Assess the contribution of World Bank Report- the East Asian Miracle (1993), to our understanding of the success of ‘High Performing Asian Economies’ (HPAEs). You should use supporting research in developing your assessment of the World Bank (1993) repor

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Home >Business & Finance homework help >Economics homework help >Assess the contribution of World Bank Report- the East Asian Miracle (1993), to our understanding of the success of ‘High Performing Asian Economies’ (HPAEs). You should use supporting research in developing your assessment of the World Bank (1993) repor

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The East Asian Miracl e Economic Growth and Public Policy

Published for the World Bank CxCORD UNIVERSrrYPRS

Foreword

EBATES ON THE APPROPRIATE ROLE OF PUBLIC POUCY IN

economic development have occupied policymakers and scholars since the study of developing economnies bcgan in

earnest at the dosc of World War IL. The success of many of the economies in EastAsia in achieving rapid and equitable growth, often in the context ofacivist public policies, raises complex questions about the relationship between government, the private sector, and the markern Seningly, the rapidly growing economies in East Asia used many of the same poficy instruments as othcr developing economies, but with greater success. Understanding which policies contribuced co their rapid growth, and how, is a major question for research on development pol- icy. Forthese rcasons I announced at the time of the 1991 Annual Meet- ings of the Board of Govemors of the World Bank in Bangkok, Thailand, that our Development Economics Vice Presidencywould un- dertake a comparative study of economic growth and public policy in East Asia.

This volume is the summary ch. appears as the first in a series of Policy Rcsearch Reports, which arc intended to bring to a broad audience the results of research on development policy issues carried out by staff of the World Bank.As reports on policy issues, we intend that they should help us to take- stock of what we know and cIealy identifir what we do not know; they should contribure to the de- bat in both the academic and poli-y communities on appropriate pub- lic policy objectives and instruments for developing economies; and they should be accessible tX nonspecialiscs. Because they sunmarize re- search, we also anticipate that Policy Research Reports will provoke far- ther debate, both within the Bank and outside, conceming the methods used and the conclusions drawn.

What does this report tell us about the East Asian miracle? The re- seawh shows that most of EastAsias extraordinary growth is due co su- perior accumulation of physical and human capita. But these economies Were also better able than most to allocate physical and

buman resources to highly productive investrents and to acquire and master txchnology. In this sense there is nothing 'miraculous" about the East Asian economics' success; each has perfirmed these essential func- tions of growth better than mosr other economies.

The eight economics studied used very different combinations of policies, firom hands-ofTto highly interventionist. Thus, them is no sin- gle 'East Asian moder of development. This divcrsity of experience re- inforces the view that economic policies and policy advice must be country-specific, if they are to be effectivec But there arc also some com- mon threads among the high-performing East Asian economies. The authors conclude that rapid growth in each cconomy was primarily due to the application of a set of common, market-friendly economic poli- cies, leading to both higher accumulation and berter allocation of re- sources. While this condusion is not strikingly new, it reinforces other rcsearch that has sressed the essential need for dcveloping economics to ger the policy fundamentals igIL The research also firther supports the desirability of a two-track approach to development policy emphasizing macroeconomic stability on one hand and investments in people on the ocher. The importance of good macroeconomnic management and broadly based educational systems for Easr Asia's rapid growth is abun- dandly demonstrated.

The reporr also breaks some new ground. It condudes that in some economics, nainly those in Northeast Asia, some selective interventions contibuted o grwth. and it advances our undersmading of the condi- tions required for interventions to succeed. The authors argue thar where selective intervcntions succceded they did so because of th o es- sential prcrequisites. First, they addressed problems in the functioning of markets. Second, they took place within the contex of good, finda- mental policies. Third, their success depended on the ability of govern- merts to establish and monicor appropriate economic-performance criteria related to the interYcntions-in the authors' terms, to create eco- nomic contests. These prerequisites suggesr that the institional con- text withLin which policies are implemented is as important to their success or failure as the policies themselvcs, and the report dcvotes sub- stantial artention to the institutional bases for East Asi-a rapid growth.

While these factors help to explain why apparently sinilar policies did not succeed in mrany other economies, the report also leaves unan- swered many important questions. The market-oricnted asj ctxs of East Asia!s polides can be recommended with few reservations, but the more

institutionally demanding aspects, stich as contest-based interventions, have nor been successfully used in other settings. Noneconomic factors, induding culture, politics, and history, are also important to the East Asian success story. Thus, there is still much to be learned about the in- teractions between policy choices and inscitutional capability and be- tween economic and noneconomic factors in development. Work in these areas will continue beyond this report.

The support of the Government ofjapan for the research program 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 necessarily reflect the view of its Board of Directors or the governments they rcprescnt.

Lewis T. Preston President The World Bank

Augur 1993

vii

Overview: The Making of a Miracle

AST ASIA HAS A REMARKABLE RECORD OF HIGH AND sustained economic growdh. From 1965 to 1990 the twenty-three economliies of East Asia grew faster than all 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 Republic of Korea, Singapore, and Taiwan, China; and the three newly industrializing economies (NiEs) of South- east Asia, Indonesia, Malaysia, and Thailand. These eight high- performing Asian economies (HPAEs) are the subject of this study.*

Selectinganysecofeconomiesand attemptingto undesand theorigins of their successful growth are necessarily arbitnary processes.' Botswana, Egypt, Gabon, and Lesotho in Sub-Saharan Africa have also been among the world's top growth performers in the past two decades, as have such diverse economies as Brazil, Cyprus, Greece, and Portugal (see figure 2). Why focus on eight economies in East Asia? In part the choice reflects popular interest; it has become common to see references to the "Asian Economic Miracle., In part it reflects recent artention by the aca- demic and development policy communities to the relationship be- tween public policies-which some authors have argued have a number of common threads in the eight economies, especially Japan, Korea,

*Recendy China, particularly southern China, has recorded remarkably high growth - ates using policies that in some ways resermblc those of the HPAEs. This vtay significant 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 differ- ent from the those of the HPAEs, and in such mapid flux, that cross-economy comparison 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 De- parment ofthe World Bank (see Bibliographic Note).

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Described in the presentation as

CHAPTER 1

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Figure 1 Average Growth of CNP per Capita, 1965-90

East Asia | _ ; _____

HPAEs

East Asia without HPAES

South Asbi

Midae East and Meditermean..

Sub-Saharan Africa

OECD ec__ , ;

Latin Amedcm and Carlbbean

0 1 2 3 4 5 6 GNP per capit growth rate (percent)

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Singapore, and Taiwan, China-and rapid growth. And in part it re- fleas 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 success would have been so regionally concentrated.

The HPAEs have also been unusually successfiul at sharing the fiuits of growth. Figure 3 shows the relationship between the growth of gross do- mestic product (GPD) per capita between 1965 and 1990 and changes in the Gini coefficient, a statistical measure ofthe inequality ofincome dis- tribution. The HPAEs enjoyed much higher per capica income 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

Figure 2 Change in GDP per Capita, 1960-85

Taiwan, China Indonesia

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Lescotho Egypt

CYPMUS . o Gabon Greece Brazil Syria

Portga :wA Malaysia

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Pakistan Colombia .Middle 20:

United Statbes United Kingdom ----- ________- _

Philippines ----- ,.-----.------------ Venezuiela .-. ..

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India __ _ _ _ _ _ _ _ _ __ _ _ _ _ _ _ _ _ Benin__ _ _ _ _ _ _ _ _

Senegal Haiti

Uberla Sudan

Somalia I___ Zaire_ __ _

NIgerfia _ Afghardstan ~-*

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Ghana . .. Guyana ___ -

Madagascar .- Chad__ _ _ _ _ _ _ _ _

Zambia ------- ---- H A s-- Angola_

Mozamibique I - Kuwalt __ _ _ __ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

-2. 0 1. 2 3 45 Percentage change In GDP

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-RACLLE

F.gum 3 Change in Inequity and the GDP per Capita Growth Rate Change In avenage Glni coeffcient (1980s minus ISGOs)

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

NYet:Figurc3 plots the relationship bcetwen averagc per capit incomc groth and changes in the decade avege ofthc Gini cocfficient fim rde 1960s to the 190s; a negative number indicates thar income becume lss concentraredL The decade avcge is used because data are available for different years in diffacmr conornies the decade average fbr the 1960s begins with dat from 1965.

Sowrer World Bank dam.

inequality. Moreover, the fastest growing East Asian economies, Japan and the Four Tilgers, axe the most equal.

As a result of rapid, shared grovth, human welfare has improved dra- matically. 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

in Malaysia during the same period. Absolute poverty also declined in other developing economies, but much less steeply, fiom 54 to 43 per- cent in India and from 50 to 21 percent in Brazil fronm 1960 to 1990. A host of other social and economic indicators, from education to appli- ance ownership, have also improved rapidly in the HPAEs and now are at levels that sometimes surpass those in industrial economies.

'What caused EastAsia's success? In large measure the HPAEs achieved high growth by getting the basics right. Private domesric investment and rapidly growing human capital were the principal engines of growth. High levels of domeLic financial savings sustained the HPAEs' high investment levels. Agriculture, while declining in relative impor- tance, experienced rapid growth and productivity improvement. Popu- lation 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 ef- fecrive system of public administration. In this sense there is littde that 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 non- traditional savers, raised the levels of financial savings. Education poli- cies 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 intervened- systematically and through multiple channels-to foster development, and in some cases the development of specific industries. Policy inter- ventions 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, establish- big and financially supportng government banks, making public investrments in applied research, establishing firm- and industry-specific

r1A!N. -M IRACLE

export margets, developing export marketing institutions, and sharing in- formation widely between public and private sectors. Some industries were promoted, while others were not.

At least some of thesc interventions violate the dicturn of establishing for the private scaor a level playing field, a neutral incentives regime. Yet these strategies of selective promotion were closely associated with high rates of private investmenc and, in the fastest-growing economies, high rates of productivity growth. Were some selective interventions, in fict, good for growvh?

In addressing this question, we face a central methodological prob- lem. 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 specific inr.w..tion and even more difficult to establish causalityr Because we cannot know wrhat would have happened in the absence of a specific polii); it is difficult to rest whether interventions increased growth rates. Other economies attempted similar interven- tions without success, and on averge they used them more pervasively than in the HPAEs. Because the HPAEs differed from less successfiil economies both in their doser adherence to policy findamentals and in the manner in which they implemented interventions, it is virtually im- possible to measure the relative impact of findarnentals and interven- tions 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 counterfactual sce- nano. Instead, we have had to be content with whar Keynes called an &essay in persuasion," based on analytical and empirical judgments

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 otherwise would have occurred. However, the prerequisites for success were so rigorotus that policynakers seeking to follow similar paths in other developing economies have often met with failure. What were these prerequisites? First, governments in Northeast Asia developed institutional mechanisms which allowed them 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 fiscal costs threatened the macroeconomic stability of Korea and

Malaysia during their heavy and chemical indusrries drives, govern- ments pulled back In Japan the Ministry of Finance acted as a check on the ability ofthe Minisrry of Intcrnational Trade and Indusry to carry out subsidy policies, and in Indonesia and Thailand balanced budget laws and legislative procedures constrained the scope for subsidies. In- deed, when selective interventions havc threatened macroeconomic sta- bilty, HPAE governments have consistently come down on the side of prudent macroeconomic management. Price distortions arising from se- lective interventions were also less extreme than in many developing economies.

In the newly industrializing economies of Southeast Asia, govem- ment interventions played a much less prominent and frequently less constructive role in economic success, while adherence to policy finda- mentals remained importamt These economies' capacity to administer and implement specific interventions may have been less than in North- east Asia. Their rapid growth, moreover, has occurred in a very different international economic 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 understand which specific policies may have contributed to growth, but also to understand the institutional and economic circumstances that made them viable. Indeed, the experience of the Southeast Asian economies, whose initial conditions parallel those of many developing economies today, may prove to have more rel- evance outside the region than thar of Northeast Asia.

The book is organized as follows: chapter 1 describes the distinguish- ing characteristics of the East Asian economic mirade, rapid growth with equity and uscs economic models to attempt to account for this growth. Chapter 2 reviews policy explanations for East Asia's economic success and introduces the framework that we will use throughout to ex- plore dte relatonship berween public policy and economic growth. Chapter 3 discusses pragmatism and flexibility in the formuation of policies that led to two impormnt characteristics of the HPAEs' economic performance: macroeconomic stability and rapid growth of manufac- tured exports. Chapter 4 disLcusses the role of institutions. Chaprer 5 looks at the role of public poliqc in the HPAEs' unusually rapid accurnu- lation of physical and human capital, while chapter 6 analyzes the means used to achieve efficient allocation of resources and productivity growth. Chapter 7, in condusion, assesses the success of East Asian polices and their applicabiliy in a changing world economy. The remainder of this

-' -.-- V IICACLE

overview parallels the organization of the book, highlighting the central arguments and conclusions.

The Essence of the Miracle: Rapid Growth with Equity

T 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? First1 as we noted above, they had rapid, sustained growth between 1960 and 1990. This in itself is un- usual among developing economies; orhers have grown quickly for periods but not for decades at such high rates. The HPAEs are unique in that they combine this rapid, sustained growth with highly equal in- come distributions. They also all have been characterized by rapid de- mographic transitions, strong and dynamic agricultural sectors, and unusually rapid export growth (see chapter 1).

The HPAEs also differ fiom other developing economies in three fac- tors that economists have -traditionally associated with economic growth. High rates of investment, exceeding 20 percent of GDP on aver- age 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 two- thirds of the growth in dte HPAEs. The remainder is attributable to im- proved 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 success at allocat- ing capimt to high-yielding investments and at catching up technologi- cally to the industrial economies.

Public Policies and Growth

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 produc-

tivity growth? There are several explanations for East Asias success. Geog- raphy and culture were dearly important; however, dthy do not entirely account for the high-performing economies' success, as the presence of unsuccessful economies in the same region attests. Among the variety of policy explanations, two broad views have emerged (see dcapter 2).

Adherents of the neoclassical view stress the HPAEs' success in getting the basics right. They argue that the successful Asian economies have been better than others at providing a stable macroeconomic environment and a reliable legal framework to promote domestic and international compe- tition. They also stress that the orientation of the HPAEs toward inter- national trade and the absence of price controls and other distortionary policies have led to low relative price distortions. Investnents in people, education, and health are legitimate roles for govenrnment in the neoclas- sical framework, and its adherents stress rhe importance of human capital in the HPAEs' success.

Adherents of the renisionist view have successfilly shown that Easr Asia does not wholly conform.to the neodassical model. Industrial pol- icy and interventions in financial markets are not easily reconciled within the neoclassical fiamework. Some policies in some economies arc much more in accord with models of state-led development. Moreover, while the neoclassical model would explain growth with a standard set of relatively constant policies, the policy mixes used by East Asian econ- omies were diverse and flexible. Revisionists argue that East Asian gov- ernments "led the m.narke"e in critical ways. In contrast to the neoclassical viev, which acknowledges relatively few cases of market &il- ure, revisionists contend that markers consistendy fail to guide invest- ment to industries chat would generate the highest growth for the overall economy. In East Asia, the revisionists argue, governments remedied this by delibemtely "getting the prices wrong"-altering the incentive struccure-to boost industries that would not otherwise have thrived (Amsden 1989).

The revisionist school has provided valuable insights into the history, role, and extent of East Asian interventions, demonstrating convinc- ingly the scope of government actions to promote industrial develop- ment in Japan, Korea, Singapore, and Taiwan, China. But, in general its proponents have not claimed to establish that interventions per se accel- crated growth. Moreover, as we shall show, some important govemment interventions in East Asia, such as Korea's promotion of chemicals and heavy industries, have had little apparent impact on industrial strucmrt.

-4iE$AS,kAN MIRACLE

In other instances, such as Singapore's efflort to squeeze out labor-inten- sive industries by boosting wages, policies have dearly backfired. Thus neither view fiully accounts for East Asia's phenomenal growth.

The Market-Frendly View. In describing the policies associated with rapid growth, World Development Report 1991 (World Bank 1991 b) ex- pands on the neodassical view, darifyring systematically how rapid growth in developing countries has been associated with effcctive but 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 enter- prise, keep the economy open to intemational trade, and maintain a sta- ble 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 cxhaustive review of the experience of devel- oping 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's success. 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 out- come of many different policy instnuments. And the instruments cho- sen, particularly in the nordteastern HPAES, Japan, Korea, and Taiwan, China, sometimes induded extensive government intervention in mar- kets to guide private-sector resource allocation. The success of these northeastern economies, moreover, stands up well to the less interven- tionist paths taken by Hong Kong, Malaysia, and more recendy In- donesia and Thailand.

A Functional Appmach to Undemtaing Grwth. 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 classifjr policies into two broad groups: fundamentals and selec- tive interventions. Among the most important fimdamental policies are those that encourage macroeconomic stability, high investments in

human capital, stable and secure financial systems, limited price disror- dons, and openness to foreign technology Selective interventions in- dude mild financial repression (keeping interest races positive but low), directed credit, selective industrial promotion, and trade policies that push nontraditional exports. We try to understand how government policies, borh fundamental and interventionist. may have contributed to faster accumulation, more efficient allocation, and higher prnducriv- ity growth.

We maintain as a guiding principle char for interventions that at- tempt to guide resource allocation to succeed, they must address filures in the working of markets. Otherwise, markets would perform the allocation function more efficiently. We idenrify a dass of economic problems, coordination failures, which can lead markers to fail, espe- cially in early stages of development. We then interpret some of the in- terventionist policies in East Asia as responses to these coordination problems-responses that emphasized cooperative behavior among pn- vate firms and clear performance-based standards of success.

Competitive discipline is crucial to efficient investment. Most economies employ only market-based competition. We argue that some HPABs have gone a step further by creating contests that combine com- petition with the benefits of cooperation among firms and berween gov- ernment and the private sector. Such contests range from very simple nonmarket allocation rules, such as access to rationed credit for ex- porters, to very complex coordination of private investment in the government-business deliberation councils of Japan and Korea. The key feature of each contest, however, is that the government distributes rewards-often access to caedit or foreign exchange-on the basis of performance, which the government and competing firms monitor. To succeed, selective interventions must be disciplined by competition via either markets or contests.

Economic contests, like all others, require competent and impartial referees-that is, strong institutions. Thus, a high-quality civil service that has the capacity to monitor performance and is insulated from po- litical interference is essential to contest-based competition. Of course, a high-quality civil service also augments a government's ability to design and implement non-contest-based policies.

Our framework is an effort to order and interpret inlformation. We are not suggestng that HPAE governments set out to achieve the func- tions of growth. Rather, they used multiple, shifting policy instruments

R AC LAN MIRACLE

in pursuit of more straiglhtforward economic objectives such as macro- economic stability, rapid export growth, and high savings. Pragmatic flexibility in the pursuir of such objectives-the capacity and willingness to change policies-is as much a hallmark of the HPAEs as any single pol- icy instrument. This is well illustrated by the great variety of ways in which the HPAEs achieved tvJ important objectives: macroeconomic stability and rapid export growth (sec chapter 3).

Achieving Macroeconomic Stabilty and Export Growth

More than most developing economies, the HPAES were characterized by responsible macroeconomic management. In parricular, they gener- ally limited fiscal defcits to levels that could be prudently financed without increasing inflationary pressures and responded quickly when fiscal pressures were perceived to building up. During the past thirty years, annual inflation averaged approximately 9 percent in dtese economies, compared with 18 percent in other low- and middle-income economies. Because inflation was both moderate and prediaable, real interest rates were far more stable than in other low- and middle-income economies. Macroeconomic stability encouraged long-term planning and private investment and, through its impact on real interest rates ai, 4 the real value of financial assets, helped to increase financial savings. The HPAEs also adjusted their macroeconomic policies to terms of trade shocks more quickly and effectively than other low- and middle-income economies. As a result, they have enjoyed more robust recoveries of pri- vate investment.

Many of the policies that fostered macroeconomic stability also con- tributed to rapid export growth. Fiscal discipline and high public sav- ings allowed Japan and Taiwan, China, to undertake extended periods of exchange rate protection. Adjustments to exchange rates in other HPAEs-validated bv policies that reduced expenditures-kept them competitive, despite differential inflation with trading partners.

In addition to macroeconomic policies, the HPAEs used a variety of approaches to promoting exports. All (except Hong Kong) began with a period of import substitution, and a strong bias against exporEs. But each moved to establish a pro-export regime more quicldy than other developing economies. First Japan, in te 1950s and early 1960s, and then the Four ligers, in the late 1960s, shified trade policies to encour- age manufactured exports. In Japan, Korea, and Taiwan, China, govern-

ments established a pro-export incentive structure that coexisted with moderate but highly variable protection of the domestic marker. A wide variety of instruments was used, including export credit, duty-free im- ports for exporters and their suppliers, export targets, and tax incentives. In the Sioutheast Asian NIEs the export push came later, in the early -1980s, and the instruments were different. Reductions in import pro- tection were more generalized and were accompanied by export credit and supportinginstitutions. In these economies exportdevelopment has relied less on highly selective interventions and more on broadly based market incentives and direct foreign investment.

Building the Instutional Basis for Growth

Some economists and political scientists have argued chat the East Asian miracle is due to the hiigh quality and authoritarian nature of the regions institutions. They describe East Asian political regimes as "devel- opmental statee' in which powerful technocratic bureaucracies, shielded from political pressure, devise and implement well-honed interventions. We believe developmental stare models overlook the central role of government-private sector cooperation. Whle leaders of the HPAEs have tended to be either authoritarian or paternalisdti they have also been willing to grant a voice and genuine authority to a technocratic elite and key leaders of the private sector. Unlike authoriruian leaders in many other economies, leaders in the HPAEs realized that econornic develop- ment was impossible without cooperation (see chapter 4).

The Principle of Shard Growth. To establish their legitimacy and win the support of the sociey at large, East Asian leaders established the princi- ple of shared growth, promising that as the economy expanded all groups would benefit. But sharing growth raised complex coordination problems. First, leaders had to convince economic elites to support pro- growth policies. Then they had to persuade the elites to share the bene- fits of growth with the middle class and the poor. Finally, to win the cooperation of the middle class and the poor, the leaders had to show them that they would indeed benefit from future growth.

Explicit mechanisms were used to demonstrate the intent that all would have a share of future wealth. Korea and Taiwan, China, carried out comprehensive land reform programs; Indonesia used rice and fer- filizer price policies to raise rural incomes; Malaysia introduced explict wealth-sharing programs to improve the lot of edtic Malays relative to

- IRfLMIRACLE

the better-off ethnic Chinesc; Hong Kong and Singapore undertook massive public housing programs; and in several economies, govern- ments assisted workers' cooperatives and established programs to en- courage small and medium-size enterprises. Whatever the form, these programs demonstrated that the goverment intended for all to sharc the benefits of growth.

Cualmg a Business-Fiendly Environment To cacide coordination prob- lems, leaders needed institutions and mechanisms to reassure compet- ing groups that each would benefit from growrth. The first step was to recruit a competent and relativcly honest technocratic cadre and insu- late it from day-ro-day political interference. The power of these tech- nocracies has varied greatly. In Japan, Korea, Singapore, and Taiwan, China, strong, well-organized bureaucracies wield substantial power. Other HPAES have had small, general-purpose planning agencies. But in each economy, economic technocrats helped leaders devise a credible economic strategy.

Leaders in the HPAs also built a business-friendly environment. A major element of that enviromnenr was a legal and regulatory strucmre that was generaly hospitable to private investment. Beyond this the HPAiEs have with varying degrees of success enhanced communication between business and government. Japan, Korea, Malaysia, and Singa- pore have established forums, which we call deliberation councils, in which private sector groups are invited to help shape and implemnent the government policies relevant to their interests. In contrast to lobbying, --where rules are murky and groups seek secret advantage over one an- odter, the deliberation councils are intended to make allocation rules dear to all participants.

Using Deliberation Council. In Japan and Korea technocrats used delib- eration councils to establish contests among firms. Because the prvate sector participated in drafting the rules, and because the process was transparent to all paricipants, private sector groups became more will- ing participants in the leadership?s development efforts. One by-product of these contests was a tendency to reduce the private resources devoted to wasteful rent-seeking activities, thus making more available for pro- ductive endeavors. Deliberation councils also &cilitated information ex- changes betwren the private sector and govecnment, among firms, and between management and labor. The councils thus supplemented the market's inforrnation transmission function, enabling the IPAEs to re- spond more quickly than other economies to changing markets.

'14

Institutions of business-government communication have not bem sta- tic in the HPAJ. The role of the deliberation ouncil is changing in Japan and Korea to a more indicatve and consensus-building role, along finc- tional as opposed to industry-speific lines. In Malaysia the councils appear to be increasing in importance and scope. In Thailand the formal mecha- nisms of communication have generally becn used to present businesses' positions to goverment and to reduce the private sector's suspicion ofgov- ermnent. In institutional development, as in economic poliymaking East Asian governments have changed with changing circumstances.

Accumulaing Human and Physical Capital

Drawing on the strength of their institutions, East Asian economies used a combination of fundamental and interventionist policies to achieve rapid accumulation of human and physical resources. Funda- mentals included such traditional government obligations as providing adequate infrastructure, education, and secure financial institutions. In- terventions induded mild repression of interest rates, state capitalism, mandatory savings mechanisms, and socialization of risk (see chapter 5).

Bilding Human Capiti. The East Asian economies had a head start in terms of human capital and have since widened their lead over other de- veloping economies. In the 1960s, levels of human capital were already higher in the HPAEs than in other low- and middle-income economies. Governments built on this base by focusing education spending on the lower grades; first by providing universal primary education, later by in- creasing the availability of secondary educations Rapid demographic transitions facilirated these efforts by slowing the growth in the number of school-age children and in some cases causing an absolute decline. Dedining ferdlity and rapid economic growth meant that, even when education investment as a share of GDP remained constant, more re- sources were avilable per child. Limited public fimding of post- secondary education focused on technical skills, and some HPAEs imported educational services on a large scale, particularly in vocation- ally and technologically sophisticated discplines. The result of these policies has been a broad, technically inclined human capital b±ve well1- -stited to rapid economic development.

.IHPAE education policies also contributed to more equitable income distributions. To be sure, initial conditions helped to set up a virtuous circle: initial low inequality in income and education led to educational

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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 access to education.

bcreasing Savniug and ImnestneuL The HPAEs increased savings and in- vestment with a combination of findamental and interventionist poli- cies. 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 HPAEs have 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 wvere strong prudential regulation and supervision, limits on competition, and institutional re- forms In Japan, Korea, Malaysia, Singapore, and Taiwan, China, postal savings systems lowered transaction costs and increased the safey of sav- ing while making substantial resources available to government. These initiatves promoted rapid growth of deposits in financial instiutions

Figu 4 Savings Rates of HPAEs (see figure 4) anda Selected Eiconomies, 19704 (se fiur 4)

Some governments also used a variety of more interventionist mecha-

HPAEs nisms to increase savings. Singapore and Taiwan, China, maintained un- I - - - usually 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 so- 0 2.0 20 30 40 called luxury consumption. Whether these more interventionist measures

'Percenta,ge ar GDP to increase savings improved welfare is open to debat On one hand,

Nenar. Finlind,uds Austria Bthee um. making consumers save when they would not have otherwise imposes a Dcrnmark, Finland, Fmncc, the E:ederol Republic of Gcmany bebore reunificaion, welfare c -r. On the other, the benefits are apparent in the rapid growth of Greece, Iceland, Iredand. Imly, Luxem- these ecovomies. Savings, forced or not, generaed high payoffs based on bour, dte Netherlands, Norny, Portugal. consistendy high rates of return to investments. In conwnt to other Spain, Sweden, Switxrland, and the United Kingdom. 'Orie indudes these economies that have used compulsory savings, such as the fonrer Soviet &-veoping cconomies: Argenona Brazil,T developin eColombia. Carenina SEl, Union, welfare costs were dearly offset by substantive benefits.Chile, Cdlombia, COre divoire, Egyp4, Ghana, India, Mexico, Morocco, NiScria, The HPAEs encouraged investment by several mans. First, they did a Pakistan, Pem, Sri Lnka, Turkey, better job than most developing econom>es at creating -infastructure

Urugua. Ycnzuels the fone upEraUrgan y Venezuela. the YugosIiaI that was complementary to private investment. Seco.d, they created an and Zaire

SawreuSummer and Heson (199l). investment-friendly environment through a combination of tax policies

ivoring investment and of policies that kept the reative prices of capi- mal goods low, largely by avoiding high tariffs on imported capital goods. These fiundamental policies had an important impact on pnvate invest- ment. Third and more controversial, most HPAE governrents held de- posit and lending rates below market dearing levels-a practice termed financial repression.

Japan, Korea, Malaysia, Thailand, and Taiwan, China, had extended periods of mild financial repression. To be sure, increasing interest rates from negative to zero or mildly positive real rates and avoiding fluctua- tions (by avoiding unstable inflation) encourages financial savings. But because savings are nor very responsive to marginal changes in positive real interest rates, HPAE governments were able to mildly repress interest rates on deposits with a minimal impact on savings and to pass the lower rates to final borrowers Because savers were mostly households and bor- rowers were mostly firms, this resulted in a transfer of income from households to firns and in a change in the form in which savings were held, from debt to corporate equity.

Holding down interest rares on loans increases excess demand for credit, which in turn leads to rationing of credit by the government it- self or by private sector banks working with goverrunent guidance. This heightens the risk that capital will be misallocated. Thus there is a trade- off between the possible increase in investment and the risk that the in- creased capital will be badly invested. There is some evidence that in Japan, Korea, and Taiwan, China, govemments allocated credit to activ- ities with high social returns, especially to exporcs. If this was the case, there may have been benefiEs from mild financial repression and government-ided allocation; mirroeconomic evidence from Japan supports the view thar access to government credit increased investment (see chapter 6).

Generally, financial repression is associated with low economic growth, especially when real interest rates are strongly negative. But test of the relationship between interest rates and growth in Japan, Korea, and Taiwan, China, do not show the negative relationship between in- terest rate repression and growEh found in cross-economy comparativ studies (see chapter 5). While we cannot establish condusively that mild repression of interest rates at positive real levels enhanced growth in northeast Asia, it appaently did not inhibit it.

Finally, some governments, especially in the northeastem Asian tier, have encouraged investment by spreading private investmcent risks to the

s;~ A? -o m v y LRC~~~~~~~~V- . ZiN [.IA RC L E

public In some economies the govern-ment owned or controlled the in- titutions providing investment funds, in others it offered explict credit

guarantees, and in sdll others it implictly guaranteed the financal via- bility of promoted projects. Relationship banking by a variety of public and private banking institutions in Hong Kong, Japan, Korea, Malaysia, Singapore, Thailand, and Taiwan, China, involved the banking sector in the management of troubled enterprises, increasing the likelihood of creditor workouts. DirectEd-credit programs in Japan, Korea, and Tai- wan, China, signalcd directions of government policy and provided imn- plicit insurance to private banks.

Effcient Allocation and Pmductity Change

Some policies thar favored accumulation in the HPA,s, induding fi- nancial repression and the socialization and bounding of risk, could haVe adversely afFected the allocation of resources. Similarly, industrial targeting could have resulted in extensive rent-seeking and great ineffi- dency. Apparently rhey did not The allocadional rules folowed by H4PAE govemments-particularly the devices used to shift mareke incentives-- are therefore among the most controversial aspects of the Eat Asian suc- cess story (see chaprer 6).

Like policies related ro accumulation, policies affecting allocation and productiviy change fall into findamental and interventionist cat- egories. Labor marker policies tended to rely on fundamentals, using the market and reinforcing irs fiexibility. In capital markets, govern- ments intervened systematically, both to control interest rates and to direct credit, but acted within a framework of careful monitoring and generally low subsidies to borrowers. Trade policies have indcuded sub- standal protection of local manufacurs, but less than in most other developing countries; in addition, HPAE governments offiet some dis- advantages of protection by actively supporting exports. Finally, while interventions to support specific industries have generally not been suc- cessfil, the export-push straregyE-the mix of fundamental and inter- ventionist policies used to encourage rapid manufacured cxport growth-has resulted in numerous benefirs, including more efficient allocation, increased acquisition of foreign rechnology, and more rapid productivity growth.

Feible Labor Markets. Govenment roles in labor narkets in the suc- cessul Asian economies contrast sharply with the situation in most

other developing economies. HPAE governments have generally been less vulnerable and less responsive than other developing-economy govern- ments to organized labor's demands to legislate a minimum wage. Rather, they have focused their efforts on job generations effectively boosting the demand for workers. As a result, employment levels have rnsen first, followed by market- and productivity-driven increases in wage levels. Because wages or at least wage rate increases have been downwardly flexible in response to changes in die demand for labor, ad- justmenr to macrocconomic shocks has generally been quicker and less painfiul in East Asia than in other developing regions. Rapid adjust- ments helped to sustain growth, which in turn made more rapid real wage growth possible.

IHigh productiviry and income growth in agriculture helped to keep EastAsian urban wages close to the supply price of labor. In contrast to many other developing- economies, where the gap between urban and rural incomes has been large and growing, in the HPAEs the incomes of urban and rural workers with similar skill levels have risen roughly at the same pace; moreover, the overall gap between urban and rural incomes is smaller in the HPAEs than in other developing economies.

In Sub-Saharan Africa, Latin America, and South Asia, where wages in the urban formal sector are often pushed up by legislated minimum wages and other nonmarket forces, urban wage earners often have in- comes twice their counterparm' in informal sectors. In contrast, the gap between the formal and informal sectors in East Asia is only about 20 percent. Smaller income gaps contribute to overall social stability, thus enhancing the environment for growth.

Caprtal Markets and fllocatio. Most HPAEs influenced credit allocation in three ways: (i) by enforcing regulations to improve private banks' pro- ject selection; (ii) by crearing financial institutions, especially long-term credit (development) banks, and (Li) by directing credit to specific sec- tors and firms through public and private banks. All three approaches can be justified in theory, and each has worked in some IIPAES. Yet each involves progressively more government intervention in credit markets and so carries a higher risk.

Goverrunent relationships with banks in the HPAEs have varied widely. In Hong Kong banks are private and regulated primarily to en- sure their solvency. In Indonesia, Malaysia, Singapore, and- Thailand, banks are prvately owned and exercise independent authority over lend- big. While governments have broadly guided credit allocations through

isACLWMIRACLE

regulations and moral suasion, project selection is generaUly left 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, tightly controlled the allocation of credit by public commerial banks.

Each of the HPAEs made some attempts to direct credit to priority ac- tivities. All East Asian economies except Hong Kong give automatic ac- cess to credit for exporter. Housing was a priority in Singapore and Hong Kong, while agriculurc and small and medium-size enterprises were trgeted sectors in Indonesia, Malaysia, and Thailand. Taiwan, China, has recently targeted technological development. Japan and Korea have used credit as a tool of industrial polic34 organizing contests through deliberative councils to promote at various times the shipbuild- ing, chemical, and automobile induscries.

The implicit subsidy of direcred-credit programs in the HPAEs was generally small, especially in comparison to other developing econ- omies, but access to credit and the signal of goverunment support to if- vored sectors or enterprises were importanL In Korea, the subsidy from preferential credit was large during the 1970s, resulting in a large gap be- tween bank and curb market interest rates. This gap has dedined sharply in recent yea, as Korea has shifted away fiom heavy credit sub- sidies to selected sectors. In Japan imnplicit subsidies were small, and the direction of credit may have been more important as a signaling and in- surance mechanism than as an incentve.

Although East Asias directed-credit programs were digned to achieve policy objectives, they nevertheless induded strict performance criteria. In Japan, public bank managers chose projects on basic economic crite- ria, employing rigorous credit evaluations to select among applicants that fell within government sectoral trgets. In Korea, the govemment individually monitored the large conglomerates using market-oriented criteria such as exports and profirabiliy. In some cases, major enterprises that filed to meet these tests were driven into bankruptcy. Recenr as- sessments of the directed-credit programs in Japan and Korea provide microeconomic evidence that directed-credit programs in these econo- mies increased invesnnent, promoted new actvities and borrowers, and were directed at firms with high potential for technological spillovers. Thus these performance-based directed-credit mechanisms appear to have improved credic allocation, especially during the early stages of rapid growth (see chapter 6).

Directed-credit progras in other HPAES have usually lacked strong, per- fbrnance-based alloation and monitoring and therefore have been largely unsuccessful. Even in the norther-tier economies, the increasing level of financial sector development and their increasing openness to international capiml flows have meant that directed-credit pograms have declined in irm- portance, as the economnies have liberalized their financial sectors.

Openness to Foreig Technology. The HPAEs have actively sought foreign technology through a variety of mchaisms. All welcomed technology transfers in the forn of licenses, capital goods imports, and foreign training. Openness to direct foreign investment (DRi) has speeded tech- nology acquisition in Hong Kong, Malaysia, Singapore, and, more re- cently, Indonesia and Thailand. Japan, Korea and, to a lesser extent, Taiwan, China, restricted DFI but offier this disadvantge by aggressively acquiring foreign knowledge through licenses and other means.

In contrast, odter low- and middle-income economies such as India and Argentina have adopted policies that hindered the acquisition offor- eign knowledge. Often they have been preoccupied with supposedly ex- cessive prices for licenss They have refised to provide foreign exchange for trips to acquire knowledge, been restictive of DFI, and have at- tempted prematurely to build up their machine-producing sectors, thus forgoing the advanced technology embodied in imported equipment.

Prmofing Specific lidusies. Most East Asian governments have pur- sued sector-specific industrial policies to some degrce. The best-known instances includeJapan's heavy industry promotion policies of the 1950s and the subsequent imitation of these policies in Korea. These policies induded import prorection as well as subsidies for capital and other im- ported input& Malaysia, Singapore, Taiwan, China, and even Hong Kong have also established programs-typically with more moderate incentives-to accelerate development of advanced industries. Despite these acions we find very litde evidence that industial polices have af- fected either the secroral structure of industry or rates of productivity change. Indeed, industrial structures in Japan, Korea, and Taiwan, China, have evolved during the past thirty years as we would expect ven factor-based comparative advantage and changing factor endowments.

It is not altogether surprising that industial policy in Japan, Korea, and Taiwan, China, produced mainly market-conforming results. Wile these govemments slectively promoted capital- and knowledge- intensive industries, they also took steps to ensure that they were foster- ing profitable, intermationally competitive firms. Moreover, their

I rRAA CVLIACLE

industrial policies incorporated a large amount of marker information and used performance, usually export performanc, as a yardstick. Ef- forts elsewhere to promote specific industries without better informa- dion exchange and the discipline of intemational markets have not succeeded. This has been the case with the ambitious industrial policy programs in Brazil and India, and with the more limited but also disap- pointing efforts to build an aerospace industry in Indonesia and to pro- mote heavy induswtries in Malaysia.

Export Push: A Winning Mix of Fundamentals and Interentions One combi- nation of fundamental and interventionist policies practiced in the HPAEs has been a significant source of rapid productiviy growth: the ac- tive promotion of manufactured exports. Although all HPAEs cxcept Hong Kong passed through an import-substitution phase, with high and variable protecrion of domestic import substitutes, these periods ended earlier than in other economies, typically because of a compelling need for foreign exchange. In contrast to many other economies, which tried to preserve foreign exchange with 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 liberal- ized, and currencies frequently devalued, to support export growth. Overall, these policies exposed much of the industrial sector to interna- tional 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, China- halted 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 sub- siclies 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 cx- port would come.

East Asia's sectoral policies were usually geared toward export perfor- mance, in contrast to the inward-oriented policies of less successful de- veloping economies. Japan, Korea, Singapore, and Taiwan, China, all relied on economic performrance criteria, usually exports, to judge success. For example, in Taiwan, China, the government suspended domestic- content requirements that interfered with the exports of foreign in- vestors. 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. Be- cause firms that export have greater access to best-practce technology, there are both benefits to the enterprise and spillovers to the rest of the economy that are not reflected in market transactions. These information- reated 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 signifi- cance of exports to rapid productivity growth.

These experiences suggest that economies that are making the transi- tion from highly protectionist import-substitution regimes to more bal- anced incentives would benefit from combining import liberalization with a strong commitment to exports and active export promotion, es- pecially in those cases in which the pace of liberalization is moderate.

Policies for Rapid Growth in a Changing World Economy

5 IT>71AT ARE THE BROAD LESSONS OF SUCCESS IN THE HPAEs? 'sKI/ Their rapid growth had two complementry elements. Firz,

v v getting the fundamentals right was essential. Without Jhgh levels of domestic savings, broadly based human capital, good macro- economic management, and limited price distortions, there would have been no basis for growth and no means by which the gains of rapid pro- ductvty change could have been realized. Policies to assist the financial

2-3

-XIAIEMI R AC LE

sector capture nonfinancial savings and to increase household and cor- porate savings were cental. Acquisition of technology through openness to direct fbreign investment and licensing were crucial to rapid produc- tivity 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 sec- ondary 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 inter- est rate controls. Unlike many other governments that attempted such interventions, HPAE governments generally held costs within well- defined limits. Thus, price distortions were mild, interest rare controls used international interest rates as a benchmark, and cxplicit subsidies were kept within fiscally manageable bounds. Given the overriding im- portance ascribed to macroeconomic stability, interventions that be- camne too cosdy or otherwise threatened stability were quickly modified or abandoned.

Whether these interventions contributed to the rapid growth made pos- sible by good fundamnentals or detracted from it is the mosc difficult ques- tion we have attempted to answer. It is much easier to show that tie HPAEs limited the costs and durtion of inappropriately chosen interventions- itself 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 com- bined 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 north- eastern 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 mar-

Icets to the outside world. Furthermore, strong bureaucracies and a gen- eml climate of government-private sector cooperation meant that their restrictions on capital outflows were more effective than similar restric- tions in many other economies. In today's increasingly global economic environment, few governments have the ability or desire to close their fi- nancial markets. Indeed, many East Asian governments are in the -proes of liberalizing restrictions on capital flows. In such circum- stances, the scope for repressing interest rates without provoling capital flight is sharply narrowed. However, in some exceptional instances, very mild financial repression of short duration to increase corporate equity remains a viable optiOII. This has been the case in Malaysia, which has wide open financial markets but nonetheless succeeded with very mild financial repression for more than a year.

The export-push strategy appears to hold great promise for other developing economies. But the conditions of market access under the General Agreement on Tariffs and Trade (GArr), and odlier trading arrangements, will hamper developing economies' use of policies viewed as unFair in major industrial-economy markets. Subsidies to exports and directed-credit programs linked to exports are not generally consistent with the GATr and may therefore invite retaliation from trading part- ners. Furthermore, like financial repression, these highly directed inter- ventions require a high level of insttutional capacity now lacking in most developing economies. Fortunately, many powerful instruments of export promotion are nor only within the institutional capacity of many developing economies but remain viable in today's economic environ- ment. Creating a free trade environment for exporters, providing finance and support services for small and medium-size exporters, improving trade-related aspects of the civil service, aggressively courting export- oriented direct foreign investmnent, and focusing infrastructure on areas that encourage exports are all attainable goals that are unlikely to provoke opposition from trading partners. Indeed, some or all of these have 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 generation of developing economies to follow export-push strategies.

The phenomenal success of the HPAEs is already inspiring attempts at imitation. We have shown that the HPAEs used an immense variety of

' _Ni1A CCLE

policies to achieve three critical functions of growth: accumulation, al- location, and productivity ,rowrh. The sheer divenrsiy of these policies precludes drawing any simple lcssons or making any simple recommen- dations, exccpt perhaps that pragmatic adherence to the fundamentals is central to success. These market-oriented aspects of East Asia's experi- ence can be recommended w;ith few reservations. More institutionally demanding strategies have often filed in other settings and they clearly are not compatible with economic environments wlhere the fuindamen- tals are not securely in place. The use of contests in Japan and Korea re- quired competenr and insulared civil servants. In parts of Sub-Saharan Africa and Latin .Amnerica, and elsewhere in Asia where such institu- tional conditions are lacking, activist government involvement in the economy has usually gone awry. So the fact that interventions were an element of some East Asian economies' success does not mean that they should be attempted everywhere, nor should it be taken as an excuse to postpone needed market-oriented refonn.

The success of the HPAEs broadens our understanding of the range of policies that are consistent with rapid development. It also teaches us that willingness to experiment and to adapt policies to changing cir- cumstances is a key element in economic success. In the following chap- ters we explore more fully the contribution of fundamental and interventionist policies to East Asiis remark-able growth, and the crucial role that institutions have played in their evolution and application. As we shall see, maaking a miracle is no simple matter

Note 1. Japan, which has been firmly in the ranks of indus- have been used subsequently by devdoping economies.

trial economics arguably for all ofthis century, may at first Thus, notwithsranting Japan's longer history of modem seem to be an inappropriate subject for study. However economic growrh, it may provide some useful insights many of the policy instruments used by the Japanese gov- into the relationship between public policy and growth. emmnent during the period of rapid growth, 1950-73,

R.TE 2

Public Policy and Growth

HAT ACCOUNTS FOR THE REMARKABLE record of rapid income growth and declin- ing 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 economuic sectors 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 po- tentially 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 chap- ter 1-accumulation of resources, efficient allocation of those re- sources, and productivity growth, that is, increasingly grearer output for given resources.

How much of East Asia's success is due to geography, common cul- tural characteristics, and historical accidenit Certainly some-but def- initely 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 ben- efited from the kind of informal economic linkages geographic prox- imity encourages, induding trade and investment flows. For example,

S_ MIRWACLE

throughout Southeast Asia, ethnic Chinese drawing on a common cul- tural 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, Myan- mar, 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 tradi- tional trade networks, reinforced in the nineteenth and twentieth cen- turies by surges of emigration, have fostered elements of a common trading culturc, including two lingua francas, Malay and Hokein Chi- nese, thar remain important in the region today.

In our own cenrury, key Asian ports were integrated into the emerg- ing worid economic system as the result of European military and trade expansion. Cheap ocean transport and shared historical experiences fir- ther knit together a far-flung, culturally disparate region. U.S. assistance in rebuilding Japan after World War 1i, followed by massive U.S. eco- nomic assistance and military spending in the region rbroughout the cold war, also helped to set the stage for rapid gowth. Positdve impacts included enhanced security, which enabled governments not directly in- volved in the combat to focus on economic development Perhaps as im- portant, the U.S. military's exensive purchases in Asia provided a ready market for emerging export industries. Japanese industry received a sub- stantial 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 trad- ing companies and directing the structure of industry; Malaysia fo- cused 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, particu- larly in the past decade, as Northeast Asian manufacturers of labor- intensive exports moved their fiictories south to take advantage of lower

PUBLIC POLI

wages. A surge of inves-tment (since the real appreciation of the Japan- ese yen following the Plaza Accord)-flowing first from Japan and later from Hong Kong, Korea, Singapore, and Taiwan, China-has con- tributed significantly to the dynamism of Indonesia, Malaysia, and Thailand. From the policy viewpoint, these linkages have been encout- aged 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- tively freely.

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 farmiliar with Asian business, established networks for sourcing East Asian products, and gained respect for East Asian quality. Later, U.S. trade policies im- posed 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's remarkable success. If geography, history, and culture were an ad- equate 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 Philip- pines 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 cate-A gories. Below we present a summary of these, focusing on ihe

differences in interpretation that have arisen among observers con- fronted with the same set of economic facs.

-8i

SvA C LSYXN MIRACLE

The Neodassical View

In the neoclassical interprectaion of East Asia's success, the market takes center stage in economic life and governments play a minor role. For ea- ample, Wolf (1988, p. 27) found it 'a striking fact that the few relatively successful developing [economies]-Hong Kong, Malaysia, Singaporc, the Republic of Korea and Taiwan, China-have greatly benefited from decisions and policies that limit government's role in economic decision making, and inscead allow markecs--notwithstanding their imperfec- tions and shortcomings-to exercise a decisive role in determining re- source 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 largely absent. "Wha. the state has pro- vided is simply a suitable environment fior the entrrc -ne.iurs to perform tieir functions."

The neodassical interpretation of the axperiencc of die HPAEs, and e; pecially of Korea and Taiwan, China, presents a coherent and powerul view of one path to successful industrialization.' In this view, govern- ments in all of the HPABs provided a relatively scablic macrveconornic en- vironrment, 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 import- substituting 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 for- eign trade regime and domestic factor markets. In the neodassical view, East Asia's export success is due to similar rewards for selling in the do- mestic and foreign markets. iBecause variation in incentives across sec- tors, 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 ae- porters have iced an n.ternational price regime in making their deci-

-St

PUBLtC P OTC P

sions. Finally, factor markets have been roughly competitive, so positive real rates of interest have prevailed, and thcre has been an absence of du- ality in the wage structure by size of firm or sector of production.

The Revisionist Vww

In the past six years, the neoclassirl interpretation of the sources of rapid growth has been criticized for its lack of factual validity, at least as it applies to Japan, Kor=a, and Taiwan, China (Pack and Westphal 1986; Amsden 1989; Wade £990). Advocates of this new view, sometimes dubbed revisionist, have systematically documented that governments in these three economies cxtensively and selecivelypromored individual sectors. They have convincingly shown that levels of protection and the variation of protection across sectors has been greater than recognized in

&> i rthe neoclassical interpretations.2 Indeed, governments in each of these three economics at times inter-

vened forcefiilly in marker Korea, for example, strongly encouraged heavy and chemical industries by setting targets and offering a variety of financial incentives (Pack and Westphal 1986; Westphal, Rhee, and Pursdl 1988). Japan promoted the development of several weak indus- tries in the first fifteen years after World War II, offering protective mr- ifis and financial incentives to encourage the introduction of advanced technology and establishing rationalization cartels to &cilitate the exit of inefficient firms?3 Taiwan, China, used public investment in large-scale manufacturing enterprises to ensure inputs for predominantly small and medium-scale exportng industries.

Moreover, capital markets were not free in these three economies. Proponents of the neodassical view have focused on the reduced inter- -vention, particularly in the 1960s, that allowed real interest rates to shift from negative to positive levels (McKinnon 1973). Buit while interven- nion declined, it nonetheless contnuedL 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 crtidcal ways In this view, the experi-- ences of Japan, Korea,. and Taiwan, China, provide evidence that gov- ernments can foster growth by "goveriing miarker and "getting prices

; * - : RA C ~~~~~L E

wrong" and by systematically distorting incentives in order to accelerate catching up-that is, to fadlitate the establishment and growth of in- dustrial sectors chat would not have thrived under the workings of com- parative advantage. Amsden(1989, p. 14), for ex-ample, asserts that all "economic expansion depends on state intervention to create pricc dis- tortions that direct economic activity toward greater investment State intervention is necessay even in the most plausible cases of comparative

-1 - -advantage, because the chief asset of backwardness-low wages-is counterbalanced by heavy liabilities."

The Market-Fdendly View

World Devlopment Report 1991 (World Bank 1991 b), in a compre- hensive attempt to describe the policies needed for rapid growth, falls in the middle ground between the neoclassical and revisionist views. It condudes that rapid growth is associated with effectdve but carcfully de- limited government aciivism. In the sMarrkea-tendly"suategy it artica- 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, World Development Report 1991 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 in- ternationally uncompettive sector, and resulted in widespread rent- seeking. 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 -2.1 MakingtheMostofMarkets; IN-THE;AST;-TWEN YYEAS A CONSENSUS.HA -;trenologi 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 (WdrId Baiik.1? ' r 1199 Ib). ,-h' 'help he respond.i_ The Repor+t highlighted te 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,ta muchreduced role or.,goveiment, ope- du-r' toucutrcosts byw inrdi holopos-;:r -,nessroXd,'o eom ndvs w t rds ) Ce,oft and deveoping newand tcerpruct. By' esame:

K' world;,and; macroeononmc-stability TIh~s' idcas -token,3protonSr erc ind usa ol -'''av c#lled into;whAt is now cae te-he mark' d6elom decades .He -gon np '

rv.m rriL- ' okvole. Injapan an.d Korea, foruinstace,gov~-9' Y -;appro&; 0'- T eReporrcnotedtrhtare economicufronim. ement :agen and-indut asaton co' bo-

t investng mi peoppl can be high, bur many govern-. rate to gahier and. disseminate i:normation on:.-J,. 'no..t- on] a r rd-'- tt and deop qu aity control 'Ibrp& t.. ' -ntarget thcir snbapkpmropacrod ecoanro,-in':',-Ale'rocr micc foundtionoi. on of the Brazil 2nd Pakistan,'f alone5 did' m,sost i ' OOpublic oosihagormenrs ca

- derto; 'w hie sot l indicators;i Ce.and .rovide,- as o. Wt%an.unprovt. ~f th neotpule.ot jamnaica,howevr c to CarS inprov eVe. i mnt ocr th o times, ofKislogw.wth. .Governments must ais - . Mr overspens, terdui senoonowinaj '- stmonetayryl opnin n fnniscordfiute,'

.-prov- th 4ini fhes To, hled by inflation, choni i '''o% o pvisios, for -recurrent: pen ' are ina de- of ,thel y alssof o 'p

? i, quam te rEsuldjiawasrefilu undemrutli2ation> Thd economies with a:bs-orof macn&o'c u"r>Motsessfuuonlei nudhJai;Si-" iaiitprruesleionthaiidd ArgeCntn.'olivia < =ic o' m s~~~~~~~~~~~~~~~n -sf- .y>ir l- -~~~iposr-,adoc~hv salihdter~o on tabedili ie d hnOh&nu~rj

ItcP%%Y :avarae.a through rhen riors,- of~' ke,'..' doeia Koe,Maas; nTalidhiemn K L .markeslcqi .k%versely; retuctionson competition' gecL tod "keep. thefir rmacroononic:. polid&s on.' I

(fo e5pe;Indsiadcensn o nappopriate. course adteir-.bioaUednoic jerfbr~cehaihes ?P opeoi) .biddk'.b ' betarizlyo S > , ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~.,

human capital CtiaaCion, openness tO nternational trade, and an en'n- romnmenr that encourages private invrestment and comjpetition. Effective policy in one diension (such as human capital f hrmation) imprves. the results from effectve policies in others (such as openness or 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 captures important aspects of Eastcr Asia's succe:m. These economies are macroeconomnicallystable, have vEry

Asia-s suc=ss These .oniies are macroe-onomiay stabl, he v85, ... -, ,,. . X -.- ' ' ' 0' - :'~ ~ ~ ~ ~ ~~~8

high leves of human capital, are thorughly integrated into the world economy, and have very high levels of competition among firms. More-

oe,East Asian success sometmsocurdin spite of rather than be- *,~~~~~~~~~~~vr tmc ocure

cause of market interventions. Koreas heavy and chemical industries (Hcr) drive and Japan's computer chip push did not live up to expecta- tions. Even so, other interventions combined with export targets appar- ently were consistent wick rapid growth: quota-based protcaion of domestic industries in Japan and Korea; targeted industrial policies in-. dluding directed credit in Japan, Korea, Singapore, and Taiwan, China; heavy reliance on large state enterprises in Japan, Korea, and Taiwan, China; and so on. Furthermore, the successes of these three northeast- em economies compares favorably with the successes of Hong Kong, Malaysia, and more recently Indonesia and Thailand, where policy choices have been less interventionist.

-NMultip Paths to Gmwth

As these three views show, while it is easy to see how elements of East Asian experience contributed to rapid growth, it is nor easv to identifyr a single recipe followed across the region. An alternative approach is to recognize this diversity ofpolicies and to assess whether and how various mixes of policies contributed to successfil implementation of three cen- tral functions of economic management accumulation, allocation, and ---productivitygroth. 4 Thi4 s approach recognizes that policies, like tac- tics, can and should vary depending on the situation, while the central functions, which are crucial to development, musr always be addressed.

One of the hallmarks ofeconomic policymaking in the HPAEs was the pragmatic -flexibility with which govenments tried -policy instruments in pursuit of economic objectives. Instruments that worked were re- tained. Instruments that failed or impeded other policy objectives were abandoned. Thus, the Korean and Malaysian governments reduced in- tensive promotion of heavy and chemical indusries when the fiscal costs and strains on the financial system thrdatened macroeconomic stability. Indonesia abandoned capital marker controls ancd attempts to control interest rates when they werc found to be ineffeccive. Japan shifted from higly selective interventions to promote exports in the 1950s and 1960s to industrial policies designed tO reduce trade friction in the. 1980s (see box 2A later in the chapter). Taiwan, China, gradualli priva- tizel key public sector investments-made to support the rapid growth of

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PUBLIC POLI

exports by small and mediutm-size firms. Singapore shifted from a policy of repressing wages to one of promoting mpid wage growth, finally con- cluding by coordinating the increase in wages with rising productivity. And Malaysia shifted from policies that resultcd in business-government conflict to highly structured mechanisms to encourage business- government cooperation. Chapter 3 discusses the pragmatic flexibility of HPAE governments in pursuing two goals, macroeconomic stabiliry and growth of manufactured exports.

Obviously, our three functions of growth-oriented economic man- agemnent were not objectives in themselves for policymakers in the rapidly growing EastAsian economies. Instead, they are simplya frame- work 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 policies varied over time and place, the formulation and implementation of policies were purposeful, with an overriding objective of 'shared growth." (This tcrm is described and discussed in chapter 4.)

In contrast to the diverse, changing, but purposeful mix ofpolicies in the HPAEs, ocher economies have either rigidly adhered to policies that were demonstrably unsuccessfil-fbr example, extended periods of im- port substitution in Latin America and Sub-Saharn Africa, policies to develop domestic technology in India, and state-led industrialization in Easteem Europe-or have lacked a purposeful direction, as the history of adjustment pograoms in some economies in other regions attests. In- deed, as we illustrate in the next chapter, the flexibility and pragmatism ofpolicyrnaking in most of the HPAEs reflected governments' willingness to try new approaches to achieve particular purposes, discard unsuccess- fuil ones, and keep those perceived as successful.

Th Functional Growth Frameworlk

F _ IGURE 2.1 PORTRAYS THE FUNCTIONAL APPROACH TO UNDER- standing 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>

Figure 2±1 A Functional Apprach to G :owh

Comnpetitive Policy choices discipline Growth functions Outcomes

Fundanmentabe Accnnmulatn Rapid andsustained growth . Stable macroeconomy * Increasing humancapital * Rapid growth of * High human capital *Hg,aigsexports

-~~~~~~~~~~~~~~~~~~~ Hihsa.g

: Effective and secure MdHgll Rapid demographicfinancial systems Metetransti Um.t-ig price distortions isin Export RFoapid agricultural Openness to foreign Rad competiin transformation* Hlgh human capital ~~~~~~~~~~~~~capital I ai hoS Openness to foreign It

*technolrtY p Domesc . _

A Ficultuial depelopment I Contit ron . industalizadon - § ~~~pollicis v Alboatin

: Directed credit credit-Reduceyfective use of} . ~~~~~~human capital in. : Selective Intprventions - labor rnart

I rI\ * High reurts on I Export push _ Ilmestmrent < >Equal Ineeme

I vz Financial repression Contest4edtu clstributbon

* Directed cedit > *Export credit . Reduced poverty

I * Seiectivem prormotion I * Lfwestmnent . Improving sorlal

coordination Productty change inditrs * Information * PmduftJvpbased

W InsUtUdons S exchange catching up

o Technocratic Insulation R tec_ & 0- . _ * H gh-ualfty civil service +_______________________.______________

____

- Monitoring I

managemenrt and tie outcomes of growth and equity discussed in chap- ter 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 con- tributed 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 nmastery of technology. Effective and secure financial systems helped to increase the 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 technologies and innovate. Openness to foreign rechnol- ogy was a major vehide for productivity-based catching up, and agricul- tural sector policies that promoted rural development were cental to both growth and improved distribution ofincome.

The arrows indicate that the system has numerous self-reinforcing feedbacks. For example, rapid growth and relatively equal income distri- butions contributed to the HPAEs' superior accumulation by increasing savings -rates and generating largr and more efective investments in human capital; they also contributed to superior allocation of human capita by fostering labor mobility and marker determinaton of wages. Similarly, they helped in the creation and protecton of instimtuions, par- ticularly the dcvi service, by reducing incentives for corruption.

The six policies listed as fumdamentals are so defined in the sense that they affect the attainment of growti functions primarily through market- based mechanisms of competitive discipline. Three-macroeconomic smbifiry, effective financial. systems, and limited price distortions-assist markets. The two others-high investment in human capital and open- ness to foreign tecLnology-require efficient markets to operate.

But the HPAEs also went beyond the fundamentals, intervening with varying degrees of intensity to alter market incentives. The broadest in- rervenrions were generous incentives for manuhactured cxports. (These are discussed in some detail in chapter 3.) As part of this export push, all the HPAES permitted exporters automatic access to imported intermedi-

- are inputs ar intemational prices. Most also offered subsidized credit, often performance-based, for exporters. In Hong Kong and Singapore, Where international prices guided the domestic economy, massive pub- lic 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 medium- size 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 T governments also directed credit to other activities, induding agricul- ture, small and medinm-size enterprises, and, in Japan and Korea, large- scale imvestments. By intervening in credit makets, governments

- f - - - - - - . ~~~~~~~~~~~~89 -

selectively promoted industries, ownership groaps, and, in some in- stances, individual firms. (These issues are analyzed in detail in chapters 5 and 6.) Some HP'AE chose 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-hemical industries (Hcas). In Ta-iwan, China (and to some extent in Indonesia), the public sector in- vested directly in technologically sophisticated industries. Singapore and Thaiand have attempted to attract foreign investment in capita- and knowledge-intensive sectors. Malaysia initially undiertook public invest- menus in HCI firms but has recendly shifted to a strategy of promoting private investmnent more akin to that of japan and Korea.

Some selective interventions went beyond helping markets perform better. Rather, theyr guided 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 under- taken by HPAE governments addressed these marker fihilures, effectively (if not necessarily intentrionally) reducing the gap between social and privat-e gains.

Market Failures: The Coordinatiom Prohiem

A primary function of markets is coordination. The price systemn is a mechanism by w-hich the production decisions of the myriad firms that make up the economy are coordinated; for instance, they signal to inter- mediate goods producers what outputs are required by final goods pro-

ducer. 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-e great potential benefits ofsharing information. Even in well-developed market economnies, information is conveyedi in many ways other than prices. Trade journals, trade association meehings, and information newsletters are al inportant minsitutions for the trsnsmission of informiation.

Adam SmiteHs invisible hand paradigr argueso hat ach indcividual, in pussuing his or her self-inters also maidmizes the common welare; cooperation is therefore unne lssary- -In rafiuty modern economies are characterized by extensive cooperation. Among firms im economis that

'90

PUBLIC POLI'CY 44$Dt½N`

':belong to the Organization for Economic Cooperation and Develop-- ment (OECD),for example, formal and informal sharing of information is common. Cooperation among firms is maintained whenever the gains from cooperating outweigh the gains fromi cheating. Coope-rative rela- tions are ensured because of benefits from maintaining a good reputa- tion. 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 ex- change in developing economics are weak-er than in industrial econo- minis, yet the needs for these forms of coordination are undoubtedly gre'ater. When economic change is.siow, making predictions about fu- ture 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 mar- kers 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 af- fectedi by information problemns are capita markets. Even in industrial economies, equity markers generally do not finance much new invest- ment, largely because of information asymmetries (Stiglitz 1993a). In economies where'equity markers are weak- or absent, credit mecha- nisms 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 anonymnity that char- acterizes resource allocation in an idealized marker.

In some oftdie IHPAEs, governiments intervened aggressively to address this problemn in the credit marker, going beyond the normal regulatory functions and prudential supervision that help ensure consumer confi- dence. 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-nd Korea, government set up and managed directed- credit programs,.and through explicit and implicit guarantees or other forms of interventions, reduced the risks borne by investors.

Scale Econmnies, Externalities, and Ciooperation. Coordination may yield substantial benefits when large indivisibiliries in investment lead to economnies of scale. One such case arises when investments are inter- dependenc. 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 hap- pens. Market failures due to incomplete markets, such as the absence of capital and risk markets, exacerbate thi~s situation. With such large- scale investments, no single entrepreneur could amass the capital required for both investments, and capital marker imperfections mean that investors hiave dlifficuilty obtaining the funds required. Moreover, there are likely to be large risks, and the market provides no mnecha- nisms by which these risks can be divested.

Economists have traditionaly found exteralities a persuative argu- nent 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 spillovers assocated wevith the incomplete appropriability of tecnological knowledge. In each case, fims undertaking a new actvity face long-term, noncollateralizable ivestments that are difficult to finance. Coordination failures loom especialy large where "diFuse externalities exist and there are mutiple linkags between firms (Stiglitz s993a). It is in situ- ations where there are many participants tat markets are particularly use- -fi and where the absence of markets is particularly cosdty Examplies of hese diffuse e mrnalities indlue, for insance, dith development of hgh-

technology services and nontraded intermediare goods. In the earlier developent liteature, the coordination problem aris-

ing from interdcpendenc investments, economies Of scales and exteral- ities was giene 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. Plnmning ministries were not adept at generating the infornation needed to support investmnt dceisions; as a rexsultemny planned investments filled. Moreover, because many of the planned in- vestments were in monopolistic public sector companies, severe prob- lenms of economIiic performance arose related to- corporate govemance and market powec:

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Some HPAEs tackled problems of ;cale and externalities by setting up mechanisms through which business and government could exchange information and coordinate investment decisions. Japan and Korea, and later Singapore and Malaysia, developed institutions and market rela- tionships that facilitated this process. In doing so, however, these gor- ernments did not attempt to supplant cxisting information networks. Rather, thcy built on the superior information that firms had as dcci- sionmakers Their approach to these problems, emphasizing informa- tion and cooperation through formal and informal interactions1 is discussed in chapter 4.5

Creating Contests

Cooperation raises several problems, however. First, cooperative be- havior may become collusion, if firms act together to raise prices. Scc- ornd, cooperation may inhibit competition, leading to managerial slack or a more general loss of efficiency. Third, business-government cooper- ation may encourage firms to seek &vors from government.

How did the East Asian economies that encouraged cooperation avoid these problems? They combined cooperative behavior-indcluding sharing of information among firms and between the private and public sectors, coordination of investment plans, and promotion of interde- pendent. investments-with competition by firms to meet well-defined Table2.1 Concentration

RtoinManufacturing-conomic performance criteria They developed institutional structures Ratiosm in- - in which firms competed for valued economic prizes, such as access to -

- credit, in some dimensions while actively cooperating in others; in 7%em0cewhflia-. 1 short, they created contests (see box 2.2). Market-based compeiition J S i8 56Z'.

K&R9:oi962A* and contest-based competition both included prohibition of monopo lies, although the number of competing firms was sometmes small .' Even though Japan and Korea have tended to have high levels of con- nI9 4;

. 0; f centration in their manufacturing sector (see table 2.1), domestic com- KBraz4 1980 ; AtiZN petition has usually been vigorous. The Japanesc government has proceeded- on the assumption that competition among fewer, more '-- evenly matched firms is preferable to having one large firm competing s4 with many smaller rivals, a principle that is well-recognized in athletic .

- -competitions (NalebuffadSii193.v Contest-based compeution included dear well-enforced rules, and

& ~~~~~~ prizes for winners. Table 2.2 briefly describes some of the contests orga- nized by HPmE governments.6 The simplest and most widey used were

b . A R RA C L E -RC-

j:~~~~~~~~~~~~~~~~~~~~~~~~~~~'t.- ,. .. W 'X47 '- .'. '

Y'Oi'3m2 Running a Contest, Rewais;,Ruies, n ?Rdees . JT-H-lE,ECONOTC CONASTS.IT GOVERNMENTS . Contests in NortheastAsian.economics have suc-

:i.japan,.Korea, and Taiwan,.Chi'Ta,-ser up-amoi g ceeded pardy becauserthe prerquisits were right. *flins eo'combime die b&eherts orfcohpetidod and co- 1.:Preferential- access~ to .credit .and- Ibrdgn excchange:month , J - wri; sQi ian -d * .

coh: l ies-. montns and 7somchmes arrl&hi' base, however, these :-centere 'caconomicpertormance,primarilawull - ::Cj_ -!j;-- , -.>. '''.; .;--: . ... .............. .- .Y .. !.;,. e 5..,| 1_...-

rcontestis,anddiir-role-mthe economy resmble chl7-" understoodd:mpcrauve to ,expor; Referees, he gov-- ren,sprc gaes - .''ernmenc officials-wh&hbave design'ed ~andsprie

ti.- .O:ganiihg conrc s ts is a more t5m pccaned way to . ,ihetonresrs -have:been gFnerally comperciu and fir., run! ;a e:,oomv than,el:'i.i r:i Esez-fi*i; , j a r t . -W .' ."' . been

- .L ,, nA rC economy nng.on ssz-talre, just as same time, ;parcipation has nortbeen ,; -b'f , °p s s ' - r r:,Complcate, anatoq. c at prce cd rrtosit out'a, contest g. ! Thul IC ffi.l1iezi dobeeni phdinr pAovA KaA~ieana-p ayingfid etunga-hcxiuo nave not punished igo.; In some in-tnAy-fied, L both 'vk. -.-srancessuchas Hondasshifr toHau- -

-; l easc., i-fa ie -fi; . s;-l--vm *i*o -*e-toau ut7laeyp"' and-u&ec"oplay game,:e-. 6ioniobile' maniffctrang .at a1 time whenzfJapines:^- .: .Bu--a-wdll-run.contesr, luce a well-mrri pgarta ugb .p

; X i can:erite6er nibec&r ul&by prpVidhig i .-..i~ offiaiaIs consideredthe eautnomotiv fieldsatruraced th i X for cwii.c peduiioh~nL aidnducingpartipantsto cooper- !. . ffhtolerance ofz5nconfdrmss has d offandsomely0 qX~~cop ta es .pnt --icac or iLn :llE pal ; P.;-

CYb - -l, m C ' -J . I .Cnet. won't w cvcryw er,.4 , c: - - mnzatr as.. onttr. steprpoi

6I lioihjmstances there arc .threc prerequisites for.. deraince ot:uuois m o:dvec6mga. success:~ rewards,'rules,p andr&rees.Rewairds mutts`tic be econiorreine'tat: .-p.of~ la' tck.a.e0~ ~~~S . ; f -g ec _6 e reoo -st uak-clear orov r,,,veJ-.;l-

-r- :- o-u-h/t i-. ; .eliit .broa' .partiipationan 'r.ues. and, retre m . M e in eA&rt&c .oCnbeutidon :Rulesr ebe dearcut so -; economies with-strong government instirutions,an-k .iW ,vih:fehvllb e, > ; 6 otestu 'e- ing contst be -.cd.es harde a, fs growand ther, : -wardedL-ahcL. whih puiserh'Fnuly cur"acy+;:z iy&.wardyAandL.who ch -om1 b~c- punssned*- ... L_ a powurncreascin icladon to. tat othe bureau y

* . ay .w hsrneclespary gamnes-- .: As Japanese officials who ate nowjmoving4ay.fom., : .- ,knosi;cet,aieraare cmcal. 'conrescard a morefinuonal ow,

:..cd & h :pa1ntnz r niz thed_`hi rel- -: ;pevs ghavdicoverd.runmng pakygaineTor". -- -peten'to!-W/nLZhaeF i dZ...-.&voin.dow d,ild. Uiildren- Si -9 ,lgdi.byrfessil'- ,C'r

;. -w _ . . . -

scr rexport contests fior access to credit and sometimes foreign exchange. rum -t aWhile eaprt credt schemes varied widely, all made credit available to

-: : . - ~~~~~irms with confirmed export orders. For many small and medium-scale p- ts n entrprises, export credits were their only access tO the fbral financialS

: - .- sector (Levy 1993). Monitoringperfomiance was simple; firms were re-i- ;quired to show evidence of export orders to receive credi

In Korea and Taiwan, China, export contests were more elaborate. Nor only did export projects er easier access to fids, but firms char ex-s ported successfilly had an easier time getting fiure loans. Because such credit was fungible and credit generally was tight, firms sometimes dil verted export financing to higher-yielding nonexport investments. its

'.4-

f . - - -; ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~P U B Li l-C. '2

exports became a performance criterion for projects that were not di- rectly aimed at serving the export market. In these cases monitoring problems were greater, since both export perfomnance atid the related projects needed to be monitored.

A second type of contest used the power of government to grant li- censes. Table 2.2 shows two of these contests, based on Japanese experi- ence. In the first, the Bank of Japan created a contest in which commercial banks competed to provide financial services in line with government policy-for exampic, by opening rural branches-in hopes of winning highly sought-after urban branch licenses. The contest also gave banks a strong incentive to comply with technically nonbinding

Table 2.2 Examples of Contests -It. w *

d.t . . . . ... ... . . ..-

_,p Voooehaaniernaef £ndn to; Fctdmi eX.einI ses Cana bob a,nno - ea ditM in. Noon ep. .r1 t- niaja lmeroroulbe.C). 1. Nomadidnbvn UCaMmnd MaIqt3 bonge po.lpmeoe u ofkrlnnL, : 7.1..,;:-:-. -Ctnin. lndrn±npons Cnrsqjdknm spnennd mqr an .tita, -vo' .4

unto &smk LC. C. *11.CUU~~Lordto iI1 mOtmuanmati deump kl RM11112NEW411W ~~~~~(siwtubmncnwCa)ocscaonI t

~~~,;1* - . <' lftvo.epena&f pn- - r r.h 7'_,>: 'JI, .

; ~ zb a 0 ~ 1 '' 9 * n-iai es i1 ' iR : - : ...::............ : - ', io an. .ed- . n, -; nt,htMepmpm- ( . o u .w *tep u *a-;k.

* 6 F-v to.m , ; _. n 'mut : dexpnplocmfpeypm a- , ee.r ,e at ,inInn ,n hav ,pntoe pre edm hymn An ;seadeomnu (Ja gonuesu .-&hudue eem ankmpnda-I

,-ef , .C -: : cadSwt-e nepnder-idsbanwud.......................r-hsnnnccenahe ..... . ... p is etttitre'-'-\ '>biw

.,boglCaeg .- ,s'. I, , '. , 7'-7'' " ' ' . '4 t ' 'i _

kfim Muhinewrder Pamnodom tow (194141 B onSk- DOz3 < b.;-.. : . . *, . ' Oneith obetves.deFl Tuyo;e.ayMemrnao e , -rr *

.~~~~~~~~~~~~~i~f pei, l .;-t dkmi

danh"okma cmin UPbnie n

'~~~~~~~ ~~~~ ' -0pcmr'ti156 7 :--- - : - . - . - Z . . . : ..6

.'' ' J - - , - 'M .7 ' - ' :,7:

~~~~~~~~~~TegIdaPund.,,'-: '..' - :C - , : .9 : C, .. .r . . -. . .g . - .j--g. : . -"

t., ,- .. . . ..... yoteJvbgrnnueppn. . esnndafdSepne&u .¼ ,$ ,.-.-7.

.c . .

'.-''' AYf 4Z~- , CL{~, 7hr.r I' S a ~ Ct~. 9,e . - . -. -. : . ' .. .~ -,: . .. . , . . :- - '.: , :,: -;5

RA C LE

'Table 2.2 (contfinued)

IN-

Jt rP o u a u h d S i d h m :~ T iw h nk k u fj p uimppn wkteu m at h d m h u u m ulnabSInInxhlnhm.um udncmhhAnadit . -,two?"

44-. ~~~~~~~~~~~~ . t~~~~~iflncrwimm"AS1 ain ls kMhlngaahmla. Am* rudpmiadl bmulmyrnL

* h~iwIUcDlvsnn andvbmmrad. Mise a-. h. zdlIc.M lie. *. -~~~~~~~~~~~~~~ko (1d ~ wte d,nknm o"A.).. -...~kiW*rnnd , (dr iime rd rJrmmck rW61~~~~Th ~~~~~~~~~~ I . .. I~ ~ ~ ~ ~ ~~~~d yKrjymn&

initu cm mm, dwhmmsd&dtuW ~~ bmm.Kq~ .1 Damr mguhcflsp-dykdLn p"c apwtnruaiiitli uilidwaI ade

.1 *lugemlmerpand ammafc SlpI.nsio.la ~ uhidgl*p*lluuca ~ Nlazm afirms SsAflCs. .,. dto mul. ~ ddr£rtmu aaa aS . lca ;'L, Iwam ais mas, huh alps .

-'h Z- PC f'Wi Wdurn .. tmunymhiepiRaIMacMftWOI. 1 tapumumnnsuuchatmaecdlmsrniiza~~~rnaum.- . '"Mr

.'Z J

uilobmalbr mapnhdma.* 'V *1~~~~~~~~~~i (C- i Mm*mm:armshV,.a lafaryolavcn

- 2 ItS nheppamatn4talmUd. tedon Amaik

C ', '. - Nandi ladmim'strativ. guidoMancemf thcauirau S ulending banksotbar failneydIm oco pl

it. cm dehpmim Cumitla mmihqClr3lesc-usuanmkn.y hev-n hniclidstis r h 90 n 19 -s

admsinistrpatsiveguda of cpithei ledig:bak thatwas feqired to complye wirsthaguidaceiabou the spreatsdubetwee depositiand lni-rngrtes were- nrepermitteo t rexpandt thesepoir brnhnewrs (Yohin o19)

Duringtherapidgrothperiod the acMtinsr ofd Ineratonlt Trad andonduisrysal (Mrr lieamnsedIt capacit Thpasio in sevral keytibindu-t deries-usueall heavyc andichemicald induestiesgI makt'hea195s ands 1960s, Dmflpimted entrydoandi mrkestrce compewtinga irmpworts. ofim in-the pro-

tected ndustrywerereuireds tos cordnaeivsmnstopeeta pcsite expansion.1offupacit ibutby tyheeas equiedtn to ompete

796~ ~ ~ ~~~~Frs htrcie etaprft let euaio"(us-et)wr

PUBLIC POLI 0:

economies of scale or leaming permitted industries to cxpand export 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 con- test, one that combined licensing of capacity, access to credit, and pro- tection against competing imports with both physical and economic targets fbr performance. Its economic success is still not clearly estab- lished, 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 struc- ture 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 ac- dusive 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 govern- ment support during business cycle downturns.

These incentives have been the source of disastrous economic perfor- mance in other economuies. The check on poor perfornance in Korea was the result of rwo performance-based rules. Fi-st, government estab- Iished a timetable for the attainment of international competitiveness in each industrial sector Firms that failed to maintain the pace of cost re- cductions in 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 bene- ficial as their rules. If perfbrnance criteria channel effort into unpro- ductive 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 yard- stick ainst which the success of other allocation decisions-for exam- ple, credit allocation, domestic content requirements, and industrial licensinwere judged. Accordingly, there was a high degree of com- petiion among finns, in spite of the &fct that in certain domains and

'97

rttC LVRcE

at certain times they acted cooperatively. The export performance rule was broadly shared among HPAE governments and is almost unique to the East Asian economies. Chapter 3 illustrates how each of the HPAEs used shifting combinations of fundamental policies and selective inter- ventions to maintain the pro-export orientation. Box 2.3 describes how some HPAES used apparent constraints on their ability to export to create export contests to new markets.

Using exports as a performance yardstick generated substantial eco- nomic 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 compet- hiive than domestic markets. Even if the firm's success is based on find- ing a niche in a foreign market, its contribution to the domestic economy is still as large as if it had succeeded by developing new pro- duction processes or othenvise boosting efficiency9

''-~~~~~~~* '~ '~t W;'X 5 l'i . -r ~~~~~M ~R zmo.g

C}:*ahezspmrheJsccPIAaEasJencdtixar&icellzngSowoFuha*cm irk'~~~~~~~~~~~~k

u -~~~~~~~~~~~~s 'n.amamiarllot YE;uats~amcRA orthers lP.asy¶V: ~~~~~~ ~ ~ ~ S " __tij.;!str* p8p_no R X FrsRER>^*z.zbV.F ^gg;2ii5X;t> ~~~~~~~Isoii f

, - -. Eiwa a~~~goyrmmen< tioo D or

amodo

Zsa&UO%%OOi5UDnaV3flCPeSw reihogn. .r emuncess,U

.'-~~~~~~~ .'~4r~ -0 ,g

p8~~~~~~~~~~~~~~~~~~~~~~~M

- V §9 ,*>w~~~~M.14o<tjf, -- rSi,'22...{ e Sz >o c uc nt areusofdlereamorun

, . . gs,s BB,..N.X>.^*,>t S *.co - : - - - lR a*t; M S~~~

. . . t>;I:6Sy 3 ncollnpSaEpovtcotowDhsnRneurApmanceMDo6luonsqo a~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

9s- oXBg,.sp ttXs +;X:j 8

PUB LIC PO LI C.YAbrD4rO z

There are, of course, other advantages associated with exports. In the process of entering international markets, firms learn a great deal and nor only about the particular markets they are entering. There are spill- overs related both to mnarketing know-how and to producrion know- how, topics to which we shall return in chapter 6. For instance, success in the production of intermediate goods requires producing to standards that are typically higher than those tat prevail within developing economies. The contacts made in the process of exports may also be of value when the firm decides to enter related markets. It will know to whom to turn to acquire advanced technology.

While from a social perspective, success in exporting may be a better indicator of whether a firm merits additional fuinds than success in selling domestically, banks have (in the absence of govemrnment prodding) typi- cally preferred domestic lending to foreign lending and for a simple rea- son (Stiglitz 1993b). Banls are likely to be less informed concerning external markets than they are concerning internal markets, and from the banks perspective, there is greater risk associated with lending for export- oriented projects than with lending for products for the domestic market.

HPAE governments were also less heavy-handed than some others that have attempted selective interventions. Though they made mistakes of judgment, they generally did not force decisions on others who were will- ing to risk their own capital (The creation of the Mitsubishi Automobile Company in) 965, rejectng m's gtidance ro refrain from entering the production of automobiles, is a case in point.) This is one ofthe strengths of decentralized decisionmalcing it provides insurance against mistaken views being given too much dominance.

Running the Gamen The Role of 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 refuse to abide by the rules.

In the contests described abovei the referees varied. For exporc credit, the contest was largely self-enforcing. Banks had the incentive to moni- -tor export performance, since execution of the export order was essential to repayment Banking supervisors and customs authorities could also

.-,use their coercive power to enforce the rules. In the case of banldng in Japan, the supervisory authorities of the Bank ofJapan were responsible for running the con Tlhe officials of mm were the arbiters of indus-

.99

RAC LBE

trial policy in Japan, and in Korea during the HCI drive both the political leadership and the economic administration monitored performance.

The. Liits and Coustaints of Cootests

What determines whether contests can be effiecively used to promore better allocation and fitster growth? There appear to be two important elements the relative benefits of coordinated behavior and the institu- tional costs of implementing nonmarket, contest-bared compeiitive discipline.

Where the benefits of coordinated behavior are not great-for exam- ple, in small, highly open economics with good entrepreneurial skills and small nontraded goods sectors-the benefits of coordination of in- vestment decisions or sharing of information are likely to be small. International prices convey sufficient infiormation for markets to be efficient, and social and private returns will coincide- This may explain why HPAEs such as Hong Kong and Singapore have not found it worth- while to run contests and establish the types of highly structured information-sharing mechanisms (deliberative councils) found in Japan and Korea, despite the high quality of their bureaucracies.

Even in cases where coordinadion benefits are potentially large-in nontraded goods, externalities, or interdependent investments- govermnents may not be able to enforce performance-based coordination rules. Taiwan, China, is an example. Despite benefits fiom coordinated behavior that were presumably potentially as large as in Korea, and the presence of a high-quality-civil service, contests of the types employed in Japan and Korea were not used. This may have been due to Taiwan, China's, different industrial structure. With a large number ofsmall and medium-scale firms, in contrast to Japans and Korea's relatively small number of major industrial groups, the institutional costs of attempting to coordinate all but the simplest activities were prohibitive. Instead, Taiwan, China, addressed the coordinaton problem through public in- vestment in large, indivisible industries.

The absence of effective conrests-except for the export contest-r the Southeast Asian economies, Indonesia, Malaysia, and Thailand, can also be interpreted as a case of high institutional costs. Civil services in these economies are nor well insulated fiom political or economic inter- - ference It is not surprising, then, that effirts to coordinare economic ac- t-vity tirough selective interventions have been less sucssfL The

*100-

contests cithcr bave had poorly defined rules or have bcen bijacked by -their pardicipants.

-- These nwo factors may also explain why the reliance on contest-based - :competition may change over time in the samne economy. Box 2.4 doc-

urnents the changing nature of industrial potigr in Japan, from selective tO functional incentives and fiom extensive reliance on contests during the rapid growth period tO market-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.-

4waiJ.wISYt~OFuOsDEt etdf6i-r.iu -- et"N'Vith. e eonos(ni ; .- ;v,==auSmat luc>S as<ol^ nuL. o "mtsincl-u) ^c. or-moseb thnoi tsucr-asi--.:o;

~~~~~~~~~~~~~~~~~~~~~&~ig- dj#et.uiibyi nnNaarnlnen,-\nttniioegn cmPulnscV a ura.N-U- gmii ' w3 s = 3 <m . ,v-¢.v; P1 71 ¢2-. l p;., $st

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m usg£aousmfluestrXn^SDriomeg-¢w li tel\97osaaI-S-lsineznotXiiaN gi yjmr&|w[1Sim;-W*t;S>-rt-4r4---R,-F,3 98,' ;;~- w-t C q i£M t- sovv

- )sD~~~~~~~ ~~~~ inreqmnemure,nnn;otdaterneationalreemisvaiSSnieEt R ;uncustue,Xandh8D~silldadrmcdl m&m i;>snonaerDqns tua~an-dc Oro!E,

B t n>- FSl.gr.-otXZ ^se-i>t>tzr~¢<<;Qv lRitFl-r|J-t -s LtR g2J;i-*; stX-lr -9 5fS=§tX 9 - f~~~~~~~~~~~1~l g>l~-leimR^ow fZpno;MTp ZEnSLEool>qcao^adeeomnhpnhat

3;is iR 9¢+j=,-t%rin- iC g>z. sF^ ,>:* .>+; i1L e t 5s- ,>:~ "rn|y;E>.fi#.ana z+mmal DoMan;.was~~~~~ ~~~~~~~ sQaxoamolaI4- mos<Xsor;cell!loLeaElDr-u=¢Es{

~ =>. > $t05Ar '>4XAS-rW3^DRbRX 2*^t ttti >,== 84tSitt 8 -u^'§.^&a> t J-8 *iX45r£W .+5=i 9s.+N :-~ ~ ~~~~~~~~~~~~Pq . Drexnod7sw;:nEnUte,uedM ms;n. iotlkhEdasaloyEt

- 'gS 95,>uW,-^Q* ............................... Rr".wrl,>,,oE.isi,4e,a.2*,sw044> i' -z-'tt.Z'^: [^sl^ttt>'}Y'-'^F4EaZ,oAaodnra:$rDvdcpcyTa-ytt '-ru blcne le.d>ndu ngn l 5W.^grLtg'@eS=< @X<' ncg- 4cot.2-Xti.>C{vlsgt/4't. =.E$*-.w'xjl2>(g,.<t,'.X>an >i

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Br n ea Ostbrecnsructo,lSycmDeesacm -coinasoofiie or d- ots

: ~~~~~~~~~~~~~~~~~~~~~~io _

A MI~RACLE

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 poli- ces (Km and Leipziger 1993).

.;e -t i,_ xe_^,r,>,U.le.x-U..

The searc hfrpolicyexplanations forEast AsiA succss hasnotbeen completey successfulL Each of the broad views of the relationship be- tween 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 oh atteauunt v of t hree centml Sanctions: aci- nulation, allocation, and produc growth-neocl. Markcr-orienited poi-

cies, the fundamentas, were widely used by al the HPAEs and formed the basis for their rapidh growth. More interventonist policies have the potenti to contribute to growth in cases wohrec the address economic coordination problems, but to succeed they must combine the benefits of cooperation with competitive discipline by creating contests.

Effective implementation of contests depended on two sets of&fictors - almost unique to the northern HPAEs. The first is the competence, insu- lation, and relative lack of corruptibility of the public administrations in Japan and Korea. The historical origins of these economies' high-quality economic administrations and the mcchanisms that they used to main- cain quality and limit political influence and corruption are the subject of chapter 4. The second is the pragmatism and flexibility of govern- ments in the high-perfonning East Asian economies where contests were tried and abandoned or continued dependig on their results. We .examine this flexibility in policy formulation in two importnt areas, macroeconomic management and promotion of export, in the next chapteL

102

PUBLIC. PO'LICyA i

Notes 1. Forgoodexamples,seeBalam(1982) Bhgwvati (1978), 5. Popular discussions of the success ofJapan and sev-

Krueger (1978), and Litle, Scitovsky, and ScoEr (1970). erl other economies of East Asia have stressed the coop- eranve relations between government and business,

2. Moreover, some of the measures presenord, such as between workers and cmployers, and among businesses. those of Itoh and Kiyono (1988) for Japan, are probably This phenomenon is sometimes rerred to as 'Japan, minimum estmates insofar as their calculations of efieclve Inc." or "Malaysia, Inc," conveying an impression of a rates of protection (Em's) are based on triffdata, not on es- single-minded direcrion to economic activity, promoting timates of nominal levels of protection derived from com- the collective inuerescs of the economy. Clearly, dtis pop- parisons ofdomestc and international prias. On Korea, see ular imge caggeractes. Like all governments, govern- PadcandWcstphal (1986) andtherefrencrscitedthercin. ments in EastAsia lack the control t cnforcea common On Taiwan, China, see Wadc (1990). On Japan, see Itoh set of goals. and Klyono (1988). Wade does not present or dce estimates of effecive rates of protection in Taiwan, China, for the pe- 6. The list is by no means exhaustive, nIor does it in- riod afer 1969, while the other two present evidence on dude examples of failed contests, of which there are ERPS forjapan and Korea Conversely, Wade does offer care- many. frfly documented qualittivc evidence ofthe extent ofselec- tive intervention. Despite the frequent use of Taiwan, 7. See, for example, Kim and Leipziger (1993) for a China, as a modd of limited intervention, therc are no esti- dicussion of the instiutional features of the Ha drive mates of which we are aware of effectrive rates of protection and an evaluation of the success of the program. or dome resource cost for the period after 1970.

8. Amsden (1989) in a seminal workl oudines the na- 3. See Yamawaki (1988) on the steel industry, Mutoh ture of perfiormance critera used in Japan and Korea to

(1988) on cars, Yamnazawa (1988) on textiles, Yonezawa discipline interventionist policies. (1988) on shipbuilding, and Tanaka (1988) on alu- minum refining. 9. Again, this is perhaps not quite accurate; there may

be spillovcrs from Iarning how to produce some com- 4. A formal exposition of this concept is contained in modity more cheaply.

R%g and Peuri (1993).

103