Why is the economic miracle so elusive and how can we achieve it | Daily News


Why is the economic miracle so elusive and how can we achieve it

Part 2:
The NEACs are global leaders in innovation
The NEACs are global leaders in innovation

Though many developing countries both in Asia and the rest of the world used various policies to nurture domestic manufacturers, it is only the NEACs that succeeded. The critical difference in NEACs approach was to align their national development goals with that of their businesses.

The second stage of economic development for the North East Asian Countries (NEACs) was provided by manufacturing and exports. In the NEACs, the state directed entrepreneurial talent towards manufacturing rather than services. It further nurtured manufacturing by protection and provision of subsidies which created breathing space for entrepreneurs to learn to compete.

The reasons why manufacturing is critical for rapid economic transformation is two-fold. First, since there are a large number of semi-skilled and unskilled labour among the rural poor, mechanized production which requires minimal training on machines can have an outsized impact on economic development. In manufacturing, the productivity gains are very much higher than in the service sector where greater education is needed for people to perform the tasks. The second reason is that manufacturing products are easier to export than services. Trade in services usually face practical and political difficulties in comparison to manufacturing items especially because there is no free movement of labour around the world.

The understanding of the critical importance of developing a manufacturing sector which complements trade allowed the NEACs with very high growth rates to forge ahead of the other developing countries. Additionally, the global market in manufactures provided the natural channel for quick technological learning process for domestic manufacturers. Not only did the NEACs learn to produce goods which are internationally competitive, but also paved the way for exports of services later.

Though many developing countries both in Asia and the rest of the world used various policies to nurture domestic manufacturers, it is only the NEACs that succeeded. The critical difference in NEACs approach was to align their national development goals with that of their businesses. For instance, in the private sector, the manufacturing entrepreneurs were allowed to make profits, but also were forced to compete internationally. Protection and subsidies were only provided for manufacturers that were successful in exporting where international sales acted as a barometer for indicating whether domestic manufacturers were approaching global standards or not. The unsuccessful enterprises were culled, and the successful ones were nurtured. The culling or weeding out losers meant forcing some to merge with more successful ones, withdrawal or threatening to withdraw capital from state-directed financial systems, and forcing some to file bankruptcy. In Japan, the amount of depreciation a firm was allowed to charge depended on exports. In South Korea, access to bank credit depended on export performance. In Taiwan, cash subsidies and preferential exchange rates were used to encourage exports. Hence, the NEACs were very well disciplined in preventing rent seeking – obtaining subsidies and protection from the state for firms, without delivering the technological progress and global competitiveness that development required.

Another intervention that NEACs employed was to provide state aid to successful exporters. One important support that they provided was to assist the manufactures in acquisition of foreign technology. The NEAC’s as well as China used collective bargaining strategies to purchase foreign technology. In order to assist manufacturers, each of these countries had key industrial and foreign trade policy decisions concentrated in a single government agency: Ministry of International Trade and Industry (MITI) - Japan, Economic Planning Board (EPB) - South Korea, Industrial Development Board (IDB) - Taiwan and the National Development and Reform Commission (NDRC) in China. These institutions played a key role in the success of the manufacturing sector in the NEACs.

Furthermore, these countries moved sequentially from proto industrialisation to producing light industrial goods and then to heavy industrial goods. Moving sequentially from one to another was a critical aspect because the technological know-how and the learning process in each stage was different and the prior stages had to be completed successfully to move on to the next stages. These countries also worked according to their comparative advantage. That is, cheap abundant labour. The countries with scarce capital that moved straight to heavy industrialisation without completing the earlier stages didn’t succeed. The import substituting industrialization (ISI) prior to 1976 in Sri Lanka was one such instance (e.g. Sri Lanka – steel) In addition to this, ISI was also capital intensive, and thus expensive. Such policies without mass markets was a recipe for failure. For the NEACs, bringing in these reforms, the state played a pivotal role in creating markets and providing the necessary know-how for success in both the manufacturing and trading sectors.

Financial repression

The NEACs also followed a financial policy that targeted its limited resources towards both the agricultural and manufacturing sectors. They understood that their financial policy should target the small farmer community which brings in the higher yields than the larger plantation types which brings in lower yields. As for supporting the industrial sector, they recognised the need to provide funds for industrial investments that brought in higher returns in the longer-term than near-term. This allowed profits to be deferred until an adequate industrial learning process had taken place – a classic case of funding infant industry. What this meant was to encourage financial institutions to refrain from consumer lending which usually produce higher returns in the short-term. In contrast to the NEACs, in most of the other east Asian countries, the banks are more profitable and industry remains technologically backward. Sri Lanka is a good example where banks have always performed admirably better in comparison to industry as a whole.

Alternative theories of development

It is argued that the lack of institutional development (lack of private property rights, rule of law, governance, open access to political power and democracy) in Sri Lanka could have contributed to its lacklustre economic growth and development. This would be the position of the institutionalists who believe that western economic development in general and British industrial revolution in particular was possible because of these superior institutional developments (See “Why Nation’s Fail – The Origins of Power, Prosperity and Poverty” by Daron Acemoglu & James Robinson.) But, looking at the NEACs and China’s ascent to economic heights, it can be argued that it is not the institutional developments nor the neo-liberal policies that propelled these countries to such heights, but activist and pragmatic state aided policies. Neither the NEAC’s nor China had institutions that were developed enough to guarantee a formal democracy, rule of law or property rights when rapid industrial development was taking place. The question is which way the causality runs. Institutional development causes economic development or the reverse. Looking back, it is more likely that the reverse is true.

Among the many alternative development theories, the majority of economists tend to favour the neo-liberal economic policies espoused by the Washington consensus. It is argued that countries such as the UK, US and other western countries have developed into advanced economies by following neo-liberal economic policies (Laissez faire and free trade) under well-functioning democratic systems and that the NEACs performance was just idiosyncratic. This is further from the truth. A careful reading of history would show that both Britain and the US pioneered and used interventionist industrial, trade and financial policies in various stages of their development (See “Reclaiming Development: An Alternative Economic Policy Manual” Ha-Joon Chang and Ilene Grabel. p10.)

Britain industrialized under mercantilist policies to challenge the supremacy of Netherlands and Belgium. The USA, on the other hand, had the most protected economy in the world between 1850’s to 1945. It is fair to say that almost all the industrialized countries used activist state intervention in one form or the other in their quest for economic growth and development in the initial stages. (To be continued)

(The writer is currently a lecturer in Economics and Finance at both Charles Sturt University and La Trobe University in Australia. He obtained his PhD from Temple University, Philadelphia, Pennsylvania, USA). 

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