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News Release

"Asian Model" Of Industrial Policy Unlikely To Drive Growth In Other Developing Countries

April 2, 2003

Contact:    Marcus Noland    (202) 328-9000

Washington, DC—Industrial policy à la Japan, Korea, and Taiwan in the earlier postwar period is not an apt model for poor countries pursuing development today, according to a new Institute study. Such policies made a positive but very modest contribution to the growth of the East Asians themselves. However, they fostered corruption and weak financial systems that subsequently levied major costs on those countries. In addition, few of today's developing countries possess the political stability, equitable income distribution and extensive human capital that enabled state intervention to increase East Asian growth. In addition, a tightening of the international trade rules prohibits export subsidies and some of the other East Asian tools from the earlier era.

This issue arises because disappointing development results worldwide have shaken faith in the "Washington consensus" reforms of secure property rights, fiscal discipline, sectorally neutral tax and expenditure policies, financial liberalization, unified and competitive exchange rates, openness to foreign trade and investment, privatization and deregulation. One response has been to augment this package with so-called second-generation reforms such as strengthening prudential supervision of financial markets or competition policy. Another impulse has been to reconsider the more dirigiste policies that the consensus marginalized. Japan, Korea, and Taiwan are sometimes regarded as exemplars that have derived great benefits from increasing integration with the international economy without surrendering national autonomy in the economic or cultural spheres-in effect, beating the West at its own game by promoting specific industrial sectors.

In Industrial Policy in the Era of Globalization: Lessons from Asia, Senior Fellow Marcus Noland and Wharton School professor Howard Pack address the key issues for policymakers considering these alternative paths. Was industrial policy—-that is, supporting individual manufacturing sectors—indeed a major source of growth in these three economies? If so, can it be replicated under current institutional arrangements? If it can, is it worth replicating or would contemporary developing countries be better off embracing the orthodoxy suitably refined?

Was Industrial Policy Responsible for Growth in East Asia?

Table 1 reports per capita income and a human capital index in the mid-1950s for a number of countries. The physical capital stocks of Japan and Korea had been devastated during the Second World War and the Korean War, respectively, and, as a consequence, the level of per capita income was relatively low. But they had the world's highest ratio of human capital to per capita income. Moreover, the rate at which they subsequently accumulated human capital was more rapid than in other developing countries.

Japan, Korea, and Taiwan experienced varying degrees of industrialization, underwent substantial political upheavals and initially were attempting to reestablish production in sectors in which they had at least some prior experience. Even after this was achieved, and they began to enter new industries and activities, they remained well behind the technological frontier defined by the United States and were essentially engaged in catch-up along a reasonably well-defined industrial path.

To this end it is quite clear that they pursued a variety of selective intervention policies including direct subsidies, indirect subsidies through public-sector financial institutions, tax breaks, subsidization of research and development, international trade and investment protection, and lax competition policies. The issue is whether these policies accelerated growth and development.

A comprehensive review of the evidence suggests that the growth-accelerating impact of industrial policies was modest. So why would policymakers consistently intervene in ways that apparently did not do much to enhance welfare? One possible answer is that policymakers simply did not get their interventions right. Another is that the interventions were largely determined by political competition among self-interested groups, as in the case of Japan where more than 90 percent of on-budget subsidies for decades went to the declining agricultural and mining sectors—rather than the emergent high-technology sectors of popular lore. Indeed, it appears that the impact of public policy during the heyday of Japanese industrial policy was on balance a tax on industrial output rather than a subsidy.

Given the politicized nature of this decision-making, it is not surprising that evidence of the benefits of industrial policy intervention is elusive. The authors conclude that industrial policies accelerated growth by perhaps 0.3 percent annually—nontrivial if maintained for decades but not the predominant explanation of Asian growth of about 10 percent a year.

Did These Policies Have Unintended Side-Effects?

The question then arises as to whether selective intervention policies had negative side-effects that should be weighed against the possible benefits. The short answer is "yes."

State intervention in the economy encouraged rent seeking and corruption, and the repression of the financial system. All three countries developed bank-centered financial systems that were amenable to state influence. As a consequence, bankers did not develop the necessary skills to evaluate alternative business plans and models. The current banking problems, with expected net clean-up costs amounting to more than 10 percent of GDP in all three countries, cannot be blamed on selective intervention policies but the industrial policy legacy clearly contributed to their financial sector difficulties.

Are These Outcomes Replicable?

Would a developing country today be able to achieve 0.3 percent additional growth annually with corruption closer to the Danish than Nigerian standard? There are multiple reasons to think that they would fall short of this mark. First, Japan, Korea, and Taiwan are characterized by a high degree of political stability and a low degree of ethnic fragmentation compared with the world average. Second, all have relatively equal distributions of income and wealth. Third, the factor endowments of the Asia trio are different from almost every other country in the world: they have a very high ratio of people to arable land and have accumulated human capital at an astonishing rate. One would therefore expect these economies to begin manufacturing activities relatively early in their development and to specialize in these activities. In such a situation, industrial policies are effectively "leaning with the wind" and giving rise to "growth with equity."

In contrast, much of today's developing world is characterized by political instability, ethnic fragmentation and considerable income inequality. In some cases, they have substantial extractable natural resources and are relatively scarce in both human and physical capital. As a consequence, industrial policies may run counter to comparative advantage and are more likely to generate "growth without development."

Beyond these economic fundamentals, the institutional environment was more amenable to industrial policy a generation ago. The World Trade Organization (WTO) has tightened its rules, making some things that the Asians did a generation ago, such as export subsidies, illegal. Moreover, the end of the Cold War means that the dominant players, especially the United States, are less constrained about pressing their advantage under the strengthened dispute settlement system of the WTO.

What, if Anything, Is to Be Emulated?

The experiences of the Asian countries hold three lessons. First, political stability is important. Countries should try to maintain their own stability and act forcefully to encourage stability among their neighbors. No one will invest in an unstable environment.

Second, investment is important. The Asians maintained high rates of saving and high rates of investment in both physical and human capital for a sustained period. The development of indigenous engineering talent was critical since a key to development is the adaptation and exploitation of technology developed elsewhere. The secret of the Asians' success was not so much rapid growth of total factor productivity but maintaining that rapid productivity growth in the face of adding 30 percent of GDP to the physical capital stock year after year (table 2).

Export orientation was key and accomplished three things: a vent for output, avoidance of balance of payment problems; and a clear neutral standard to evaluate the performance of firms receiving industrial policy favors. As one practitioner described it, "[The export statistics] were the only numbers that couldn't be faked." There is considerable evidence that exporting was essential to integration into world supply networks and that, through these cross-national contacts, significant technology transfer occurred.

About the Authors

Marcus Noland, senior fellow, was a senior economist at the Council of Economic Advisers and held research or teaching positions at the Johns Hopkins University, the University of Southern California, Tokyo University, Saitama University, the University of Ghana, the Korea Development Institute, and the East-West Center. He received fellowships sponsored by the Japan Society for the Promotion of Science, the Council on Foreign Relations, the Council for the International Exchange of Scholars, and the Pohang Iron and Steel Corporation. He won the 2000-01 Ohira Masayoshi Award for Avoiding the Apocalypse: The Future of the Two Koreas (2000). He is also the author of Pacific Basin Developing Countries: Prospects for the Future (1990); coauthor of No More Bashing: Building a New Japan-United States Economic Relationship with C. Fred Bergsten and Takatoshi Ito (2001), Global Economic Effects of the Asian Currency Devaluations (1998), Reconcilable Differences? United States-Japan Economic Conflict with C. Fred Bergsten (1993), and Japan in the World Economy with Bela Balassa (1988); coeditor of Pacific Dynamism and the International Economic System (1993); and editor of Economic Integration of the Korean Peninsula (1998).

Howard Pack has been a professor of economics and professor of business and public policy at the Wharton School since 1986, and professor of management there since 1995. He was a consultant at a number of institutions including the World Bank, the Asian Development Bank, the Inter-American Development Bank, the Agency for International Development, and the Overseas Development Council. He was a fellow at the Harry S. Truman Institute for Peace Research, the Hebrew University, Jerusalem, and the Jerusalem Institute for Israel Research at the same university. He is on the editorial boards of World Bank Research Observer, World Development, Journal of Development Economics, and World Bank Economic Review. He is the author of Productivity, Technology and Industrial Development (Oxford University Press, l987) and Structural Change and Economic Policy in Israel (Yale University Press, l971).

About the Institute

The Institute for International Economics, whose director is C. Fred Bergsten, is the only major research center in the United States that is devoted to global economic policy issues. Its staff of about 50 focus on macroeconomic topics, international money and finance, trade and related social issues, and international investment, and cover all key regions—especially Europe, Asia, and Latin America. The Institute averages one or more publications per month; holds one or more meetings, seminars, or conferences almost every week; and is widely tapped over its popular Web site.