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Monitor
PUBLISHED : Thursday, 13 June, 2013, 12:00am
UPDATED : Thursday, 13 June, 2013, 6:49am

To get rich, poor states must ignore the Washington rule book

A new book argues that in East Asia, there are nations that protect their industries and prosper and those that heed others' advice and fail

The line of latitude at 20 degrees north neatly bisects East Asia.

Skirting Thailand's northern border, and passing eastward between the Philippines and Taiwan, it divides the region into two distinct economic zones.

To the north, Japan, South Korea and Taiwan - three places that long ago achieved developed-country wealth levels. More recently, China has emulated their development, stunning the world with three consecutive decades of rapid growth.

South of the 20th parallel, however, economic development has lagged behind. Although in 1950 Indonesia and the Philippines boasted similar incomes per head as Korea or Taiwan, today their levels of gross domestic product per capita - even after adjusting for differences in purchasing power - are less than a quarter of those enjoyed by their northern neighbours (see chart).

Over the years commentators have suggested all sorts of possible reasons for this divergence, from cultural proclivities to climactic differences.

Joe Studwell has a different explanation. In his new book, How Asia Works, the founding editor of China Economic Quarterly argues that in the 1980s and 1990s governments in Southeast Asia made the mistake of accepting the policy recommendations of the International Monetary Fund and World Bank.

In response to advice from Washington, they distanced themselves from business, opened up their domestic markets and scrapped controls on capital flows.

In contrast, governments in northeast Asia adopted a much more interventionist, and protectionist, approach. In Japan, Korea and Taiwan post-war governments rode roughshod over property rights, redistributing farmland in order to maximise output from their underemployed rural populations.

Meanwhile, governments maintained a tight grip over their financial systems, holding domestic savings captive and directing cheap capital into favoured manufacturing industries.

The result was Japan's rapid growth of the 1960s, achieved thanks largely to the state's allocation of resources into nascent manufacturing industries which benefited handsomely from a protected home market and generous export incentives.

Similarly, in South Korea, the government directed investment into heavy industry - steel, shipbuilding and carmaking - promoting their development with subsidies and shutting out competitors with tariff barriers. Imports were restricted to raw materials and capital goods necessary for boosting productivity, with controls only relaxed once Korean industry was able to hold its own against international competition.

The lesson was well learned in Beijing. Although China never fully pushed through land reform after the disaster of collectivisation, Beijing enthusiastically embraced the other main elements of the northeast Asian model. The government retained control of the financial system, allocating cheap capital to protected state industries and promising export sectors. Growth took off.

According to Studwell, it's a model governments in newly developing economies in Africa and elsewhere would do well to study.

Throw the Washington rule book out of the window. First, equally redistribute your agricultural land to encourage small-scale intensive farming and boost output.

Next, protect your home markets from foreign competition, while picking winners in likely export sectors.

Finally, keep control of your financial system so you can lavish cheap capital on your favoured manufacturers until they can compete with all comers.

It's hardly a liberal approach, but it's worked a treat for Asia north of the 20th parallel.

tom.holland@scmp.com

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John Adams
I am only 1/4 of the way through Joe Studwell's new book ( it is indeed heavy stuff ! )
But I am already sold on his thesis.
Land re-apportionment was the key to success of the northern SE Asian countries
And the proof is the graph that Tom Holland published today !
Also the proof is that we are inundated with poor amahs from - guess which countries ? - the Philippines, Indonesia (and even Thailand)
When did anyone ever hear of a Japanese, South Korean or Taiwanese amah ?
And thank heaven that China is lifting itself up by its own bootstraps ever since the days of Deng Xiaoping - my eternal hero
(And for those of you who may read this and question my stance re Tiananmen 6.4 etc .... whoever played a game of chess and did not sacrifice a rook or bishop or two in order to protect the queen and above all the king in order to eventually win the game ? . Deng Xiaoping and his successors made sure that China will eventually win economically, which means 1/4 of the world's population will eventually be free from the impoverishment of the Philippines, Indonesia ( and Thailand)
webbocybase
It is a way to play catch-up, for sure. But I suspect the difference between Japan, Korea and Taiwan and the rest is that these policies were not the whole story - if they were, India would be up there too (and we would be unable to explain the rise of HK and Singapore which did not follow similar policies but have suceeded with very open economies). What these three countries have done is move on from protectionism to allowing the development of their own domestic economies and, crucially, promoting the development of innovation and ideas though education and openness. That's where the other nations, like China, will hit problems: some have poor education systems and some have governments that are suspicious of the kind of free thinking that leads to innovation.
webbocybase
Actually I agree with most of your points, but I think people may have misunderstood the essence of mine - it was not that the sort of policies as set out in Tom Holland's article don't work: clearly they do, and some of the other countries in the region (and beyond) would do well to emulate them if they want to get their economies to start to take off. But my point was that if a country wants to move on beyond the middle income trap its policies will have to move on too, beyond mercantilism to the promotion of higher productivity that tends to come about through innovation and the efficient exploitation of design and invention.
Japan, Korea and Taiwan all have their world class companies that have shown the way (albeit with much protection at an earlier stage in their development). Whether China can do the same with its overbearing state mechanism in industry and the universities is moot.
impala
A good piece, but there is really nothing new in Mr Studwell's ideas. Economists like Ha-Joon Chang (Cambridge), Robert Wade (LSE) and many others (J. Stiglitz comes to mind as well) have been making this argument for 10 years or more.

In particular the Mr Wade's "Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization," published in 2003, seems like a book from which this Mr Studwell has taken many a leaf, or at least his theme.

Mr Chang has looked far beyond East-Asia in this field, and has empirically shown that the Washington Consensus is also historical quatsch. Today's developed nations didn't get developed by practising free trade, small government and open capital markets. On the contrary. Powers like the USA, the UK, France and so on, were (by today's standards) excessively protectionist (mercantilist even), with steep government subsidies for nascent industries, and isolated, fragmented financial sectors with heavy capital controls.

Mr Chang signals the fact that these countries are at best being hypocritical by telling today's emerging economies NOT to do everything they did, but instead open up, deregulate, privatise and liberalise, which is really detrimental for the economic development and often leads to a middle income trap. He called this trend 'Kicking Away the Ladder,' also the name of a book he published in 2002.

I hope Mr Studwell acknowledges his sources of inspiration properly in his book.
whymak
Those who have strong opinions may not have looked carefully at the simple chart Mr. Holland presented here. Both pans and raves about China are likely ideological bias at work.
Japan is perhaps the best example of economic miracle. Former zaibatsus morphed into vertical and horizontal integration into keiretsus with a large trading company at the core of a conglomerate. Crony capitalism and government industrial policy were Japan’s core values. Elites rotate jobs back and forth between MITI, a policy instrument, and companies. Politics is subjugated to interests of Japan Inc.
From 1950 on to the next 3 ½ decades, Japan was the world beater. If one wants to compare China and Asian Tigers to Japan, one must pick the correct point in time – 1950. Only then will it make sense analyzing domestic specifics and environments.
Korea adopted Japan model with chaebols and cronyism but ended up better off today. Japan has a tough time shedding its obsolete, erstwhile successful, practices, which have become a millstone around its neck. Taiwan focused its development on SMEs and government initiatives in science and hi-tech. Obviously, culture and vested interests are handicapping Japan.
China 1990 should be the starting point for comparison. For Taiwan and Korea, this is pegged at around 1965. Even then one must consider that China’s accession to WTO did not come around until 2001.
All Asian countries in the developed rank are steeped in the Confucian ethic.
whymak
FIND HOW EACH COUNTRY PERFORMS AT SIMILAR STAGE OF ECONOMIC DEVELPMENT
Tom, there is a 5-minute exercise with your data that might shed some light to students of economics on the speed toward convergence in developmental economics. This will avoid comparing apples with oranges.
In your chart, draw a horizontal line starting from the point at Japan's GDP per capita in year 1950, this will intersect the same statistic for various countries in different years.
Shift left the points of intersection for all these curves until every country has the same starting GDP per capita as Japan. Now you can see how these countries perform against one another at the same stage of development. In other words, you can now unambiguously compare the growth rates of all these countries for a specific time span.
Use logarithmic scale for the vertical axis.
It takes only a few minutes if you still have the raw data. If you don't have the original, I can still scan, print the chart and use a straight edge to arrive at an eyeball guesstimate. It's just a little time consuming.
whymak
Tom, I enjoy your column. My bias is toward materials positioned between textbook economics and cocktail conversations. This isn't a facetious remark. Hong Kongers are badly in need of economics education. More criticism of Studwell's book is welcomed.
With this preamble, I offer my humble opinion using your present piece as an illustration.
The chart you posted could be improved by plotting GDP in the logarithmic scale. It will give a better visualization of growth rate. Better yet, start all countries at the origin normalized to100 as a second graph. This will let readers readily compare China from 1980 to present with Korea and Taiwan 1 1/2 decades earlier over the same time span.
Whereas Japan's economy has reached "convergence," the state of "balanced growth," Taiwan and Korea are at least two decades from this point. China is even farther away. Comparing growth doesn't mean much unless we take this into consideration.
Two most important variables are savings rate and total factor productivity in understanding growth. Savings rate determine the point of convergence. TFP tells us whether it's quality growth and its sustainability.
My impression is Studwell has latched onto his preformed opinion as a dominant ad hoc theme for growth. This has little economic basis. The culture of the Confucian Belt (China, Japan, Korea) is a better argument.
Let you in on a secret. I don't take Solow's theory as gospel. But it's the only accounting tool.
impala
I don't think you understand the idea. India has far from the kind of strong institutions needed to implement the type of agricultural reform and industrial policies we are talking about here. Policies they (therefore) don't have either by the way.

Singapore a free economy? If there is one classic example of state-led development outside of East Asia, then it is Singapore. A controlled currency, and lots of long-term economic planning, with (very!) active government support and outright ownership of entire industries like property development. Ever heard of Temasek? Do you not know that Singapore Airlines, SingTel, CapitaLand, the SMRT Corp, and so on are all SOE's?
John Adams
No .... China is handling the same issues that have confronted every SE Asian country , but (overlooking the Mao era enormous mistakes) China is honestly and sincerely ..... and without any USA style hypocrisy - see Snowden etc - trying to "do it right" for the good of its general population = 1/4 of the total world .
China also has the biggest reserves of economy- savvy business people ( also a lot of the most corrupt business people - even in government positions)
So China will eventually come out top.
I believe in China !
pseudotriton
Usually in discussion of some major phenomenon, there're always groups of doubters who try to throw in a monkey wrench, even in the face of mounting evidence. Climate change deniers is an example.
Here, let's throw in factors like education system or free thoughts. Well, those are luxurious qualities that improve WITH the economic development of a country, not preceding it. Entities like Korea and Taiwan were ruled by authoritarian gov'ts before their economies took off in the 1970's. India has free press and presumably allows more "free thinking", but we can see how much innovation and progress that has brought them relative to, say, China.
(And the type of suspicion against free thinking in China you're thinking of mostly applies to political thoughts anyway, not economic or technological innovations.)
As for the success of HK and Singapore, keep in mind that models that work for small city-states with a few million people do not necessarily work for larger entities that constitute countries.

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