Economic Development in Asia
International stocks also
Chapter 1 –Introduction and Overview
Economic Development in Asia
• Interest in economic development has
expanded from the post war era up to the new
millennium.
• The recent economic history is noticeable by an
“economic miracle” that cross for several
decades followed by the financial or economic
crisis.
• Although, there are still problems of
widespread poverty, and inequality despite
gaining significant economic progress.
• The East Asian miracle is a showcase of
development up until the Asian crisis.
• It has achieved significant economic growth and
development during the post war era.
• The development pocess began with Japan. And
then followed by South Korea, Singapore,
Taiwan, and Hong kong.
• Economic Growth in these Newly Industrialized
Economies (NIE’s) or “Asian Tigers” average to
8% prior to the Asian Economic Crisis.
• Asian crisis created a number of questions
about the continued viability of a rapid growth
profile for the region.
WHAT IS THE ASIAN ECONOMIC CRISIS? HOW DID IT
AFFECT US?
• The Asian financial crisis, also called the "Asian
Contagion," was a sequence of currency
devaluations and other events that began in
July 3, 1997 and spread through many Asian
markets. The currency markets first failed in
Thailand as the result of the government's
decision to no longer peg the local currency to
the U.S. dollar (USD). Currency declines spread
rapidly throughout Southeast Asia, in turn
causing stock market declines, reduced import
revenues and government upheaval.
The Asian Financial Crisis
• As a result of the devaluation of Thailand's baht,
a large portion of East Asian currencies fell by as
much as 38 percent.
declined as much as 60 percent. Luckily, the
Asian financial crisis was stemmed somewhat
due to financial intervention from
the International Monetary Fund (IMF0 and the
World Bank. However, the market declines
were also felt in the United States, Europe, and
Russia as the Asian economies slumped.
BREAKING DOWN the Asian Financial Crisis
• As a result of the crisis, many nations adopted
protectionist measures to ensure the stability of
their currencies. This often led to heavy buying
of U.S. treasury, which are used as global
investments by most of the world's
sovereignties. The Asian crisis led to some
much-needed financial and government
reforms in countries such as Thailand, South
Korea, Japan and Indonesia. It also serves as a
valuable case study for economists who try to
understand the interwoven markets of today,
especially as it relates to currency trading and
national accounts manager.
• As mentioned above, the IMF intervened,
providing loans to stabilize the Asian economies
— also known as “tiger economies” — that
were affected. Roughly $110 billion in short-
term loans were advanced to Thailand,
Indonesia, and South Korea to help them
stabilize their economies. In turn, they had to
follow strict conditions including higher taxes
and interest rates, and a drop in public
spending. Many of the countries affected were
beginning to show signs of recovery by 1999.
Lessons from the Asian Financial Crisis
• Many of the lessons learned from the Asian
financial crisis can still be applied to situations
happening today and can also be used to help
alleviate problems in the future. First, investors
should beware of asset bubbles — some of
them may end up bursting, leaving investors in
the lurch once they do. Another possible lesson
is for governments to keep an eye on spending.
Any infrastructure spending dictated by the
government could have contributed to the asset
bubbles that caused this crisis — and the same
can also be true of any future events.
Difference between development economics and other the ultimate criteria for assessing the development of a
branches of economics country, not economic growth alone.

• Economic Development concentrates on The HDI can also be used to question national policy
economies that have low per capita incomes. choices, asking how two countries with the same level
of GNI per capita can end up with different human
• It considers the experience of industrialized
development outcomes.
countries in Europe, North America, Japan, and
Australia/New Zealand in analyzing the process
of economic growth.

• Development Economists use analytical tools in

growth theory, macroeconomics,
microeconomics, and labor economics to name
just a few.

Measuring Growth & Development

• Economic Development is a broader and much

more encompassing view than economic
growth, and relates to levels of social and
humanitarian achievement and income
distribution, as well as narrow measure of per
capita income.

• It is economic growth with accompanied

improvement in peoples quality of life.

New Approaches to Measuring Economic Development

• Human development index (HDI) - is a summary

measure of achievements in three key
dimensions of human development:

3 Dimensions:
1. Long and Healthy life
2. Knowledge
3. A decent standard of living

The HDI is the geometric mean of normalized indices for

each of the three dimensions.

• Healthy life expectancy – Measures the

expected number of years to be lived in full
health. Cut-off Points for HDI Groupings

• Green GDP Very high human development Above 0.800

- assesses the impact of environmental High human development 0.700 – 0.799
degradation in the development experience. Medium human development 0.550 – 0.699
Low human development Below 0.550
Human Development Index (HDI)

The Human Development Index was developed by

Mahbub ul Haq and Amartya Sen and was adopted by
the United Nations Development Program to
emphasize that people and their capabilities should be
  Land was assumed to be included within capital.
 Other factors were not considered until it was
noted by Solow that there was a large residual
factor that was unexplained.
 Substantial time has been spent explaining this
residual.
 This residual has been called total factor
productivity (TFP) or sometimes multifactor
productivity.
 TFP is very large in industrial countries,
explaining as much or more than 50 percent of
economic growth in the postwar era.

Total Factor Productivity

Question: What factors are contained in the residual?

Y = f (K, L, A)

Such a list might include:

- the adoption of new technology,
- better educated workers,
- better management,
- better coordination within the organization,
- more efficient production techniques,
- better inventory management,
- better and cheaper distribution and marketing
skills and organization.

Testing Different Growth Theories

Many different approaches have been devised to test

these alternatives. In doing this, it is useful to
distinguish between embodied and disembodied
technical progress (TFP).

Embodied TFP can be measured by adjusting the factor

inputs of labor and capital. Disembodied TFP cannot – it
has to go into the residual.

Economic Development in Asia Growth Theories

Chapter 2 – Growth and the Asian Experience 1. Keynesian Theory/Harrod-Domar Model
2. Solow Model
Why do economies grow? 3. Power Balance Theory
Why should they grow? 4. Structuralist Approaches
Why do we want them to grow faster? 5. New Growth Theory
These are the types of questions that economic
development is concerned with. The Harrod-Domar Model

Theory of Economic Growth  Dynamic version of a simple Keynesian model.

s
 Traditionally labor and capital were introduced
g*    
as the only variables determining the level and 
the growth of output. Y = f (K,L).
  Growth is dependant on the rate of capital
formation and the efficiency of the use of
capital (capital/output ratio).
 Population growth can be added and it reduces
the rate of growth ceteris paribus.
The Solow Model
 It introduces diminishing returns to capital and
focuses on the long run.
 Convergence to a steady state level of per
capita income occurs despite differences in
initial conditions.
 Total income grows at the same rate as
population.
 The higher the rate of saving, the higher the
steady state level of per capita income.
 When we add technical progress to the Solow
model in the form of more efficient workers,
then we have growth in per capita income at
the same rate as the rate of growth in worker
efficiency.
 There is still a steady state but it now relates to
efficiency units of capital.
Power Balance Theory
 Emphasized exploitation of poor “southern”
economies by the rich industrial “northern”
economies.
 Deterioration of terms of trade of
agricultural products in poor economies
further aggravates the situation.
 The theory has generally been discredited.
Structuralist Approach
 The structural approach was developed in the
1960s and 1970s by Hollis Chenery. Chenery
was initially trained as an engineer and this
approach reflects his training.
 Structural approaches stress the shift in output
among the sectors of the economy and the
rigidities that hinder them.
 A shifting balance between the three major
sectors of the economy – agriculture, industry
and services.
 Agriculture diminishes over time and industry
increases. Productivity is higher in industry so
higher growth depends upon this shift.
 A stereotypical pattern of economic growth
which has been observed in many countries.
 Initially, agriculture has a large share of output
when the economy is at a low level of
development. Share of industry and services are
small.
 As industrialization takes place, the share of
agriculture declines and that of industry and
services grow.
Two Sector Model of Growth
 The Lewis-Fei-Ranis model (LFR), named
after the three economists that developed
it, is a two sector model – a modern and a
traditional sector.
 Resources move from the traditional to the
modern sector and this spurs growth. More
on this in chapters 4 and 5.
 The beauty of the LFR model is that it
describes many of the characteristics of the
Asian economies when they were just
beginning on the path to rapid development
in the 1960s and 1970s.
 That is why it has become so popular
among development economists studying
Asia.
Solow Growth Model
• (1+ ) k (t+1) = (1- ) k (t) + s y (t)
• where k and y denote the per capita units of
capital and output, respectively, i.e. k(t)=
K(t)/P(t) and y(t)=Y(t)/P(t).
• This fundamental Solow equation says that the
amount of per capita capital in the current
period depends upon the per capita capital in
the last period, the saving rate in the previous
period and the rate of population growth.
• From the foregoing, it follows that as the
economy moves to a steady state level of per
capita capital stock regardless of initial
conditions.
• In the steady state, there is no deepening of
capital and the amount of capital per capita
remains unchanged from period to period as
 does the level of per capita income. That is,
there is no long run growth in per capita income.
• Total income growth rate  is thus assumed to
be the same as the rate of growth for
population.
• Further, in the Solow model framework, the
saving rate has no effect on the long run growth
rate of per capita output which is zero.
• However the saving rate does affect the
equilibrium level of per capita income.
• The higher the saving rate, the higher the steady
state level of per capita income.
New Growth Theories
 New growth theories that go beyond Solow
have been developed in the past decade.
 They stress the importance of externalities
and the possibility of increasing returns to
scale rather than the decreasing returns to
scale of the Solow model.
 The key to this is human capital formation.
 Higher per capita incomes tend to slow
growth because of diminishing returns but
higher endowments of human capital tend
to speed up growth.
 Returns to such investments may be
increasing.
The Asian Growth Miracle
 For the last forty years, a group of countries in
East and Southeast Asia have grown at
remarkably high rates.
 Japan led the way, beginning right after World
War II.
 It was joined by Thailand, Taiwan, Korea,
Singapore and Korea in the 1960s.
 Southeast Asia followed in the 1970s.
 Although individual experiences vary, South
Asia did not generally begin to grow more
rapidly until the late 1980s and early 1990s,
when government policy shifted toward
supporting a more open and competitive
environment.
Policy Environment Before the Transition to Rapid
Growth
 The policy environment in most developing
countries throughout the world stressed import
substitution policies for industry.
 The theory was that developing countries had a
comparative advantage in primary products and
so they should export these products.
 The import substitution theory also argued that
since incomes were low, savings rates were also
low. Inflows of investment and financial aid
were needed to lift growth.
 To minimize on foreign exchange outflows,
industries that substituted for some imports
were promoted by government policy.
 Such a strategy, which was followed for several
decades after World War II in many developing
countries, simply perpetuated the cycle of
North-South trade and reinforced protectionist
policies that contributed to a lack of
competition and economic inefficiency.
Policy Environment
 What Japan and later the countries of East
Asia did was to begin to develop an
environment that stressed outward looking
trade policies and the acquisition of foreign
technology.
 In the case of Japan, many believe it was an
attempt to develop a mercantilist strategy to
help it recover its influence after the defeat
in World War II.
The Asian Growth Miracle
Primary factors
1. Openness
 The first factor in the primary strategy was
outward looking policies and emphasis on
exports and acquisition of foreign
technology.
 First, some industrial capability was built up
by focusing on import substitution in
industries with ties to agriculture - footwear,
food processing and textiles.
 Second, after some years, industrial policy
shifted to promoting external markets.
 Initially, this focused on extending the scope
of the industries that were producing for the
domestic markets such as textiles and
 apparel, leather products and footwear and
food processing.
 In Southeast Asia, the focus was also put on
rubber, sugar, coconut and palm oil products
as well as some specialized textile products
such as silk.
 Slowly the emphasis shifted toward labor
intensive industries that were not
necessarily tied to the agricultural base such
as electronics assembly and apparel.
 The shift from import substitution to export
promotion was led by a shift in the trade
regime so that there were lower tariff rates
on exports and imports (see Table 2.3).
 Non-tariff barriers, including bureaucratic
procedures and graft/corruption as well as
import bans on some items, were also
reduced.
 Transformation to labor intensive export
oriented industry was supported by flow of
foreign direct investment – initially from
Japan and the US, particularly in Korea,
Taiwan and the Philippines.
 Later the volume increased and more flows
began coming in from Europe.
 A virtuous cycle of growth was created by
this shift in emphasis from import
substitution to export promotion (see Tables
2.4 and 2.5).
 In South Asia, on the other hand, the shift
occurred much more slowly.
 Technological transfer served to reinforce
the shift in export emphasis.
 Foreign technology acquired by buying
from foreign companies under license.
 By copying it without license –
sometimes legally and sometimes not.
 By entering into joint ventures (FDI).
 East Asia (Korea, Japan, Taiwan) by and
large followed the first route while
Southeast Asia followed the second.
 The flow of FDI increased following the
Plaza accord in 1985 when the yen
appreciated and Japan began to move
some of its labor intensive industries
offshore.
2. Macroeconomic Stability
 The second set of primary factors focused on
the importance of macroeconomic policies and
the role of the government.
 Governments generally followed polices that
created and supported a competitive
environment for export oriented industries but
not necessarily for the domestic market. Japan
is a good example of the latter.
 The amount of government intervention didn’t
seem to have a direct effect on performance.
 There was a lot of government intervention in
the industrial and financial sectors in some
countries and little in others.
 In Korea, Japan and Singapore, there was a lot
while there was less in Malaysia and Taiwan.
 In Hong Kong and Thailand, on the other hand,
there was virtually no intervention.
 What was important was the efficiency and
incorruptibility of the bureaucracy.
 In the Philippines and Sri Lanka, policy
environments were similar to those in the
successful countries but growth was slowed by
other factors such as corruption, lack of political
will, corruption and domestic unrest.
  The efficiency of government as well as policies
followed were important. Taiwan and Singapore
are good examples.
 Efficient governments are characterized by little
rent seeking, salaries are competitive and
promotions are based on performance not on
seniority, patronage or crony connections.
 Some policies such as financial repression and
directed government lending programs were
wasteful.
 But the flow of resources for investment were
substantial and the wastefulness and distortions
created by these policies didn’t surface until the
1990s bubble broke.
3. Education and Labor Productivity
(Labor Market Flexibility and Education Policies)
 The third set of primary factors focused on
education and labor productivity.
 As stressed by the new growth theories,
education played a critical role in both the
transition to an export led growth strategy and
to the ability to sustain it (see Tables 2.8 and
2.9).
 By 2000, some of the educational advantages of
Asia had began to erode.
 There were two reasons for this:
 diminishing returns since more resources had to
be devoted to secondary and tertiary education.
 rapid rate of income growth that tended to
outstrip the corresponding growth in human
development.
 Behrman and Schneider concludes that
schooling attainment in miracles economies
was not particularly outstanding.
 The conclusion is that labor market flexibility
has to be considered along with education.
 The miracles economies did not have strong
unions until recently (Korea) and weak
minimum wage legislation.
 ILO rates the miracle economies as among
those with the most flexible labor markets.
 Mobility from rural to urban is also high.
Secondary factors
1. Initial Conditions
 Initial conditions played a part in the success
of the miracle conditions.
 Land, income and wealth distribution in the
miracle economies were generally more
even than in other countries and regions.
 Average educational attainment was high at
the beginning of the high growth period.
2. Sector Policies
 Sector policies were influential to the growth
of the miracle economies.
 Agricultural sector policies were not
particularly onerous. There were taxes on
agriculture but sector was still viable as we
will see in Chapter 4.
 Industrial policies were benign and
competition flourished in most countries.
 In Korea and Taiwan, “infant industry”
protection policies were strictly enforced
and favored export industries were
monitored for efficiency and export
performance. Subsidies were withdrawn if
performance was below expectations.
 There is considerable debate about whether
industrial policy in these two countries was
beneficial or not.
 Whatever the outcome of these discussions,
it is a fact that growth was rapid in both
countries.
Aspects of Economic Performance
 High levels and growth rates of savings
and investment in miracle economies.
 Both of these variables increased
dramatically as a percent of income (see
Tables 2.6 and 2.10).
 Furthermore, the saving-investment gap
was small or even negative for some
countries (see Table 2.11).
 Convergence of Income

Question:

The Solow model tells us that incomes will converge

to a steady state irrespective of where they started
out.

This assumes that the technical progress coefficient,

, remains constant across all countries.

Is this a realistic inference?

 To test this hypothesis of absolute convergence,

we can see if there is a relationship between
per capita income in an initial period and the
growth in income in successive periods.
 Using logs to denote growth we have, for the
period 1960 to 1990,

log[ Y (1990)  Y (1960)]  a  b log Y (1960)

 Tests of this model for several sets of

countries shows that it doesn’t hold for a
heterogeneous group of countries
around the world.
 It does hold for OECD countries and for
OECD and Asian countries together.
 It does not hold for developing countries
in general.

 A less restrictive form of convergence is

called conditional convergence.

 In this form of the model, we allow the

various parameters of the growth
equations to change between different
countries or groups of countries

 There would still be a convergence in

growth rates of income but the level of
income in the steady state would differ.

 This level would depend upon saving

 Increased productivity in miracle economies.
 Measures of TFP show a modest contribution to
output growth until the middle of the 1980 and
an acceleration afterwards.
 The latter is the combined result of previous
transfer of technology and more rapid FDI
following the Plaza accord.
rates, population growth rates and
depreciation rates of capital.
 Tests of this model show that there is
still a lot of unexplained variation in per
capita income, although variations in
population growth rates and saving rates
did explain about half of the variation in
per capita income across countries.
  However these results imply that the
rate of convergence is very slow.
 What is likely is that a number of other
factors are involved aside from the
saving and population growth rates, such
as the spread of technology and the role
of education.
 We return to these issues later.

Convergence

• There is evidence that there is convergence

within groups of countries with similar
geographic and economic similarities such as
the European Union or countries in East Asia.

• However there is less evidence that there is

convergence between rich and poor countries

• For example globally there is strong evidence

for divergence.

• Rich countries get richer and poor countries get

poorer.

• This does not hold within countries although

the convergence is slow.

• German states and Japaneses prefectures and

states of the US are converging.