East Asian Economics Research Paper

1. East Asian Economic Development

In East Asia, the second half of the twentieth century was a period of strong economic development in one form or another. The newly industrialized economies of South Korea, Taiwan, Singapore, and Hong Kong were viewed as the most dynamic economies in the world, having leapt, in the postwar period, from the status of poor underdeveloped to strong industrialized economies (Clark and Roy 1997). The last two decades of the century also saw great success in the economic transformation of the Chinese economy. The patterns and trajectories of change within these nations have challenged conventional wisdom about how developing nations modernize and industrialize, and about the role of the state in these processes of change.

1.1 The Newly Industrialized Economies

The three decades following World War II were a period of enormous enthusiasm about the economic prospects for developing countries. These were the years when a large number of such countries embarked on ambitious projects of agricultural and industrial modernization. Indeed, it was this effort that gave rise to ‘development economics,’ and more broadly, ‘development studies,’ as new disciplines in the social sciences. In the halcyon years of development planning, most eyes were focused on the larger or more industrialized countries such as India, Brazil, Mexico, and Egypt. Few expected very much, if anything, from East Asia, large areas of which had been colonized by Japan in one way or another in the first half of the twentieth century, and parts of which seemed hopelessly backward. Taiwan had a minuscule industrial base in 1950, Hong Kong and Singapore were tiny city-states, and South Korea seemed to be sinking in a morass of corruption and inefficiency by the end of the 1950s. Yet, a quarter of a century later, the tables had been turned: East Asia emerged as the economic ‘miracle’ of the postwar period, witnessing some of the fastest growth rates of the modern epoch, while Latin America and South Asia were mired in political and economic crises. Given this regional growth phenomenon, does it make sense to talk of an ‘East Asian Model’? There are some important similarities in development strategies across the cases, enough to persuade many commentators that the appellation is warranted. But there are also interesting differences that are worth noting.

Among the East Asian NIEs, South Korea and Taiwan have attracted the most attention. Over the years, two general views have emerged about the reasons behind their spectacular economic success. One, which was perhaps the dominant one for much of the 1970s and 1980s, held that the two countries were successful because of their fidelity to free-market policies, particularly an open trade regime (Lal 1985, Bhagwati 1988). But this view has come under a great deal of criticism from many quarters, and a new argument has emerged in recent years, which offers a different explanation for Korean and Taiwanese success. In some ways, the two countries achieved their remarkable economic success the ‘old-fashioned’ way: both started with highly successful land reforms, which immediately set them apart from much of the developing world; both managed to bring about extraordinarily high savings rates, which were then channeled into correspondingly high rates of investment. But the two countries did not simply grow by increasing the rate of accumulation. They also succeeded in acquiring, and then unpacking, technology from advanced industrial countries, so that they were able to move up the production chain into manufacturing and exporting high value-added goods. The involvement of the state was crucial to this process (Gold 1985). First, both governments launched highly effective campaigns to increase literacy rates, which accounted for a highly educated work force (World Bank 1993). Furthermore—and this has been one of the most heralded facts about their experience—the two states played a crucial role in facilitating the acquisition and transfer of imported technology. These technologies were brought in sometimes through foreign direct investment, but mostly through licensing agreements with multinational corporations (MNCs). Agreements were carefully crafted to ensure that foreign partners did not simply hand over obsolete technology, and that local engineers were able to acquire blueprints as well as the training necessary to master the technology. Firms were also encouraged, assisted, and even coerced to produce for export markets, in order to submit them to the rigors of international competition (Amsden 1989, Wade 1990). Success in export markets was used by both states as a benchmark for efficient production. Even firms producing mainly for the domestic market often had to show export success in order to be granted credit, investment licenses, and other state benefits (Aoki et al. 1997). Finally, the state was active in maintaining, for many of the crucial years of take-off, a tightly policed and powerless labor force, which added to the ‘flexibility’ of production.

While South Korea and Taiwan shared these elements in their development strategies, they also exhibited some important differences. Korea emphasized a reliance on the private sector, which was not only encouraged to grow, but also to become increasingly concentrated. In this, it resembled the Japanese experience: the Korean economy was dominated by a small number of highly diversified business groups, known as the Chaebol, which together accounted for the majority of the country’s domestic product. The Chaebol quickly emerged as the pivot on which industrial policy turned, establishing a close working relationship with the ruling regime (Amsden 1989). The Taiwanese state, on the other hand, did not have such a close relationship with private capital. Taiwanese planners relied much more on a large agglomeration of state enterprises as the nucleus for development policy; private capital was influenced—in comparison with the Korean case—more through pricing and procurement policies than by direct negotiation. The private sector was, in turn, not actively encouraged to become highly concentrated. Taiwanese industry was, much more than its Korean counterpart, characterized by small enterprises (Wade 1990). Nevertheless, a kind of quasi-corporatist structure was used to bargain with some sectors. Indeed, in both countries, a similar structure was put to use for this: firms in targeted sectors were organized into sectoral or trade associations, which were given the right to bargain with the state (Fields 1995). The overall complexion of industrial policy, however, remained visibly different in the two cases, with Korea relying on a highly concentrated private sector, and Taiwan more on state enterprises and small firms.

Singapore and Hong Kong are usually regarded as contrasting cases to Korea and Taiwan, in that whereas the latter two are examples of state-led development, the former pair embody a free-market path—or so the story goes (Rabushka 1979). There is some measure of truth to this. Hong Kong, in particular, did not experience anything like the selective industrial policy witnessed in the larger countries. And both of the city-states were much more open to foreign direct investment than either Korea or Taiwan. But there are important respects in which the city-states converged with the experience of their larger neighbors. First, like Korea and Taiwan, both Hong Kong and Singapore actively suppressed labor rights. Second, the state was of some importance in facilitating industrialization. Singapore, despite being more open to foreign investment, relied greatly on state enterprises to facilitate the entry of MNCs by forming partnerships with them, hence reducing the risk of such undertakings; further, the domestic market was not thrown open to imports, and was protected much like that in Taiwan and Korea. Local firms were also offered carefully targeted fiscal incentives, under the guidance of an Economic Development Board. Hong Kong was, of the four, the furthest away from the interventionist model. But here, too, the state played a crucial role in solving a host of collective action problems for local firms: most directly through its considerable expenditure on infrastructure, training programs, and, perhaps most importantly, its massive socialization of wage costs through the construction of an extremely generous welfare state. Between 1949 and 1980, government expenditure in Hong Kong grew by 26 times, and expenditure on welfare by an amazing 72 times (Castells 1994). This was absolutely crucial to the success of Hong Kong exports, in lowering the wage costs to producers.

In sum, despite their differences, the four cases do exhibit certain important similarities. Perhaps the most important of these is the critical role played by the state in fostering the transition to highly productive industrialized economies. The differences lie mainly in the instruments used by the various regimes: selective intervention in the larger two countries, and more macro-level policies in the smaller ones.

1.2 China’s Transforming Planned Economy

While the NIEs were executing successful development processes, the first three decades of Communist Party rule in China (1950s through 1970s) were organized around the establishment of a socialist planned economy (also called a ‘command’ economy). In this system, markets were eliminated and replaced by governmental plans that guided the economic decisions of enterprises and individuals. China’s one-party government replaced private ownership with state ownership, established economic targets for industrial enterprises, and set up collective farming in the agricultural sector. Economic agents (whether industrial enterprises or farmers) were instructed to whom they would sell their goods and for what price. Revenues were then collected by the government and redistributed to enterprises and individuals in the economy. This system was thus more than a purely economic system; it was also the basis for the social security system in China (Walder 1986, Whyte and Parish 1984).

Without a competitive marketplace to regulate and guide economic behavior, planned economies, such as China’s, are often rife with inefficiencies. In 1978, after a decade of upheaval wrought by the Cultural Revolution, the Ten Year Plan of 1976 was already faltering, and the need for some degree of economic reform was clear. Following a political struggle that pitted reform-minded Deng Xiaoping against the economically conservative Hua Guofeng, Deng Xiaoping took control of the economy in late 1978 at the Third Plenum of the Eleventh Central Committee of the Chinese Communist Party. Once in control of the government, Deng launched China on a path of economic transformation.

One of the central debates in research on transitions from planned to market economies revolves around the extent to which privatization is a necessary part of this process. Some scholars have argued that without rapid and complete privatization—the so-called ‘shock therapy’ approach to reform—true economic reform is impossible (Kornai 1990, Sachs and Woo 1997). Other scholars have argued that China is the case that disproves this view: in contrast with the rapid changes that characterized the economic reforms of Russia and Eastern Europe, China’s reforms have been introduced in a gradual and stepwise fashion, where the government has experimented with new economic policies and incrementally implemented the successful practices on a wide scale (Naughton 1995). Proceeding in this gradual fashion, the Chinese transition to a market economy has been unquestionably the most successful in the world. (China sustained the fastest rates of growth in the world for the first decade and a half of economic reform. Throughout the 1980s, its real GDP grew at an average annual rate of 10.2 percent, a level that was equaled only by Botswana. From 1990 to 1996, the average annual rate of growth for real GDP was 12.3 percent, the highest rate of any country in the world for that period. It has also had the highest industrial growth rate (an amazing 17.3 percent average annual growth 1990–96) and the second highest growth in services (9.6 percent per annum, 1990–96) in the world.)

In the industrial sector, often regarded as the backbone of the Chinese economy, five key changes have reshaped this system. First, the government gradually removed itself from day-to-day decision- making, effectively placing the responsibilities of economic decisions on the shoulders of industrial managers. In the early years of the reforms, enterprises were still expected to produce a certain amount of goods for the government’s plan, but anything they produced above this residual plan they were allowed to sell in China’s emerging markets. This transitional system was called the ‘dual-track’ system (Naughton 1995). Second, a private economy was allowed to emerge to compete with the state sector, a factor that was critical for the creation of a competitive marketplace. Thus, while privatization was the cornerstone of industrial reform in other transforming planned economies, Chinese firms were introduced to market economic behavior without privatization (Rawski 1994), and state firms eventually ‘grew out of the plan,’ producing an increasing proportion of their goods for the marketplace (Naughton 1995). The success of this transition, however, has varied in accordance with a firm’s position in the former command economy: firms under township and village governments, most of them the so-called Township and Village Enterprises (TVEs), have been managed closely by local governments and thus have weathered the reforms much more successfully than those under the central and municipal governments (Walder 1995).

A third change that has defined China’s economic reforms is that foreign investors were allowed in the Chinese economy for the first time since the communists expunged the foreign presence in the early 1950s. This factor has been very important for the transfer of technology and the transfer of international management practices. Fourth, the government adopted a decentralized and piecemeal approach to development regionally: in the late 1980s, the government adopted the coastal development strategy, in which the goal was ‘state-directed’ export-oriented growth (Yang 1991). Finally, Chinese enterprises have been relieved of their responsibilities in the provision of social security benefits to their employees and, perhaps more significantly, they are no longer required to make lifetime commitments to the workers they employ. In the agricultural sector, a similar process of change has unfolded, where farmers have been given the freedom to sell whatever they produce beyond the plan in the marketplace, until eventually the market has overtaken any vestiges of an economic plan in this sector. All of these economic changes have been formalized through the passage of some 700 national laws and more than 2,000 local laws (Pei 1994).

Transforming the planned economy of the world’s most populous nation has been a complex process and is far from complete. Nevertheless, the first two decades of transition from plan to market have been impressive and, compared to the reforms in Russia and Eastern Europe, a dramatic success. For the first decade and a half of economic reform, China had the fastest growing economy in the world, sustaining double-digit growth figures for much of the 1980s and 1990s. Where it was a third-world developing economy as late as the early 1980s, by the beginning of the twenty-first century China had the seventh largest economy in the world overall in terms of gross domestic product (GDP), and it is second only to the USA when GDP is adjusted for purchasing power within the country. (For example, if a bushel of rice costs half as much in China as in the USA, then a unit of currency is twice as valuable there. GDP statistics can, when appropriate, be adjusted for ‘purchasing power parity’ (PPP): a statistic that adjusts for cost of living differences by replacing exchange rates with relative measures of local purchasing power.)

Among the challenges that still lie ahead are the continued reform of the state sector—the leviathan organizations that remain inefficient and insolvent after more than 20 years of reform; the continued reform and clarification of property rights; the liberalization of several critical sectors, such as the telecommunications sector, and the development of the western provinces, which have fallen far behind the development in the eastern coastal region.

2. National And Regional Economic Crises

It is, in part, because of the great successes of development in East Asia that recent economic crises have hit the region so hard. Two related, but distinct, economic crises are worthy of note here. The first is the economic downturn that Japan suffered in the second half of the 1990s. The second is the Asian financial crisis, which gripped much of East and Southeast Asia in 1997 and 1998.

2.1 Japan

Japan was, for most of the postwar period, one of the fastest-growing economies of the industrial world, racking up huge rates of growth year after year until it had achieved its current position as the second largest economy in the world, with an annual GDP of more than $5 trillion. Its economy was the engine for the broader regional development of East Asia, both through its capacity as a market, and as a source of capital and technology. A more intangible, but nevertheless important, role was that it provided the model on which the two Northeast Asian ‘tigers’—Taiwan and South Korea—based their economic strategies.

By the end of the twentieth century, however, the Japanese dynamo seemed to be losing its energy. It spent most of the 1990s mired in an economic recession that turned out to be the longest and most severe of its postwar history. The precipitating event behind the crisis was the collapse of the asset bubble of the 1980s, which burst in the beginning of the next decade. The bubble itself had been built up during the 1980s as the Japanese state had initiated a policy to ratchet upwards the domestic rate of investment and make the economy less dependent on external markets. Spurred on by the constant pressure by the USA to raise the value of the yen, the Japanese government moved by the late 1970s to trigger a massive investment drive by raising the value of domestic assets. At one level, it worked very well—as asset prices rose, Japanese firms launched a massive drive to retool and invest in new technology. But the flow of investment soon exceeded anything that actual returns could justify, driving up asset prices steadily into a speculative bubble. Sooner or later all speculative bubbles burst, as did this one in the 1990s. And once the bubble burst and the economy slowed, firms found themselves stuck with massive overcapacity and onerous levels of debt. Through much of the decade, business and residential investment continued to fall, throwing the economy into a downward spiral.

The Japanese downturn was one of the background factors that laid the conditions for the East Asian crisis of 1997–8, which is now regarded as the most significant economic catastrophe the world has seen since the Great Depression. As the economy slowed down, firms compensated by turning outward, in a massive wave of investment in Southeast Asia. This led, in turn, to a process not unlike that witnessed in Japan: corporations went into deep debt to pay for new investments, leading to the build-up of extraordinary industrial capacity; after a point, money also began to pour into real estate and other forms of wealth, driving up their prices until a speculative bubble was created reminiscent of the Japanese bubble.

2.2 The Asian Financial Crisis

Though much of East Asia had bounced back from the Asian financial crisis by the spring of 2000, this crisis revealed some weaknesses in the rapid development of the ‘Asian Tigers.’ The crisis itself was set off by currency devaluation: in the spring of 1997, as the pace of growth in the Thai economy fell below projections, currency investors began to speculate against the baht in hopes of profiting from the inevitable devaluation of the currency. When the currency devaluation came in July, foreign investors fled from Thai markets, and similar behavior spread quickly throughout the region. Stock prices plummeted, currencies went into free fall, and banks began to call in loans that their customers—many of them large corporations—could not repay. By the end of 1997, the International Monetary Fund had bailed out Thailand, Indonesia, and South Korea with $17 billion, $43 billion, and $57 billion, respectively.

Two explanations have been advanced to account for the crisis. In one view, an over-reliance on foreign capital and international institutions, changes in regional economies—namely China’s and Japan’s—and reliance on the dollar brought about the crisis (Ahn 2000). First, the strength of the Japanese yen in the 1980s and the dollar in the 1990s led to excessive foreign investment in the strong East Asian economies, particularly for Japanese investors. As local banks sought strong currencies, investment and lending agreements were structured to attract these foreign players, and excessive capital led to high-risk investments, many of which would prove to be insolvent when the crisis stripped the veneer of economic discipline. Second, as China’s economy began to expand, it took over a large share of the export market, the centerpiece of development for many East Asian Economies. Third, when European currencies depreciated against the dollar in 1995, dollar-pegged East Asian currencies appreciated—relatively speaking—leading to a decline in exports. Fourth, as the flow of international capital increased through such institutions as hedge funds and short-term loans, speculative behavior on the part of international currency investors in these rapidly expanding financial markets led to market volatility.

A second explanation acknowledges the problems listed above, but places the blame of the crisis on the East Asian economies themselves. This explanation often veers into a cultural argument about the prevalence of ‘crony capitalism’ in the region. In this view, the East Asian business model, often led by government-directed investment in key industries, is also often built around implicit guarantees from the government for the liabilities of local financial institutions (Krugman 1998). Thus, the so-called ‘soft budget constraint’ (Kornai 1994), which was the hallmark of planned economies, some economists argue, was also fundamental to the East Asian business model more generally. Governmental guarantees led to risky behavior on the part of financial institutions, which ultimately led to the financial crisis itself.

3. The Balance Of Power: Regionally And Globally

Despite the economic crises experienced in the region in the 1990s, overall the second half of the twentieth century saw a dramatic shift in the economic balance of power both intra-regionally and with regard to Asia’s position globally. Within the region, while Japan was far and away the economic powerhouse of the region by the end of the 1980s, at the dawn of the twenty-first century the balance of power looked very different. Partly because of the rise of the NIEs, but perhaps more importantly, because of the dramatic growth of China’s economy, Japan’s economic dominance in the region has unquestionably waned. It is difficult to predict what the exact economic balance of power will be within the region in the coming decades, but it is certainly clear that China will challenge Japan as the center of the Asian economy.

Globally, the economic balance of power has shifted as well. While Japan has been counted among the group of seven (now group of eight) industrialized nations since the organization’s inception, during most of the twentieth century Western economies have dominated the global scene. However, with Japan and China both among the top 10 largest economies in the world and four Asian economies among the top 20 (five if we include Australia), Asia is certain to play an increasingly important role in the balance of the global economy.

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