payments" are more responsive to changing economic circumstances than are base wages, thiis arrangement could help account for the greater flexibility of wages in East Asia than elsewhere. During the period 1958-83 in Japan, econometric evide-nce, shows that rthe ratio of bonus payments to base wage-svaries positively and significantly with such indicators of aggregate economic conditions as cnrporate profits. By contrast, there was no significant relationship between base pay and corporate profits (Freeman and Weitzman 1987). Nevertheless, the impact of changes in bonuses on coral compensation appears to be marginal. Whlile bonus payments as a proportion of total current compensation (15 percent or more in Japan and Korea) or of corporate pois(40 percent or more) rend to be large, the elasticity of bonus payments with respect to profits is small. In Korea, most bonus payments have become contractually linked to the base wage, and in Japan the implicit link of bonuses to base wages appears to be strong (Shah and Mathur 1992). How represseduor H-PAEla bor ma rkeex? Repression in the labor market can rake two forms: dlirec restraint on wage levels or growth (wage represion) or restraint on organized labor (labor repression) with indirect restaint on, wages. Wage repression was dlearly nor a necessary ingedintin -the East Asian recipe for economic sucesThgorn
7-7 --
USING
RESO
merntsof Hong Kong, Japan, Korea,and Taiwan, China,did not repress wages,ant yet in these economicsoutput, exports,and ultimatelywages all increased at rates well above the international norm. These economies were adept at adjusting to changing comparativeadvantage as labor abundance gaveway to labor scarciy. At the other extreme, the and of Singaporerepressedwages, at times quite severely, govcrnmnent the consequent costs of labor shortagesappear to ha'vebeen high, leading the government to abandon. the policy (Fields 1992; Freeman i 1992). Several HPAE governments have reprcssed labor organizations.
Korea, Singaporc, and Taiwan, China, suppressed indepcndent unions.11 Malaysia has independent unions but highly restrictivc labor laws. Hong Kong and Japan do not intervene in labor relations. H-owever, ir Japan most unions are company based. In Korea and Taiwan, China, real wages increased at roughly the same pace as real GDP. Nevertheless labor relations in Korea have been deteriorating in the 1990s, so that labor relations problems serious enough to threaten economic growth have arisen, partly in reaction to repression of unions (Freemanl 1992). In Singapore during 1972-79, r real wages increased at less than one-quarrer the rate of increase of real GDP.This divergence was the consequence of the governmenes aggressive, and quite open, intervention on the side of wage repression in the market for labor1 2 The minister of labor was quoted in the press as saying, "It is clear that an essential clement in our new strategy must be a tighter grip on wage increases.... If we donor tquicldy and willingly change to low gear on the wages front, we shall fisrher discourage investrnent and aggravate the unemployment problem" (reprinted in Fields 1992). * . EIfwagesfall well below market-dcearing levels and employers are prevented by the government from using wargecompetition to bid up the price of labor, chronic shortages of labor are likely to be the result. This is what occurred in Singapore, with the result that the rate of growth of output, as well as the rate of improvement of living standards, declined.. In 1979 the government recognized the costliness of this corsraint and * changed course: a policy of "wag,ecorrection" was adopted with the acplicit aim of alleviating labor shortages and shifting the economy away from labor-intensive and toward capital- and skill-intensive industries. Although the high wage policy was abandoned in 1981, in the 1980s ..the grovth rate of wages accelerated:and matched the growth rate of
SGDP(Fields 1992).271
*CL
Hong Kong repressesneither wagesnor. unions. With respecr to the labor market, the govemment of Hong Kong is among the least interventionist in the world. Despite labor laws that are favorableto union formation and action, union membership in private sector fims is low; unions engage in relativelylitde collectivebargaining and are generally considered to be "weak." Perhaps becausewages were rising rapidly in Hong Kong, workers did not fcel the need for collectiveaction. Hong reKong demonstrates that East Asian economies need not aggressively press unions to have a weak union movement, suggesting,for example, that in Korcathere may have been frw benefits to offset the politicaland economic costs imposed by labor repression(Freeman 1992). to the Japan'sexpenencewith labor unions is another counterexample of labor.The repression beliefthat East Asiansuccessrequiredgoverrnment Japaneseexamplemay be the more tellingof the two becausein Japan, in contrastto Hong Kong,union membershipishigh and unions are, at least potentialy, quite strong.Yetunions did not extracteconomic benefitsfor their membersat the expenseof econornicgrowth(Freeman1992). CoutnIbute to Growth? Labor Markets DidEfficient Fow The benefitsof maintainingwagesat or marginallybelow,rather han 13 FiSt, were numerous and substantial. levels well above,marker-cleawing becauseinflatedwageswere avoided,the profits of firns and, most likely, aggregatesavigs rates were higher.As a consequence,retained earing fiora higher proportion of investinent finance than orherwise accountecd would have been the case,redung reliance ornunderdevelopedcapital markets. The probable net effects,therefore,were higher levelsof investment, greatercompeitiveness in internationalmarkets,and fasterrates of
growth of output, employment, and ultdmatelyeanings.
14
Superior labor market performancein East Asia thus contributed to sustainingthe extrordinary dynamicsof labor demand we documented above.Moreover, by not allowingthe price of labor to become inflated relativeto the price of capital,wagerestraint encouragedthe use of more capital inlabor-intensivetechnology.Ar a means of avoiding excessive tensity,this was particularlyimportant, given that government interventions tended to lower the price of capitaL Efficient use of skilled labor also contributed to the high levelsof publicsector savingsin most of the HPAEs.If the govenment capitulates to demandsfor make-workjobs the subsidiesrequired to finance the te.272
USING
RESOURO
: :
sulitinggap between the wage and the marginal product of labor are likelyto divert scarcesavingsfiom productiveinvestments,loweringthe rate of capitalaccumulationand stcadilyerodingthe grwth potential of 15 For a time, Malaysiawas an East Asian illustration of the economy. this point, but there are manrymore examplesoutside the regionwhere governmentshave been slowerto rake corrective action. If the government provides make-workjobs, squandering the producdivepotential of human capitalmay be another consequence.In the worst case,which unfortunately is quite common, workers in whom a substantialeducationalinvestment has been made are paid the prevailhigh public secrorwage to do jobs in which their maring (relatively) 1 6 In this way creation of ginal productivity is zero or even negauve. makei-work jobs impedesthe processof hunan capitaldeepening that is cen-tral to education'scontibution to economicgrowth. Had the labor market been allowed to functon without intervention, these same workcrswould have entered lower-payingoccupations,and the conscquent mcreasein the educationallevelin those occupationswould have contributed to an increasein labor producdviry. Becausewages were responsive to changesin the demand for labor,adJustent to externalmaaoeconornicshocks,suchas those inducedby the oil crisesof the 1970s, was ofien quickerand lesspainful in the HPAEs
(Mazwrndar,forthcoming). Ifthepriceoflabordoesnotadjustquick-lyand smoodily to macroeconomic shocks or to secular changes in the macroeconomic environment, then either the quantity of labor must adjust or the ratesof output growth or inflation are liely to. In relaton to fluctuauionsin aggregatedemand, employment stabilitytends to be much greater in East Asia than in other rgions, so that East Asian econonies genelly adjust to downturns without laying offworkers (Shah and Marhur 1992).
Assisting theMarket Fnancial Markets andAllocaioDn

-T-L MARKETSSPERFORM THEIR ALLOCATIVE FUNCTION IN
-ways:they aggregate savings, allocate funds to competing and monitor performanc Without financial a_J uneat, intermediation, firms would have to rely on retained earnings to finance investment, so marginal retums to investment would diverge
2173
'.,
..
J:RACLE
Markedly,especiallyin the short run. Thus the policies descrilbedin chapter 5 that contributed to the deepening of financial sectors also contributed to better capital allocation. In addition to private capital markets governmentsin East Asia,like governmecnts in many developing economies, have attempted to allocate credit directly to high-priority activities. Elsewhere,directed-credit programs have been catastrophic failures.In some HPA-Es-parricu.larly Japan, Korea, and Taiwan, China-these programs have caused less damage to capital allocation and may have been beneficial. Our examination of capital market performance begins by documenting the highirare of financial deepening in the H-PAEs. We then describethe nature and magnitude of directed-creditprograms and assess their performance. We show that, where these programs appear to have had the most beneficial results, they supplemented fundamentally sound capita market policie-s with improved selection and monitoring. Interest rate subsidieswere small, loans were repaid, and strict performance criteria were used to ration fumds.These preconditions for efThctive directed credit were present in only a few of the HPAEs. Where they were absent, directed-credtitprograms largelyfailed.
East Asia'ls Record ofGrowing Financial Depth

The growth of financial assets in East Asia has been ve-ryrapidfaisrerthan the growth in aggregate savings-leading t usata grwth in the financial depth of East Asian economies. Figure 6.3 comparesEast Asia'sratio of M2 (rime plus demand deposits) to GDP, which is often used to measure the depthi of the financial sector, with the M2IGDPratio for a group of low- and miiddle-incomeeconomies and the OECD econom-ies. The relativelygreater financial depthi in East Asia far surpassesmost developingeconomies and comparesweli even with the OECDeconomnies.. A broader meaure of financial depth, the ratio of financial liabilities(M3) to GDP?, shows a similar trend. Korea is unusual in that its ratio of M2 to GDP? is low compared with many developing economies at similar levels of per capita mcome,
and theseratioshaveinacrased moreslowly than Korea's income
growth would predicc. The largest incremental change was evident after the inte-restrate adjustments in 1965. However,M2 fails to capture the presence of a vast nonbank financial sector. The rapid growth of income in Koreasince the 1970s has been accompaniedi by large in:74
USING
RESOI5
Figure 6.3 Financial Dept in IPAEs, Other Developing Economies, and Selected OECD Economies
.~~~
~~~~~~~~~
Maidde East Etrope and Lai HAmaEs
190:7
Sub-Saharan Afrks
OECD economiesI_________________
0 20 40 60 M2/GDP (percent) so 100
Not
latin America includes Argendina Barbados. Bolivia, Brazil. Ch_c. Columbia, Costa Portugal. Syria.
and Trinidad and Tobago, Uruguay. Cuatemala, jamaica. Panamna, Rict, Ecuador,El Salvador,
Venezuela. Earopc and Middle East indudes Algeria, Egypt, Greece. Morocco,
Sub-Saharan AfricaincludesCameroon,Congo. C6te dt'lvoire,dhe Tunisia, and Yugoslavia.

Gambia, Gharn, Kenya. Madagascar, Madriania, Nigeria. Senegal, Sudan, Tan.a.ia, Togo, Uganda. and Zirbabwe. OECDeconomies include Atriza, Belgium, Canada, Denmar
and Switzerland. Germany,Ireland,Netherlands,Norway,Spain,Swecden Finland,l + savings deposits(except NoweM2IGDP= [currency + demand deposits,+time deposits, ofgross domesdtc product. largecertificates of dcposit)jas a percentage SawrrrIntemnatonalMonetaryFund data.
.Mg-~~~~~~
CP
creases in die assets of' nonbank financial instirutions (King and

Levine 1993). Fnancial assets in industrial and developing economies, incling
East Asian economies,are held largelyin depositswith banks and other financial institutions and to a very limitedtextent in government or pi vate securities (World Bank 1989c). The public policies described in chapter 5 that have-emphasized the development of banks and other savings institutions may partly explain this composition, but there also are market explanations.Equity and bondtmarkets developslowly,espe.daiy in emerging markets. In East Asia, the combinaton of rpid
growthof financial assets in the banking system and rising savings dut-
have played an maceasigthe past two decades has meant' that bankcs
inly i an role in capital allocation.
2.75
AL C
EACt
FinancialMarkets,Coordinaion Failures,and the Roleof Government The lackof perfect information that characterizesall markets is most seriousin capita markets, where acquiringinformation to ficilitate better selectionand monitoring of projectsis a key function. Imnperfecr information has severalconsequencesfor allocativeefflciency. As we noted in chapter 5, bond and equity markets are slow to develop. This places increasedemphasison the role of banks in selecringborrowersand monitoring their performance. But credit markets are not like auction markets or markets for ordinary commodities. Because banks cannot discern perfecdy the probability of default, they cannot simply aUlocate credit to the highest bidders-those who promiseto pay the highest interest rates. Rdther, they must chooseamong agents willing to pay the
going rate those that seem most likely to repay the loan. This allocativc process is, in effect, a form of rationing. Moreover, it gives banks some
control over entrepreneurs, who must maintain their good credit standmgin order to renew loans. Financal institutions evolvein responseto these market limitations. For example,bank-dient arrangementsrespond to incomplete in$onmadon through relationship banking. Loan contacts are characterizedby more than lust interest rates. The namre and amount of collateral become key. Yet despite efficiency-enhancingmarker responses, capital markerS remain imperfct. Market power by banks may raise inrermediation margins, resulting in monopoly rents for the banking sector Banks also faceincentives to misallocateresources;underfunded banks risky projes. Social returns on investment rend to finance excessively may differ markedly from the private remrns to investors, and social perceptionsof the riskinessof investmentsmay differsubstantiallyfrom pnvate assessments. For the abovereasons,most governmentsare reluctant to rely entirely on private markets to allocarecapital. Twotypes of government involvement are thereforecommon: first, efforts to reducemisallocation of resourcesby financial institutions; and second, eflorrsto control banking spreadsro limit monopoly rents. While these measuresare by no means unique to East Asia, the HPAEs have been unusually active in exercising them. In addition, most HPAs have gone a step further and attempted..
to direct credit to specific sectors, industries, and even firms. We discuss this more complex and controversial topic in a separate section below.
-76
U S I N G R E SOUlCM
Reducing BadImuestmentChoices. Portfolio requirements,
eitherto avoid
excessive lending in some areasor to increaselending in others, direcdy influence the allocationof credit by banks. In chapter 5 we argued that East Asian govemmcnts bave emphasized the safety of banks through both regulationsthat monitor and enhance the solvencyof banlksand
measures that avoid financial disruptions. These have positive effects on resource allocation. Solvent banks have fewer incentives than underfunded ones to take excessive risks in lending. Solvrentbanks can also lend more. Portfolio requirements to enhance prudent lending-such as limits on lending to real estate projects- -also may guide credit away from some activities to others with higher-perceived social returns. In general, restrictions on lending have favored producers. For example, East Asian governments have often restricted lending to real estate and other speculative activities. These governments are concerned nor only that such lending increases the riskiness of banks' portfolios but also that it diverts lending away from manufacturing. Thailand, for example, does not specifj how much of their portfolio banks should lend to industry, but it provides lending guidelines that favor lending to industry and agriculture and limit lending to other activities, induding real ,-r e. and securities. Most BAEs were assisied in their efforts to influence lending decisions because they directly held a high proportion of savings deposits. Table 6.4 shows that in Indonesia, Korea, until recendy, and Taiwan, China, very large shares of total deposits of the financial system were held in publicly owned commercial banks. In addition dte governments ofjapan, Malaysia, Singapore, and Taiwan, China, have discretion over a large (and growing) prop ,rtion of total deposits iri postal savings and/or provident and insurance fi^nds. Some governments have also been able to complement those resources with budgetary allocations or borrowing fiom abroad. Japan and Singapore have the most well-defined programs fior allocating s;-vingsheld by public finanicial institutions. The financial insttutions created under the Fiscal Investment and Loan Program (FuLs) of Japan allocate finds originating from the governments postal savings, national welfare deposits, and national pension deposits. The FILaabsorbed 20-40 percent of household savings during the rapid growth period. The Development Fund of Singapore, whose resources originate primarily from the provident funds, lends direcdy to the governrmcnes
277
Table 6.4 PropotinofTotal Deposits with Government Financial Instutions in East Asia
(percentage oftotaldeposits)
c3
-
.:mmcw
or Wi.h it eI pus ed sings pwvidearinsturance Economy/year insa*adem fiends ~~S ^ -
Wi.h IM
.3-
rid aem n s~Pecielixzdi banks'

7M
Thud 1
XjiOQ~~~~~~et-r .,1971-76
-. N'
-,
NA
:0;
>ing-sy
,91960 81-8 5
-
-6
N-.
NA
;-
: .
NA 8.79.9a NA. 5F-A

4.
7
7 1.
'
61.3
NA.
461.3
7 1. 7
-10-.
108,
151
1971-75'
1981-85
~~~~~~
44308 14t3} 36
.19 0
--.
Noa
N'
NA61 ~ ~~2.280.7
855 4 22-.3;-':r. _
.~~~~~~~~~~8 ..
_1971-75-
197
1976'-80
-. -
'.0
24.7
.
NA.
02.
~~ ~ ~ 22,N.37
I 0-~~~~I
198145:~ ~ ~ ~ efiieg 1906-89 ~ ~ ~ 15 itede
dcigtevlrl9o 57rsueealoainb
netel
30cora4 prdn
beavo
an3nhne
1ovnq9
.~~~~~~~~~2 .
.2
: -0 - coprateos. ; ;. - - - =.: - -~~~~~~~~~~I stradbtutory boardsinand goernment ndesprad Kreauete
Mhal aysa and Thailand hyagven guided theisaig.Tate-ownedcomerieal banks ofinanen priority projmbiiets. cilsngsb rmougi duvenc thoeef bewe fcmptto banks and mn borwn.n edn inceas ihsrasrdc thecen averageins.h
n~ ~ ~
~~~~sra
aes
2t78
-:
USING. RESOI1
**
With pvernsmen t or
Vit? pensoi
~~~~~~postalsavings ~provident awntrance
4 J pbi commercdialad
*SingPapre
1971-75 1976409. 19814~5 1986-90

-.
2.1-1.0-
~~~~~12.7
10.8 92N.53.5 19.4 .12.7 10.
8.2
21.6 30.0 34.6 34.9A67978.7 NA. NA N.1.1 NA.

NA1.
-23.7
39.4 456' 47.6
1971-751976-80 ~~~~~-13.81 t18-5

-
63.6 52.4
-:1986-90
77.4 727 71.8-13.8 13.7

. .
.Thailand
-1971-75 1976-80 * -1981-85 *1986:190
. 2.2
7.6
NA-
is fbr 1978-80. a.Th fguxre P6rpotd c Te figure -for-Taiwan, China, are bed on the depositsof all COMmercial banks and'accneunl vrsiae eas ny1 f he16 commnrdalbans& aregov&nmncnr owned. Nvtlds,xgocnnrwndbanks acon forthe mjrshare of!commer-, cilbankdeposits. SomorrlndoesizIndonesian Financial -Sratiirk (Vadlouis issues). Japan: jDDIFJI (1993); ooi Staijsnal(aiu er) Kore= fronmndcWSraisdt Yew-book (ari,ous years).MaasaQuartrl(yBaliab (199O)-. Singaporc~ Yearbook ofSaiac (1991);Eoomic ~a.uSoraiSwszi 1:160-2,195).Taiwan, China: Sraisrca Yebrnoak (variou vears). Thind& QnarurlyBulletin(vrosise)
-
Except for Hong Kong and Singapore,all HPAES at Various times have
simultaneously reguated deposit and lending rates and consequently the spreads of financia institutions. As a result, rents derived from imperfrct competition have been modest. Our evidence led us to condude -in chapter 5 that, in comparison with other developing economies, bankcing system spreads were relat-ivelylow in East Asia. and have declined as entry restrictionsand interest races have been liberalized (see table 5.7). Given the rapidi growth of dhe financial sysems in the HrAs and their limited intermediation margins, we conclude that regulators -have done a good job of balancing the need to limit competiton in. order to enhance bank solvency with the need to limit imperfect ornm279
~~~~~~~A LE-
petition renrs. HPAEregulatorsdid not alwaysget it right, however.It is notable that, in Indonesiaand Thailand, regulatedintermediation marginswere substantiallyhigher than those afterliberalizarionof entiy and interest rates.
UsingDirectedCredit
Like many governments,those in East Asiahave gone beyond the indirecr guidancedescribedabove to target credit direcdy at priority acrivities.The categories to which they directed crduit have differed litde from other developingeconomies.However, HBPAEs, particularlyJapan and Korea, have uscd unusual mechanismsthat have helped to increase loan repayment rates and overallsuccessof directed credit. They have limited the size of credirsubsidies,and theyhave applied stringent standards to the selectionand imlplementation of projecrs. Criteria forSeecting Dreeed-Cree. Tagts. There are three broad types of directed-credit interventions. First, governments can direa credit to specificfirms or ind ries.Second, they can direct credit on the basis of broad functional criteria, such as promotion of exports or small and. medium-sizeenterprises.T ird.they can direct credit to accomplishsocial objectives,such as mass housing or redistributon of assets among ethnic groups.HimAE governmentshave engagedin all three. Ta?etingfirms or indutdes. Japan cuinng its postwar reconstruction and Koreaduring the 1970sdirectedsubstantialcredit to specificsectors and firms, mostly in heavy and chemical industries (Has) (see table 6.5). Japan'sFILPaccountedfor about a third of newequipment lending in the 1950s. Between 1973 and 1981, Korea'spolicy loans were about 60 percent of the total loans of its deposit money banks. Most ofJapan's priority lending targets through the early 1960swere industries associated with large optimum scalesand increasingreurns to scale; so were Korea'sduring the HCi period. Indonesia and Malaysia,conversely, had disappointing experienceswith credit interventions targeted to specific industries in the 1970sand early 1980s and abandoned the schemesin favor of more functionally directed credit Hong Kong and Thailand have not been active in using credit instruments to push selected
industnes.
In contrast with many other develop'ingeconomnies, where directed credit often went to public and quasi-publicenterprises,direcred credit in the BPAEs has generally gone to the private sector.Consider the cases
o80
USING
RtESOURGWE,j
Table 6.5 Pmoportion of Loans Accounted forbyGovernment's Policy Loans, Japan andRepublic of Korea
I96'':. iV
4965. 09
. 1 lons Pol.
'Pa/C
Japan -22. .SE5.9uS: sare f ne'.7--
Republic~~~~~~~~6 fKa:reat k'onsas a' o sa or

, -:
..
~~~~~~~~~* ;,..e i
.. .-
1955
.,W
J3~~~.2.
32.
~~,1970 ~~~~~~9.8 ~ 1975

,;;
-13.8
................
47.41 w:
tht,
.,1 '
"11.~~~~~~~~~~~J771:
............
'
t; .. ',
''
I'
W 106' :1.75.390 *~~~ PoS loan indude loans0 udrJ t some kind oftexii ;rrna ;&I prg;m 1980 1 141 ,~~~w'.u 176, .D,>,,0 inuerestzat eandaada8llt or suppor;tend b'' ch Cenra Bn's auomr 8:12'.~~~~ Srnc:JpaCiDqE ;Wr;-;rfX (
7,
oF
'nicws&tdnglar
59.78"
' -
lon eted&emnali h au
ofal lan
19.4
term
and d-
19).0 i-r uS-.rn;n-oth:
(192.
8- :,
:;rl)w
Table6. loanspertainwi Lows Adeounder c-unts -ob
byiavemmentad
Imn'Policgram (FIlP) Outstanding Rloancre ', cd

_
f2 finanKial
_
* fi:'ir -',ey b- ', j'Ban privasector madeby &- '::'; of ICor&de-'o' va7&bni
,_,_ iwo
rh6~~~~~~~~~dveometinttuin ~2U'Foreig 'rmd.nn
o icudkey allansfo foa- i n se b,dt
banI d
a d loa
;te
of Trkeyand exio. Lans y te bakng systemto public enterprises in Turkey'in 1975were 28 percent of bank assets,and to the public administration, 19 percent; those proportions rose to 24.9 and 35.9 per-cent,repectively, in 1980. In Mxico,- the largest developmentbank provided about 75 percent of its industrialloans to fbur state-owneden-. terprises.UJhfortunatelyv, t-hese public enterprisesoften did not perform --a n econmic c193)ep oIn S-goes 1 9t* Malaysia,and well economicallyor fina-ncially. East Asia, Indonesia, Singaporehavedirectedcredit to state enterprises,but the proporions of total acrdit were not p tversistently Ehigh the parastatalstended to perfbrm better financially, and thae intLerest ratesubsidies werenor large (except in 7 Indonesia).1 1Korea was an exception; its lending to the public steel *plant, Posco, was substantia but is widelyconsidereda succes story. Ta.rgeting eorerne and smalland medium-size enteTiprises. The broadest functional-targetingof credit in the HPAEs has been to exporte-rs. All
Easturke an ecnmisexcept Hong Kong and Sigpem have subsidized -f creit -- Sngaore o ste avedircte nterriss, ut he popotios o export credits, often through the centralbank redis onSt te (see table 6.6). Exportersfrom all industries' have had access.Smalland medium-size-firms, whichoftenhad to relyon curbmarkets ibund axportfinancing one of theirfewreadysources of fnral finaneow. Box6.1
rAa, Maltznus onpagd284)
.AC
SKAN MIRACLE
Credit Schemes in East Asia Table 6.6 Characteristics of the Export

Hong Kong OfQers export credit insurancewith a slight subsidy through the Hong Kong Export Credit Insuance Corporation
(HKECIQ.
Japan
Between 1946 and 1972, the Bank ofjapan (BO,Irediscountcd axport bills at low.ratesof interest (I to 2 percentage
points lower than that applicable to general trade bills). During this period, the HOy directed 10 percent of its loans to export finance (which financed 50 percent of toal exporrrelated bankIcnding).
Kara, Rep. of
Offers concessional rediscounting of prreshipment credit based on Ictters ofcredit (tcs). The differential betwecn loan rates of this cxport credit and general loan rates was between 3 and 20 percentage po;nts until 1982, when this difFerence was eliminated. In 1984 the dififrcntia was restored ar 1.5 percentage points. The KoreanExporr-Inport Bank provides longer-term postshipment finance. Provides export credit insurance, but this has been used sparingly (by about 3 percent of exports in 1980).
Malaysia
faciliry has Since 197i7, the Export Credit Refinancing (ECR) rediscountd export bills fbr postshipmcnt financing Since 1979, the ECRrefinances peshipmenr export acedits at subsidized rates for cligibleexports, based on lectersof crediL A domestic leter of credir was also introduced to enible the financing of indircct expores.
Singapore
In 1975 the government established a rediscount facility for

exports
andre-exports.
The Export Credit Insurance Corporation provides insurance for exports by Singapore.
Taiwan,Cbina Offersfirms short-tcrm preshipment loans based on LCs.

After products are shipped, firms are cligible for loans based on LCs.documents agait acceptance of payment, and shipment documenrs. In addition, the Central Bank provides a special discount rate to designated domestic banks for export loans, usually at 1 percentage point lower than the usual discount rate The oeporrloan rate was about3 to 5 prcentarV,points below the minimumn intercsr rate for secured loas between 1970 and 1980, and it dropped to I tO 2 percentage point after 1980.
Thaand
The Bank ofThailand rediscoun:s at subsidized rates 50 per-
cent ofthe value of Icnding to exports by comrmeraal banks.

Commercial banks lend on the basis of LCs.
28z
USING
RESOURCS
Work.s-Cref'it Box61 Directed

r
CREDIT TOE-:
as aSupplemen, ,Bed
HAVE mID TO USEDIRECD
MANY ECONOMIES
- counge
fewhavesucceeded.The smalland mediuni-sizeen erriss;, proulumately unsusinuiable -contrast betwcen an unsuccessfiulland -a .. , =;.tE,.,;-n'; in K ,.. i.. why. gram in J-Idonesiaand a successhflprogram in Koreatshows reprcssed f--' .- In Indoncsiawhich itdl 'th_early.198 s hada heavily developingeconomies,heav-, financialsystemsimilartothatof' niany, to enterpriseir. pnvdmnent-d&ignared '..ysubsidizedcredit dixectcd wre divcn-bypoliticalf allocautions - categonesoften went awry.Cr&diz Repaymentrateswereas iow as 53: = aswellas conomicconsiderations. percent imone program supporredby'the World BanL Meanwhile,. that lacked the politcal medum-ze ; firms porentialy aedrcwdrth -,P. q.R. d-,--,!j,:i V d R - ' ;,m a um' .. cret access cnjoyedby -:influenceofireenterprises and the speci.al
*
h finanial systeCM..-.. smallfs werefirzen-'ourtof began .o liberal-' the goveniment to re=edj thesewproblemts PartyP
in te -early1980s, permitringa rpid increase "'-izz he fiianial systmm -d. dimann intert 'iralizin in thenuiiiber of'banls, firms'access to iii' programs.Aa result,medium-:size cdirccted-credit althoughte situation mayhavewors.nance hasevidentlyimproved, l-that lack-ur established for vey small firms died somwar tack record. :commercial .; In contrast, -Korea's ectcaei -or small.. nd -M., t-progrmn - erMe- : . .= .. -. ~h;--.;.S a medium-size. enterprises has beencompaiblefromthe outsetwlm'-aks; whlchflave isysen.B miarket-responsiveFminal: disci&pnecialarge degreof autonomyin:choossingborrowers,,havepref-r-ed. ''..had i 'estiblisheduack'record:of 122firms su2rvd, only20 frinwith '' -., during rhei.start-Tuhje Kiorean.inaik&trcsouraes :.,drew.onKflnand Tosector program raiieed hrms withournor acesothe banking sapMrv idcdfoSorldng,aswdl Mep keent&rpdsesgoi 5 eexp,r&avafable on pariutvesm nt finance,\xth workingcirzal far ii Kbrea hare beeAin.-excess-.. -libenltem&,Repayment.rates .:cuailawly
npn;rnr .
..
-. '.
.-
Perhaps
program,Jn,:. KoreanP success&4I{e most important-todme

modestthoseT in wtcompason wih
,.!],
subsidies haveben -. teresr.iates
r,0I.
h'hdy;epies-ed fiand other developzg-e'onoiiest .:I. n*edonesia KoreanD perveitnrern gov.emnenr's Despite the nancal systems -a.. -.,; .Fs.,,. ,., {, c lx, > ysr =n iumsz dr:f4o'r.srn4all dleedcr 2n ti7;nfiacamar
rt
_..
_',pi,'
its;'-
-4h
0--
'
Prlss-
2:rCm
SU-
c.
*II.MIRACLE
enterprises in contrastsdirected-credir efforts forsmalland medium-size Indonesia, wherethey fiiled and werediscontinued, and Korea,where they have been moresuccessful. As we arguedin chapter2, the sizeof the subsidywasprobablylessrelevantto firms,especially to smalland
medium-sizeexporting firms, than was the automatic access. Allocation
and commercial banksmoniwasstricdybasedon exportperformance, toredperformance, sincetheyonly collecred repayments on realized export sales; governments, through customs, had the means to verilfr
performance. This createda simplecontestfor exportfinance. There areother morelimitedexamples of functionaldirectedcredir. Indonesia,Korea,Malaysia, Tlailand, and Taiwan, China, have required banksto extenda proportionof their loansspecifically to small and mnediun-scale enterprises. Smalland medium-size enterprise lending throughspecialized development banksis a growingproportionof Japan'sdirectedcredit There are also attemptsat facilitaring crecliaccess of technology-inrensive producers,especiallythrough Taiwan, China's,Bankof Communications. Targeting social objecaieL. SomeIuAEs haveuseddirected-credit programsto achievesocialobjectives. As we noted in chapter5, Japanhas directed credit to facilitarethe adjustment of decliningindustries. Malaysia and Indonesiahavedirectedcreditto promoteincomeredistributionamongethnicgroups.EvenHong Kongand Singapore, which have fewother directed-credit programs,providesubsidized credit for
mass housing. KeepingSubsidies toDirected CmditSmalL Compared
nith most other de-
veloping economies, the subsidies for directed-credit programs in most HPAEs weresmall.In part this was due to the way in which directedcreditprograms werefinanced.The creditprograms of Japanand Taiwan, China, werefinancedby postal deposits, whose repayment set a limit on subsidies. Singapore alsoensuredthat the Development Fund financedby the pension funds wasself-financing. It was also the case thar,with theexception of the HMc periodin Korea(1973-81),the more prudent macroeconomic and interestrare policiesof all HPAEs meant
that realinterest rates to borrowersof directed credit were generallypos3 itive, if not at market-clearinglevels.' Measuring effectivesubsidiesto borrowersacross economies is difficult,since it requiresestimates of equilibrium interest rates for eachtype of credit in each economy. Table 6.7 contrasts real interest rates on directed credit for the HPAES with a sample of other low- and middle7,84
USING
RESOURCES*'EflI
Table6.7 RealInterestRates onDirected Credit, Selected HPAEs andOiler Developing Economies

(percent) Economy Direcedit -1.7-4.0 0.5-3.0 -2.7 -6.7 1.9-3.9 1.5
-23.5
Nonireted credt
FIPAESI Indonesia, 1981-83, liquidity credits Japan, 1951-60 Korea,Rep. of, 197040, industry cxporrs Taiwan,China, 1980-89, industry 1984-85, exportsQOterdevelopingeconomies Brazil, 1987
3.1-4.6 2.9 2.9 4.6 4.6
Colombia, 1981-87, industry

India, 1992 Mexico, 198748 Turkey, 1981, indusay 1980-89, cxports ,,- _No: mIvilable.:
.iurerJDB/JER (1993); World Bank d2t:L
1.5
-2.5-4.0 -24.0
13.5
7.0 6.0 13.9 13.0
-4.0-15.0 -14.0
income economies. Directed-credit programs in the HPAEs had higher real interest rates than in other developing region&s Given capital's high international mobility, we conclude that interest rate subsidies in the HPAEs were lower than in other regions.' 9 The HPAEs generally have smaller shares of their credit systems subject to government direction than other developing economics. For exampie, in the early 1980s, roughly tiree-fourths of loans from Turk-ey'sfinancial system were made at government directive. In Pakistan directed credit as a proportion of nongovemment credit was 54-68 percent in the late 1980s and I990s (an internal World Bank report). In Brazil, about 80 percent of the total average stock of credit was directed in 1986-87. Colombia's directed credit to indusay in 1984-87 was on average 56 percent of total credir. By contrast, in EastAsia, Korea's policy loans in the HCIperiod were more than 50 percent of total credit, and Japan's never exceeded 15 percent of total credit. Indonesia briefly had 48 percent of its total loans in priority liquidity credits in 1982, but it reduced these rapidly following the liberalizations of 1983 and 1991. Moreover, dircted credit is becoming less importanL WhiLe earlier efforts of govremments in East Asia concentrated on developing the
285
'
S!WNMIRACLE
banking systemand guiding its lending decisions,more recent policies have been directed at deregularingfinancialmarkets:Japan started in the are sim1970s and the others in the 1980s.The fearuresof deregulation ilar: interest rates are gradually deregulated 1 directed credit is reduced, and entry restricrionsare slowlyeased (seetable A6.5, at the end of the chapter). The majority of HPAEs deregulated their interest rates during the 1980s, jointly with efforts to liberalizetheir economiesand their financial markets. The deregulation of entry has been much more limited, however, except in Indonesia. This process in the East Asian economies has been gradual and was meant to minimizedisruption in the manufacturingsector.
In contrast forSelection andMonitomng. Institutional Mechanisms
romost
other economies that have rried but fiiled to use directed credit, Japan and Korea appear to have strong institutional capacity for project design, appraisal,and monitoring. Becauseof this, direccedcredit has generally gone to projects that are creditworthy and viable. More importan-and in sharp contrast to many developing economiesfunds have usually been utilized for the purpose for which they were allocated. The result has been a high level of loan repayments and a correspondinglylow levelof loan losses. In Japan, officials working within government sectoral guidelines operated much like loan officers in private commercial banks, scrutinizing projecr proposalsand the firms involved to ascertain their abiliry to repay. Once a loan was approved, close cooperation between development and commercial banks ensured continuous monitoring of the performance of the borrower and enabled development banks to take early action if loan repayment was in arrears.Coupled with Japan's overall economic success, effltive pre-appraisal and monitoring resuited in very low loan losses.The Japan Development Bank, the main government lender,experiencedwrite-offsof a mere 0.09 percent of average loans outstanding in 1951-55 and just 0.01 percent in 1956-65, and trust banks that focused on short-termn lower than comnmercial lending and had a more diversified portfolio. The JDB's superior performance may be partly explainedby its greater reliance on collateral
security, particularly equipment purchased with the loans. Fear of losing collateralized equipment gave borrowers a strong incentive to repay their loans. In Korea, the government, banks, and industrial firms worked together and shared responsibility for the success of directed-credit pro-
286
USING
RESOURCESO
jects. Various institutional arrangements such as monthly axport protrends, discussed motion meetings and monthly briefingson ecoonomic in chapter 4, supporred this close consultation (Cho and Hellmann 1993). Enforcement of government goals--primarily the imperativeto export-was achieved by rewarding successful firms with continued credit support while reducing credit to less successfulfirms. Such continual and pragmatic reviewand adjustment of policy implementation reduced, but did not alwayseliminate, the moral-hazard costs of government intervention.
Other HPAEs fiall alonga spectrum betweenTaiwan, China, whichhas utilized mechanismssimilarto Japan and Koreaand has had similarsucbelow cess,arndIndonesia,which wasplagued by the problems discussed and has largelydiscontinueddirected credit. In contrast with Northeast Asia, credit allocation decisionsin many developing economies were often motivated by political and noneconomic considerations. Projects were designed with conflicting objectives and lacked proper evaluation. Moreover, the very large rents that could be obtained from subsidizedcredit werea strong incentiveto corrupt practices. In smaHereconomies,credit allocation to specificsectors became credit to individual firms, because of the limited number of companies involved. Consequendy, projects were subject to government-monopoly negotiationsand were prone to poor appraisaland disbursements without proper documentation. Credit allocation to large and politically powerful firms or state-owned enterpriseswere characproducing terized by weak monitoring and follow-up on debc recovery, high loan losses and eventally large-scale failure of directed-credit programs. HowDidFinancialMarketPolicies Contribute to Growth? Capicalm;arket policy fundamentals are undoubtedly the major actor explainingthe contribution that capital marketshave made to the 6fficient use of resources in the HPAEs. Rapid deepening of financial markets, combined with prudent restrictions on lending by banks for real estate and stock speculation, are probably the most important contributions of East Asia's financial policies to growth. Recent crosseconomy evidenceshows that the averagelevelof financialdevelopment is strongly correlatedwith the averagerate of per capita incomegrowth, both before and after contuolling for initial conditions (King and Levine
287
3iR
LqR"A`ThMIRACLE
1993). Moreover, the level of financial development imporEandypre20 dictseconomic growth. What about attempts by government to direct the allocation of credit? Here tie record is mixed. NWe conclude that credit directed to exporters was a positive factor in acceleratinggrowth. All East Asian economies provided automatc, generous access to credit (or credit guarantees) to exporters with varying degrees of subsidies. Japan, Korea, and Taiwan, China, went a step further they used exports as a criterion to determine whether priority firms, regardlessof the market for the actual priority investmenr, continued to receive credit.21Other more specific directed-credit programs had both positive and negative results. In general, the economies with strong civil servicesand highly professional public financial institurions-Japan, Korea, Singapore, and Taiwan, China-apparendy had some success in implementing credit policiesto promote priority industriesand firms. Key to this successwas the use of economic performrance criteria and the monitonng of firms by banks and bureaucrats. T hese traits were evident in an extensive study of Japan!spolicybased lending in the immediate postvar period (DB/JERI 1993). The study found thar interest rate subsidieswere no more than 2-3 percentagepoints and that effecive monitoring kept loan lossesvery low. Moreover, direct,. :redit was a minor aspect of the overall financial system, accounting for less than 10 percent of total loans. The study identifiedthree characteristicsofJapan's policy-basedlending: reliance on the private sector; the dose correspondencebetween national economic plans and directed credit; and respect for the managerial independence of the government financial institutions responsible for channeling funds to the targeted sectors by selecting individual firms accordingto purely economic criteria. By comparison, Korea's use of directed credit during its economic and interest rate takeoff in the 1960s and 1970s was more extensive, subsidieswere larger. As in Japan, the governmnent in Korea consulted dosely with businessesand banks, attempted to monitor perfbrmance dosely, and relied on a competitivebusinessenvironment to providean objective measure of performance.Accordingly,policy-based lending probably contributed to the rapid expansionof Korearn indusy, particularlymanuFacturedexports (Cho and Kim 1993). Most of the directed lending to priority industries in Korea translated into investments in equipment. Despite Korea'ssevereadjustment problems due to the HCI
288
USING
REsot1RCE`S,r
drive during the early 1980s, rapid growth resumed easily in the mid1980s, in part because of increasing utilizationof the HCI investments, which were in physicalcapital, as demand increased. However,the cost of extensiveand highly subsidizeddirected credits was substantial-and likelyto increaseas development proceeded. Directed credits burdened banks widt nonperforming loans, interfered with the financialsystem'sefficient operation, hindered the growth of financial savings, and sometimes threatened macroeconomic stability. Koreawas able to weather thesedifficultiespartly becauseits closed capital market at the time enabled the governmentto suppressinterest rates on deposits, thereby funding the subsidiesfor loans to corporations. In addition, relatively easy credit in international capital markets and Korea'sstrong relationship with two key lenders,Japan and the United States, helped to ensure the availabilityof foreign capital, which was either fimneled into directed credit or went to bail out troubled enterprises unable to repaysubsidizedloans. Today,boch the greater openness of capital markets in most developing economies and the heightened competition in international capital markets suggest tiat financial repression and directed credits are now less viable options for developing
economies.
22
To argue tlat directed-credit programs in general reached their target groups and that loans were effectively monitored does not establish that they contributed positively to growth. To do this, microeconomic evidence is needed to establish two facts: government lending promoted investment and did not simply displace investment from other sources, and the social returns on the incremental investment exceeded private returns, justifying the targeting of specific sectors. Such evidence is rare-even for the northern-tier HPAEs-but two recent studies attempt to address these questions for a sample of firms in Japan.Z3 A careful microeconometric study of Japan's industrial credit programs in general machinery, electrical madcinery, and precision instruments during the 1980s-sectors selected because of their high potential for externalities due to innovation and learning-reaches the following conclusions: * Government lending had a large, positive, and statistically significant impact on both gross and net investment; the three-year cumulative effect of a one-dollar increase in debt financing from
289
MRACSN
MIRACE
government sourceswas more than two dollars of additional gross investmentsin fLxed capitalassers. * Government lenderswithdrew credit once firms had earned access to privatecredit marketsand, in turn, extendedcredit to new borrowers rather than preexistingborrowers,consistentwith (though certainly niot concdusively establishing) the daim that credit was being allocated according to objective lending standards, rather than on thc basisof political considerations. * The characteristics of firms receivingincreasinggovernmentcredir indicatc that assistancewas targered toward firms most likely to grow,invest, and generate rechnological externalities;firms receiving credit had researchand developmentinvestmentshares in output approximately twice those of finms not receiving increasing government financing. The authors conclude: "Possibly because of the institutional structu of these lending programs, it appears that economic logic rather than political capture motivates policy-based lending decisions. Govemment credit is withdrawn quicldy from seasoned firms, is targeted toward growing, R&D intensive firms, and produces substancial increases in investment and access to private credit. The fact that these results are measured with data from the 1980s leads one to expect even larger effects for earlier periods? (Calomiris and Himmelberg 1993). Limited evidence fiom the 1960s tends to confirm Calomiris and Himmelberg's conjectare. Horiuchi and Sui (1992) examine the role of the Japan Development Bank's directed crcdit in promoting private investment during the 1960s, when JDB was the major policy-based institution lending to medium-size and large firms. Their sample consisted of 477 medium-size firms listed on the Tokyo Stock Exchange in 1965. Among their results are:
* JDB
*
lending resulted in a net increase in new investmenL JDB loans were accompanied by incremental lending from private banks, suggestng that JDB's loans did not crowd out private bank lending. JDBs loans to firms preceded the firms' increased borrowing fiom private banks and improved the access to credit of firmnsthat were
not artached to private "main banks" (often firms affiliated with a
keiretsu bank).
290
USING
RESOURCESj
Thus, directed credit appears to have acted as a signalingand insurance mechanism. By selecting among borrowers, the JDB encouraged complementarylendingfrom private financialinstitutions with a consequent net increase in investment. Moreover,policy-based lending was most successfiul wlhenit was directed at nontraditional borrowers.The JDB's loans stimulatedgreater lending by private banks to firms not affiliated with main banks but did not have the same impact on firms affiliatedwith main banks. Another study of credit programs in Japan and Korea based on an analysisof the objectivesand outcomes of the programs adds an additional element, noting the positive role of coordination achieved through govrmment lending programs. During the 1950s the bulk of directed credit in Japan was given to "basicindustries"-electricity, iron and steel, and coal mining-that were characterizedby increasing returns to scaleand that produced basicinputs for other parts of the economy. Once these basic industries were developed,Japan subsequendy promoted industries whose expected spilover effectson the economy were large, for example, machine toolS (JDBIJERI 1993). During the 1970s, Koreachanneled most ofics directedcredit for fixedinvestments in manufacruring to the HCI industries, among them such producer goods industries as steel and machinery.Using a frameworknot dissimilar to the contest frameworkoudined in chapter 2, the study reachesa similar conclusion: the coordinating role of government in Japan and Koreahas diminished overtime, and hence the effectiveness and desirability of using credit programs to improve coordination among private firms are diminishing as well (Cho and Hellmann 1993). But many other directed-credit programs, even in the HPAEs,did not mect their objectives.In fact, the track record of most directed-credit programs in Indonesia, Malaysia,and Thailand was so poor that their governments, demonstrating the pragmatic flexibilitytihat we have argued characterizes economic policymakingthroughout the HPAEs, abandoned many of them. Limited differentialsbetween directed credit and market interest rates and smaller volumes of directed credit relativeto the size of the financial system meant that financial market disrortions in the HPAEs, even from unsuccessfulattempts to direct credit,were not generallylarge. In addition, the focus of HPAE governmentson providing credit for the private sector meant that, in gcneral, loss-making public enterprises were not priority lending targets, unlike in other developing econonies.
Z91
ANL~MIRACLE
Using the International Market: Trade andIndustrial Policy

economic growth is widely accepted,the precisenature of the relationshipis controversial. Earlywriting on trade policy and growth stressed the benefitsof neutral incentivesbetween production for the domestic market and production for export. With neutral incentives, it was argued, resourceswould flow to sectors in which the economy was most internatonally competitive (Corden 1971), and gains in technical efficiency(or "X-efficiency") would result from a more competitive environment (Nishimizu and Page 1991). Studies in the late 1960s and early 1970s convincinglydemonstrated the extreme bias in incentivestructures against exports and agriculture in most developingecononmies and the resulting high costs of import4 substituting industrialization. Recent theoretical work has argued that, where market power, economies of scale,learning, or externalities are significant,departures from neutral incentiveregimes (lowand uniform rariffs)may improve economic performance (Krugman 1986). This literature, however,unlike the earliercarefiully doctumentedstudies of the costs of protection, providesvery litde evidence conceming the importance of these factorsor the potential benefits to grwwh of departures from trade neutrality25 Proponents of trade neutrality and interventionboth dee the records of the high-performingAsian economies as evidence supporting their views.As we noted in chapter 1, international trade is important in all the HPABsand is the factor most consistentlycorrelatedwith their success.Balassa(1991), Krueger (1993), Hughes (1992), and others argue that opennessto international trade, based on largelyneutral incentives, was the critical factor in East Asia'srapid growth. Conversely,advocates of trade interventions, while acknowledgingthe importance of trade, note that incentivesderiving from quantitative restrictionson imports, tariffs, and subsidieswere not neutral among sectors (or firms) during their periods of rapid growth. They argue that the HPAE govemments successfully intervened to change comparative advantge (Amsden 1989;Wade 1990;Singh 1992). Industrial policy interventions, which often use trade policy instruments, are motivatedby the belief that shifting industrial structures toward newer and more modern sectors increasesthe opportunities for
292.
HILE THE LINK BETWEEN INTERNATIONAL TRADE AND
USING
RESOURCESF
capturingdynamicscaleeconomies that resultfrom learning.During theirheavy and chemical industries programs, Japanand Korea werethe
most active HPAEs in promoting individual industriesand sectors.Sing-
apore and Taiwan,China, have also activelyprovidedincentivesfor tednological upgrading. Malaysia had an HCIprogrm reminiscent of Japan'sand Korea's, while Indonesiahas attemptedto leapfrogfrom labor-intensive manufacturing to high-technology industries suchasaircraft and electronics.
How havetradeand industrialpolicies affecred growthin EastAsia? To answerthis questionwe first examinethoseconditionsthat might justif government effortsto promotespecific sectors. We then describe
the trade and industrialpolicy regimesin the HPAEs and compare their domesticrelativepriceswith internationalpricesto determinethe extent of interventions. Finally,we evaluaterwo approachesto increasingproductiviry.We find, on the one hand, that governmenteffortsto promote specificindustriesgenerallydid not increaseeconomywideproductivity. On the other hand, the evidenceshows that broad governmentsupport for exports was a highly efFective wayof enhancing absorption of international best-practicetechnology,thus boosting productivity and output growth.
Market Failures, Trade, and Industrial Policies

Why should governments inreriere with the level playing field created by the international market? Our ditcussionof coordination failures in chapter 2 touched on many of the reasons,but it may be useful to reviewsome of the arguments specifically as they apply to trade and 5 industrial policy26Among the many reasonsfor discrepancies between socal and privatereturns cited earlier,four stand out: X Interdendent investments and economiesoficale. Increasingreturns fom scaleand capitalmarket imperfectionsmay mean that investments that could be internationallycompetitive at optimal scaleswill not be undertaken. This is especiallytrue with large, interdependent projects for which optimum scale depends on simultaneous investnent in upstream and downstreamindustries.The larger the indivisibilities and returns from scale,dhemorelikely that private initiativeswill be absent. a Straegic negotiations.In negotiatons with other economiesand foreign companies, governmentscan alter the nature of the marker environment by intervention. The outcome of any bargaining problem
293
RACR"MM!IRA CL r
dependson the strength of competition on both sides. By coordinating

thc actions of buycrsof technologyand trying to increasecompetition
amnongsellers, governments can appropriate more of the surplus associ-
ated withlthe transfer of technologythan they otherwise could (Stiglitz 1993a). e Pecuinay externalities. Pecuniaryexternal economiesarise if, as the size of a competitive industry increases,the long-run supply curve faills (Marshallianreal externalities).Such gains in productivity are attributable to economies of scope in the use of specializedequipment and greater specializationof individual skills. When economics are small, currcnt prices may not convey adequate information about prospective lower costs of production through largerplant size (Scitovsky1953; Chenery 1959).27 Externalitiescan also arise from the interaction between suppliersand buyersabout the design or production of a product leading to a better or cheaper good than is availableinternationally.In this case,the sourceof the externalityis the nontradabilityof some types of inputs or knowledge-otherwise the improved method or product could be obtained from internationalsuppliers. * Learning.Externalitiesrelated to learning have traditionally been identified as important sources of mark-et fai]ures in developing economies.When firms gain knowledgeof production from other firms 2 8 Becauseof inwithout incurring cosrs, real externalities are present. completeappropriability of knowledge,individual firms may spend less 3 9 Exteron obtaining production knowledge than is socially optimal. nalitiesdue to learning may alsobe conferredon other firms by the first entrant. These indude the demonstration that the sector is physically and economicallyfeasibleand the leakageof information on technology and marketing (Pack and Westphal 1986; Rob 1990). Economists initially responded to these market failures with arguments supporting the protection of so-calledinfant industries. Protecdon wasseen as necessaryso that firms could gain the experienceneeded 30 Industrial policy advocatestakethe to lower costs and become viable. aTgumenta step fiuther. Becausethey associatelearning with capitaland knowledge-intensiveindustries, they advocate a rapid shift in industrial structure toward these activities,evenif they are not intemationally competitive at present levels of scale, knowledge, and fiactor prices. In this view, the short-mn aflocativecosts of establishingintemationally uncompetitive industries will be outweighed by the long-run benefits of rapid productivity change in the promoted and linked sec294
USING RESOURCE
RCE
tors. But as tlc many inf.int industries that have never grown up amply
demonstrate, prorection does not enisurethat the promised learning and economies ofscale actually materialize. Trade Policies in the HPAEs
Most IHPAESbegan industrialization with a protectionist oricntation
and ihave%radually moved toward increasinglyfreetrade. Along the way (as we showecd in chapter 3), they often tappcd some of the efficiencygeneratingbenefits of international competition through mixed trade regimes:they granted exporters duty-free imports oFcapital and intcrmediate goods while continuing to protect consumer goods. Export prices were set in the international market and were often substantially 31 Losseson axpart producless than current marginal or averagecosts. tion offset profits in the protected market, while competition in the international market ensured that the firm would not suffer from loss of have reduced their proteccost discipline. More recently,all the HPIAEs dionof import-substituting industries. Belowwe describe the evolvingpatterns of protection in the HPAEs,
with the exceptions of Hong Kong and Singapore, which adopted essentially free trade stances early in their development. Japan. Japan pursued an early import-substituting industrialization strategy, similar in many dimensions to those of Argentina, India, and
ocher less successfideconomies. As late as 1968, effectiverates of protection (ERPs) in Japan were still quite high and exhibited the cascaded
pattern from raw materials (low) to consumer products (high) that is rypical of most developing economies (see table 6.8). Unlike many import-substituting economies, however, there was surprisingly high protection of machinery (final producer goods), confirming other research indicating that the Japanese atuthorities engaged in an intensive effort to develop this sector. Eiu levels in the machinery sector were reduced during the 1970s, only after it was evident from export performance that the sector had become internationally competitive (Itoh and Kiyono 1988). Quite high levels of protection were afforded sectors such as iron and steel and nonferrous metals as late as 1970. Protection in capital-intensive sectors such as pulp and paper and chemicals also remained high, to say nothing of the remarkably high levels in textiles.32 Korea. There is considerable evidence, summarized in Pack and Westphal (1986), that Korea selectively protected sectors that the gov295
RACLE
Table6.8 Effective Ratesof Protection in Japan

(percent)
By type afgoork 1963 Type
19 8
ERP
_-NRP
-A 3.1 -13.7
12.3
.
Rawmatcrials Producer goods Finalproducer goods
-P. 0.8 29.6

28.0
NARP
1968
3.9 15.2
14.1
0.9 22.3
21.7
.
-2.3 15.9
15.7
-3.0 7.1
7.6
Intermediate producergrods
Consumer goods
15.9 21.6
32.3 44.6-
16.9 23.6
23.2 .35.8 .
15.4 23.0
6.3 12.2
B yindry'.r Iad*m 1 :*1963 1968 1972
Manufacturin Tattiles
Spinning
32.3 54.3
27.1
24.2 282
12.5
14.4
.18.6
I.0
Weaving
Products
-44.6
72.8
30.5
32.8
15.5
22.4
Woodproducts
14.0
25.6
16.1
Pperandpulp
Publishing Learher and rubberproducts Chernicals Perroleum and coil products
Nonmeallic minerals
.
9.7-16.7
30.9 33.4 19.5
22.2
18.0
1.0 21.8 17.7 14.5
15.7
.
11.0
-0.9 12.3 8.8 7.1
8.1
Iron andsterl Nonrfrous metals Metalproducts Machinery Genemal machinery Electrical machinery TransportequipmentPrecision instruments
30.1 30.4 13.8 36.7 23.0 30.9 61-5 34.9
30.0. 34.1 -19.9 20.0 14.5 16.5

31.0
22.9
17.1
22.1
9.9 7.7. 8.7 -5.49.2-
IG.4
a. NRP=Nonial RateofPro tcdon. b.-ERP=Efficdvc RarcofProtecion. c. ERPbased on simple averages of riffraes-Sovw Fortop panel, Itoh mnd Kiyono (1988); fior bottompancl,'Shouda (1982).
erinent hoped to promote. Protection consisted of both tarifis and nontariff barriers.Table 6.9 presentsa summary measurethat combines 33 The figures span the effect of nominal tariifs and non:ariff barriers. the period 1966-85, and thus indude the earlyefforcsat industrialpromotion, the HCI drive,and the subsequent liberlization. The 1966 figures show a relativelyprotectionist stance that becomessomewhatmorc 2.96
USING
RESOURC
SE E
Table6.9 Overall Degrees of Import Liberalization byMajorIndustry forthe Republicof Korea,Selected Years(ConsoEdating BothQRs andTariffs) (percent)
Mgjor indunrLy * II. 966 1970 1975 1980 1983 1985
Printary Industry Food,beverags, and tobacco - III. -Textiles, clothing, and lcathcr products IV. Woodand its produas V. Paper,paperproducts, andprinting and publishing VI. Chernicals, perroleurm, coal,rubber, and plasticproducts mineral products VII. Nonmetallic VIII.Basicmetalproducts IDC Meral protucts,machinery, and eqwupment X. Othermanufiacturing Allmanufacturing (II-X) Lighrindustry(II-VX) Heavyand chemical industry(VI-DC) All-industry avcrage (I-X)
I.
30.0 34.7 24.2 39.5 47.9 41i. 44.7 41.0 31.8 37.5 33.7 44.5 39.6
5.5 56420 32A .36.6 64.0 54.7 57.1 77.0 73.3 59.3 39.5 47.7 38.2 62.5 50.8
55.1 38.4 43.8 69.1 54.5 58.4

76.8
58.8 49.6 74.0 76.5 78.4
65.3 49.6 74.3 82.7 88.8 75.2 89.2 90.1 69.7 65.4 71.3 63.8 76.5 70.4
71.2 64.1 87.8 92.4 90.8

80.0
65.9
89.1 86.2 63.6 58.2 66.8 62.3 70.5 65.6
74.8 55.4 38.7 52.6 43.7 61.2 52.3
91.7 92.0 77.8 76.1 79.8 76.8 81.7 78.5
Near: This table givcs thedegrees of import liberalization bymajor indusuy theseare obcained by averngig scrmal damweightedby
producton forrespcrive yer the current pricevaluc ofdom:sric Sowcan:Sakong (1993).
liberal by 1975. Nevertheless,even by 1983, when Korea'ssuccesshad become an establishedfact, most sectors were still protected by some combination of tariff-s and nontariff barriers.While Koreautilizeda variety of instruments, especially export targetsand rebates,to ensure that exportersfaccd internationalprices for their tradeableinputs, there was considerableprotection of goodssold on the domestic markec. Taiwan, China. Wade (1990) provides a carefuldescription of the extent of intervention by authorities of Taiwan, China, in product markets. The pattern of protection is not dissimilarfrom that of Korea.As late as 1972, a significantpercentageof items were subjeccto nontariff barriers, and two-thirds of potential imports were subject to nondinal tariffs in excessof 30 percent. As late as 1980, more than 40 percent of imports receivednominal protection in excess of 31 percent Indonesia, Malaysia, andThailand. As we describedin chapter3, Indonesia, Malaysia, and Thailand all had import-substitution regimes that
while modest by international standards, nevertheless favored production of manufhacturedgoods for the domestic marker at the expense of 2.97
MURN!iL IRACLE
agriculture and exports. Malaysia was notable for low, if variable, protection of import substitutes, while protection levels in Indonesia and Thailand were higher. All three economies began export-push trade strategies during their periods of protection of the domestic market. Tables 6.10, 6.11, and 6.12 provide recent data on the structure of effective protection for these three economies. Effective prorection rates are declining but in Indonesia and Thailand they remain sufficiently high to result in some anti-export bias. The free trade regime for exporters in these economies partially offsets the structure of protection. Pricesto Intemational Prices The Closeness of EastAsian Domestic Notwidtstanding the protection thar exists in all the HPhEs except Hong Kong and Singapore, domestic prices in these economies are closer to international prices than in other developing regions. Two bodies of evidence lead us to this conclusion. First, nominal tariff rates adEffeciveRates of Protecticn, Table6.10 Selected Malaysia, Selected Years
(percent)
Sector 1969 83 1979 1987
Foodprnducts Bev:rages Tobaco Textiles

Apparel Wood products Furniure Paper and paper products Printing and publishing Industrial chemicals 1Peroleum refineries Rubber products Plasticproducts Iron and sted Fabricatedmetal products Nonelectrical machinery Electricalmachinery Transport equipmenr
-Not
20 125
-
400 33 40 140 230 60 265 84 40 1,600 130 185
88 38 58 45 38 84 66 26 32 22 129 312 63 26. 89 4 59
-22 -26 15 6 82 43 29 -9 12 5 14 163 289 30 19 12 65
available.
Note Theeff&cive mce of prorection is thepercentgebywhichvalue added at
domestic pnices excereds valucaddcd atworld prics. SoweSalleh,Yeah. andMeymnathan (1993).-
298
USING
RESOURCE-SC
Table 6.11 Selected Effecve Rates of Protection, Years Indonesia, Selected

percent)
Seaor
Food, beverages,andtobacco
1975
336.2
1987
122
1990
124
Textiles, cloth,and foonvear

Wood products
231.8
-12
102
25
Paperandpaperproducts Printingand publishing Industrial chemicals Petroleum refineries Rubberand plastic products Ironaandstcel
Fabricatedmeaulproducts
873
-
31
-
35 33 20 13
28.4
-
14
-1
57 13
-
-I
48 10
-
426 18.2
-
*Nonelectrical machinery
Electricalmachinery
Transport equipment
Non-oil : -Cement Manu&crmnrng Total (eclduding oilsector)

-Nor ailablo
-1
63.6 74.1 60.2 68
1
53.6 59
Nan The cflicrfie rareofprotection is thepecenngeby wcb value added at arworld prices domestic prices exceeds valuC added
Pngestu (1993). Sowr.cBhmacharyaaand
jusred for the presence of nontariff barriersare lower in the HPAES than in most other developingeconomies.Second, comparisonsof real GNP
across a broad range of economies indicate that domestic relative prices fortradablegoods in theH-iAEsare doser to internationalprices than in
other regions. Table 6.13 presents one of the few systematicattempts to compare nominal taiff rates for a broad range of developingeconomies (Erzan and others 1989).34The authors have also atrempted to adjust for the eflc of quantitativerestrictionson levelsofprotecion. (We have added comparable data for Taiwan, China, and have computed the average 35 ) nominal tariffi for Korea, Malaysia,Thailand, and Taiwan, China. Nominal tariffs in the HPAEs are lower than for any other grouping of developingeconomies except the island economies of the Caribbean and the oil states of West Asia. The differencebetween Latin America (albeit before its recent trade liberalizations) and the HPAEs is striking. Thus while these economiesfavored production of import substitutes, they did so less than most other developingeconomies.
299
WN MIRACLE
Rates of Protection, Thailand,SelectedYears Table6.12 SelectedEffective (percent)

Sept Secor Averages Allseccors Exdudingfood,beverages, and tobacco 1971
87.2
1974 18.6 45.9 -
1978
70.2
1981
-
Marc/i 1983
-
Oct 13984
-
Nov. 1984
-
April 1985
-
44.2 -
90.3 -
7.4 248.5
67.4 144A 199.7 53.7 43.0 52.9 46.0 102.7 62.0 23.6 33A
65.3 127.8 199.0 55.0 43.0 51.9 46.0 102.3 61.9 23.6 33.5
57.0 108.0 167.0 49.7 39.0 46.6 39.3 89.8 53.9 21.0 30.6
Manfacmuring
prmducts Textikl
66.3 118.4
152.7
Leacherppmducs
Woodproducts Paperand pulp Chemical products Rubber products Othernonmetal products Metl products Machinery vehicles Consumer goodsandmotor
-
151.3
60.7 39.5 54.3 48.7 99.8
62.0
53.5 44.5 42.0 108.5 70.9 29.3 45.6
633
14.1 34.9
Nor available.
at domestic prices exces value addedatworldprices Noz The effective mrre ofprmtecton is the percentage bywhichvalue added SwxrcBrimble (1993).
Table6.13 Average Tariffs andPara-tariffs, byRegion 1985

Tranip
para-ta
Tarffi
Ceatral Caribban America
Soudt
North Saharan West

Africa Asia
Otler
Asa
DeveAlpg
PEAt'
All
aglow
America Africa
Economies unweighlted
Economies
16
23 24
34 38
29 30
32 35
7 4
36 22
19 17
26 24
-import-weightedb 17 Tariffplus
pars-tar:ffi
. Economics unweighted"
Economics
18.
65 66
46 51
36 39
34 36
9 5
42 25
24 20
34 30
import-weightedb 17 -
a Simple averages across products and economies.*b.Simple aveages cwss productsacross countries, avcegs weighted by otal impor. c Indudes Kdrca, Malaysia, andTaivan,China.
d. For Taiwmn. China, 1981 dat:.
now= Erzan andothers(1989).
300
USING
RESOURCEStURECF
This is borne out by comparisons of internationaland domestic prices. Figure6.4 showsan indexof outwardorientationbasedon international comparisons of pricelevels and price variability forthe HPAEs
comparedwith other regional groupings(Dollar 1990). The HPAEs as a group are moreoutwardoriented than other regions;their relative prices are doser to and more consistentlyrelated to internationalprices. Of course,there is substantialvariationamong the HPAEs. As would be axpecred, Hong Kong, Malaysia,and Singapore rank in the top nvo decilesof the index, consistentwith evidenceon their stmcruresof effectiveprotection.Somewhatsurprisingly, Thailand, with higher effective protection,alsois rankedin the top decile,whileIndonesiais in the top third. Japan, Korea,and Taiwan,China, rank in the fifth and sixth deciles,below such developing-economy compararorsas Brazil,India, Mexico,Pakistan,and Venezuela. This is consistentvith rhe evidence that the three northern HPAEsintervenedfar more frequendyand systematicallyin their economies than the southeastem HPAEs (Dollar 1992).While anylarge,multi-economyeffortat real price comparisons is subject to methodologicaland empirical criticism, the results are broadlyindicative and consistentwithother evidence: EastAsiasrelative pricesof traded goodswerecloseron average to internationalpricesthan other developingareas.
Openness to Forin Technolo

An important fctor in East Asia's successfulproductivity-based catchingup was opennessto foreignideasand technologyGovernments encouraged improvemrents in technologicalperformance by keeping Figure 6.4 Index ofOutwanr Orientaion
HPAEs OECD economies
South Asia
Latin Ameadca and Cadbbman

Mldcile East
I
0 1 2 3 4
SabSaharan Africa
Svnnre: Dollar (1990). 301
.SIAN'-MIRACLE
of international technology transferopen at all times, several channels even thoughsome, such as directforeigninvesunent(DFi), wererestrictedor dosed for varyingperiods.In contrastto mosteconomies evenwhcnprotecstrategies, industrialization withimporc-substituting marker,the searchfor dionwaspracticed with respectto the domestic and absorption of foreign technology wasencouraged iWhile Japanand though to licensing, Koreaset obstadesto DPI,theywerehospitable attemptedto ensurethat theydid not incurexevenheretheJapanese into directforeign welcorming wasexceptionally cesscosts.Singapore planningagencywas to vesunent,and a majortask of tie economic locate appropriate foreign investors. Malaysia hasaggressively sought exfromJapan(see box6.2). Noneof the DFI, particularly port-oriented by interof localbuyingoffices HPAEs washostileto the establishment nadional purchasers, an importantsource of productionand marketng knowledge. This selectively pennissive attitude towardthe acquisition
to MablysiaTechnology BuigsExport I stEn Box 6.2.ri -Forign a : , . :;W.6.:--,

.INmTHE 1970SAND EARLY 1980S DIRECr FOREIGN
chemical2 ;priductsC toward eecrcal- and electronic
Gonenbbe investment Was weloMe in Malaysia.
rduc
-. e
melproucs, and
ye the eec policy -encourd foregn investor ing a of i i byinhibited was.

;-Dlocal partcpaton incorporateowner. Then, -receson of 1985-86 largefiscalantrdedefi
: oftheinvtents were-dedicated:pelm. More before. t- exorsiv
htanaur and declinig invesmt broun

.,pC . . . . . for . -xpos . : . PO.. ,
spuh for
. o
The-benefits toMaysia of DF havibekensubgenrang reign echange stnal par that er, some citics -argue a ploymenr.-.Howe
-
atogas i neighig& t--- cenives ax andrladdomesticquity strast,not cpits of DETwoimportntreasonsfirtatare, potentialinvesto, bparigpaiong requzrcnmcis-or :#ny g of the investments LIn tecleogy and-e-portan& employment thec young MC Wr-.-an ~~-.,,CO~31
opporrumnes.
MU O
Z . -
eloc .
no-my V .
. .. .
..
I.
The newflcdilihad a draiaic
confo
eaiescaz&cl ofmangainet cac ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~Malayuiidd supplieratelbor,and h-qualiy padiyIskilld
in198385,jmpe averagd U US$300millionayear
foreig inveset
pj
cts thmselves
-h
to US$2
-''. Som-L.@
to blng. no-hoyw in iec t "became rnbuied d-- ! - f-mc 1985tn tirie mrcnsmiocntrm Ere,T og moredynaic. n>198a qU2rerF
bbi981
-.
tii&&ibJanii
nare frriiJapzi>fllo~1..arwah,Chi&anc y hd'bcen_:W when thegreatest soureof-D.El gaporet afraed nanfrlly tiicafti&and
&crrinMlysase9io~ u i;L bfisb&ffrtedrd a
than$0 ilo
e -k kceepu
tsi hertcnooyr
302
USING RESOUPRCEts;EPfl
of knowledge of international best practice was a reflection of the view that the world market for goods and services provided an opportunity, not a threat. In contrast, many other developing economies that tended to emphasize the dangers ofopcning to world markets were equally suspicious of open policies with respect to knowledge acquisition. Suspicion of ex-
ternal trade was often reflectedin a mistrust of
DFI and licensing. The
absence of exports reinforced the suspicion. EvenwhiereDPI was permitted in inward-oriented economnies,it was not viewed as providing access to international best practL e but rathieras a source of additcional domestic production. Thus some economies in Latin America that were hiostile to licensing nevertheless allowed DFIin production for the domestic market. The basic difference between these economies and Singapore, which was much more heavily dependent on DFI, is that the multinational corporations locating in the latter could only do so to export,
b~
~
-
er
~~
., --
actmis M2)Sa. .o
eprs
i-h&
t'u
--
semiconductorsto their assembyatvtes hr s toMlyi. The eiets aysihabulupn also no doubt that Dfl has,creaceda lot of empiloy electronics.is.Con sidemrblcNIxdrTomue AG, mea-often.fbrpoor. rua aay. women-=to, e- .wiEc recen'dyestablished.aUS$3,'' iniIl souibfware:ztune of 85,000 inelectronics alone in the late 1980s cetr ocreate4applications6r, UN-aeworkism MAiyaysihas found :that,-ainetments mature- sin>a trce oMl yiabth&r'arts adluand ndrginl'ikae aefrtifed ml-. sotaeegnes&roe-fifth of Germany4 snre nainl hat' are fe' huh fa "foodoiose" *.called ii its Mlyineprst_hpstu;ci;. stay, and the~ poiiplovers ~created-ysuccesfu asmlline iinArzo'na.' vntures encouragemore.investment.Fo xapc Mlasa spanproduce:a:-rang-fpout*-~ Si c th 90,DI1 nd aysi '& rom coiorTy<~,xado6Lassett-pyepl;;ar ioatD5asters cx word'sithird argest,--producer f. semic-bondiu"cto&compdze"eiiheras. Mcomom istat scarte& .n.flt.2 -garnering billion. almost US$' in-ne, exportsin: asnl inme Mavlyahved!n jon 19 I6.hth-laiil 980s,-_Siemhbuiltin iiMalaysiitts 's bcm i4le i-svmioinrecrsi fourt plat in he wilctto manulicture m~egach ~ Maaia -hreit .asernle;col& ilvisoi ad:
i--, Tmrld' I liMa -
Unfiterie-s).
Birocincmais
a&okp
os
oief die ornporflezfbr:itsnew clri th&tat&-1980 Matus

ìa's
to _seinc5ndu&rois-vestments in dectroAics have
plntffaiya,jn
r~ ~eincohduccbrPa4s.A ~uppljilocal Motbrolaind ~llo(r& Hiachilii~e tSei~a&has
i%5Pi~&nr4' ~conchcioner n
rei:ywor1d= m rke Sr-room tair,-'op.(-1991)
303
MiR
LN.MIACE
given the small internal market. Korea and Taiwan, China, with larger domesticmarkets, created a similarsituation by encourging DFI in production for acport and in those sectors where substantial technology transfer could be anticipated. In contrast, the large import substitution economies, such as Argentina, Brazil, and Mexico lured investment of foreign firms by offering access to protected domestic markets.
Poicies Industrial
We define industrial policies, as distinct from trade policies, as govermnent efforts to alter industrial structure to promote productivitybased growth. Productivity-based growth may derive from learning, technological innovation, or catching up to international best practices. All the HPAEs, exceptX llug Kong, have employed industrial policies as defined above. Japan and Korea had che most systematic set of policies to alter industrial structure. Efforts in Taiwan, China, were less systematic but were nonetheless widespreacL Industrial policy in Singapore was more functionally directed at the rapid upgrading of technology by direct foreign investors, regardless of type of output. Indonesia, Malaysia, and Thailand have all used industrial policies but much less systemaucaly than the northeastern HPAEs. Industrial GrowthandProducivit Change. HPAE industrial growth pattems diffier from the patterns in most other low- and middle-income economies in the relative size and growth rates of two important industrial subsectors: metal products, dectronics, and machinery; and texies and garments. Table 6.14 shows the share of value added in nine Internatonal Standard Industrial Classification ('sic) subsectors as a percentage of the tota value added of manufacturing. Among the HPAEs, metal products, electronics, and machinery (isic subsector 38, or MPM) have grown unusually fast The sector's share of manufacturing value added doubled in Japan and Singapore, nearly tripled in Indonesia and Korea, and quadrupled in Malaysia. More surprising than the importance of
growth
in MPM, which provides vital inputs to numerous other manu-
facturing subsectors, is the contnued importance of tctxiles and garments even as the rapidly developing Asian economies shifted fiom labor- to capital-intensive production. Appendix 6.1 describes our method for determining the projected relative importance of specific industrial subsectors in cross-economy comparisons. As can be seen in table 6.15, both capital-intensive seccors
304
USING
RESOURS
Value Added of Manufacturing asa Share Added PriceValue Table6.14 Current

Eismjf HPA&
3973 0.05 0-. ' .I gm 0.12 Ut 0.01 0. 33 gmJZ
-m hwo~~~~~~'"
TM"&
ad
w-d
ad...d "ad u
X.-
~a
pA'
;dr
3573 3511 3053
0.-16 IL"9
L15 .4 0.35 0.36 am 0.39 0.35Om0

5
0333 all WI
oi3 -
"I 0.01 0.10

e5 .
0.36 0.35 0.36i

-0.6
00) 0.05 035

0.4 s
DA3 an0 0.12

os 1
0.0 0.34 ON2

0.46 e
DA. .03 0.02
IW 0.59 IL"
a
MP
-Y196
a"
.2 0.13
0.36
I.3l1
0 0.05
ISO538
1960
0.21 .3
0.27
00Ms as6
-O0
013 Alli
0L
013 0am
a0
Wu0 .0
0.23
3.00 La
J1A
0.7
all
3583
0.18
0.07
07
00
p.27
0.06
0.1
0.27
013
tAO0
3,319
1313
0.05
e.s
0.0
L137
WI3
0.33
0.05
1.04
0.20
O
003
0.16
0.01
-D0
0.6
0.32
"I
.Ot
a."
1A
3936
0.42
02 0-
0.03
0.103
0.9
DA0B
0.0
0.1I
0.01
1.03
3970
1916
0.32
0.12
0.23
0.5
3101
001
0.A5
004
WO3 0L4
04
05
0.120.10
0.2
0.9
O.01
01
0IL"
.03
1970
0.24
034
0.0
0.0
0.0
0.04
Om.02
0.06
014
14"
Iwo * 3965
0-17 0.24
0.33 -04Z
0.5 am
.06 0.0
0.19 0.24
OA 0.0m
0.12 0.011
-
020 .27 0.0
I0D 30IJ
g 3970 1916
1970 19[g
0.37 Gm2
o0e5 0.30
0.12 0.33
0.3
013 103
.3 01 -L30
0.06.C0
W0 0.36
0617 01.15
0.03 0,4
00e4 a3
'-56
4.36 0.23
0to GAe
0.7
.314 ILl5
0 am0
0.l 01
Lot
30 .00
0-5
I=7 *1,34
0.31 0.~~
~~28 AM3 OA05 ~ ~~~~~
0.8
D101
0.0 01
0.35 0.37
0AS 0.33I
0.24 41.1
01e 0.5
0.0 amo
1.03 3.0
(mpm)and labor-intcnsivesectors(textles) play a greter-than-predicted
role in manufacturing in most of the HPAEs (excepr Indonesia and Malaysia).Besidesthe unexpectd prmninenceoftextiles and garmencs,
the aaalysi yields another surprise. Chemicals and nonmetallic minerals, two sectors often assciated with indusErial modernizadon, ameno o.ndards. -largein the HPAES by interatdonal s
Detailedsectoralgrowth ratesof total factorproductivty areavailable

for Japan, Korea, and Taiwan, China. There are now sufficiendy long time-series dat to conclude that in these economies, T* growth has accounted for a substantial raction of the growth of constnt price value added in manuFacturing. Table 6.16 shows a varety of-esmates oflong305?
AiRAC
MIRACLE
term rFP growth rates. Given the length of time of the observations,it seems unlikely that the measured growth rates of TFP could be attributable to cyclical phenomena or growing capacity utilization of initial large investments.3 6 Sbtres of Selective Prmnonion. Here we describe the strategies of selective promotion that have evolved in the HPAEsas they developed their industrial policies. Japan. Early Japanese industrial policy aimed to encourage sectors that faced income-elastic demands in the international marker and exhibited economics of scale, large fixed costs, and the potential to learn from experience. This purely economic rationale was supplemented by a sense that some sectors were critical to national morale and the
Sectors Table6.15 Actual/Predicted Shareof GOP Originatingin Manufacturing

ITC
&nwqd# hnnwj. a&d a"
ir..
_d
P4ad
ukA
a
N..Mlfk Uhr
;,.daV
sad
TsIt
m -
rqi"
gadbe
&tS..
p-AKw
jminaAw
ruUvr
uhmn6wf
nuMb
0nay ter
ftrn
1973 9ISBt
e12
lo 10-3
.89
0.53
0,7
e.14
0.37
2.6
0o35
1 2s
0.43 1.63 0.75' 19
IMF95 [.7 03'
036 0h30 1.42
065
Dh67
0.14 0.20 095 0.63 0rt 0:73 02 0o.e5 0.70 Jo57 0.75 0o27 1.9 135
0.17 0.00 Z.62 I.Woil 0.52 1.13 @0A
11.6 0.44 a.ll
0.3 0." 0.01 '
1.2 Oda 0.57 423W7 e0 1.04 1.26 0D4 OS7 IAI to3J 0.95 3.s
1973
15SC
O3 IAO
0.6 0.54 0.73 0.67 0.94 0.56 G." C."9 L09
_,~~~~~~~~~~~~~~~7 :-5
2.412 13a52 17 2:4 025 0e5 2.14 11.32 121 3.33 1 36 a,66 1.04 0.64 O." 0.7 0.49 0.47 al 071
on
9s
1329 O.98 0.99 D35 0. 0.J5 0.94 0.31 0@36 0.!0 .34
ns
2.0
o.n1
L69 2.0 276 1.03 '.44 1236 50 3.16 1.32
0,14 0.20 0.32 1.43 0.07 0.13

0.34
Kar. Rxor d
1563 19 155 19B1 1973 t9S9 1968 19: 6 SeM 1I56 19S6
Lai . AM 'listS_;a -
1.55 33 2.40 0.31 4.35 1.85
t.7
0.3 0.65
1.53 oa 02 033
0.09 022
0.50 0.56
6.00 2.39
0.54 (L
233 1.02
033 0.39
0.37 0.35
1so 3,74 0.63
L51
0.32 D.09
1.10 052
'-
1 3963 1785:
0.91 03 4 1.11 1.1 : _ 37 1.57
I10 170 3.04 3.M6 0.45 4
1.34 1.21 1.21 I1 '[94 0.41

0.15 t
1.03 0.73 1.07
Q69 LIZ oi9
0.51 0.48 0.73 0.43 0.84

1.04
1.31 0.11 L63 436 37
218 1.92 2.65 D.8S am64

am e
G.AD GaG 0.24 4.03 0.0

_32 l
1.02 1.09 121 1.1
Chile
193 19t0 1915

1954
-. 67
15
a
-76
a.70
'
?dkcJ
uhiew
90711C
aku*t-l.t..p..
-306
US ING RESOURSCOU
Table6.16 Long-Tenn TFPGrowth Rates bySector TFPgrowtld rare

Taiwan,
Sector FoodBcverages Tobacco Apparel Tcxctiles Lcather Shoes

Wood
Kirea 7.30 7.90
Japan, 1960-79 -1.76 0.0

-
C-/ina, 1966-6 2.0' 10.5 7.6 _

o3b
13.40
10.70 12.60 9.40
1.98 0.47 1.03 1.03

2.81
Furniture Paper Printing Chemicals

Pecroleum
12.10 8.20 10.70 13.10

-0.30
1.74 1.44 -0.18 3.36

_3 55d
2.3c 3.3
O.Ob
Rubber Nonmetallic minerals Basic metals Ironand-steel Metalproducts Nonelecrical machinery Elecncalmachinezy Electrical equipment Transportequiptnent
Prccision instrumencts
11.40 2.80 3.70 7.60 .00 10.70 11.20

-
1.02 134 3.41 230 537 432

-
63b 2.4 7.2 4A 67' 7.1 2.7

11.0
0.0
Plastic products Oilhermanufacturing Average -Not availablc.

a. Foodmndbevrages.
o.92f:
7.50 8.8
-1.76 1.2
4.6
b. Rubber, petroleum, andwood products. c Paperandpaper products.

d. peuroluem ref and coaLc. All machincry.
f Plasdc.. SowrePack(1993b).
achievement
of international
respect3
In later years, industrial policy
had a narrower technological focus, for example, promoting establishment of the technological base for very large-scale integrated circuits (Borrus, Tyson, and Zysman 1986). Among the sectors carefyl 7 nurtured were steel, automobiles, textiles, shipbuilding, and aluminum refining in the earlier years and then electronics and semiconductors in
307
A :LA?WUIRACLE
38 (Effective later years. ratesof protection in these industriescan be seen in table 6.8.) Japanese industrial policy until the early 1970s had severalstrands and Yasuba 1985). The government di(Yamamura1986; Yamnamura rected credit to large firms and protected the domestic market to help allocated the firms realizestatic and dynamic economies of scale.mmTt foreign exchangeto favoredlargefirmsand tried to ensurethat technology payments to foreign firms were neither excessivenor duplicated, often forcing licenseesto share their information with other Japanese firms.Relativelyhigh levelsof protection were used as part of a strategy As late as 1978, the averageof effecto help firrns to export successfully. tive rates of protection across the manufacturing sector was 22 percent? 9 Such rates may have been responsiblefor the very low level of manufactured imports, an issuewidelydiscussedin the scholarlyliterature (Balassa and Noland 1988). Korea.Korea'spolicieswere similarto Japan'swith respectto selected aredit,protection, and limitation of entry into specificsectors(Padcand Westphal 1986). However,the Koreangovernmentpromotedindividual firms more often to rectifyperceivedentrepreneurialand skill deficiendes, usingexport performanceto determinewhether firmsdeservedcontinued promotion. Other policies to encourage industrial growth and at exportsinduded making directand indirectinputs to exportsavailable promoted sectorswere the heavy world prices. In Korea,the selectively and chemicalindustries:iron and sreel,metal products,machineiy,electronics,and industrialchemicals. The motivationfbr theseappears to have been both strategic-to increasedefensecapability-and economic-to shift to capital-and technology-intensive sectorsin anticipationof a loss 4t The costs of the of competitive advantagein labor-intensivesectors. Ha: drive are still not filly known, but theywere high (seebox 6.3). Although there are no recent esrimatesof Korean rates of effectiveprotection, there is considerableanecdotal information suggestingthat the governmentaffordedthesesectorsrelatively high protection. Taiwan,GCina.The intervention of Taiwan, China, in manufacturing has been similarto Japan'sand Korea's,though less important quantiratively. Wade (1990) has documented tariffs,quantitativerestrictions, and selectve credit policies, maintaining that the successof Taiwan, China, was at leastpartly attributable to an intensivegovernmenteffort to direct the economy'ssectoralevolution. This conflictswith the standard neoclassical view that its developmentwas primarilyattributableto
308
USING
RESOURCES.E
low protection, tde availability of inputs to exporters at international prices, a conservative macroeconomic policy reflected in low inflation, and competitive factor markets (Little 1979). Unlike the situation ill Japan and Korca, in Taiwani,China, it is difficult to discern a pattern of economic incentives. Wade (1990) notes that a guiding principle in the 1960s may have been the existence of
. ........~~~~.. ~
Box 63.31Te HCIDrive:Costsof lidtervention

THE-KOREAN C;OVERMENT'S INTERVENTION sidered the lower bound, however. Those industries
.policy,most notably ihe HCIpromotion, has often . been evaluateCd from thc.perspective of the successorfEijure of industrial policy. !Aniorher ;inporrant ..
whose credit was squeezedwere,frced to borrow at curb markerrate. The rCI reaL effectivetsubsidies fior the Korean goverment opted to bail our.the. strugglingheavy machiney; shipbuilding, overseas
construcrioh, and shipping indusries in' th mid1980s, nonperfbrming lo of conmrcial banks accumud rapidly and accordny bank profi;abi.y seriously detoed During 198-7, fr
ap; . - borrowers weitreherd6rcbas hrigh as3 percentof GNP.
proach in evaluaing int-rentioh policy, however, woud -betoestirmate the fisal/financial cost assoWo
r CaCed wit intervenCiin. Govcrnment intervention in-:X-.- ',.cureddiecthefosts thform ofsubsidies to strateic sectors through-policy loans andl tax-exemptions, esecialfr during the..1973-79 periodof.HCI .promoMcQf nflosPA tidon. Intervention rred idirici c t
eInost
exaanplIe, the share of nonperfmii lons I to -rmn .of accuimiated nonperorming loans assets readied 10 percent. Between -1985 and: resulting port:bli difficties'ofcommeicial banks.: 1988, 78 coqorations were "rationa DrC ThepornmoUooftea scows spporteda ti process, rn b. abroaod ran.oft fscalae,dFCa.ncirwa.i'srumets. iwntie-o. of principal aonc amounted iy~-oroid-='rangds deo vted- totheCninstrent. Far tr*illonwn,-orabour-I.prcentofcNxin 1985. .Z Goiernment ids t.devotedal dtoe-tc dHC.,isector Farmaging-was d-am tihe frter issunceofsubsiamounwird roperceatord2tc -romotrionpmo.n aton, Upfipjwo 100pr.fr:hi percht-irfor the` ew yas
;'-rate aboutatwo-tl
in:iec
rationaiefis ations ea ad 50 to Cen .. balaces .
adt
p hash:urtbthe
-provi
eK
Bakdiscoun-rswhich ; .0 overnmeab r
rf
nt of. l ugb'p
beilijoeawon q-;~
<collecned)>a.~~~~~~~~~1ost of fi
'
owerfor strategic IndustrIs-, drive in.197 alone,abou& 82 e vbenuo percenmeofrtot won .
~
.
encesd uring the traumatic economic adj(nt 1l979-8; the direct costs ofS s o(3t sixt
5qt;ra;n it has taken,mre tan-a

ind .th costs i n
;XstedT ha..spredomnant -. ?-.-,.&asupoirH U-wa:pr&etl pOliclon 1 dirtedtokey-industes. snp n977r percent wfahe:oiidome tioflthe T& kaMng rhplicinin&i&~~~~P ib .nanci I r iii dHCIi uppsorCof Insfpoic theiic
+ ba
.idede toawith .sdircefipr N
form of accuulated.nonpdomn'on
C45 93t tKore governt oubida
an
'squed
to separate.; Da&k-
aonce med pl n6perceinnt domesais,eilo stlact
,.sectr: I.l
1977-a wroe ati5& 75io
HdVseccoI'in. more than40 .
of tot
ad to.z adle.t tc
piceit
Afrgen&al
_;-
4 tGNP '(6kIiby
bankIoSii4- Ths
L-:-,
aitg
VIt...
&
an
nerest<
con-
troughicbuaet
(1993 NM-stB.
orin:.gounentannoLnce~a-memura-; ;.-...;
atyet to bedeermicos:ts.-:.
ank
eshdmshoulbe
(1987) LKep
Pew
.pan---- -
issW_-_.
309
?SdRA C
EMIRACLE
gaps in the domestic input-outrput table that revealed potential areas of import substitution. The autobiography of a major architect of the island's development supports this view (Li 1989). Although anecdotal
evidencesummarized by Wade demonstrates considerableintervention in many sectors, there are no studies of effectiverates of protection or subsidy after cheearly 1970 . The more recent intentions of the government may be discerned directly from two infrastructural effiorts, namely, the Hsinchu Scicnce Park and the Industrial Technology Research Institure. Both were major investmentsundertaken by the government to providethe basisfor a rapid shift toward higher-technology sectors. Malaysia.In the 1980s Malaysia experimented with a heavy and chemical industries drive similar in focus to those of Japan and Korea but dependent on public investment.The Look East policy adopted in 1981was, apart from its socioculturalaspects,an explicitattempt to emulate the heavyindustrializationeffortsof Japan and Korea,which Nvere regardedas successes. The governmentcreatedthe Heavy Industies Corporation of Malaysia(HICOM) to be the vehide for the heavyindustrialcapital-intensive izaton push. HICOM targeted a number of large-scale, projects for development including iron and steel, nonferrous metals. machineryand equipment, paper and paper products, and petrochel... ails. Whilepublic investmentswere intended to be catalyticin each of these activities, die government activelypromoted joint ventures with had set up nine comprivate (usuallyforeign)investors.By 1988 HICOM panies, employinga totai of 4,350 workers,involved in steel, cement, motor vehicle,and motorcycleengine manufacruring.The highest profile of these investmentswas the PROTON car project, a joint venture with Mirsubishidesignedto produce 100,000 units per year. The ambitious targets of the HICOM program ran into the maaoeconornic constraints described in chapter 3-declining terms of trade and a deteriorating fiscal position. Prompt responses to the deteriorating macroeconomic situation induded reductions in public investment in the HiCOmprogram. Poor management and low profitability also forced the treasury to bai out loss-making enterprises, a practice it could not sustain under the fiscal austerity of the adjustment program. With the shift to policies of privatization of public enterprises and private sector develonment in the late 1980s, the HICOM period had ended (see box 6.4). Indonesia and Thailand. Neither Indonesia nor Thailand has made the systematic efforts to change industrial structure characteristic of
310
US ING RESOURCESCE
'-'Box6.4Ro-' gnizingeaMistke, Malasi Pratzes.

-THE PUBLIC SECIOR IN MAIAYSIA WAS RELATIVE-
many so-lled
pivarized
firms becae
more pr
ly snall util the late 1970s,wheni the gopertlnment - ductiveand innovative.Nor can the macroeconomic .rapidly,expanded the umberof stat efirms, pary to bencfits be overlooked.in the end, tihecderal gDi'-,;;givehMlay'sopportuniuesand.partlyoutofa convic- -emuent anticipatesthata-tleast15 percentofitsouri, noniat the govea entcould s de&elopmentr. snd -in debeen trred to privafizedi MLSifuch of th& vgrowt i the early 1980swas due to firms. 'HICOM,. the Heavy and, Industrial Corporation of Malaysia'sslow but steady divestiture and' the Malaysia,which esiablishednine subsidiaries 'in such, b enits it realized by 'adaping flexibly to thcir=areasassteel,automobils, cement, ant paper. cumsrances of-each--cas provide anI examplefor .- , :fkis, especiallEy State in HCOM, performed less. . niany m oter deveopig cnos, wh privatiza,'wl
p'ublic enterpnses tached 3.7 p ercentofGNP.Asris-.Dipg fiA:il cEdfictraa&la mngs of trade threatstability sthe govemenc -ened -macroeconomic
thanexpeced
nd in 1984
:thedefici of the-
'tion' is an offical goal, yet much less has been
achieved A derailed analysisof the compauies that

fare. As two cases belowillte, changes m incen-
,,
-w:er privatized'showsconsistentgains in soial we0

tives and a broader role for priate sector interests have 'frequently been more imporrant.-lthan the change in. oners pe . M A&r?Systems Berhad (MM).- -Wlhi48 .percent of ASwas sold to the publicin 1985,ther
wa no gc in an Eve so, managment gnd investrment decisions t or de 'jur autl{orit'" de t contrl over permission'
begat pdvaize in 1983.iOf m orerhan 800 state fiMrs existing Mi th mid9Os, about a hundred had, been by'WO.Maire s conmecial .manuring oper s,butsome were quite big,.
incl=du,ding an--airline; a shipping' company,, and a

telecc}tnmuincatiotis fim, * there have beeinglitches.-For offeingshave
Imps l
6
instance,
public
been
as much
heavily
as US$150
esscbed,:suggt
and eventulywon
; the:government in that
sing
upde.*ied.i'
million
sha'res s
i, t sl
perof
to. raise domescconsumers,
fares. Whie
the farie
ra c
har.
less, rationing
-o -tickets
ur big companies.A-lso, morc atenon to promorw r Moreoe, h wr',p monopolisriasitu?aribnsvol r; 'in 18sir , b- mg5mpedrion u "O ';L the early Mocvr-1ic Dnont-. Finally,priver&.to-h _a; 17Y corporation?
while ir contintue to
Sect or r -femain ; X sL .,ibni , ,, d .
ile
b becamec profitablta-paying ALA a~ l'i2bu ',R b-,cn :. even,
;'on-as proceededveslowl; s day, -ie Malysia

--e.; ;; --. . T
Ii.-mg ;piblic
-
Co.tainer Temindl (z).. 'In 1985,90f Kr was sold to de-izep dlS. . . to.,t the ;, pia
more.than
:schems
tovrpro t H-tover
ounigh
sales. Ith.
~~rodxicri tvi&de 6& tiea cotrings

*as-
hysia. s -meant thoughte ublic secor retained control, the indmcude'l ashosr"of ' ;.rm that took over, many repres'nnt'' Bumi -p d h c.thh' ontro srests, -' ireincentvet to ear Pr6fit.nK
'-;
eII&' 'ubl-PiIcsc~ r phec

theaiSaxontrall PRO-
s a luc
ui
c traicinand
r out
es, ofdie
nopbzcaf reion nil
-- 1,ing container.
ON,taornil
company
no, t. .nb-e'rir
inWCOM. E ienad Even ref.ier

the-fi-ms&vi
o
s.s sub tanrlyimprove
. ah
:2 ~flrn ihake Ke, 'SczE,,edr
y__Fxpcrcnxe
,h&,,,6nrinf
m mnagrsinat-nyaestanisinad
taonintd
r''
shamtrome.' w,
(iu) L
iworkeri,productv--
Sw,,t;
(1992);
kspoldec rk&4he~~ mor' toit~z
wa tha
~ Slkii(199);
od Bn
(.1988)"'-
3"I
-C
_A IRACLE
Japan, Korea,Malaysia,and Taiwan, China. Thailand's Boardof Investment (BO}) has attempred to promote variousactivitiesviewedas having the potential for technologicallearning, but, as we pointed out in chapter 3, it is difficult to discern any sysrematiceffort to change industrial structure from the pattem of promotion of the BOI. Indonesia has used public investment in an effort to move roward high technologyindustries. Indonesia'stechnologydevelopment efforts representan cxtreme case of state-supported technologicalupgrading, but the public sector research facilitiesand strategicindustries have fev linkswith the private industrial sector. One experimentwith leapfrogginginto high technology industries-Indonesia's attempt to create an aircraft industry-is describedin box 6.5.
DidIndushial PolicyIncrease Productiv?

Have atrempts [o alter industrialstructure helped accelerateproductivity change?We attempt to answerrhis question by addressingrwo related issuesin appendix 6.1: * Firsr, did industrial policy alter the sectoral configuration of industries in ways that we would not predict based on facror intensities and changing relativefactor prices?If changesin dhe seaCoral composition of output are largely rnarket-conforming, industrial policiesmust have failedirhat least one of their objectives: to guide industrial development along paths thar it would not take if it wereguided by market forces. * Second, what were the rates of productivity changein industry in the HPAEs, and what were their sectoral patterns? If rates of proctucivity change in industry are low overall or in promoted sectors,prima facie, industrialpolicydid not meet its productivityenhancing objective. In both cases,our answersleadus to conclude that industrialpolicies were largelyineffecnive.
Indusbial PolcyOnly Marginaly Altered Induri Structure. The cross-econ-
omy comparisonsof industrial structure raise quesrionsabout the efficacyof government effortsto promote or discouragespecificsectors. In Korea, for example, despite the government'sextensiveefforts to speed the privatesector'sshift from labor-intensive to capitmland technologyintensive industries, the relativelylabor-intensivetetiles and garments
312
USING
RESOUCES
sectorwasnearly threetimesbigger thanintemational normsprediaed in 1988, a substantialincreaserelativeto internationalnorms from 1968.Duringthe sameperiod,Koreamerely maintained the internationalnormin chemicals, a heaviLy promotedsecror, whileocherheavily promoted sectors, basic metals and metal products and machinery,
achieved only modestimprovements. Similar surprises are evidentin Singapore, which,likeKorea,hasa government that aggressively inter-
Box6.5 Indonesia's Turbulent Leap into High Technology

* SECr1oRAL-.TARGETING TO ACHIEVE RAPID PRODUCTIN
change is a rislybusiness-paTilarly when publicly funded firs arepemiedm toily onprotecred domestc mardratherdian bing subJece to international compeunon. Thedanges oof sucha coursc *areevidentin thedifficulties encountered byIdonesianai.ramfpro- ducerPM. Industri Pes;wat Terbag Nusantaa(iv),
whichhas
since its: esitablishient in 1979 but has yet to becomeinternatonally compmtive or geniiney.profitble Intheory, IPN is exectcd to use the domesticmarkeras a springboard toiinternation2lsales.Te strategy is to shift-froiproducing' aircraftunderlicnse, tOco-design -.and co cton, tohsole designa -and production.In practice, vns.pcpdo meticxmruuei is tooe:.small togenciate the economies ofscalenecessayfor efflciehtaircraft. pro<pductio& Moreovcr,the company hasihad lidelexposureto the :-worid mker-.Of the 230 aircraft(30 hlic:opteri, 100fixl:-wing,r -. that IPiNhasmanufacrured sincerits inaiion, .beensold to Indonesianairlini<the miiaiyrhe pmoli and th& stame-ruoi in Foreign salesareuniikelyto imptrove.While other aircaaftaimanu&u--r&sJcihaive been zibusy,foginhnological ianc&,to%Iinkrhe
-Cl
absorbed $1 billion in goverment. fiud
-timefrom design compleonoplucon, i isigXto~ gDIt
iesil
alone. Its majorpwd@ forthis decadan dendeily designed fifyaurboproppi .nor. rs fr el u.
h designicoxpiieon By -1995,f ieryearseim for slmalarar f&alr~adywedwill .. havexseral hern en t -ranrsall pncing their uairdfrCaggressively. rr cn ill affztpnC arompyr srbu195'hle, m ostsrc:,o4i:catethat IPTN-was.nor pfiptirabWlewhen capitaL coAstsarleen into acCOUUL Noduogin xhompP2a,nys pinCrtormancsnce rhenindic-te3 thgat thesztuandiibs iniproveI:. . >-
313
:AN MIRACLE
vened through a variety of mechanisms to promote capital- and industries. Here, the importance of textiles relative technology-intensive to the predicted norm has increasedeven more sharply.The textile sector went from double its predicted size in 1973 to eleventimes in 1989. Over the same period, metal products and machinery declined from rwelve to fivctimes its predicted size. Appendix 6.1 describes a simple rest of the impact of industrial policy on the basis of the factor proportions theory of comparativc advantage (Hecksher-Ohlin-Samuelson). We assume that given the relative labor abundance in all of the HPAEs early in their industrialization, the share of labor-intensive manufactures in toral manufacturing should rise as they begin exporting. We compare statistically the pattern of growth of the industrial sector in each economy with its pattern of factor intensities. We argue that if industrial structure is derermined primarily by market forces, low wagesand low capital intensity at the beginning of the period of active industrial policy will predict the pattern of industrial growth. If industrial policy to promote capital- and knowledge-intensivesectors was important in determining the sectoral pattern of growth, however,this should not be the case. Indeed, the opposite should be true; high wages (a measure of human capital intensity) and high capital intensity at the end of the promotion period should predict changes in industrial structure. We have performed thesetests on each of the Four Tigers plus Japan for periods relevant to their industrial promotion efforts, using twodigir isic classifications of industrial sectors (seetableA6.2 in appendix 6.1). Our efforr to differendare berween a comparative-advantagebased evolution of industrial structure versus one characterizedby significant intervention is notable mainly for a number of negativeresults. In particular, in Korea-the economy for which significant intervention is best documented-during 1973480 the most rapid growdt in seac 'I shares of value added occurred in lower-wageor lower valueaddeC_ per worker sectors. In Korea at the two-digit level, sectoral growth was broadly market confbrming in terms of traditional factor intensities.The resultsfor Japan are incondusive. In Hong Kong there is no relationship between our explanatory variablesand patterns of production. In Singapore, for the period 1980-89, output grew more rapidly in more capital- and knowledge-intensivesectors, supporting the view that the Singaporeanauthorities successfhlly intervened to encourage increasingly capital-intensive development. But, given the 3"4
USING
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rapidgrowthin the capital-labor ratioin Singapore, this resultalsoconformsto factorproportionstheorypredictions.

These findings do not imply that governments were not attempt-
ing to influence industrialstructure. They undoubtedlywere. But they suggestthat, despitegovernmenr intentions,the manufacturing sector seemsto have evolvedroughlyin accordwith neoclassical expectations;industrialgrowthwaslargelymarketconforming.
Ratesand Patterns of Product Change in Industry. There is both good
newsand bad newsfor advocates of industrial policyin the productivity

performanceof East Asian industry. The good news is that, on average,
of productivity change in industry in Japan (before 1973), Korea, and Taiwan, China, which are the only economies for which we have derailed sectoral estimates of TFP growth, were high by international standards;productivity-based catching up was tak-ingplace (Page 1991). The bad news is that, in general, productivity change has not been higher in promoted sectors. Japan may be an exception. Between 1960 and 1979 chemicals and the metalworking machinery complex haveunusually good TFP performance Jorgenson, Kuroda, and Nishimizu 1987). Japads industrial srructure differs from international norms in these sectors and exhibits quite high values of the share of value added in total manufacturing. These industries are those that observers usuaDy point to as having received significant government support, induding efforts to stimulate producrivity growti. A number of calculations of Tr have been carried out for Korea for a variety of periods (Dollar and Sokoloff 1990; Lim 1991). From these studies a number of patterns can be identified that are broadly consistent with one another. Most striking are the high values ofTFrP change in most sectors by intemrational stndards (Nishimizu and Page 1991). Although the Korean government selectively promoted chemicals and iron and steel (included in basic metals), the large growth in the share of iron and steel was accompanied by quite low TFP performance between 1966 and 1985; textiles and clothing conversely, had very high rates of TFp growth. The promored chemical sector, whose relative size was decreasing, was characterized by considerably higher-than-average TFPgrowth during this same period. The government in Taiwan, China, did not attemnptto influence sectoral evolution as strongly as the government of Korea. Nevertheless, there was more than a small efforr devoted to encouraging specific sectors, particularly those viewed as either capital- or technology-intensive.
rates
315
STN
MI R A CL E
in the shareof the greatestexpansion The threesectorsthat exhibited equipment,and metalproducs-are valueadded-apparel, electrical rarios,and labor capital-labor wages, by below-average allcharacterized between wageor relationship there is no statistical product.Moreover, In fact,the at the sectoral level. change inrensity and productivity capital in textiles and apparel. sectoral ratesofTFPchangearerecorded highest Recent sectoral TFPgrowthraresfor industryin Malaysia from 1973 cheTr growdtrates pattern ofgreatvariabilicyin to 1989showasimilar and paper machinery in promoredsectors,from high in nonelectrical and paperproducrsto lowin iron and sreeland transportequipment. sector,areamongthe TFP leaders Textiles and apparel,a nonpromoted between the (Maisom 1992).In short,thereis no apparentrelationship growth. sectors promotedunderthe HICOM driveand rapidproductivity Overall, the evidence that industrial policysystematically promoted change isweak InJapanthereissomesupsecrors withhighproductivity seccors, while thatTFPgrowth washigherin selected port for theassertion thatwerenot promoted(forcxChina,activities and Taiwan, in Korea ample,textilcs) had TFPperformance as impressive as those that were. whedter highratesof TFpgrowthcomto determine arrempts Moreover, the can plausibly explain binedwith rapidgrowthof promotedsectors in manufacuingyieldmosdynegratesof TFPchange veryhighoverall for manufactrings ativeresults(seeappendi 6.1).The mainreasons success inJapan,Korea, andTaiwan, China,layin the highgeneral rates sectors nonpromoted thosein labor-intensive, ofT"Pgrowth,including
Increased Productivy Exports How Manufactured

OES THIS MEAN THAT PUBUIC POLICYHAD NO ROLEIN THE
We befoundformanyof the HPAEs? rapidratesofTFP change

lieve not. In chapter I we describedhow rapid UP change in developingeconomies can be a result of the ability to move quicldy doser to international best practices.We termed this "productivitybasedcatching up." We believethat rapid growth of cxportsi a resultof the export-pushpoliciesof the HwAEs, combinedwith the superiorperin creatring and allocatinghuman capital, formanceof rheseeconomies provided the means bv which they attained high rates of productvitybased catchingup and TFPgrowth.
3I6
USING
RESOURCESC
How did the unusually high rates of growth of exports and human capital contribute to the productivity performanceof the East Asian econonies? Most explanationsof the link betweenTFP growth and exports emphasizesuch static factors as economiesof scale and capacity utilization.While thesemay account for an initial surge of productivity soon after the start of an export push, they are insufficient to explain continuing high TFr growth rates. Rather, the relationshipbetween exports and productivity growth may arise from exports' role in helping economies adopt and master international best-practice technologies. High levelsof labor forcecognitiveskills permit better firm-leveladoption, adaptation, and masteryof technology.Thus, exports and human capital interact to provide a particularly rapid phase of productivitybased catching up. Of course, it is possiblethat the move to a higher production finction occurred beforethe growth in exports-that TFrgrowth causedex41 But even if expors began on the port growth rather than the reverse. basis of productivirychangedue to such domesticeffortsas plant reorganization, the cumulative magnitude of productivity growth over nany yearsis most unlikelyto have been a resultof purely domesticefforts.42 It stretchescredibilityto suggestthat the largecumulativeeffcts of TFPgrowth in Japan, Korea, and Taiwan, China, could have been achieved by the plant floor innovationsproposed as important sources of productivity growth at lower TFP growth rates (Packand Page 1993). Were that the case,it would be difficult to explainwhy these gains far outstrip productivityincreasesin the industrialeconomies during their own rapid-growthperiods, when TFP growthwas attributable largelyto domestic factors.Clearly,then, an increasedability to tap world tech43 nology has been an important benefit of exports.
Exports' Rolein ImpedectKnowledge Markets

Why do exportsfacilitatethe move towardinternationaIb&, :-practice technologies?The knowledgethat pernits this shift is availableonly in quire imperfectmarkets. Often the marketsdo not exist-some knowledge is simply not sold, because its owners fear that licensingor direcc foreign investment will eventually Ieakthe knowledgeto future competitors. Evenwheremarkets exist, they are likelyto be characterizedby bilateral monopoly,so thata varietyof difficultiesconfirontfinns trying to purhase such knowledge(Arrow 1969).
317
4MIfA
CL E
In markecs with imperfectknowledge,mechanismsthat help an economy or firm obtain technology can conferan cxternality-apecuniaryone if knowledgeisobtainedat a lower cost,a realextemalityif the knowledge turasferis more efficient. For example,the transfermay be more beneficial if knowledgeis obtainedas a resultof the self-interest of purchasersof exports in the OECDeconomies, rather dtan through arm's-length purchase. Exporting helps to overcomesome imperfectionsin the market for knowledgeand permits its acquisition through a varietyof mechanisms. These include: mPurchase of new eqiupment.The purchase of new equipment is a straightforwardmethod of obtaining new technologyinsofaras it is embedded in equipment The two main impacts of exports in this case are in providing the competitivepressure for firms to make such purchases (if the equipment is used to produce exports),and, more generally,in earning the foreign exchangeto finance the purchase of machiner)y a Direct#irieztinvestmentThe firms that generatemuch ofthe world's
new technology are reluctant to part with it. They perceive that the best
use of tieir newknowledge with respectto developing economnies often is through exporrsof producrsto them. In East Asia,however,most of the incoming DFI has been intended for production of exportsrather than as a strategyfor domesticsales.An economy's recentexport performancefrequendy signalswhether it is a desirablelocation for export-orientedDPI. Economieswith rapid export growth are preferredin part becausesuch growth often reflects good macroeconomic management Moreover, econornieswith significantexport growth have generallyprovidedmore infrastrucure useful to exportes than internallyoriented economies44 DFImakes crucial production and marketingknowledgeavailableto developing economies.It permits them to begin manufacmringalong the world'sbest-practice producton fiLnction by substitutingforeignphysical 5 As locallaborlearnsfrom the and human capitalfor absentlocalfactorsfi presenceof best-practice knowledgeand equipment, knowledgerends to become diffiLsed through labor mobility and informal contacts among managers.Even when the investing firn attempts to hinder such diffusion, signicant knowledge ranfers are inevitable.6
* Technology licensing. licensing exsting technologies,both rights to

proprietaryequipment and derailsabout production pocesses,offersdevelopingeconomies substantialopportunitiesfor improvingdteirlevelsof best practice.During the 1950s and 1960s,Japan benefiredconsiderably fiom licensing (see, for example, Nagaoka 1989). The net gains were
3I8
USING
RESO URCC
low cost comparedwith were obtainedat relatively large,as the licenses avoided.However, there issomeevidence, the domestic sarch expenses sense,that arz's-lengthlicensing is decreasing as anda growingsubjective the licenan option for dosingtechnology gaps.Technology developers, sorsin the OECD economies, havebecomewaryof helpingpotentialcompetitors, even if contractspredude exports to ochereconomiesfor the duration of the license.Particularly in R&D-intensivesectorssuch as firmsare increasingly unwilling to chemicals, machinery, and electronics, technology-, they believeroyalties providean inadequatereturnfor license This creates actionsthat mayimpairtheirownlong-termcompetiuveness. an irnperfect or nonexistent marketfor critical technology transfers. Exporting economieshave an advantagein coping with this situation. Licensingfirms prefer cross-licensing agreementsin which they obtain accessto the licensee's own technologyor to its manufacturing skills.Given asymmetriesin knowledg. the best test of the potential parner's abilities is its performancein export markets. Moreover,the fact that a firn has exportsand the requisitetechnicaland commercial skillsto producethem improvesthe bargaining position of the licensee Salesof licensescontain a significantelementof rent (Pack 1993c),so the cost of licenseswillbe lowerwherethe sellerperceives the strengths of the purchaser as signaled by exports. Finally,where a mark-er does the foreignexchange to pay for feesis more existfor technologylicenses, in economies experiencing rapidgrowthin exports. ikely to be available technology. The freeor inecpensivetrans* Trasfir of nonpmprietary fer of nonproprietry knowledge is easierif an economybeginsits industrialization effort in labor-intensivesectors using relativelyold machine designsand production technology. When exports are based on comparativeadvantage,preciselythese conditions are met. Hong Kong,Korea,Singapore, and Taiwan,China, all beganrapid industrialization in labor-intensiveand low-technologymanufacturing. The equipmentwas readilypurchased,and the production knowledge was availale at low cost from engineering publications,trade literature,and 4 7 independent consultants. The simpler equipment was conduciveto liocal productivity-enhancing improvements,often on the part of blue collarworkers (Ranis 1973). Moreover,in labor-intensive industriesic waseasierto acquire and absorbinformationfrom customers withour a largestable of educatedengineers. * Infibmwonfrom custorme.In the presenceof imperfectlytraded information, knowledge providedby purchasersof an economjs cx319
-ALRACLE
Rhee, portscan be quiteimportant.This hasbeenshownbyWesrphal, corroborated in Taiwan, (1985)in Korea and independendy and Pursell Gee 1989).Buyers (see,for examnple, China,bya numberof researchers To obtain better-quality productsfrommajorsuppliers. want low-cost, from knowledge proprietary this, they transmittacit and occasionally
transfers suppliers. Such knoNvledge their other, often OECD-economy,
are morecommonin simple productionsectorssuch as dothing and that are eitherin the publicdofbotwear and with older technologies guarded. mainor arenot closely
a Knowledgefrom returning naiondls. Drawn partly by the high wages
and Taiwan,China, of Korea madepossible by exports,many residents and comsuchaselectronics in newsectors trainedabroad,particularly puting, have returned home to work. Many retuming nationals have and then workledfor OECDeducationin OECD economies received 48 transferof besreconomy firms. Their return hasprovidedsignificant nationalsaccountfor mnethods. For example, foreign-educated practice in the industryof Taiwan,China (Pack employed al/the postgraduates of internationalbest practicesbe1993a).This source of knowledge comesmoreimportantaschangingfactorpricesdictarea shift to more skillsare sectorsin whichhigher-level capitaland technology-intensive in patents,licenses, that maybe embodied neededto unlockknowledge nontradedequipment. or the useofspecialized China,a considerable rseanrck. In both KoreaandTaiwan, * Domestic exports and reducproportionof R&D has beendevotedto improving that the gap betweenR&D ing productioncosrs.There is no evidence econoneedsfrequently seenin the import-substituting and commercial mieshasbeena problem. Increase Productivity and Human Capital How Exports technology and rapidfiomnarion of Access to intemational best-practice humancapiml supplement and reinforce oneanothecIt isdoubfl that tie
and imported useofforeignknowledge engieers and workers.Convey, capital without highlysilled domestic
HPAEs couldchave madeasprductv
without foreign knowledge it is vey untlikelythat total fiLctorprductivity
gowth wouldhavebeenaslamrt IntensveefForts by ghly skilled managers and techniciansin individualplants in inward-oienredLain American smckwith internal economiesto improvetheproductiviLy of eitig capital
innovationsdid not generate high- productivitygrowIY49
3Z0
USING
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The HPAEs' rapidexportgrowthhasoftengenerated positive interactionbetween humancapital, physical capital, and knowledge. The externalities generated by manufactured exportsin the high-performing Asianeconomies in the formof cheaper and moreeffective knowledge transfers wouldhaveundoubtedly beenlessproductive had therebeen fewer skilledworkersto facilitatetheir absorption,while the HPAEs' rapidincrease in education levels reflected in part rising private rowards
50 for greater education made possibleby exports and export income.
Thus laborforceskills, flexible markets for labor,lowdomestic disrortions, and exportincentives all interactedto promote high ratesof technologicalupgradingand productivitychange. We can use the cross-economy regressionframeworkdevelopedin chapter 1 to look at the impact of trade and indtLstrial policies on growth (seetable6.17). We introducetwo variables into the basiccrosseconomyregression: the index of openness(as describedabove,the degree to which domestic prices conform to international prices) and 51 Openness to the world economy measuresof export performance. capturesnot only effidencr gains induced by the need to remainglobally competitivebut alsothe likelyallocativebenefitsof having relative pricesdose to internationalprices. Introducing these two trade-relatedvariablessubstantiallyincreases regression. The effect of the explanatorypower of the cross-economy opennessis positive.Economieswith limited relativeprice distortions 5 2 We chooseas our measureof export performance grewmore rapidly. two indicators-the averageshare of manufacturedexportsin total exports and the share of manufacruredexportsin GDP.5 3 Manufactured export performanceis stronglycorrelated(at the 1 percent level)with high rates of per capita income growth. When the share of manufactured exportsin totl exportsis introduced togetherwith the openness index, only the latter is significant.Conversely, when the share of manufactured exports in GDP is used, the opennessindex remains positive and significant.One possible interpretationof theseresultsis that a high concentrationof manufacturedexporcsrelativeto total exports, rather thanopenness,contributesrelativelymore to productity change in a cross-economy framework, which would be consistentwith our reasoning concerningexport externalities.54 Estimates of the sources of total factor productvity growd (described in appendix 6.2) confirm the results of the cross-economy re-
gressions andadd someinsightsinto possible interactonsbetweenexports

321
-MIRAC LE
Table 6.17 Output, Growth, andInvestment (dependent variable: rate of growth of real GDP per capita, 1960-85) NrinnJerefobneations:
Intercept
92
-0.4237 (0.1650) -0.1033 (0.0268) 0.0259
86
-0.0124 (0.0083) -0.0459 (0.0108) 0.0210**
69
-0.2324 (0.1550) -0.0837* (0.0256) 0.0216'
97
-0.0055 (0.0085) -0.0381 " (0.0123) 0.0221
79
-0.3943 (0.1748) -0.0892 (0.0280) 0.023!W
GDP relativeto U.S., 196O
Primary enrollment, 1960
(0.0081)
Secondaryenrollmcnt, 1960 0.0317 (0.0203) 0.1322 (0.2699) 0.0568 (0.0259) 0.0042 * (0.0017)
(0.0064)
0.0211 (0.0134) 02693 (0.2346) 0.0659 (0.0232)
(0.0079)
0.0218 (0.0210) 0.2054 (02806) 0.0625 * (0.0291) 0.0023 (0.0016)
(0.0069)
0.0206 (0.0148) 0.1856 (02376) 0.0444 (0.0242)
(0.0085)
0.0156 (0.0210) 0.1222 (0.2870) 0.0436 (0.0276) 0.0040 (0.0018)
Growth of population, 1960-85
AverageinvesrmenrlGDr. 1960-85
Dollar openness index
Averagemanufacturedexpotslrotal exports, 1960-85 Averac manufacturedexportslGDP. 1965-85 AdjustedR2 RMSE Statisicailysignifieanrax the 0.01leveL
Smotisdally significantarthe 0.05 level
0.0002 (0.0001)
0.0003 (0.0001) 0.0011 (0-0003) 0.001a oi (0.0004) 03938 0.0155
0.3947 0.0159
0.4912 0.0124
0.5217. 0.0132
0.3530 0.0147
NotwCoefficient is top number. Standard erroris bottomnumberin parnthees. Suree.World Bank staffestimtnes-
and human capital.We attempt to explainvariationsacrosseconomiesin

TFP growth rates in terms of relative income, educational attainment (as
measured by the average stock of education per person), openness, and our measures of manuFactured export perforrnance (see table 6.18). The education stock variable, while positive, does not explain variatons in TiFP growth among economies. This is appropriate, since we have measured TFPgrowth net of human capitals contribution. Openness is consistenTly
322.
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PT
associatedwith superior TFP performance,controllingfor other variables. Both indicatorsof export performanceare alsoconsistentlyand positively correlatedwithhiglher rates of T PPgrowth. We alsofind some evidenceof.- positiveinteractionbetween the share of manufactured exportsin total exports and in national income and the stock of education. The coefficientof the interaction term between these two variablesis positivebut not significantat conventionallevels,and dte export share variablebecomes insignificant.When we consider the contribution of the variablestaken together to explainingthe variation in TIP positive.We conclude chatexport growth rates,however,it is statistically
1960489 of TotalFactor Productivity Growth, Table6.18 Determinants (dependent variable: rate ofgrowtlh of real GDPper capita, 1960-89) Numdrmrofobservatons:
Intercept
67
-64.9123 (14.0585)
-4.8047
67
-71.1186
51
-72.0692*u
51
-70.8604
(14.8657)
-5.5757 **
(15.6104) -2.3509 (2.3225) 0.1574 (0.1064)

0.7225
(15.4608)
-2.1562
*GDP relatve ro US., 1960
(1.9771) Educationalattainmcnt, 1960 0.1471 (0.0874)

O.6493
*
(2.0637) 0.0680 (0.1082)

0.7154 IA (0.1508) 0.0159
(2.3008) 0.0738 (0.1207)

0.7134 (0.1558)
Dollar openness index
(0.1417).
Average manufactured cxports/mtoal exports,1960-85 0.0314
(0.1574)
(0.0066) Interaction ten: Educarionalattainment 1960 times manufacturedexports/totalexports, 1960-85 Average manufaccured expors/GDP, 1965-85
- .. . . m:
. .
(0.0142) 0.0032 (0.0026) J.0686 (0.0966)

0.02 0.0284....................,
Interaction term: Educationalattainment 1960 times -1965-85 manufactured cexpors(GDP, AdjursedR2 0.6333 0.6376
0.0625 (0.0269) 0.4507
. 0.0284
(0.0201) 0.4628
;-
** Smzisically significant at the 0.01level. SmziricaHllyiignificantat the0.05 leveL. XNoeC dicmt C is top number Standard error is bottom numbernpathes.-
SoureWorld Bakstaffesdma.---
323
r&IAN"MIRACLE
performanceand education interactpositivelr;higher levelsof education raise the contribution ot manufacrured export concentration to TFP 5 5 This is consistenc with our hypothesesthat manufacturedexgrowth. port orientation and high labor force skills interact to faclitate the acquisition and masteryof technology with attendant spillovers. estimates is supported by a The evidence from our cross-economy studiesthat attempt to test the link benumber of recentmicroeconomic tweenexportsand productivitygrowth. Packand Page(1993)present evidence from Korea and Taiwan, China, that ar the sectoral level rapid export growth is correlatedwith the pattern of productivitychange; axporting sectorshave higherseoral ratesof rF growth.Wei (1993)uses city data from China and finds a statistically significantrelationshipbetween exporrgrowthand productivitygrowdi.Perhapsmost compelling, Aw and Hwang (1993), using firm microeconomicdata from Taiwan, significantrelationship between productivity China, find a statistica[ly differences among manufacturingfirms and export orientation. Contibuted to Growth? TradeandIndustralPolicies HowHave trade policy dearly overstatedthe neuThe early admirers of HPAE trality of incentivesbetweendomesticand foreignsalesand understated the variation across sectors. But the revisionistswho see in the HPAEs' successevidencethat highly targetedindustrial policy worked overlook the fac that the calculationson which borh reliedwer- static,that firms based their decisionsnot only on current levelsof protection and factor pricesbut on the certain knowledgethat thy would need to competein the fuiture.Effective rates of protection may shape short-term tactics but the long-term strategiesof currendy protected firms are more likely ro reflecttheir expectationsof the future. Thus, the emphasis on exportswas decisivefor the entire manufacturing sector;promotion of individualsectorswas less important, since all bur the very dull knew that their turn to export would come sooner than they would have preferred.Given the widespreadnational understanding establishedby government statements and actons in Japan, Korea,andt aiwan, China, that exportingwasthestandard by whichall economic actity would be judged, even firms benefitingfrom higherthan-average rares of protection in the domesticmarkcet understoodthat in the near future they would be forced to compete in world markets. Sustainedreduction in import protecton sent a similar messageto pro3274
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ducersin the SoutheastAsiannewlyindustrializingeconomies.Governments were credibly committed to export competition. Exports were important becausethey ensured that, giventhe HPAEs' high human capital base, productivitygrowthwould be facilitatedby the improvedability to tap international knowledge.
*..
What are the m2in faors that contributed to the HPAEs' superior allocationof physicaland human capital to high-yielding investmentsand their ability to catch up technologically? Mainly,the answerslie in fimdamentally sound, market-oriented policies. Labor markets were allowed to work Financial markets, although subject to more selective interventions to allocatecredit, generallyhad low distortions and limited subsidiescomparedwith other developingeconomies.Import substitudiorn, although an earlyobjective of public policy in all the HPAS exceptHong Kong, was quicklyaccompanied by the promotion of exports and duty-freeadmissionof imports for exporters.The result was limited differencesbetween international relativeprices and domestic relative prices in the HPAEs. Market forces and competitive pressures guided resourcesinto activitiesthat were consistentwith comparative advantageand, in the case of labor-intensiveexports, laid the foundadon for learning international best practice and subsequent industrial upgrading. Does this mean that selectiveinterventions played no role in East Asia'ssuperior growth? Our conclusion is that selectiveinterventions were neither as imporant as their advocatessuggestnor as irrelevantas their critics contend. All eight economiessucceededin establishingautomaticaccessto creditfiorexporters; this simplecontest wasan important component of their export-push strategies. Other directed-credit programswere lesssuccessfulWhere rheyappear to have resultedin almainlyin Japan, Korea,and locationof credit to high-yieldingactiviries, Taiwan, China, it was becauseof carefulszieening and monitoring of projectsand an orientationtoward the privatesector.Where they failed, governments limited the damage by offering more limited subsidies than the credit programs in other developingeconomies. Finally,we have conduded thac industrial policy,with the possibleexception of Japan, did not alter industrial structure or patterns of productivity change. The most successful selectiveintervention in the HPAEs-the commitment to manufactured exports-was also the most general.
3Z5
x&EXkMIRACLE
Flexiblemarkets, low price distortions, high levelsof humancapital,and industrial and trade policies that tilted incentivesin favor of exportsall combined to allow rapid growti of manufactured exports and, through it, rapid technologicalcatchingup.
Appendix 6.1: Testing theImpact of Industrial Policy onProductivity Change
OVERNMENTPOLICIES THAT CORRECT MARKET FAILURES
should give rise to growing total facror productivity in the entire industrial sector,though the resulting pattern ofrFrpgrowth across subsectors is not easily predictable. Knowledge-basedimperfections are likely to yield TFP gains, primarily in the subsecaors in which the intervention occurs. Subsidization of knowledge acquisition in textile production will mainly benefit other textile firmnsas knowledge seeps out to them or trainecdengineers go to other textile firms. Some knowledge in textiles may benefit dosely related sectors such as dothing through production of ftbrics that are better suited to local conditions, that is, are not obtainable on the world marker. T-he secroral locus of gains is important for several reasons. First, empirical efforts to relate government interventon to productivity growth are desirable as aweak restofthe efficts of intervention. Productivitygains in rhe entire industrial sector or the entire economy attributable to other
factors might mistakenly be ascribedto the intervention, even if it had ac-
tually reduced productivity growth. Undoubtedly, the productivity gains ftom correcting various market Miluresmay diffse to many sectors, bur most should have a major impact in the initial sector of intervention. Empirically, many of the intersectoml interactions will be measured as intrasectoral at the two-digit level. Improved production engineering in spinning may improve TFPin weaving. Both, however, are induded in the Ewo-digitisic textiles branch. Equal diffusion to all sectors seems implausible. While there are individual cxdmples in
economic
history (Rosenberg
1976), there is no evidence that this is the general prototype. Moreover, recent research on the pattem of spillovers of R&D in industrial economies demonstrates that the major beneficiaries are dosely related sectors, often sectors that would be identical within a two-digit classification Uaffe 1986). The nonsubstantiated claim that the spread of external326
USING RESOURRCES
itiesis both largeand diffiuse provides an all too easyrefugefor those who argue for the benefitsof selectiveintervention and then offer as evidence effectsthat are plausibly attributable to the effortsof marketagencs. How WeCompared the Relative Importance of Industrial Subsectors To comparethe tansformation of the sectoralstructure of manufacturing in Asia with the transformation projected from international norms, we utilizedthe followingequation: log(VA/GDP) = b0 + b1log(GDrPIOP)+ b2(PoP) where VA,is value added originating in sector i in economyj, GDPis
gross domestic product, and vcl; is total population (Chenery 1960). The equation attempts to capnure dte influence of demand elasticities and dte evolution of supply. POPfactors in scale economies, although in 5 6 The equation is purely dea world of free trade this may not matter. scriptive and has no normnativecontent Indeed, a given pattern might indicate that all economies follow some initial leader and undertake policies to emulate its sectoral evolution. Despite its flaws, the equation provides benchmarks to determine whether the relative importance of industrial subsectors in the HPAEs differed significandy from the weightings observed in other economies. For purposes of comparison, we utilized equations estimated by Syrquin and Chenery (1989) to derive the predicted sectoral shares of value added in GDP. Table 6.15 presents the results for eight branches of manufacmring, showing the ratio of actual, VI,to predicted, vp, shares of gross domestic product for various sectors. Thus a value of 1 represents confbrmance t the international norm, values less than 1 indicate that the sector is smaller than predicted, and values greater than I indicate that the sector is larger than predicted. In general, the results conform to our expectations of these economies. Three economies known as manufacturing powerhouses have larger overall manufacturing sectors than international norms based on the international norms for economies with similar incomes would predict Hong Kong (1.26), Korea (1.26), and Singapore (1.38). But there are also several surprises; these are the focus of our narrative. Given the rough nature of the cross-economy analysis, we have not attempted to test the statistical significance of deviations fom the norm.
327
43
-yASrAN MIRACLE
Growth Efects of Industrial Poricyon AggregateProductivity AggregateTFRin any period can be decomposed by weighting each secror'slevel of total fitcror productivity, A,0 by the sector's share in value added, v.r The growth of TFPwill then depend on changesin A,, this relationcan be written as: and changes in v2..Algebraically, (6.1) ALogA = `,v,tlogA4,- via1 logAUr.l
Equation 6.1 gives the growth in A due to the increasein productivity of existingsectors, logAi.> logAi r- or the growti in th.evalue-added As will share of thesesectors, vi,>z-, 1 whose productivity isgrowing.57 in table A6. 1, small differencesin die rate of growth of be seen belowv sectoral TFP, A*i,, lead to large cumulativedifferencesin Ai, As the text of chapter 6 points out that on the basis of international comparisonstwo sectorswere generallyoverrepresentedin rhe industrial sectors of the HPAEs:metal products and machinery,and textilesand ap that used indusparel. Only the former sector was promorecdin HPAEs trial policy.We define two types of sectors, those fiavored by government policy, f and those subject to benign neglect, h. The implicit model of those who believethat industrial poLicyhas had an important effect is that changes in the deployment of reso' rces were nor based on conventional competitive advantagebut that the governmentcreated competior tiveness in new sectors. Sectoral growth was stimulated in capitaltechnology-intensivesectors rather than unskilledlabor-intensive sectors that were more "natural" fur economies such as Koreaor Taiwan, China, in the 1960s. Moreover,it is implicitly assumed but not emphaComposition on Table A6.1 Effect ofSectoral Manufacturing-Wide Growth ofTFP
TFPgrowh, :TFPSrow*,,
Economy Korea,Rep. oE 1966-85

Japan, 1960-79
actua vae-ad 6.7

2.3
weighn
-adIjal wegkh 6.1

1.9
NeArWeightod by value-added shae datwould haveprvaied ifthe meal products and macduneysectorhad conformneddt redictp d by txcquatuion estimatedby Cheneryand Syrquin (1989).SurarzPack (1993b).Basedon Kuroda.Jorgenson,and Nishimizu(1985) fbr TFP-
esimares forJapan.
328
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sized that rFPgrowth was greaterin the selectively promoted sectorsas a 58 result of static and dynamic scaleeconomies. If industrial policy was important in determining the rate of industrial productivity growih in the HPAES, it should be the case that a. Sectorswere begun or grew more rapidly in terms of factor commitment than would have occurredwithout intervention.In terms of edquation 6.1, Vf more than woulc havebeen "normal" 1 increases from its initial level,vf Thus, ir is necessaryto demonstratethat the sectors to which resourcesflowedwere not those that would have grown on a simplecomparativeadvantagebasis.If, however, the sectorsthat grew by low wages,or 1, 1 > 'M' are characterized low capita intensityas measuredby capital-labor ratios,this is consistent with growth accordingto comparativeadvantage. b. Favoredsectorshad higher levelsof TFp, Af> A,,,l. Evenif (a) can be demonstrated, it is necessaryto show that the governmentcorrectly forecastfitture growth of TFPin sectorsor thatit createddifferential rates of TR) growthresultingin * >A*t c. There was a quantitativelyimportant introduction of new, modern sectors, v,, which exhibitedhigher levelsof TFPthan existing ones. In terms of (a), the sectoral structure of output is radically changed by the growth of modern sectors that are introduced at high levels of TFP, and this raises average manufacturing-wide productivity. Becausethe HPAEs weresuchsuccessfhl exporters,predicting the impaca of selectveinterventions on the sectoralpattem of productiondependsto a considerableextent on one's preferredtheory of internationaltradeRicardian, Hecksher-Ohlin-Samuelson, neotechnology,and so on. To demonstratethe impactof selectveintervention,it is necessary to posit a counterfictualmodel.This is obviouslyexceptionally difficult,and to be of rigorousrequiresa generalequilibrium model that in turn has difficulties its own, such as con-crdyspecifyingsectorl production fimctons and learningpatterns.Again, the "natural"evolutionof an economyalso depends on one's preferredtheory of internationaltrade- Nevertheless, a weakertest can be applied. If the evolutionof the secaorat stucmre of industry in the HPAEscan be attributedto comparative advantage,it is difficult to support the viewexpost of a strong impact of industrialpolicy. Implicit here is that the "naturatl evolutionamong industrialsectors can be predicted by the factor endowmentstheory of comparativead329
;M-IRIARACLE
vantage,or Hecksher-Ohlin-Samuelson (Hos).Although large numbers of addirionalexplanationsof the patternsof cradehave been put forward in the last two decades,many of them are actemptsro explainintrasector trade and specializationarnong products that broadly require the same Factorproportions. HOS theory yieldspredictionsabout the factor content of exportsand imports, not directlyabout Ehe structure of rotal production. However,given the extraordinary growthof exports in the Four Tigersand rheir sizein the GDP, the changingstrucaureof production in theseeconomies was decisively affcted by trade patterns. This is lesstrue of the largereconomies,Indonesia,Japan, Malaysia,and Thailand.
Predicting the Pattern of Sectoral Growth

The newerliteraturesettingout the meritsofinterventionhas not rested whetherthe sectoralevolutionof successfil Asian economieshas differed fiom what would have occurredhad therebeen neutralpolicies. Nevertheless,showingthat many instrumenms wereselectively employed is not the sameas provingdat they had a significant quantitativeimpact on the sectoral structureof production. Even'whereeffective rates of protectiondifferamongsectors,the impact on sectoralstructureisnot easily predictablc. In general equilibrium,the movementof resources has no monotonicrelation with ERPs (Blackand Taylor1974;Bhagwati and Srinivasan1979). For each economy,four simple regressions are run of the form: (6.2) ei= f(x,)
where ei is the change in the current price share of value added in secror i, relativeto value added in all manuficturing. The independenr variables, xP,are the wage per workerat the beginning, zv5,or end of dte period, we,or value added per workerat the beginning or end of the period, vZab or va. La competitive labor markers, the wage per worker shouldmeasurethe skill intensityof workersin each sector.Valueadded per worker should reflectboth skill and capiralintensity and is a proxy for technologicalcomplexity. Although valueadded per worker and the wagerate are likelyto be correlared,both are used, as there is a possibility of divergence. Governments also may have employed one or the other as indicators in targeting sectors.Wageper worker may be translated as "goodjobs,' while value added per worker is a natural measure of "high productivity." 330
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'E!jl
Consider the movement from inward orientation to more neutral incentives.The static Hecksher-Ohlin model predictsthat for low-income economies sectorsthat exhibit low physicaland human capital-laborratios by international standards are the natural candidates for growth. Hence, the prediction is that dvu/zdwband dvl.Idvab c 0. While many newer theories of trade, including neotechnologyand those emphasizing increasing returns subordinate differenccsin factor endowments. they are more likelyto describe intra-industry patterns of tradc among industrial economiesthan the evolutionof the sectoralstructure of production of developingeconomies whoseproduction structure islikelyto reflect differences in factor proportions. If interventionhas been of great importance in promoting the expansion of capital- or knowledge-intensive sectorsand, eventually,affecting tradepatterns, the data should show dvjldwb>0 and/or that do 1.Jdva 6> 0. An alternatetest of the impact ofselectivepromotion is to testwhether the sectors that expandedexhibited high capitalintensityor wagesat the end of the period. A result fvoring the interventionistview would be ehi-iIdw or dzIlIdva > 0; the sectors that grew most exhibited a high. capitalor high-wageintensity at the end of the period. We have performed these tests on each of the Four Tigers plusJapan, wsing two-digit lSIC classificationsof industrial sectors. Table A6.2 shows the sign of the regressioncoefficientand its significancefor each period for each economy. The years chosen reflecta distillation of rhe existing literature for each economy on significant intervals during which intervention was practiced. It is not possiblein all casesto utilize the ideal interval. In Japan, for example, data from before 1953 vary considerablyin definition from those after 1953. These are clearlyvery simple tests of the determinants of structural changes in production but capturc the spirit of the opposingviews. The statistical results must be employedcarefully.Even if it is slhownthat there was a significanr negativecorrelation between 9i and w1 , supporting the HOS view,some of the individualsectorsthat grewmost may still have been high-wagesectors. Thus, we will examine some individual sectors as well as report the statistical results. Korea.For most periods, the signs of the wage and value-addedvariables in Koreaare negative.For the period 1973-80, the one characterized by promotion of the heavy and chemical industries, the negative coefficientsof w and va for the beginning of the period are significant. The same pattern occurs in 1980-88 as well as the entire 1973-88
33'
*;EA?rM1RACLE
Explaining of Regressions TableA6.2 Signs Share of Sectors Change in Value-Added

Economy Kong IHeng Period
Wu
-
WE
VB
-
VE
+ +
+
1973-80
1980-88 1973-88
+
+ +
+
-
+
-
Japan
1953-63
1963-73 1973-80 1980-89 +
4-
+
-
+ +
---
+ -
+ +
+ +
+
-
Korea, Rep. of
1968-73
1973-80
1980-S8 1973-88
_
-
Singiporre
1969-73 1980-89 1973-89
-;
+
+
-
-+-
+
-
Taiwan, China
1966-86
+ and - signs re sign of cDdenciLent

-
Signficncatthe0.10IeveL
'
Significnurartie 0.05 klveL at tie 0.01 leveL Significant

(end) of
NbOwtWSmZa Wage per emPIoyeeac the b%eing
heperiod. VB
= Value
added per workr at the bginning (end)of the period. SouxerPack (1993bl)
period. This implies that at the two-digit level the relative size of more
labor-intensive seccorsincreased during each period On the face of it this result is surprising. Quite apart from policies of selective promotion, this was a period in which both labor skills and the capital stock were growing. One would have expected, according to the Rybcyznski theorem, that the labor-intensive sectors would have declined in importance. Part of the explanation for the relative growth of labor-intensive sectors despite the promotion of ostensibly capital-intensive suzbsectorsis that the major branches that grew most rapidly in these years, and indeed over the entire period 1968-88, were machinery, electrical machinery, and metals-all sectors exhibiting somewhat less-than-average labor productivity at both the beginning and end of the period- Conversely,some of the declining sectors induding iron and steel, industrial
332
USING
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chemicals,and paper and paper producrs, were sectors with greaterthan-averageu and va 1, A more complete explanationof the contnuing growthof labor-intensive sectorsisthat they experiencedmore rapid growthin TFr, and the cost-reducingeffectof productivitychangestimulated expansionof output by more than the output growth induced in capital-intensivesectors by the decreasing relative cost of capital and skills due to accumulationand subsidies. In sum, the regressions for Korea indicate that: (a) the more laborintensivesectorsmaintained their relativeposition or grew, (b) many of the promoted sectors themselves were not capital intensiveat the tWodigit level;and (c) subsidiesto the cost of capital may nor have been sufficient to overcome the ongoing differentialsin TFP growth among sectors.Moving away from the anecdotesabout individualchaebol,the quantitative importance of governmentintervention to alter the structure of production is not confinned at the sectorallevel. Japan. The regressionresultsshown forJapan in table A6.2 have no significant coefficients. At leasta simple versionof HOS does not work, probably nor surprisinglyasJapan by the earliest year considereain the table, 1953,was sufficiendyadvaxced so that intra-industryrather than interindustry trade would have become an important determinant of the sectoral producton structure.Scale economiesor a neotechnology explanationof production and trade patterns are more useful at this stage of development. Going back to 1945, which the data do not permit, would not change this picture much insofir as this earlier period was one of reconstuction, in some casesof firly advancedsectorsthat had brken quite important before and during World War IL A simple HOS story would be interesting to test for the period from the Meiji restorationonwards.Once an economyis in a world of technology-and scale-economy-baseddevelopment, the requisite conditions exist to allowalmostany assertionto be made about the determinantsof the sectoral evolution of production. Hong Kong andSingapore. The cwo island economies revealdiffcrent patterns of development. In Hong Kong there is no relationship between our explanatory variables and patterns of production. In this sense it is similar to Japan but derived fiom different causes.The slow growth of capitalstock per workerin Hong Kon& partly reflectinglarge immigration, miliated in favor of a slowerchange in industrial structure. There is simply very litde variance to be explned in the valueadded shares in Hong Kong. 333
RAC L E
In Singaporefor the period 1980-89, outpur grew more rapidly in those sectors that at the beginning and end of the period exhibited grearer value added per worker, supporting the view that the Singa.porean authoritiesintervened to encourageincreasinglycapital-intensive development.Given the rapid growth in the capital-laborratio in Singapore, this result also conforms to the Rybcynskiprcdictions. Taiwan, China. Like the results for Korea, the signs of the wage and value-added variablesfor Taiwan, China, are negative, although insignificant.Again, this implies that the relativesizeof more labor-intensive sectorsincreasedduring each period, albeit weakly, at the two-digit level. Growvth was market conforming; government intervention did litde to alter the structure of production at the sectoral level.
The Evoluton of Sectors: MarketConformning or Not?
The precedingeflorr to cdifferentiate besween a comparative-advantagebased evolution of industrial structure versus one resulting fiom intervention is notable mainly for a number of negativeresults.In particular for Korea,during, 1973-80, the years of greatestintervention, the most rapid growth in sectoralshares of value-addedoccurred in lower wage or lower value-added per worker sectors. Despite government intentions, the manufacturingsector may have evolvedroughly in accord with neoclassical expectations. It is also possiblethat the government undertook measuressuch as the provision of social overhead capitaland technical servicessuch as the Korean Institute for Scienceand Technology,which facilitatedthe 'neodassical' tansformation. Singapore, in contrast to Korea, confirms the casual empiricism of many observers,as well as nurnerous accounts of rhe goals of governmenr policy that industrial growth emphasizedcapital- and knowledgeintensivesectors. The sectorsthat grew most exhibitedhigher wagesand labor productivity than the laggards.There is no evidence of a factorproportions-based expansion. In contrast, the evolution of sectors in Japan and Hong Kong does not permit a simple view of its determinants. This is nor surprising for Japan given that HOS is designed to predict the determinants of trade patterns rather than production, and
trade constitutes a relatvely small share ofJapanese GDP. In tie postwar
period, certainly after 1953 when our data begin, Japanese trade parterns are more likelyto have been dominated by technologicaldevelopment and scale economies. The failure of Hong Kong to conform to
334
USING
RESOURCfSts$r.
neoclassical comparative advantage is at firstglance surprising, given hie relatively litde of its trade. Therewas, however, enormousimportance variationin the dependentvariable, the changein the sectoral shares of valueadded.
of Sectoral Producfivit Growth Patterns

This sectionconsiders two issues, namely, the patternofsectoral productivity growth and the impact of the changing composition of productionon the manufacmuring-wide rateof growthof productivity. The valuesof sectoral TFr growth, issuehere is whethergiventhe observed of the sectoral patternof productionin some A*i,the unusualevolution had a significant quantitative impacton overall TFP of the economies
growth.
Going back ro equation6.1, the analysisfocuseson whether the of A*j, contributed to more changing strucure of vj, giventhe pattern. Of the rapid growth. The value of A* is taken to be exogenous. sectoral growthratesofTFP are only economies considered here,detailed sectoral TFPgrowthratesare available for Japanand Korea(surprisingly, but theseare two of the nor available for Hong Kongor Singapore), three economiesin which activistindustrialpolicieswere employed cardtingup. to achieve productivity-based mostconsistendy Korea. Calculations of A*ihavebeen carriedout for a varicty of periodsby Dollarand Sokoloff (1990)and Lim (1991).What is mnost strikt i in mostsectors. Fromthesestudies values of.A ingis the high absolute with a numberof patternscan be identifiedthat are broadlyconsistent promotedsectors one another.Thereis no simplecorrelationbetween that repromotionimportantin the sense andTFPgrowth. Wasselective sourceswere shiftedtowardsectorsin which TFP growthwas (exogenously)high, increasing A*for the entireindustrialsector? To answer this we first calculatethe manufacturing-wide growthof A*using the observed value-added shares at the end of the period1966to 1985,utilizingthe A> valuescalculated by Lin. We then recalculate the valueadded weightsassuming that the sectorsin isic 38 had been at their normsasa shareof secpredicted value,VP, on the basisof intemational torwidevalue-added and,reassigning the residualvalue added to all
other sectors equally. Thus, instead of accounting for 38 percent of
manufacturing valueadded,sector38 accountsfor 14 percentin this 59 calculation. 335
SIRANL MIRACLE
The result is shown in row 1 in table A61. The actual secrorwide growth rate, A* was 6.7 percent, the recalculatedone 6.1 during a period in which the growth rate of manufacturing value added was 17.5 percent per annum. Even if the "excess" growth of the MPM sector may have been attributable to selectiveintervention, its rare ofm'FP growth was not sufficientlyabove that of other sectors to make a large contribution to overallsectoralTFE growth. The major reasonfor Korca'smanufacturing success lay in high individual values of A;. for most secrors in most periods. Japan.As in the case of Korea, a considerableliterature argues that Japan's selective industrial policy was critical for its industrial success. Nevertheless,many Japaneseanalysts are skeptical of its effects,as are The existingliteramure indicates many analystsfrom other economies.60 that many of the criticalacts of the Japanesegovernment with rcspectro industrial policy occurred in the ten years followingWorld War II. Indeed, a verv good case can be made that many of the major policiesoccurred in the period from 1868 to 1920, but theseare more difficultto analyzewith systematicquantitative evidence rather than anecdotally.61 Chemicals and the metalworking machinery complex have unusually good performance. These industries are those thar observers usually point to as having receivedsignificantgovernmenr support, induding efforts to stimulate productivitygrowth. A calculation, similar to that for Korea, to determine the impact on A*for the entire manufacturing sector of the unusual size of sector 38 can be done for Japan. Table A6.1 shows rhe actual growth of A* for 1960-79 and the estimated growth, had the sectors constituting 38 been at the international norm, 24 percent of manufacturing value added rather than 41 percent in 1979. The value of A' would have dedined from 2.3 to 1.9, a relatively small decreasegiven the growth rate of manufacturing value added of 8.7 percent per annum. If selective promotion is interpreted to mean that only a few sectors rather than all are aided,Japan'sgrowth rate would have been only slighdy slowerwithout an industrial policy.It is possiblethat industrial policy significantly increasedthe values of Ai in sectors other than those promoted due to one or more externalities.While this may be the case, it is likely that most externalities occur within individual sectors or in closelyrelated ones. Given the many branchesconstituting the metal products and machinery sector, the externalitiesshoulldhavie been revealedin its own TFP value. 336
USING RESOURCES. -FFYCZR
Appendix 6.2: Testsof the Relationship between TFP Change andTrade Policies
T
(6.3)
HE
ECONOMY-SPECIFIC TFP GROWTH RATESCALCULATED IN
chapter 1 allowus to make an alternativetest of the relationship
between tradeand industrial policy and growth. We specifya regressionof the followingform: TFPG =
f(RGDfI PRIM,SEC,OPEN, rXPTh)
where rFPG is the estimatedrate of total Ecror productivitygrowthwith physical capital,humancapital, and laborasinputs; RGDP is GDP relative to the United Statesin 1960;PRIM and SEC are the primaryand secondary school enrollmentrates; OE'EN is the index of relariveprice conforrmity; and EXPTis our measureof manufacturedexportperformance. TableA6.3 summarizesour attempts to tcst rhc relationshipbetween these variablesand rates of TFP change derived from our production fiunction estimates.The regressions controlfor other sourcesof variation in TFP by introducing a -variable that has been shown in previouswork
to be significandy correlated widt TFP growdt-relative income level-
Table A6S3 Regrssion of TFP Growth, 1960-89 (&tpenkt variable: totalfactorproductivity growth, 19610-89)
Na&refdsa - inrn . -
67
67 f (035712 49925 (0.9791 2. 3S53 (0.56501 ( 1.1991 (1.045 50A684 23.W095) *5F311J* (189294) 2-2-1 0.6722) LOW60 (2.55)55
t4943
51
*-
St 4&5615(135162 .*t3538 (2067) 2.0941(44757)
69 -I .376(0.437) .33W (ld0219) 2-6731 (0.6646) 390430 11.1417) 4.584 (0A3041 .2.40r OM095) 2A.1(0.65939 2.604 * (1.1406)
53
5i -53.0356 (t4.5 .4.4383 (. 2599 1.6382 (L25) 3.443' (I.6325) L52Z (0.150 .356 (e.ecs
*.634 *419 (034n7 .L7120(0.)1483
*-5L119I
(24.A871. .5.0403 (2.3467) I.6WS (5.5121) 3.069* (1.5790) 015543 (LI441)
rwktivm US. I960 * .:wwPu7 iu. lnnlem I,%0 -
(0.573C :
SalmlSycndlmr9G.
-9)
2399 (2.0633)
(O.59
Dallwqrnamkrla
047!50
(0.13Z) . AmW
(0-23712 E0L=75 (0.0073) 55 (0Q4531) 0UA Q4457 %0641 (.U0246) -0 OD354 (0D33) :
*'
HiAtt
mliauraape&.n apomn. I9GWS

-.
r,-
004 (0o1073
025D0 p(0593 at7G (04261)
0.0255 (a.00W 0
a4u6 (MG02M5)
M0 54), CAW67 -
aAIeSs7 4817. (0.50

e70 03673
M)uud IV
0R5579J
CO50
.604
KNG,'tr.
N -- >- ff :
Mba. Sma_rd effrits o.dtr ::m - . n-mrn . - - . : . : --
337
Fr~~X
MI.RACLE
as a control(DeLongand Summers1991;Mankiw, Romer,and Weil on relativeincome 1992; Pack and Page 1993). The coefficient (RGDP60)is generally interpretedas summarizingthe productivity(TFP) to highertechnoasa consequence ofmovingfromlower gainsrealized
logicallevels.This catching up is the componentof TFP, change made possibleby the diflerencebetweenaveragepracticesand best practices. As we nored in discussingthe cross-economy regressions, ir rime-series analysesof aggregatecoralFactorproductivitygrowth,estimatesof TFP consistof two components-intraseccoralTFP growthand the impactof factor reallocationamong sectors.Thus, the shift variableRGDP60 may capture the reallocation effecc of structuralchangeon TFP in additionto catching up. productivity-based The use of schoolenrollmentrates is an attempt to test for externalities in human capicalformation. In our growth-accountingfiurnework, the contriburionof human capitalto output should be reflectedin the elastcity of output with respectto human capital.We have argued that primary education in particular can have growth-enhancingexternaliThese exties through the better ability to use and mastertechnology. ternalitiesmaynot be capturedby rhe human capitalvariableand would then be included in the estimatesof TFP change.We attempt a similar rest for secondary education. for Openness to the world economyis another imporcantcan.dlidate explainingrapid TFP growth. The theoreticalcasefor this viewrests not assoiated with only on allocativeefficiencybur also onlextemalities tradingactivities and on "X-efficiencyf gainsfrom creatinga morecompetitive environment for domestic industry. Severalprevious studies havefound such effects,induding Harrison (1991),Dollar (1991),and Thomas and Wang (1992). We test one definiton of openness,Dollar's (1990) measureof the correspondence between domesticand international relatrive prices. TableA6.3 presentsour restsof the relationshipberweenexportsand productivitychange.We chooseas our measureof export performnce two indicators-the averageshare of manufacturedexportsin toWtle62 When the share ports and the share of manufacturedexportsin GDP. of manufa-tured exports to cotal exportsis introduced into the basic specification, it ispositiveand highly significant(at the 0.01 level).The share of manufictured exportsto GDP is significantat the 0.05 levelin the basic spedfication; however,when the degreeof opennessor the drop out. HPAEdummy is introduced,manufacruredexporcs
338
USING
RESOURC
TableA6A Average AnnualRatesof Growth of the LaborForce bySector Gnnupasdperkvl Industrial economie?
1880-1990
DDcvropingeconomicsb
Atcunm
0.4
Indury
2.1
Serikes
2.1
Thoe
1.2
1960-70
1.1
3.8
3.9
2.0
a. Developing economics include thecountiesofAricawiththe exception of Soudh Africr LatinAmeica;Asiawith die exception of China,the DenocmaicRepublic of KoDrea, Japn; Mongoli:.andViet Nan; and Oceaniawiththe exception of Australia and NewZealand. b. Industrial economies indude Australia, Cnada. Japan.Newv Zeland. SouthAfuic, the UnitedScrcs, and countriesinXYVesrrmn Europe. - iwrc Squire(1981).
TableASS FinancialLiberalizaionin the East Asian Economies

IN Dl.-prsn a~~~~J Jfrg fly m
-
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7
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by do m. neei,i-g bush sad
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ITden dwpntncdadmifillsiA iumadiaitsdwaWnim ILkand Uno" ikerdflq'ek.it

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ben Theen,ttiian ints
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tn
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6iIss Fd6ER.PwdioInwili. b ctadseopintrtCD4)
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'--
, Lnalnbemi:: R -
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(^~~~~~~~ p:Xd im. _
dzctc
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quoky. PaSwitinamdlEueGCmrm
- inaI - :Eri*ntd . : Ninmss - -- - : :-.-
--
lil
nde
h sh &eupa
nmh339
339>
iASJ*
MIRACLE
Table A6.5
Fi_nes 1 Jq_
(confinued)
-fnanq tflnwu&gku .f?e.emw
ruin
JImeqIad
,fiecu
M." _y . elek bfldJUb-& EarnWerd Tdkyq DrLlr trannd lmae. hebd petin I97Puealing eqeriancC ietCFi) muSs mpl6. flfaRnictiuon.sinurinral eiclLd n.UhULi /misarkar(pulickmmdAutiuL I9eat*Gw nubeaeeet a u .n nrlca andt
ISW&T mmuyiuco
nwaed
IVRf=
mya andns
tse
Lading maawarmneguled bn llealminks.. droddidiol Idewldein Dql dr I manimu sep. Oqee weprr&ulyco-IaL Iw pgalt. lPf-lSC:drLl lilea. -finlrualnefetreadensnl rm.m Feed bawur hsr lotion ofin munibehinmrbskalkudIl b mrhmaClg7talwdmailunlmeuhaa (I 91 hig CWaet maeberamtnls (bean. nEcesnlldCa 'nglea Ml
eF a'el amarke ra(nS). 1 e-
flMtAlhyecd cmey.C 6lr all wIdch by IPRI wee ulpalin an qrml fnsinguith ldmik bcAl.
~n
Ifl&selandpwLeaand(pualk
I"h ly bn6 pwnal.nLapuend ceargnadrMh,lmwL by Ereiga. wesneJ TniT uu hu IJ hakbd boan.. iedlum lWtSinI9 NW btw6n(Seg)wem endvn aul BAten
Inf: l esgi Batik Iti
te ro
ng
queamalAa4d dqeie rgetrorminga nemyskLst lhew t9t Rea e Ilntve rum ncmlad. -
sudiarlsnlf iea
incs
fi.rm
Srn gpnErd Feuip atitia heniphntheTLy.Snk maian wme m ExdaKJ.wafuned p4mt Iwkueai Sesehreem (CC)mkask mmneiL
trdin . thte Us Sequlds
is bue witi iwn The MinyfFlhlna mpmnimry eauu eA U werwik pwns fr. the akae Lwa% e SecuidmitedadEhnd LnTreeleandlki .J.lr . _J.mlrghti6d J ELASp mpAmdeycaie eunainenda ituahuks.. son m pnd udea iItStnMU.ddl iaJ ndwepirle dia Mea inada In Dq* u dthellWd 191: EatbiMl prcedes aeda.ceqnr Coonamtiden I...caaaar.L cw lon& tN Itnh beanit anenimpat herniae law iftiUenUIStrd. r ed u lanird ag I
s thn tint JrpaI nraipal.
-tan.
Edia nse ered. Dan usMes rf nd intne arn almond tv psiidpau inh m Ca,ndial hajneaaMrt AtktSmckindfis ma wading ru Minr rfTey un.mj Ms-Tkofiac 5ket maut. 6at r haairnl,n
.Kern
4p.f
1* ll nareuanladlaetpm hrnitinyalaminhinld lrtam nem Rorm ttacauac rmcatlain1973. IPRAWlderadeiteecinap and ne.ro rncdveedulapd il.l Jdaapreliratth inse l. -bell 19-* Minfimumed mem&nn but incnhAwL Isa ecago won h nae niuluak hding mee.tr n enr CD. uWhi.Ll3abnUnseA
-~
~~
-r msigid.sunfreinrdepode = tnt Mm bekake .ukflntin b he.deeetw (NR loaig eiq en (NOR) imnm niem Dil insmial
dcpdtmc a MON li mlnrt A-m ihmsm.L dkpoir
csneed t% t4iodd Inla eptoh lJuCaeGnrt cheat eua-mnani cn?i.eri IWI-AS:P nwn,61 Udissad ailowdaeyof rewdmmicaeidfrnephink. eagn lt fwaegunla (enenere r`fieigs te Bn IS is I btd.ia iama incndtudi64 in 199li. Deei. p ukhleaditccank% if cngrefAmuiei6c% erpsdamenprcnbuineband tr. Noa atw bankas ma any &W tna.2 qchncAhelFlsmeded FIksaJ9c. Inen s ewi
&i*.h4n P o 1W 6r NllFIswrb-UL
Ilsotlrfeaciual eapelisn t ie td l. i pq-e takre Jilt csneni cualdieetI.Setupcstmeaed lieiwg ifnhtet-Sr i;1.. s up OTCtae Ieefarkinu and ahea my M*bUn ieU I bgewen . PIa po4u nm.nkn-aae banldlagnrld )mPAwdl kgwidaehID cace? JW lamemat lnaancnmpudics ate scaaelckshanSipuaeauadmaqqwd licthcc JNIPouaiaac fmlap a
roNaliq_iIFi r-oel vnXd
dqa.it inasunacule .cs. InEudAaIo s mt tt lRni6ill J9n1f lv e-in grcyupebieic-s Iinulcail ide d'bg Of cheOQee Madudeald mt mnd Eeaneiicn (ONSE ID enmdu Rn &eraidwa e wauphiias asally. Cpa bn Y IWSd Xlirlilnab rits UlflnS a i amkte peta nsi e cpened na lee i uhefhbne la shiauia iinpne mhlhiscynrf inae(MOljwapeniassal rma pe.tionnsftWBk pn&i6l g;dd hey.mkannrioait atcljeeitk inpdoeiii ipe
ii fahnv in rej
rnd a p.*hmfia arW

r=;o&m
f6rtLirg'
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m gd t
maini.
.a
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CD,
alloerd M eAs iFa_b

:r.'o-Sf.th,
340
_:,_
340
:.
.-
USING
RESOURCESSO
aM.opta
1971:hmnaei aianhrfind&pdewicf nmm zho flmyw,g. hiajlty 6cua ffkb loUtes aam.csa11icMFumnl Inkik&p.sitmuinr am pr uawiru
(End. nhh.rCmbsponlosasd&4 57&MA wnianuadu Laekbaing
~~~~~~~bn~nchh
1374-KNew Anaidelimuamsn
Mi.hudantf194hmo aku haiLbmab Howemi.dndc bmil kw Inured aainsO theyhawha. napmdto insni w6iiu ne&lernn
~iapig
fl%-KmJus"s Li cIS&E w nab&hd NW 50, &Ldqwia p-cer. wmardubinmnbedq rmaota nmnduat
if LRid hJAiog&t-eonpickalyddsdn p &hf. Idga Jtaincfbhulu prcaci, of dqiWmnc anvocrUe i maumpnamu andaural of 9 buil jMs--aoVmei.fUanaic 6i.& mnd 0TC 139W8 h A kaC.1'dohia Wiath gasiddnmen ogle mu' KManddhcfamdanX An budges Zudiddspli dfitpakiLm rordineindng Ktndialaw 1398 mALina%ar Finadi lasituhm.Ar-~cwjw poad rtheakingAadZ5l'Manl FonmanceGimpma Act p wdn f SoL:i..tm,.lacu .1M. lc&g guidolina andactig awtdiinmsu.darda&afiaaCd,hainnd it
ngmito inhclupo t..49 prenm

aua0cmdrm n oa sriau 19~~~~~IN-%O,SshSab,rdan cff-,bca biWngto 1 UL CLCruStbaku 6,
.aac ouhAseleiA CD% mnd hr&r sit alibe,tindaweL drpca aaqumcninamn Flame. ma h1 Bwm.l melube. tifan man roe
Ewa
plfthklAngSram
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.
h Sfiogper.l
iuqMaCCaKrhia. 1:&ibdla c ue,pWcctc 'n..-taupary. 2dIcrjta />sindl 3 aflhlsc frran
.aitardind rnamisffi.aeW upcidg an Linac

so pwpawapi.Mcnd il INtn SitdiEuaqrlam )ni cceaDTlcsdbi
~~~~~~~~~~~17r0 asa hraiaglirnbna aiiua

aWeCD*
IWI 9Aanmoderelmcnminoal ofbanWigumwawh bklbal p-x aintuudrlpmz 1 aftoe Ads=O Di. AdLs I6IxMA a nEabat boideg maskts. Hi limema in shyumgarn to.aADwiplbikano
ro
sliad6
tîi0ilbding
Sk~~ar ii7kCamplcc~fi-Nrad libaclinuam.Bankouitn
7
- dhr~~~~~.M aJeimonqefi
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and -gi
vm&g-;ia:-r-
tnO
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iyaVSaypm
aa J&odeurmia.
Alonig wmAt canal bau'ngAocticm. mope-bnoumaicsncfainea dut baki mow mimut Wit. BabigAauet oidha.apiiada aiuhnerma,tin.dBu ala r1M nms 10 .liqddkrruaz..h*j baeulamts adautraiomtea.opm.perJlomauidlnid and Mlaa1fi Stock lanti a c..mnnpecl
hniari
kg fitcennuccd*mow dqaodtand IcadhguotaJimam Rial etehaFownand watplevalldratmarlod by 197K
I= 9laUhlmI dwSIngar pveI. a!,1niidloocuiy E aFeat MqencdcwlS1VpmrCG&1dEn dbze.pupcdatnimnmsd

lnnard lacun
-_iona tSlgt
had..r bankiang
i buk par-
banlh Fontoeadat,i oaptiax

pIMatler4l oatior Jfmgn t
flflSWtFocf dooic
in apitban orfbeeW
c L
mir"uiomefluainidey*riwai
inlocalboaokomps.Poretbasik madlbomgarvhow, nuk(hd tacnve tehdi,19 poite sula,
re...
aim.
1950( Lirbclsd C
Ckit at.
194 lAI,Jna amsaimds.adinisnladugawa mnd:auccl. as. da B ncc.dbag lachain lylSCosa&lrf hanktulnuadM napinlene maewi*inanmnl bank-adaalnimnd inapt. Rrmbrd delnt an Piam cwrugahndimun hidinpia
AttaInhit 1 ban mw fmnddradcpitbd d a e ow I*oaow r.vlmrrial aJbn padpermttdartoiWtid.scutlq6a1aw .ppmnL Madaadnsmcuicaiomfiurfoaig bade.malm)ined
long-mmlendin hwodam.
-
IQiEahlsbehrx Suit.tud.a
T.iwa o19t
t mccoy nTh.alc RappmhscMakanr mlet11CP. CDaamnW.4Atwit awknntctnwinal. inauacsmm. 1956 Craed .W.&bovebadaig N Cepnui c.rtahn naaapmnicaanal InacknEacsof
D.SsxhiS ad Exitnu b Crwnuiona ucpbcnm.pnvreaepital ni.arktpeaaks. IWi tfmbl&d aedqmiIa rpnce copses . lflnlSboib rh tlni ucccmopatuy Zn6 IN*-JflA.."dclSriabTrmanatdn I.A. t acpdwMaaenrmandb.tnauborahmIthan ainp. Raiwd banbinglausnD puohlbktcrdiemn Iiewma kdaiuAwld maas aada
~~~~~mn&,uno ltmc l napdcnacuaad miumntimarrff
drpltionsadlarcog.it * iSa meien
nof oiunp
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Notes
7. The costs do not derivesolelyfrom the misallocadionof labor impliedby gaps in marginalproductamong workcrswith thc same human capitalendowments.The rarelyexceed 1-2 per2. Altematively, conscant realwagescouldbe due to a re- costs of such static misallocations duaion in surplus labor(Lewis 1954; Ranisand Fei 1961). cent of GNP. Dynamiccosts can run much higherwhen, (imfor example.employmentin enterprisesis excessive 3. A populationwilldoublein 87 yearswhen it isgrowv- plyinga wedgebetweenthe wageand the marginalproding at an annual rateof 0.8 percennwhen it is growing at uct of labor) and the subsidiesrequired to keep firms 3.2 percent a populationdoubles in only 22.5 years.See afloat divert scarcesavingsfrom productiveinvestments. Squire (1981) for a historicalcomparisonof population Sec Gelb, Knight, and Sabor(1991). and laborforcegrowthin developing countriesin the cur8. A labor market is segmentedwhen some workers renly high-income countriesin the nineteenthcentury. reccivehigher wages than others with the sarme level of 4. For the period 1989-2000 population isesrimated human capital simply by virtue of their sector of to growat an annual rate of 0.8 percent in Hong Kong, employment. 03 in Japan, 0.9 in Korea, 1.2 in Singapore,and 1.4 in 9. Clearly,a high share of the public sector in wage Thailand.Indonesiaand Malaysia are forecastto growat The share employmentgrowth is not definitiveevidenceof a relahigherratesof 1.6and 2.3 percent,respectively. tivelyhigh share of surpluslabor in the "modemsector.' of the populationlessthan fourteenyeawold was31 percent, circa 1900, in the currentlyhigh-incomecountries. The publicsectorcould be findingproductivejobs for all its employees. In 1989 it was30 percentin EastAsiaand 36 percent in LatinAmerica;in 1986it was46 percent in Sub-Saharan Africa. 10. In more than one-third of the economies,private sctor employrnentactuallydecreased, implying that the complexityof nonpublic sector accounted for all the observedincreasein 5. Increasesin the rechnological agriculturalproductionand in the sizeof establishments total wageemployment. bring greater divisionof labor and, hence, increasesin skilldifferentiation at thesame time that greateravailabil11. While there is no doubt about the roleof governmeat in suppressingunions in Koreaand Singapore,in ity of educationalopportunitiesincreasesthe supply of Taiwan, China, there is some questionwhethergoverncducatedworkers. ment action, for example, prohibitingthe ChineseFeder6. Labor market efficiencyis assessedby comparing ation of Labor from engagingin collectiveaction, was marginalproduczivities in losingand receiving activities. decisive. Market forces,and in particularthe sizedistribuworkersin Taition of firms,alsohelp explainwhyso fe%w that indiEvidenceof changesin laborallocationsuggests vidualschooseamongalremativeoccupations,industries, wan, China, are union members.See Fields (1992) and chapter 4. and geogaphic areasas though they had a fine regardfor marginalcosts and benefits.Ihough behaviorconsistenrt is 12. SeeFields(1992),who noresthat until 1972unions with rationaldecisionmaking on the part of individuals a necessary condition,ir isnot sufficientto ensureoptimal were freeto bargainoverwages,whichwerelargelydeterfor workersto be mined by marketforces,and Freeman(1992),who, refrallocationof labor. It is also necessary price-takersand to be freeto enter any industryor occu- ring to the post-1972 labor market poliqc regime, has pation for which theyare qualified.Restrictionson free- asserted,"Singaporcis possiblythe most interventionist dom of cntry arise from such sources as nonopsony government in thecapitalist world."It is irterestingto note power, discimination, government interventions,and that the sameinstrument-the NationalWagesCouncil,a deliberation councildiscussed in chapter4-was useddurworkers'associations. 342 1. See Greenwaldand Stiglimz (1988) on the effecrof coordinationfiailures in labor markets.
USING
RESOURCBS$T:
ing the period of wage reprcssion,during the accelerated growthof realwagesin the 1980s, and nowto maintainreal wagegrowth in line wid productivityincreases. 13. Lookingbeyondthegroup ofEastAsian economies on which we havefocused, 1aborrepression is norgenemlly associatedwith economicgrowth.Freman (1992) notes that 'most dictatorshipsthat supprcssunions are incompetent in economic affaiirs-vide Burma in East Asia," though he recognizesthat this generalization is not an adequate dismissalof the argument that in some economic circumstances,such as those prevailingin the "miracle" economies,repressionmight be good fir development. 14. See Ranis (1993)for documentationfor Koreaand Taiwan,China. 15. Gelb, Knight, and Sabot (1991) show how in response to unemployment the creation of public sector jobs with zero marginalproduct an overlitde more than a decade reduce a moderatelygrowingeconomy to economic stagnation whilehavinglitde or no impact on the number unemployed. 16. The governmentsof Cote d'lvoire, Egypt, Mali, and Sri Lanka all haveat varioustimes explicidyacted as "employerof last resort,"particularlyfor universitygraduates. Guarantees of jobs to workers who cannor find "Suitable" employmentelsewhere genrally resultedin the See Gelb, Knight, mushroomingof public sectorpayrolls. and Sabot (1991). 17. When Indonesiaattempted to direct credit to industryin the late 1970s,ir wasimmediatelychanneledalmost wholly to two public enterprises. Indonesia withdrew this directedcreditschemein 1986. 18. Malaysia,for excanpie, lent substantialfiactionsof credit to public enterprisesbetween 1975 and 1989; the fderal govemment lent direcdy to public financialand nonfinancialcorporations.Its lending reachedthe equivalent of 22 percentof bankingassetsin 1975, dedining to 16 percent in 1980 and 9.8 percent in 1989. These loans carried real interest rates, which were mildly negativeto slighdy positive, comparedwith the substantialnegative real racesof many other economies(Caprio,Atiyas, and Hansen forthcoming).
19. Other evidence on the extent of subsidiescan be obtained from the reduction in financialburdens to enterprises that borrow from subsidized lending programs. In Japan, the cost reductions have been large in sca transport (more than 20 percent); 5-10 percent in electrical power, transporc machinery, and the coal mining industrry but very modest in other industries. Ogura and Yoshino(1988) estimate the financial benefits arising from the reduction in interest rates of Japan's directed-creditprograms was lcssthan 2 percenc of total invcstments in manufacturing between 1961 and 1973. In Korea, some investment projects and exporters receivedsubstantial interest rate subsidiesduring the HaI drive of the 1970s, but these largesubsidies havesince declined. 20. King and Levine(1993) also show that high cenrralbank sharesin rotal credirare bad foirgrowth.Hence, in chapter 3 perthe macroeconomicrestraint disLcussed mitred rapidexpansionof private crediL 21. When exports were not used as an explicitallocaion criterion, Japan often used inremational prices as a
stndard of good performance. Its industrial rationalizadion programs used as criteria cost reductions that were based on the costsof inTernaionalcompetitors.This was enforcedthrough the tireat of internationalcompetition as imports were graduallyliberalized(for example,machine tools and steel). 22. The meritsof well-managed and fbcuseddirectedcredit programs have long been advocatedbv Japanese govemment officials.For example, a study by the Overseas EconomicCooperation Fund has argued that government involvement in directing crcdit is warranted when there is a significantdiscrepancybetween private and socialbenefits,when the investmenrrisk of particular projectsis too high, and when informationproblemsdiscourage lending to small and medium-sizefirms (OECF 1991). Use of policy-basedlending rather than other forms of industrial assistance(for example,lower taxes, grants, and so on) is premised on the argument that the main constraincfacing new or expandingenterprisesis their accessto extemal finance at reasonableterms and conditions. Directed-credit programs involving small subsidiesovercomethis consuaint, but Japaneseofficials havestressedthat to avoid the misuseof funds and abuse 343
LERAGLE
of credit programs,strong emphasismust be placed on the maintenanceof macroeconomic stabilityto minimize distortionsin incentivesand on effrive monitoring to ensure the timelyrepaymentof loans. 23. Thesestudies are preliminaryoutputs of a World of Credit Bank researchprogram on the Effeccivencss Policiesin EastAsia,which is intendedto provideempirical testsof the effectiveness of directed-credit programs.
menr, sayingthar if a firm reallywere to be profitablein the long run, it wouldpay for the firm to encounterlosses today.But this counteragument runs into problems:it is basedon the premisethat capital marketsare perfect. 31. Exportpricescan be set in the international(unprotected)markersat long-run marginalcost. Is is possible to show, under certainsimplifyingasswnpdons(see Spence(1981), dhatoptimal production of the firm entails setting the marginalvalue of output cqual to the long-runmarginalcost.
24. Among the best known of thesearc Balassa and others (1971), Little, Scitovsk,yand Scotr (1970), and Kruegerand Bhagwai (1973). WorldDevtdopmentReport 32. In the early and mid-1970s, nominal tariff rtes 1991 providesa good summarvof the argumentsfor the and effectve protectior.began ro dedine (Iroh and Kiyand growth. ono 1988;Komiya1990).Althoughthere isdisagreement linkagebetweenneutral incentives over the extent of the reductionsin effectiveprotection, there is agreementthat effectiveratesof protectionwere 25. For an interestingattempt to test one of these propositions-extenmalitiesaccruing to export-in a substantialbeforethe early1970s. gcneralequilibriumframework,see de Melo and Robinson (1992). 33. While effectiverates of prorecrionor subsidycalculationswouldprovidea better measureof thequantita26. Among the earliest formal discussion of market tive impact of protection, the figures shown furnish a areScdovsky (1953)and Chenery notional indicator,consistentover time, of the extent of failuresin developmenr (1959).A thorough surveyof many of the issuesis given reductionof nominaltariff ratesand noncariffbarricrs. includePack by Corden (1974). More recent discussions 34. It would be more desirableto compare efnective and Westphal(1986) and Itoh and others (1988).World Bank (1992c)providesa recentsurveyof the issues and an ratesof protection,sinceit is value-added pricesthat matapplication to the evaluation of World Bank industrial ter for resourceallocation,but the most recentsystematic cross-economy studies based on comparabledefinitions developmentprojects. udilize evidencefor only one year in the 1960sand early preclude the 1970s Thereare fewrecentestimatesto providecompara27. Economic growth will eventuaHly need for policiesto capmre the producrivitygains from blefigures. economiesof eitherscopeor scale. 35. Singaporehas been exduded since its zero duty rateswillbias the estimatedownwart. 28. For a reviewof many of these, see Stewartand Ghani (1992). 36. Pack (1988) expressed doubt abour the robustness 29. In general, real externalities providea validarguof the evidencefor Koreaand Taiwan,China. When che ment for trade policy interventionsonly if they allow paper was writren in 1985, the TP estmares for both goods to be produced at less than the imported c.f economieswere basedon data that began in the mid- to (costs,insurance,and freight)price.This is nor, however, late 1960sand enided in the late 1970s,a sufficiendyshort sufficientto justifjrintervention.A sociallysuccessful inperiod so that increasingcapacityutilizationor one-rime tervention depends on whether the present discounted benefitsfromscaleeconomies couldhave accountedfor a value (Pnv)of fumtre producersurplusexceeds the PDV of substantialshare of unexplainedgrowth. One study of the cost of subsidies. Korea (Kim and Kwon 1977) was indeed convincingin demonstratingthat correc measuresof capacityutiliza30. More recentdiscussions havediscountedthis argution eliminatedthe residualfor much of the period in 344
USING
RESOURCES
question.Additionalobservations are now available, and improved estimaresof the capital stock make it seem likely that the measuredTFP accurately reflectsunexplainedgrowth. 37. On these issues,a particularlygood discussionis givenby Itoh and others (1991),part 1. 38. For details,see the various chapters in Komiya, Okuno-Fujiwara, and Suzumura(1988). 39. Itoh and Kiyono(1988).Theseestimares arebased on nominal tariff rates,not implicitprice comparisons. Given the presenceof quantitativerestrictions,they are likelyto be minimums. 40. For extensive discussions, see World Bank (1987a). 41. In Koreaand Taiwan, China, the initial spurt in exports was in labor-intensive products as predictedby the static theoryof comparative advantage.These,however,arealsothe sectorsdtar Dollarand Sokoloff findexhibited greater TFPgrowth between 1963 and 1979 in Korca.Wang (1990)finds a similarpattem for TaiNvan, China, for 1966-86. Exportsmayhaveresultedfrom this initial spurt in productivity. But analysisof Taiwan, China's, early export growth by Scott (1979) and the analysis of the Koreantrade incentive systembyWestphal (1978) suggestthat factorproportions,supplemented by a smallpro-exportbias, plausiblyaccount for the earliest exportgrowth. 42. A recentstudyoFTFP growthin Chile,forexample, finds that following the 1970s' liberalization, accelerated TFP change due to organizationalchange and product qualityupgradinglastedat most sixyears(Perryand Herrara,forthcoming). 43. Undoubtedly, domesticsldllswereimportantin allowing the technologyobtained from abroad to be utilizedproductively. 44. On the roleof infi-astructure in Taiwan,China,see Ranis (1979). 45. DFIwasnot a major sourceof invesrmentgrowdt
in Japan, Korca,or Taiwan, China, but it has been very importanrin otherHPAEs. Evenin Taiwan,China,DFI accounted for 15 percent of employment growth in the viabilityof new exports. 1975-84 and demonstrated Moreover,muchof the investment wasin relatively small firms in which employeesvvere exposedto new equipment and the relevant production cnginecring.Since labor turnover in these foreign-invesred firms was substantial,the total imnpact of DFIon effeaivelyintroducing newtechnologywvas quite high (Pack1993b). 46. For efforts to assessthe empiricalimportance of spillovers from DFI,see Blomnstrom (1989) and Haddad and Harrison(forthcoming). 47. SeeRheeand Westphal(1977)fbrevidence on the use of older technologyto achieveexportsof textilesin Koreaduring the 1960sand 1970sand Ranis (1979)for Taiwan,China. 48. On Taiwan, China, see, for exanple, WallStret JounmalJune 1, 1990, and Liu (1987). On Korea, see Westphal,Rhee,and Pursell(1981). 49. Katz,cd, (1987) reportthe resultsof thesestudies. The firms investigated made intenseefFortsto improvc productivitydespitethe protectionaffordedby the import-substitutionregime,an exmple of the too oftenforgotten point that protecton has both income and substitutionefects on theeffortexpended to reducecoscs. In thefrms considered, the substituion effec dearlyoutweighed the income effect. Nevcrtheless,calculations based on most of the studies suggestvery low rates of growthof capitalproductivity, an exceptionbeingthe results for one steelplant analyzedby Dahlnian and Fonseca (1987). rTPestimatesare nor easilyextractedfrom the data reportedfir most of the srudiesin Karz,ed. 50. The impormnceof interactionsmay explain the phenomenon noted by Behrman (1987) that between 1960and 1981,the averagelevelofschoolingin all developing economnies increasedby two-thirds, yet in most economies this had littleeffectin stimulatinggrowth.Educarionhas a smallereffectwhere complementazychanges do not occur,thus, high educationmaybe necessary bur is hardlysufficient.
345
lR
A CIRACLE
51. Previousstudies using this approach are Dc Long and Summers ( 991), Mankiw, Romer,and Weil (1992), and Pack and Page (1993). 52. Severalpreviousstudies have fbund such effcas, including Harrison (1991), Dollar (1992), and Thomas and Wang (1992). We use as the opennessvariableDollar's measure of the correspondencebetween domestic and international relative prices (1990). This measure usesSummersand Heston's internationalcomparisonsof pricelevelsto develop an indexof 'outward orientation" for ninety-fivedevelopingeconomies(1988). 53. Alternativespecifications using the rate of grotvth of tomal exports were also employed with similar but less robust rcsults.Dara on the rate of growth of manufactured exports is not availablefora largesampleof economies. 54. This conclusion is reinforced by the arguments that low distortions relative tO international prices can arisefrom havinga significantshare of theeconomy operaring at export prices;in that case,the share of manufacrured exports in GDPmay be morestrongly collinearwith the openness index, 55. We ran two joint E-tescs on the regressions induding theinteractve term.The Ftests wereboth consistent with a high degree of multicollinearity between the interaction term and the exportterm. The Ftest rejectsthe null hypothesisthat, takenjoindy,the coefficienrson thethreevariables (education,manufacwured exporrsftotalexports,and the interactive term)are norsignificantly differentfromzero (taken together, the three are significantly different from zero at the 0.01 level).Likewise, the Ftest rejectsthe hypothesisthat, takenjointly,the interactive termand the ex-
port variable are not significandy differentfrom zero(tamen together,the twoamr significantly diffrent fromzeroat the 0.01 level). Where rhereisa high degreeofmulricoilinearigy berweenthe variables,the coefficients on Lhe interaction term and the export variable,despirebeing separately insignificant, shouldstillbe ueaed as besrpoinresimares. 56. The discussion of scale economies has recently beenrevivedby Murphy, Shleifer,and Vishny(1989).
57. An alternative to cquation 6.1 is: AO=

which assumesthat sectoralsharesare constant.
iVj
A.,
58. Another interpretationwouldbe that there wasan initial disequilibrium in marginal productiviEies amnong secors and that indusrrial policy acceleratedthe movement of factors ro higher marginalproductivitysecrors. Writhrespea to labor, the issueis moor in the Four Tigers as they ypicallyhad rdativelycomperitivelabor markets 59. Put differendy, it has been shown earlier that Korea'svPl4 ratio for mPp was 2.76. If this had been 1, the actualshare of valueadded wouldhavebeen 13rather than 36 percent; thar is, the share would havebeen constant ar the 1968 level.If factorshad been allocatedto all the remaining sctors equally, the sectorwide averge valueforA*would havebeen 0.061 rather than 0.067. 60. See Itoh and others (1991), Komiyaand others (1988),Saxonhouse(1983), and Trezise(1983). 61. For a very usefulaccount of many of the measures in the earlierperiod, see Lockwood(1954). 62. See note 53 for an explanation.
346
q!TER
Policies and Pragmatism in a Changing World

HIS BOOK HAS SHOWN THAT THERE IS NO SINGLE
East Asian model. Rather, die eight high-performing
Asian economies have used different and changing sets of policies to achieve rapid growth with equiy. In this chapter, we evaluatesix key policy fundamenals used by the HPAEs. We then examine institutions
to promote growth and finally assess three policy interventions. We end by considering how the changing global economy is likely to constrain fiiture use of the HPAEs'most successful intervention: the exportpush surategy.
Foundatons of Rapid GrowthGetting theFundamentals Right
eight HPAEs. These widely shared, market-friendly policies are the foundation of East Asia'seconomic success. In chapter 2 we identified several broad policy areas as fundamental, and in subsequent chapters we described their relevance to the strategic finctions of accumulation, allocation, and productivity change. Here we briefly review some key aspects of these policies. Although implementing these fundamentals successfilly is often difficult, the benefits are substantial, as demonstrated by their crucial role in the rapid growth of the HPAEs. Moreover,despite changes in the global economic environment, these policies remain viable options for developing economies today.
HESTRESS ONPOUCY FUNDAMENTALS ISA HALLMARK OFALL
347
#PACI
RACLE
Ensuring Low InflaionandCompetitive Exchange Rates Macroeconomic stabilityand low inflationwere necessary preconditionsfor rapid growth in all eight HPAEs.The keyelement was the management of the fiscal deficit. Fiscal policies havc been generally conservative in avoiding inflationaryfinancing of budget deficits, and some HPAEs, such as Singaporeand Taiwan, China, have run sustained budgetsurpluses. While Indonesia,the Republicof Korea,and Malaysia acquired considerableforeign debt, their debt to export ratios were lowerthan other developingeconomies, so creditorsnever lost faith and they never faceda fuil-blowndebt crisisrequiringrescheduling. Moreover,budget rules and legislationrequiringcharsovereigndebt be used for developmentexpenditureshelped to ensure that borrowingfunded investnent rather than consumption.The successfulrecord of low inflationand sustainedgrowthof the HPAEsreinforcesthe viewthat there is no substitutefor fiscaldiscipline. The HPAEs' successin export-driven growthwas predicaredon competitiverealexchangerates.Prudent fiscaland monetarypoliciescoupled with flexible exchangerate managementwereusedto keep exchange rate movements alignedwith dchangingstructuresof trade protectionand inflationdifferentials with tradingparmers.The HPAEsavoidedstrategies of macrocconomic stabilizationthat stressed the roleof the exchange rtc in breakinginflationaryexpectations.Rather, exchangerate adjustments weresupportedby expenditure-reducing fiscalmeasures. While Indonesia,Korea,and Thailand have had periodsof realappreciation,they did not try to maintain a fixedexchangerate regimein the faceof inflation ratesmuch greaterthan thoseof their tradingpartners. The HPAESrespondedto externalshocksmore quicklyand effectively than other developingeconomies.East Asian policymakershave been more adept at managingfiscalcontractions-cutting expendituresand increasingrevenuesin a growth-orientedframework-to attain viable deficittargets.In contrast,governments elsewhere committedto funding largeentidement prograrins-incometransfers,untrgeted subsidies, cessive public sectoremployment,and loss-making public enterprisesoften lackedthe flexibilityto deal efficientlywith budget contractions. Rather than cutting spendingon entidements,theYhave often resorted to cuttingpublic investment. In eachHPAE,a technocratic elite insulatedto a degreefiom excessive
political pressure supervised macroeconomic management. The insula-
348
POLICIES
CI
tion mechanisms rangedfromlegislation, suchasbalanced budgetlaws
in Indonesia, Singapore, and Thailand,to custom and practice in Japan and Korea. All protected essentially conservative macroeconomic policiesby limitingthe scopefor politicians and interest groupsto derail thosepolicies.
Building Human Capital
Wehave shownthatthebroadbaseofhumancapital wascritically importantto rapidgrowthin the HPAES. Because theHrAEs attained universalprimary education early, literacy washighandcognitive skill levels were
substantially above thosein otherdeveloping economies. Firmstherefore had aneasier timeupgrading theskills of theirworkers andmastering new technology. In addtion, rapidhumancapital accunularion reduced incomeinequality byincreasing therelative abundance ofeducated worker,
therebyloweringthescarcty rents associated with cognitiveskils. These
benefits were particularly evident in thecountryside. Basic educatonin theHPAES is highly oriented toward theacquisition
of generalacademicskills,while post-secondary education tends to be oriented towardvocatonal skills.SomeHPAEs have alsobeen unusually
large-scale importers of educational services, particularly in vocationally and technologically sophisticated discplines.In addition,enterpriseleveltraining, muchof whichwassubsidized, accelerated technological acquisition. The benefits of dosingthegap between girls and boys in primary and secondary schoolenrollments havebeensubsmntial, evenin economies in whichfemale laborparticipation ratesarelow.Bettereducated modtersraisebetrereducated children, complementing publicinvestments in basiceducation. The rapid increase in the educational attainmentof womencontributedto Ehe earlydeclinein fertiiy, whichin turn resultedin a lessrapidly growing school-age population.As a result, mDre
resources were available per child, in homes and in the dassroom.
Creaing Effective and SecureFinancial Systems

Financial sector policies in tie
HPAEs
were designed to ficilitate two
crucialfunctions.First,theyencouragedfinancialsavings. Second,they channeled savingsinto activitieswith high social returns. There was great varietyin the policiesand institutions used to accomplishthese
349
_RALLE
ends, but severalflmdamentalapproaches were important in all eight economies. These included generallypositive real interest rates on deposits and the creation of secure bank-basedfinancialsystems. Positivereal interest rates on depositswere the most important f&ctor in encouraging financial savings.All of the HPAES had periods, usuaily early in their development, when rcal intcrest rates on deposits were negative. But in general real interest rates were more stable and more consisrently positive in East Asia than in other developing regions, wherehigh inflation has often meant that volatileand highly negative real inrerest rates prevailed. HPAE governmentsalsoencouragedsavingsby fosteringscable and secure banking systemsthrough a combination of protection and regulation. Protection of establishedbanks induded governmentlimitson the creation of new domesticbanks, the enuy of foreign banks, and the operation of competing non-bank financial institutions. Regulation inspeculative cluded enforcement of prudent behavior, such as limniting lending. Although the HPAEs had no explicir deposit insurance, they promoted confidence in the banking system by devising rescue programs as needed, sometimes,as in Japan and Korea, pressuringstronger banks to absorb weaker banks. In addition, many of the HPAEs encouraged savingsby creatingpostalsavingsplans to lowertransactioncostsof savingsfor small savers. Balancingthe advantages of protection against die need for compettion has been a major challengefor HPAE bank regulators. East Asia's banking sector structures,as well as some measures of bank efficiency (profitabilityand borrowing-lendingmargins),suggestthat banksin the HPAEs have been at leastas efficientas those in other developingregions. Evenso, innovation and efficiencyundoubtedly sufferedfrom limits on competiton. Pardy in response, HPAEs gradually have opened their banking systems to increaseddomestic and fbreign competition. Governments have also promoted bond and equicymarketsto increasethe depth of mamring financialsectors. SeveralHPAES supplemented commercial banls-and met the need for long-term capitl-by creating specialized dvelopment banks. These banks fiuthered the growth of the financial sector by establishing proceduresfor project financingand monitoring that commercialbanks then copied. In contrast to developmenrbanks in manyother developing economies,which tend to be subject to extensivegovemment meddling, H1AE development banks controlled project selection and 350
P O L I C IES AN Dn:rIcv
monitoring independently,albeit within broad governmentguidelines. As a result,their bad debts were usuallyassociatedwith economicdownturns ratherthan die willful default common in economies wheregovernment officialsare closelyinvolvedin day-to-day management. Limiting PriceDistortions Despite the HIAEs' many market interventions, reiativeprice distortions were limited and indeed smaller than in most other developing cconomies.Flexible labor marketsand capitalmarkets with positivereal interest rates meant that wagesand interest rates reflectedmore closely true scarcitiesof labor and capital. Thus resourceswere generallydrawn into labor-intensive production in earlystagesof development, shifting to capital- and knowledge-intensive activities as physical and human capital deepened. A combination of competitivereal exchange rates and moderate protection levelsmeant that domestic pricesof traded goods were closerto international prices in the HPAEs than in other developingregions.The largeweight of exportsin total output, duty-freeimports for exporters, and extensive domesticcompetition meant that all the HPAEshad higher sectorsoperatingat or near internaproportions of their manu&acturing tionl prices than the import-substitutingeconomiesof atin America, South Asia, or Sub-SaharanAfrica. Absorbing Foreign Technology While none of the HPAEs except Hong Kong and Singaporewas entirely open to international trade, al were open to foreign technology. Japan, Korea,and to a lesserdegreeTaiwan, China, relied heavilyon licensing, imports of machinery, and reverseengineering during their rapid growth periods. Hong Kong, Singapore,and the Southeast Asian HPAEs,in addition, welcomeddirect foreign investment that came bundled with technical, managerial, and sometimeslabor force skills. Licensing has become more and more problematical because owners of technologyare reluctant to share it, even for a fee. However,the success of the SoutheastAsian HPAEs with other forms of technologicalacquisition suggeststhis need not be a seriousbarrierto growth. The alternativepath of self-reliance has litde to recommend it. Some developingeconomies,such as Argentinaand India, have restrictedcap35'
A:
-X1RACLE
ital goodsimports to promore thegrowchof domesticmachine-building
industries.In thesecases,however, domesticmachinery generally falls short of internationalstandards. Such machinery becomes yet another high-cost importsubstitutethat inhibitsexports. Limiting the BiasagainstAgriculure Agriculture has played a morecentralrolein the H1IAEs than in many other low- and middle-income economies.Wide adoption of Green Revolution technology, highinvestment in ruralinfrastructure, and limiteddirectand indirecttaxation of agriculture meantthat ruralincomes and productivity rosemorerapidlyin EastAsiathan in other regions. As in othereconomies, agricultural sectors in the HPAES werea source of capitaland laborfor the manuficturing sector. But in EastAsiathese
resouroes weregenerallypulled into manufacturing by risingwagesand re-
turns, ratherthan squeezed out of agriculture by hightaxesand stagnant or declining relative incomes. Asa result,rural-urban income differentials
weresmallerin the HPAEsthan in most other developing economics.
Creating Institutions to PromoteGrowth

rT-%HE SUCCESS OF THE EASTASIAN ECONOMIES STEMSPARTLY
Sam the policies they have adopted and partly from the insti.1trutional mechanisms they created to implement thenL AUlof the HPAEs created secure institutional environments for private investment that led to very high levels of private sector-led growth. HPAE civil servicesrange orom the highly meritocratic and insulated bureaucracies of Japan, Korea, Singapore, and Taiwan, China, to the less effective and less insulated public administrations of Indonesia and Thailand. Nevertheless,each of these economies has a core of technocratic managers. In Indonesia and Thailand, their scope is limited to
management of the macroeconomy. In the other HPAEs,competent
civil servicesadminister a much wider range of policy instruments. How did these economies create a reputable bureaucrac? First, pay mattered. The salariesof bureaucrats (exceptin Singapore)usually fel short of those for equivalent positions in the private sector, but they were sufficientlyhigh to attracr and retain good economic maragers.
352
POLICIES`
Second, in the HPAEswith high-quality bureaucracies, rules and procedures governing public sector employment were institutionalized and insulated fromn political interventions. In particular, recruitment and promotion were merit based. Third, public employment was accorded high status. These factors improved the quality of the bureaucracy, discouraged corruption, and created an esprit de corps among civil servants that helped insulate the bureaucracy from political pressures. Each of the HPAE governments created institutions to improve communication with the private sector. Formal deliberation councils esrablished in five of the economies-Hong Kong, Japan, Korea, Malaysia, and Singapore-included government officials, journalists, labor representatives, and academics. The economic and political benefits of these councils, and of the more informal mechanisms in the other HPAEs,are impossible to measure systematically. It is likely, however, that economically they improved coordination among firms and improved the flow of information between businesses and government Politically they helped establish a commitment to shared growth and reduced rentseeking. Information sharing made it more difficult for firms t curry special favors fiom the government and for government officials to grant special concessions. Thus the deliberation councils helped check opportunistic behavior. The deliberation councils in Japan, Korea, and Singapore also performed an important monitoring function, assessing performance at the industry or economy leveland administering contests. Consultative mechanisms in Indonesia and Thailand were less formatl, and their role in facilitating business-government communication was much more limited. Malaysia's experiment with deliberation councils is quite recent but appears to hold some promise in the area of macroeconomic management.
Inteirvening in Markets
OST OF THE HPAEs, ESPECIALLYTHOSE IN NORTHEAST
Asia, intervened in markets in an effort to hasten growth. All interventions carry with them costs, either in the form of direct fiscal costs of subsidies or forgone revenues, or in the forrn of implicit taxation of households and firms-for example, through the structure of protection or interest rates controls. One of the main char353
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acteristics of interventions in the HPAEs is that in general they have been carried out within well-defined bounds limiting the implicit or
explicit costs. Thus, price distortions were present but not excessive,
interest rate controls generally had as benchmarks international interest rates and were binding at positive real levels. Explicit subsidies were also kept within bounds. Given the overriding importance that each of the HPAEsascribed to macroeconomic stability, interventions that threatened to undermine thar policy fimdamenmally,were modified or abandoned-for cxuample, the heavy and chemical industries drive in Korea or the heavy industrialization push in Malaysia. These limits to intervention stand in sharp contrast ro many other developing economies, where interventions have not been consistent with macroeconomic discipline. Whether these interventions contributed to the rapid growth made possible by good findamentals or detracted from it is the most difficult question we have tried to answer. It is much easier to show that the HPAEs limited the costs and duration of inappropriately chosen interventions-itself an impressive achievement-than to demonstrate condusively that those interventions that were maintained over a long period accelerated growth. In this book we have evaluated three sets of policy interventions: the promotion of specific industries or industrial subsectors, directed credit, and the export-push strategy. We conclude that promotion of specific industries generally did not work and therefore holds little promise for other developing economies. Directed credit has worked in certain situations but carries high risk. The export-push strategy has been by far the most successful of the three sets of policy intervention and holds the most promise for other developing economies.
Promoting Specific Industries GenerallyDid Not Wark Industrial policy narrowly defined-that is, attempts to achieve more rapid productivity growth by altering industrial structure-was generally not successful. In Japan, Korea, Singapore, and Taiwan, China, promotion of specific industries had little apparent impact. Industial growdt tended to be market-confbrnning, and productivity change was not significantdy higher in promoted sectors. Although governrents in these four economies were undoubtedly trying to alter industrial structure to achieve more rapid productivity growth, with the exception of Singa-
354
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1.A
poretheirindustrial structures evolved largely in a mannerconsistent with comparative advantage. marketfoirces and factor-intensiy-based It is nortaltogether surprisingthar industrialpolicyin Japan, Korea, andTaiwan,China,tendedto be marketconforming. Theseeconomies, indusalthoughselectively promotingcapital-and knowledge-intensive firms. tries,still aimedto createprofitable, internationally competitive Taiwan,China,placedgreatemphasis on pricecomperitiveness in evalin intermediate uatingthe performance of its largepublic investments and capitalgoods.Moreover, in Japan especially, but alsoin Korea,incooperative relations and exchange stitutionalmechanisms that stressed of information betveen firms and governmentintroduced a largc of industrialpolicyfbramountof marketinformation into the process mulacion.And the yardstick used to evaluateindustrial policies' a markettestof the sucsuccess-mainlyexportperformance-provided cess or failure of the policy instrumentschosen. Thus the seeming probablyrestsnor success of industrialpolicyin thesethreeeconomies on picking winners-that is, on the adroitselection of whichindustrial subsectorto promote-but on the setting of export targetsfor promoted industries and the use of export performanceto assesspolicies.
Our testsmayhavefailedto captIe one importantaspectof indusinformationexchange in a competitive trial policyin Japanand Korea: investment coordiframework-in short, contests-may havelessened nationproblemsand resultedin earlierand betterinvestments in what ultimatelybecamemarket-conforming sectors.But among the HPAEs, onlyJapanand Koreahad the instiutionalcapacityto organize and refereethe kind of contestsusedin formulating and implementing industrial policies. Despitetheir potential benefits,collaborative arrangements, especiallywhencombined with access to scarce resources suchas foreignexchange and cradit, have a high risk of capture by the participants. Capture was avoided-and resource allocation may have been of repeatedrelaimproved-in Japan and Koreaby the combination tionshipsbetweenbusiness and government and the useof exports,not domesticGDP growth,as the yardstick by which the success of the industrialstrategy wasmeasured. In other HPAES, such elaborate contests were not used-for example,in Hong Kong, Singapore,or Taiwan, China-or wereunsuccessfil, as in the cases of the heavyindustriafization drive in Malaysiaor recent attempts at technologicalleapfrogging
in Indonesia. 355
.X4
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Repressing Interest Rates andDirecting Credit Worked Somefimes

All HPAEscontrolled interesr races on deposits and loans during much oF their rapid growth. Low real interest rates on deposits and loans increased corporare equity by transferring resources from savers (mostly households) to borrowers (mosdy firms). At the same rime, by limiting the spread between deposit rates and loan rates, govemments prevented banks from earning excessiverents. On the downside, such controls undoubtedly discouraged banks fiom taking on riskier, nontraditional dients. Interest rate repression was key to the HPAEs'directed-credit programs. Low interest rates on loans resulted in excess demand for credit, which permitted governments to take an active role in credit rationing. This in turn gave governments strong leverage with which to influence the beihavior of firms. In this section we discuss why directed credit was relatively successfid in hie HPAES but often had large negative consequences elsewhere. WVe then consider whether such polidtes could be effectively adopted in the increasingly open capital markets of most developing economies. Interest rate subsidies were smaller in the HPAEs than in other developing economies. In several HPAES, government-directed credit served primarily to signal commercial banks and private investors which sectors enjoyed govemment support Banks and private investors then selected projects within those sectors and offered them additional funding at commercial rates. Moreover, credit was frequently allocated according to export performance. Our evidence leads us to condude that credit programs directed at exports yielded high social returns and, in the cases of Japan and Korea, other directed-credit programs also may have increased investment and generated imporcant spiliovers. Even within East Asia, however, when interest rate subsidies were large, or export performance criteria were not imposed, directed credit often went to inefficient ventures and those with low social returns. The financial sector policies used by the HPAEs in the 1960s through the early 1980s took place in a world economy in which it was possible to close domestic capital narkets. Since the early 1970s, developing economies have become ever more integrated with the global capital markeL While this has reduced government? already limited abiity to restrict capital flight and speculative capital inflows, it has also given them accessto less expensive capital and offered them better possibilities 356
POLICIES
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to hedge externalshocks. At the same time, increased integration has constrained policymakers, who are finding it more and more difficultto rnaintain interest rates at variancewith international markets. The developingeconomies'growingintegration with global financial markets can be seeniin the evolurion of their stock markets. Until the mid-1980s, foreign investors'accessto domesticsecuritiesin developing economies was often restricted. Since then, fourteen of the twenty largest developing-economystock markets have become substantially more open to foreign investment. The influence of international interest rates on domestic rates reflecrsa similar trend towardglobal integration. Indonesia,for example,began to open its capital accounts in 1971 and freeddomestic interestrates in 1981. Sincethen, interest ratesin Indonesia have followedinternational rates. Although capital outflow restrictions are generally ineffective,they do hinder the movement of some institutional capital, for example,domestic pension fimds. They may alsohinder the flight of household and individual savings in instanceswhen the transactioncosts of sending capital abroad are greater than the incentivefor doing so. Becausethese barriers do marer, developingeconomies continue to be less open financially than they are conmmercially. This can be seen in the ratio of gross capital flows to CDP compared with the ratio of exports-plusimports to C;DP. For the aggregate of all developing economies, the former is only 13 percent, while the latter is 45 percent. Nonetheless, the limited impact of capital restrictions in deterring capital flight has persuaded a growing number of developing-economy governments to open to global financial markets. In some cases, for example, Chile and the Philippines, the removal of capital outflow regulations has had the paradoxical effect of stimulating a net inflow by assuring investors they can expatriate their money at will. Even where govermnents have not liberalized restrictions, the globalization of the economy, particularly increases in trade and advances in transport and telecommunications, is rapidly eroding the isolation of closed
econormies.
Under these conditions, the choice for developing-economy policymakers is not between financial integration with the global market and isolation. Rather, it is between two-way integration that permits outflows and thus facilitates inflows, on the one hand; and de facto one-way integration that consists primarily of unauthorized capital flight, on the other. The HPAEs have recognized this dcanging global environment; all
357
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IR A CLE
are moving-albeit at different speeds-to liberalizetheir financial sectors and integrate them more closelyinto internationalfinancialmarkets. Financialsector interventions-specifically repressionof interest rates and contest-based direcEionof credit-may have contributed to rapid growth in such economiesasJapan, Korea,and Taiwan.,China. Bur eadi of these economies had competent and insulated bureaucracies and banks to select and monitor projects, and each applied export performance as the main yardstickfor credit allocation.In addition, thesegovernmentswere able during the earlystagesof rapid growth to closetheir financialmarkets to the outside world. Few developingeconomiestoday have the institutional resources to consistendy impose performancebased criteria for credit allocation. Moreover,the capital markers of all economiesare becoming moreand more integraced& Thus, successful repressionof interest rates and contest-basedcredit allocationmay only be possiblefor the very few developingeconomieswith strong institutions and then only to a very limited degree.
Export Push: A Successful Mixof Fundameitals andInterventions

The export-push strareg;y-the use of findamentals and interventions to encouragerapid export growth-was the HPAEs' most broad based and successfulapplication of selectiveinterventions.Furthermore, of the many interventions tried in East Asia, those associatedwith their export:push hold the most promise for other developing economies. While the changing trading environmentwill limit the use of highly targeted policies-similar to those of Japan and Korea during their early export growth-the broad pro-xport stance characceristicof all eight HPAEs remainsviable. Trade policiesin all the HPAES (exceptHong Kong)passedthrough an import-substitutionphase with high and variableprotection of domestic import substitutes.In allcases,however, policiesthat stronglyfavoredthe production of import substitutesto the detriment of exports were abandoned, and HPAE governmentsadopted strategicpro-export policiesthat establisheda free trade regime for exportersand offereda range of other incentivesfor exporrs.This export-pushapproachprovided a mechanism by which industry moved rapidlytoward international best practice, despirehighly imperfct world marketsfor technology. Export-pushstrategieswere implenented in three verydifferentways in the HPAES. Hong Kong and Singaporeestablishedfree trade regimes, 358
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linking their domesticprices to international prices;the export push was an outcome of the very limited size of the domesticmarket coupled with neutral incentivesbetween producing for the domestic or international market. Both economicsmade export credit available,although they did not subsidize it, and Singapore focused iEs effortson attracting foreign investment in exporting firms. In Japan, Korea,and Taiwan,China, incentives wereessentially neutral on azverge betweenimport substitutesand exports.But within the traded goods sector,export incentivescoexistedwith substantialremainingprotection of dte domestic market. Export incentives,moreover,were not neutral among industries or firms.There was an effort in Japan, Korea, Singapore,and TaiwanChina, to promote specificexportingindustries. Protection was combined with either compulsionor strong incentivesto expor- In Korea,firm-specific exporttargetswereemployed;in Japan and Taiwan, China, accessto subsidizedexport creditand undervaluarionof the currencyacted as an offserto the protectionof the local market. In the HPAEs that intervened selectively to promote exports, contesrs
based on performance in global markets played the allocative role that is normnallyascribed to neutral exposure of both import-substituting and exporting industries to international competition. But these contestbased incentive strucnures required high governmenr institutional capability. One of the keys to success of the export push in some of the HPAES, especiallyJapan and Korea, was the govermnent's ability to combine cooperation with competirion. They were able to do this first, because their civil services and public institutions were largely staffed by competent and honest civil servants, and second, because rirms and bureaucrats knew that there Nvas a single yardstick for performance: exports. Export targets provided a consistent yardstick to measure the success of market interventions. When protected sectors interfered with the exports of other sectors, exporters could successfilly seek redress. For example, domestic content rules imposed on foreign direct investors in Taiwan, China were suspended when they interfered with exports. The emphasis on exporc competitiveness gave businesses and bureaucrats a transparent and objective system to gauge the desirability of specific actions. Interventions could not be made arbitrarily, as these could be appealed at a higher level of government if they interfered with exports. The more recent export push-efforts of the Southeast Asian newly industrializing economies (NIEs) have relied less on highly specific incentives and more on gradual reductions in import protection, coupled
359
S'IWN'M[RACLE
with institutional support of exportersand a duty-freeregimefor inputs into exports. Recent strategiesto attract direct foreign investmentin Indonesia, Malaysia,and Thailand have also been explicitly export oriented. Direct foreign investmentin manyother developingeconomies is roo often directedat servinga protected domestic market and hedged by restrictionson exports.
lhe Export-Push Strateg in a Changing Trading Erwiroment

The early HPAE export drives-those of Hong Kong, Japan, Korea, Singapore, aiLdTaiwan, China-took place amid the cxpanding world economy of the 1950s to the mid-1970s. Economic growth in the industrial economies was rapid, barriers to trade were declining, and global effortsto spur free trade under the General Agreement on Tariffs and Trade (GArr) were the order of the day. Times have changed. Economic growth has slackened in the mature economies thar traditionally provided the main markers for developing-economy exports. Regional trade groupings are becoming more and more prominent. Industrial economies have begun to retaliate agnst allegedly unflair export practices by imposing quotas or countervailing duties. In such a trading environment, can today's developing economies successfi&lly emulate the export-push strategies of the early HPAEs? In the following section we break this question into two parts. First, will there be adequate, open markets for developing-economy manufactured exports? Second, will the need for market access constrain the developing cconomies' use of export-push strategies? We conclude that markets will be adequate and open and thar an export push, therefore, remains possible. However, global realities will limit developing economies' abiliry to adopt rhe more interventionist instrumcnts of export promotion. The experience of both the northern HPAEs, with their mixed export-push regimes in which protection of the domestic marker coexisted widt incentives or requirements to export, and the Southeast Asian NIEs, with their gradual trade liberalizationscoupled with improvemencs in export insitutions and availability of export credit, suggests that economies thar are in rhe process of trade liberalization would benefit from providirg specific incentives to manufactured exports. Modest subsidies to exports could be linked, for example, to the bias against exports in the domestic economy and bound by strict time limits linked to the pace of trade policy reform.
36o
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Moreover, if there are important externalitiesto exporting, a firther tilt toward exports can be justified on welfire-economicgrounds, even if the trade regime is neutral between import substitutes and exports. This might argue for functional export promotion measures such as guaranteeing access to export credit, providing tax incentives, or improving market accessfor smalland medium exporters. But, these measures will necd to follow internationally acceptable rules to assure market access in importing economies, and must be of limited duration. Fiscal discipline, moreover,wiUl require that the costs of promotional programs be kept in check. WhyThereWillBe Adequate Markets The success of the southern-rier HPAEs' export drives in the late 1970s and 1980s, along with the continued rapid growth of exports from the northern HPAEs,indicates that export drives can succeed evenr when industrial-economy markets are not expanding rapidly. In contrast with the successof earlierexport drives,which depended primarily on increased consumption in the industrial economies, the later drives
have depended on consumers i industrial economies buying goods made in Asia instead of goods made elsewhere. If industrial-economy markets remain open, developing-economy exports can continue to expand in this manner. Contrary to concerns in some high-income economies about a flood of exports from the developing world, these exports remain tiny relative to the size of the major, industrial economies. In 1980, developing-economy exports of manufactured goods accounted for just 2.4 percent of total manufactured goods consumption in the European Community (Ec), North America, and Japan. By 1988, despite the success of Asian and other exporters, this had grown to just 3.1 percenL Even if exports from all developing economies had grown as fast as those from Korea during this period, their total share would srill have amounted to only 3.7 percent of total consumption by 1988 (World Bank 1992b). The scope for export expansion remains substantial. Indeed, indcidual developing economies, particularly smaller economies currently contemplating an export-led expansion, could safely assume that demand for their products is infinitely elastic This is even true for Hong Kong's exports, which in 1990 accounted for a hefty 2.4 percent of
36i
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world merchandise trade (Riedel 1988). Emerging exporters are unlikelyto approachthis level for many years to come. In 1989, for example, Sub-SaharanAfrica'sexporcsof manufactured goods amounted to just 0.43 percent of world exports (United Nations 1992). Evenif industrial economy marketsgraduallybecome lessaccessiblc, changesin the global trading environment are creating new opportunities for South-South trade. As recently as the mid-1980s, importsubstitution strategies in most developing economies forced developing-economyexporters to rely heavily on industrial-economy Since then, formerly closed economies in Asia, Sub-Saharan mark-ets. Africa, the Middle East, and Latin America have responded to debt problems, slow growth, and the need to raise fresh capital by becoming more and more outward oriented-and therefore more open to imports. They have assumed greater obligations under the GA1T and through numerous regional trading arrangements.' Under these circumstances, the potential for Soudt-South trade has increased considerably. But while global markets are growing, they are also becoming more and more competitve. Each economy seeking to emulate the East Asian axport-push model will encounter difficulties because many other economies are trying to do the same. For example, Collins and Rodrik (1991) estimate that Eastern Europe and the republics of the former SovietUnion will increase their share of world trade from 10 to 23 percent, relying initially on agricultural conmnoditiesand laborintensivegoods that compete direcdywith the products of other developing economies. Despite this heightened competition, severaltrendssuggest that expanding global mnarkets will remain open to developing-economymanufactured exports. Onc of these is the continuing effort to open markets under the auspicesof the GAIT (see box 7.1). The other is the growing role of regional trading blocs,which present a major opportunity for increasedglobal trade (see box 7.2). Who providesthe mnarket if all economies push exports? The dramatic growth of trade within Asia makes clear that export-oriented economiescreatemarkets for import. To compete internationally, exporcersmust meet global standards of quality and price, for which they need accessto technology, capital,and intermediate inputs at world prices.As a resulr, production in Asia has become more and more international, with capital goods coming from Japan, labor-intensiveassemblybeing perfbrmed in low362.
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D.
Pb~~ ~~~~-
s7fFiTr
er' he;|G
Access underthe GAiT. 7.1 Increased Box

.'THE GA7rTHAS BEENINSTRUMENTAL IN FACITATING FREER
trade.Since the end of World War II, tariff rates around the world havcplummeted.Among the major induistrial economics,weighredtanff lcevlshave been lowered to blow 5 percent. The cur-average rent UruguayRound of trade negotiationsis addressing .~~~~~~~o . .. . .V.i s is ad ci.r.
*Increasing market access,inudingmore-open trade in agriculru.-s texties, na l rsourcs and e remo or reuc-. tion ofrmainin tariff and nonrariffbarriers a Extending the GATTto new areas, principillytiradein services, standards,and the enforcementof intellectualproperty rights, investmentrequirementsimposedby governand trade-related
ad
; -rnents
CAT rules, especially those coveringantidump.: Strengthening ing subsidization, productstandards, import licensing,"safeguards" (temporary import protection)
3
ard dispute
selemenr
In short, the Uruguay Round is covering a- broai4 ambitio to knowhow successfill agenda. Evenat thislate dareiris impossible fbr the round will be. Successcould offer inip&rmnt-ropportuiities exports,particularlyin sucb arcasas agriculture :developing-economy alandtropical products.Progress in eliminating the Muiltifibre Arrangementwould also bring major benefits;particularlyto new en--. -trans into textiles and apparel-alth ough here some economies
:- -might lose eisting,rents. -Ar the same time, however, a successful
UruguayRound miy erodeprefrntial reaent thusE fr accorded ..som developingeconomies.Developing-economy governmentsmay. of intellectal propeAiy 'be:obligedtto ughihen-their7:nforcement -rights, while easing rade-related investment.reqwremens They' :couldalso -fi;e.touglie rules of oigm :and anricircumventionmnea6the -.sures-concerningdumping alhgarions. On the whole, hwe ?WUruguay >Round' holds considerable pornise forte, develon
economies.;
-wouldlose imporntopporni--Conversy,developing CononMies
agn-nies if the round fails.Thcsc would be pardq. lary seriousmin .. :culturebecause the global natuie of gn&ilrure markets,makes _*regiosounsineffectve Devopi economis udao beffecd byie increased use of unilateral and bilateralre- . adversely .- stictions in te' event oh GArile. '. U
I
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Box:7.2 Regional.Trading Blocs '
''ROGRESSTOWARD GLOBALWINTEGRATONCOULD capital flows. Stronger regional integraton need not .be reversediffdworldconory splits into regional be' assdciaredwith higher exteral barriers. Indeed, trading blocs, each centeredon a major currencyand regionalblocs could havepositive globaleffects,prodlosed ro' outsiders (Thuirow.1992).Some.observeis -vided the blocs remain open to trade from outside. worry that the emerging regional trading blocs will 'Deeper integrnwion within Europe, for example,will
imposc-subtle and nor-so-subtle protectionist' mea&cilitate trade with the rest of thc world. A common esurs'. Inboth teEurpean Comrnunity; (EC) and -set ofsrandards nakes it easier forallwho wish to se[l the :iNorth Ainerican'.Free Trade. Ara (NAFMA),for in Europenor just insiders. Tough rules to prevent ex'ample, fins' are already lobbying Forules olisnit -governments from subsidizing 'domestic firms .aid all the marker 'access of extra-regionial competiors. 'competitors, not only those located in the European Community. Typically these rules require that products entering one memrber economy contain ai inimuma regional -Eierging regional arrangements may provide an ' content to quaJr for entry to the markets of oiher . incentive -for some economies to. open, more rapidly. , members. (In--the,United Stares-Canada Free Trade than they would havcr otherwise. For example, the formation of the Ecwas an imortant inipulsc for the ,Area, a 50 percent regional value-added content re. quirement was required for eligibility for regional Kennedy Round (L.wrence 1993); As Mexico access. .In the NAFTA,tihere a`re special rules. for automoved into the' NAFTA negotiations, it simukmnemobiles and tetiles.`The textile provision is particu- . ously made overture toward the Pacific and towaid .lady protectionist-it requires triple uansformation, Cential and South America. Mexico is 'now seeking such that'finished:foihing.products have'to becuiit :to join the OECD, is negotiating to form a free trade signed agree..- "..'.and sewn flom &ibric spun rom Noth American. area wthVenezuelaandCie,andhas. 1 - fibers. This could resiilt in considerable trade diver-. :mcnts for freer trade with seven Central American sion.) Regiona:l blocs'may also,-tighten fbrcemen economes. . -. '.ofrules against -Ddeiiumping. as: another means of,' oDevelopingeconuisib' differently ,-prorecion. .by th -Eco e n of rgn b ,- .; con.erns But -. about regional .protectionist -endencurrendy enjoy prefrrentiaJacc to'the,U.S. des are easily overstaie. Unlikc-their predessors,m..arkets under schem such as thc gene tha and EC ed S
m- -. ten-of prefer th Cabbe Ina th: en 5 wblcs go beyondliberaizationoftradeto dudetlibealizdion ; of investment Lwrince 1993).- and the Lom-nConvention are likly to 'see te vale Thi- in-rai necessitates the libealinidonf naional -of, thee prege erod& 1f- hoever, w regional .production standardsthat would otherwise raise-the; arrangements further multilaibalitidn,.thy' .'.-cc'.c of=.r'*onlly nmtegt prodcton Moreover, . wl ot new opportunities r.traedaif bl-s"
-in each'insrance where-regional conomic gups-are em. ''erging, hie' movation -has b'e'a at.re LrOato* further.access and internationl succeed ,in stimilatig. e w .hose outside.the regions will.n :opportuities.
-
of teiembcrs, increased expor
wage economies cated operations from Hong utation rrade.
such as Indonesia
and Thailand,
and more sophistidespite its rep-
such as design, marketing, and Taiwan, Asia has generated
and finance being provided China. Thus particularly rapid increases in
Kong, Singapore,
for protection,
364
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RG
liT
AccessWillConsbtain intenweuions How the Needfor Market economics seekingto increase trade and attract investDeveloping ment will experience greater pressuresto open their economiesand bring their practicesmore closelyin l ne with those in industrial economies. Those that attempt to usemoreinterventionist versions of che export-pushmodel will risk retaliationfrom industrial-economy
markets or punishment under the GATT.For some policy options, such
as financial repression, increasing integration with global markets will limit the scope for intervention. Over the years, developing economics have daimed and received exemptions from GATT rules (Whalley 1990). By invoking Article XII, to safeguard their balance of payments, or Artide XVIII, which allowvs promotion of infant industries, developing economies have been able to escape GAIT disciplines more or less indefinitely. Thus developing economies have been free to implement trade policies of their choice at bome while benefiting from the openness of industrial economies. But as GATT shifts from a narrow focus on tariffs to a broad approach that seeks agreements on rules, developing economies will find it more and more difficult to hang onto exemptions. Under Uruguay Round proposals, rules governing intellectual property, subsidies, countervailing duties, and trade-related investment would eventually be the same for industrial and developing economies. Although developing economies would have up to eight years to bring their practices into line, the trade obligations of developing economies clearly are increasing. Changing rules about dumping illustrate the case. Industrial economies are increasingly applying antidumping and countervailing duty measures to developing economy exports (Lawrence 1991). These measures will make it more difficult to follow the example of Japan and Korea, which protected domestic industry in order to subsidize exports. Developing economies that seek access to the emerging regional trading blocs may find that it comes tied to increased obligations that could inhibit adoption of the interventionist policies. For example, interventionist versions of the export-push model could not be implemented within the EC with its stringent rules on stare aid and its provisions allowing for the fiee movement of capital and for the community to implement competition policies. Moreover, no economy exposed to European competition could operate an effective infant industry strategy.
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Does this imply the Asian export-push model is a historic relic? Clearly not. Indeed, an essential feature of the East Asian export push has beeatthe ability to adapt to the global environment.The world market continues to present immense opportunities for those who export.
New opportunities emerge as economies everywherelibemlizeand the NIEs shift to the production of more advanced products. Moreover, Asian exportershave prosperedduring the past two decadesdespite a decline in global growth and a rise in protectionist actions. Exports can be promoted by a var.iet of means that are consistent with developingeconomies'emerging obligationsfor market aco-rs and limited subsidies. Improved institutions-mak-ing customs services, duty drawbacks, and fiee trade status for exportcrs and their suppliers work well-are all consistent with agreements on intemational tradc and arc effectivemechanisms for export promotion. Access to export credit, while morecontroversial,wasan ePffctive instrument in all of the -PAEsand remains feasiblefor other developingeconomies.
* . C
We began this book with the objectiveof understanding East Asia's success.We found that the diversityof experience,the varietyof institutions, and the great variation in policies among the high-performing Asian economies means that there is no East Asian model of rapid
growthwith equity.Rather, eachofthe eight economieswestudied used variouscombinations of polides at different times to perform the funcdons needed for rapid growth: rapid accumulation,efficient allocation, and high rates of productivity improvement. Most of the policies that the HPAES used reflectedsound economic fundamentals:they enhanced the working of markets, helped prices communicate information about relativeeconomic costs, and fosteredcompetitivediscipline. Some economies-notably Japan, Korea,arid Taiwan, China-went beyond fundamentalsand intervened in markes with industrial, trade, and financialsectorpolicies.On balance,some of theseinterventionscontrbuted to their extraondinary growth, but this was only possiblebecause
of highly unusual historical and institutional circumstances. The govern-
ments in theseeconomieswere more successfi than most in combining the benefitsof economic cooperationwith the benefitsof vigorouscompetidion.They did this bycreating contestswith exportsas the yardsick of success,with subsidizedcredit and other government-controlled favorsas prizesand with governmentofficials as competentand usuallyhonest ref366
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PRAGMAS
erees In other economies,induding some of the HPAES, similar interventionist policieshave uiled, largelybecausegovernmentsofferedincentives without a clear link to economic perlormance and strong institutional support. They offeredprizesbut lackedthe rulesand referees. What can other developingeconomieslearnfrom the EasrAsian mirade? While there is no recipefor success,there are some positivelessons: keep the macroeconomystable; focuson earlyeducation; do not neglect agriculture;use banks to build a sound financial system;be open to foreign ideasand technology;and let relativeprices reflecteconomicscarcities. And there are some negativeones: promoting specificindustries or
attempting to leap srages of technological development will generally fAil;strongly negative real interest rates and large subsidies to borrowers debilitate the financial system; and directing credit without adequate monitoring and selection of borrowers distorts allocation. Finally, we found that a successful export push, whether it results from an open economy and strong econornic fundamentls, or from a combination of strong findamentals and prudently chosen interventions, offers-high economic gains. Of all the interventions we surveyed, those to promote exports were the most readily compatible with a wide diversity of econoamic circumstances. East Asia'sown responses to changing domestic and international circumstances put these lessons in perspective. T7h HPAEsare themselves involved in a continuing process of reform, adapting poliy inscruments and institutions to achieve the objectives of continued growth with equity. In many cases these reforrns involve reducing& modifring, or abandoning policy instruments thar were judged to have succeeded in the past. Korea's financial sector reform, Indonesia's trade reforms, Thailand's promotion of breign investment,and Malaysia'sprivatization programs are cases in point. The outcome of these initiatives will provide further valuable lessons on how successful policy instruments shift over time, as the relative roles of markets, the public administration, and the private sector change in response to economic and social development The experience of the HPAEs broadens our understanding of the range of policies that contribute to rapid growth. it also teaches us that will*ingnessto experiment and to adapt policies to changing crcumstances is a key elemenit in economic success. What we have not discovered fully is why the governments of these economies have been more willing and better able than others to experiment and adap . answers go beyond economics to indude the study of institutions and the related fields of pol-
367
1rtCA'*T3 M 1 R A CL E
icics,history, and culture. Taking such large realitiesinto account complicates rather than simplifies the caskof development. The challenge for policynakers becomes twofold: to uisepolicies compatible with axistillg institutions and to avoid policies tha. exceed the economy7sinsti-
tutional capacity,while at the same time improvinginstitutions in order to make a wider range of policy options available.
Note
1. In the past, regional armngements were motivated by the desireto pursueimport-subsrirution policieson a largerscale and were thereforedoomed to failure;the morc recentinitiatives are motivated by a desireto consoildate more outward-oriented strategies.Subregional arrangements areflourishing. In Latn America, for example, theseincludethe North American FreeTradeArea; Mercosur(Argentina, Brazil,Paraguay, and Uruguay), whichaimsat a common marketforgoods and services by 1994; the Andean Pact (Bolivia, Colombia, and Venezuela, with Ecuadorand Peru slated to join); the CentralAmerican CommonMarker(CostaRica,El Salvador,Guatemala, Honduras,Nicaragua, and Panama); Caricom; anda Free tradeareabetween ChileandMexico that aims at reducingtariffs to zero by 1998. While progresscowardformalarrngements witrin Asia have beenlessapparent(although thefreetradeareawithinthe Association of SoutheastAsianNationsis an exceprion), incra-Asian tradehas increased rapidly.
368
Bibliographic Note
terials,includingspeificallycommissionedbackgrund studies, outputs of related World Bank-sponsored research, economic and sectorwork carried out by Bank operationalstaff;and the errensiveacademicliterature _L on the EastAsian economies.Citations in the text and footnotesrefer to specificsourcesused. The principalsourcesand specific contributions to individualchapters arc discussedbelow.Lists of background and other commissionedpapersand refrences for workscited are at the end of this note. Many members of the World Bank Staffassistedin the design of the researchand made helpfidcomments on one or more drafts of the report. They indude: YoshiakeAbe, Ramgopal Agarwala,Harold Alderman, Paul Armington, Ahmad Ahsan, Mark Baird, Gerard Caprio, Ajay Chhihber, Yoon-JeCho, Jaime de Melo, Shanta Devarajan, Ron Duncan, Wllliam Easterly,Gunnar Eskeland, Delfin Go, Jeffery Hammer, JamesHansen, GregoryIngram, Paul Isenman,EstelleJames,Emmanuel Jimenez,Christne Jones, Koji Kashiwaya, Homi Kharas,Miguel Kiguel, Elizabeth King, Michael Kline, Brian Levy, Samuel Lieberman, Will Martin, Deepak Mazumdar, Saha Meyanathan, Vikram Nehru, Arvind D. C. Rao, Anandarup Ray,SetsuyaSato, Panagariya, Martin RIavallion, Andrew Sheng, Lyn Squire, Vinaya Svaroop, Shekhar Shah, Jee-Peng Tan, Jacques Van der Gaag, Dominique van de Walle, Dimirri Vrtms, Andrew Warner,David Wheeler, Shahid Yusuf,and Heng-Fu Zou. Those outside the World Bank who contributedwith comments and materialindude: AliceAmsden,New Schoolfor SocialResearch; Masahiko Aoki, Sranfrd University;Jere Behrman, University of Pennsylvania; Robert assen,Oxford University; Gay Fields, Coomell University, Richard 369
THIS
REPORT HAS DIRAWN ON A WIDE RANGE OF MA-
,JG A1':ipKNOTE
RichardHanushek,University of Rochcster; Freeman,Harvad University; Shig e.lruikawa, AyoamaGakuin Universitr,HirohisaKoharna,Universiy of Shizuoka; KazuoKoike,HoseiUniversity, Lawrence J. Lau,Stanford University; DavidLindauer, Vassar College; Kazushi Ohkawa,International ofTsukuba;MoiDevelopment CenterofJapan; KenichiOhno, University sesNaim, CarnegieEndowmentfbr IntemationalPeace;PeterPetri, BranRhee,University Changyong deisUniversity; GustavRanis,YaleUniversity; of Rochester,Helmut Reisen,OECD; Hilton Root, SranfordUniversity; 11 Sakong,Institutefor International Economics, Seoul;Hermanvander Tak; Shujiro Uraca,WasedaUniversity;Rovert Wade, Institute for Advanced HoseiUniversity Srudy,Princeton;and Toni Yanagihara, Chapter 1 The data for this chapter are taken fom. the data base compiled for a researchproject, How Do National PoliciesAffectLong-TermGrowth? directed byWiliamr Easterlyand Ross Levine.It is an expandedversion of the data contained in Summers and Heston (1991). A summary of the resultsof the resch projcct are contained in a symposiumissue of
the Journal of Monetary Economics (forthcoming). Additional data are
drawn from the World Bank Economicand SocialData Base(BESD)and from the WorldDevelopment Reportdata base. The TF estimateswere made possiblebv accessto preliminary estimatesof constant price capital stock series developedby the Banks International Economics Department, under the direction of Vikram Nehru (Nehru 1993). Stanley Fischer generously provided his country-specific estimates of TFP growth, which underlay the resultsreported in Fischer(1993). Maurice Schiff (1993) provided calculations of agricultural incentives in East and South Asia, based on the methods developedin Sciff and Valdes(1992). The discussionof export performanceis drawn primarily from Bhattacharya and Page (1992). Analysis of the demographic transition is drawn primarily from Birdsalland Sabot (1993). Ed Campos (1993) provided most of the backgroundwork on income distribution. The discussion of private investment draws heavily on Madarassayand Pfeffermann (1992). Box 1.1 draws on Birdsall and Sabot (1993). Box 1.2 draws on Pack (1993) and Packand Page (1993). Substantial research on the economic tmnsition in China has been conducted by the Macroeconomicsand TransitionalEconomies Division of the World Bank'sPolicyResearchDepartment. This researcheffort which is led by 1.J. Sirwh is summarized in Chen, Jeffrrson, and
370
BIBLiO'
Singh (1992). The Asian Miracle ResearchProject has also funded research by professor Shigeru Ishikawa and his associateson the rapid growth of China'scoastalprovinces.Preliminaryoutputs of that research will be availablein the fall of 1993. Chapter 2 This chapter draws primarilyon Pack (1993), Pageand Petri (1993), and Stiglitz (1993). The description of contests also draws on Leipziger and Kim (1993), Uy (1993), Okuno-Fujiwara (1993), and Ito (1993). WorldDevelopment Report1991 provides the basis for the discussionof the market-friendly approach. Box 2.1 draws on WorldDevelopmentReport 1991. Box 2.2 draws on a paper prepared by Nancy Birdsalland John Page for the Colloquium on Lessonsof East Asia, February 1993. Box 2.3 draws on material provided by Jaime de Meld. Helpful discussions with VimodThomas, Robert Wade, and partcipants in the Development Economics Study Group, Tokyo, and the Trade and Development Seminar at StanfordUniversitycontributed to the chapter.
Chapter 3
This chapter draws on Bhartarcharya and Pangestu (1993); ChrisDar. Sanvwdla, A.. andlu 'vicnyanona i993; Corcien (I993J; Dahlman and Sananikone (1993); Leipziger and Kim (1993); and Salleh, Yeah, and Meyanadhan (1993). Many of the data on macroeconomic perfomance are drawn from a researchproject, How Do National PoliciesAffect Long-Term Growth? directed by WilliamEasterly and Ross Levine.The concept of "export push" is due to Coln Bradford (1990). Villiam Easterly,Lant Pritchett, and Michael Walton provided major inputs. Box 3.1 draws on Corden (1993). William Easterly prepared box 3.2. Box3.3 is based on Ira C. Magaziner and Mark Patinkin, The Silent War (New Yorlc Random House, 1988), by permission.Box 3.4 was prepared by Varuni Dayaratna. Chapter4 Chiah Siow Yue, Oh-Hyun Chang, Chaianan Samudavanija,Hadi Soesastro,and Bruce Tolentino provided information and analysisfor their countries. Hilton Root and Mhary Shirley made imporrant contributions. Discussion of the role uv small and medium-size enterprises hac drawn heavily on the resultsof a researchproject, Support Systems for Small and Medium Enterprises in East Asia, directed by Brian Levy. 37'
R&fl(c
OTE
Chapter 5 Material on human capital accumulation is drawn primarily from Birdsall and Sabot (1993). Robert Gassen provided the material on vocational training. Data and analysis on savings and investment are drawn primarily fiom Uy (1993), Stiglitz (1993a, 1993b), and Sriglitz and Murdock (1993). YoonJe Cho, Dimirri Vitras, and Andrew Sheng made important contributions to the analysis of financial repression, based on the results of a research project, Effectiveness of Credit Policies in East Asia. The section on tax policy draws on Shah (forchcoming) and on preliminary results ofa research projecr, Tax Policy and Tax Administration in East Asia. Discussion of the relative price of investment goods is based on data drawn from Pfeffermann and Madarassay (1992). Lant Pritchett made important contributions to the chapter. Box 5.1 was writen by Myriarn Quispe. Box 5.2 was prepared by Leora Friedberg. Andrew Sheng provided the material on which box 5.3 is based. Box 5A was writren by Jennifer Keller. Chazer 6 The discussion of labor market performance is based primarily on BirdsalU and Sabot (1993) and draws on contributions by Felds (1993), Freeman (1993), and Ranis (1993). The discussion of the capitl marker draws primariJy on Uy (1993), SEiglitz(1993a, 1993b), and on contributions by Andrew Sheng, Yoon-Je Cho, and Dimitri Vittas. The sections on industrial policy and exports arc based on Pack (1993) and Pack and Page (1993). Data on axport performance are drawn from the BESDand World Development Report 1991 data bases. Discussion at the 1993 Canegie-Rochester Conference on Public Policy were helpful in improving the sections on export extemralities and growth. Box 6.1 was written by Brian Levy. Box 6.2 was prepared by Leora Friedbeg. Box 6.3 draws on a recently cornpleted internal World Bank report on Indonesias industrial seaor. Box 6.4 was prepared by Leora Friedberg. Box 6.5 was prepared by Danny Leipziger. Chapter 7 Discussions of the international trading environment and boxes 7.1 and 7.2 are drawn from Lawrence (1993). Discussion of the international capital market is largely based on Global Economic Prospectsand the Developing Countries (World Bank 1993a). Vinod Thomas made a number of helpful comments.
372.
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The completebacklistof publicationsfrom the World Bank is shown in the annual hIder ofPublications, which containsan alphabcical tide list and indexesof subjects,authors, and countries and regions.The latest edition is availablefiee of chargefrom the Distribution Unit, Officeof the Publisher, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433, or fiom Publications,The World Bank, 66 avenue d'Idna, 75116 Paris, France, 389
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1993 World Bank - The East Asian Miracle

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Zambia Angola_ Mozamibique

3 2 1. changeIn GDP Percentage

Soarae:. Summers and Heston (1988).

F.gum 3 Change in Inequityand the GDPperCapita GrowthRate

Ranking byGIni coefficient1980

U Middle thibd A Least equal thlrd

Brazil A .Repof Korea

Hong Indonesa Kong

-0.20 0.03. 0.02 0.03 0.04 0.05 0.06 0.07

GDP per capita growth rate (average, 165-90)

export margets, developing export marketing institutions, and sharing in-

TheEssence oftheMiracle: Rapid Growth with Equity

HE EIGHT HPAEs ARE HIGHLY DIVERSE IN NATURAL RE-

Public Policies andGrowth

Building theInstutional Basis forGrowth

ofrisk(seechapter5). mechanisms, and socialization mandatory savings

Figu 4 Savings Ratesof HPAEs

Some governments also used a variety of more interventionist mecha-

2.0 20 30 'Percenta,ge ar GDP

Nenar.Finlind,uds Austria Bthee um.

consistendy high rates of return to investments. In conwnt to other

A? m vLRC y ~~~~~~~~V. ZiN [.IA RC LE

Policiesfor Rapid Growth in a Changing World Economy

'sKI/Their rapidgrowthhad two complementry elements. Firz,

ARETHE BROADLESSONSOF SUCCESSIN THE HPAEs?

getting the fundamentalsright was essential. Without Jhgh

Growth, Equity, and Economic Change

* Generallyhigher rates of productvity growth.

Rapid andSustained Economic Gmwth

HE EIGHT HPAEs GREW MORE RAPIDLY AND MORE CONSIS-

income growth, outperforming everyeconomyin Latin Americanand

Growth Rate,196085, andGDP perCapita Level, 1960 Fhgure 1.1 GDP

U HIgh4I.come econondes -* HPAEs S Other developingecononies

I III 0.6 038 0.4 elativepercapitaGDP, 1960 (percentag of U.& GDPpercapita,1960)

SorseSumnmersand Hestn (1991);Barnf(1989);Word BankdanL

Poverty Declining Income Inequaliyand Reduced

Fruie 1.2 Growth RatePerisbence