The Snakes and Ladders of Asian Development

Picture of the author and friend Niko Nakai in the Philippines

 

  The Snakes and Ladders of Asian Development

 

My post from last week focused on a critical comparison between the developing economies of India and China. The authors of the reading did an evaluation of the strengths and weaknesses of the two nations, looking at their current positions, how they got there, and projecting into the future. They highlighted flaws in China's projected economic growth, and saw the opposite patterns in India's economy as signals of strength. This week's reading, titled Changing the Industrial Geography of Asia: The Impact of India and China by Dr. Shahid Yusuf, takes a different perspective on much of the same data, placing it in a more optimistic light. The reading took the view of Asian countries as occupying various positions, all of them with great potential, along the EOI track of development.

In the constantly evolving game of global economic development, two strategies occupy opposite corners of the debate: Import Substitution Industrialization (ISI) and Export Oriented Industrialization(EOI). The contention between these two approaches highlights the divergent opinions on development models, the proper mix of policies, which countries should applying what fixes when, and even the fundamental principles by which to create growth. Especially in analyzing the pattern of EOI, because it is still relatively new, different regions' implementation and results vary widely. These two strategies, though in many ways diametrically opposite, supposedly lead to the same place—development.

ISI focused on the establishment of a developing country's internal economy. Used a policy guideline, this model advocates replacing, or substituting, goods currently imported from other countries with domestic industry. It equates establishing economic autarky with development, stating that the independence of internal markets is necessary before competing in world markets. This model was the predominant foundation for policy recommendations and loan conditions to developing nations by the World Bank and IMF up until the 1990's. At this time, many debt-burdened nations, who had implemented these guidelines with little economic success, found themselves unable to pay back loans. There is still a need for a new strategic framework for development for the international development organizations.

In the 1980s and 90s, Export Oriented Industrialization gained acclaim as ISI's successor, though there remains with much skepticism. EOI flips the assumption behind ISI on its head: integration into the global economy is the strategic key to leveraging development. By focusing investment on areas where a country has greater comparative advantage—in developing countries this is generally in low capital/high labor industries such as textiles and manufacturing, though not always—a country can start a virtuous cycle of inflowing investment and capital to spur further growth. EOI has even been recently paired with its own set of broad policy guidelines, termed The Beijing Consensus, which vaguely state that the state can have a positive role in influencing industrial development. EOI, in one form or another, is partially credited as the model behind successful growth in East Asia, most notably S. Korea, Japan and Taiwan.

The first wave of export oriented industrialization occurred with Japan,2 which, despite having head start during the Meiji Restoration, truely began its economic ascension in the rebuilding process after World War II. Japan's industrialization, according to Dr. Yusuf, supported by the American government and businesses, then created the industrial landscape to trigger the rise of the second wave, the Asian Tigers—Korea, Singapore, Hong Kong, and Taiwan. Japan served as the industrializing intermediary based on the “Flying Geese Model,” whereby the investment and industrial pull of the US upon Japan subsequently allowed for knowledge and technology spill over in the other East Asian Nations, along with FDI. The South East Asian countries, such as Malaysia and Thailand, also followed in the so-called second wave, though to a lesser degree of industrialization.

The third wave of the flying geese came with the Chinese, who lagged two decades behind other East Asian Nations due to Mao's oppressive rule. However, Deng's liberalizations, the establishment of the Special Economic Zones (SEZs), and heavy industrial investment geared towards producing comparative advantage exports have allowed for rapid catching up.  However, economists still debate the extent that state-directed investment towards specific industires influenced relative success in those areas. Foreign Direct Investment has also provided support specifically geared towards vertical supply chain growth, and technology spillover between foreign and domestic firms. China is seen as moving up the value chain in many of its industries, technology that once only sourced a few parts from China is now being completely assembled there. Especially considering the boom in innovation as seen by patents and published scientific papers, as well as the rising status and capabilities of Chinese Universities, it seems that they will continue this steady climb up the product chain.

This second wave is now mostly complete, with the Asian Tigers having established significant comparative advantage in high level areas: Hong Kong and Singapore as the financial services hub for their respective regions, Taiwan and South Korea in IT manufacturing. Hong Kong for example, is seen as having morphed into a post-industrial economy, only receiving 4% of its GDP from manufacturing.3 Under almost every criteria of development, from life expectancy to per capita income, these nations list near the top of the world in the 21st century.

China's third wave is about to face its first major pivot. Having established economies of scale in strategic zones, the nation is now trying to focus investment on moving up the value chain. Already, China draws less of its income from capital, declining from 54% in the 1990s to 41% in the 2000s, along with seeing significant growth in its services sector. This transition can also be seen in its labor force, with the large strides in human capital investments paying off with massively improved productivity, growing at an annual 9%. The downside of this is higher wages to match that productivity, causing reduced employment. However, so far productivity has outpaced growth in wages, leading to further competitive advantage in increasingly more valuable industries such as high tech and heavy manufacturing, which has continued the high profits, high investment. This will be bolstered further by the rapid growth and efficacy of the business services sector, such as finance and consulting.45

The fourth wave of Asian growth seems to be shifting to India and South Asia, albeit in a significantly different form.  China is now India's foremost trading partner, lending financial wind behind the wings of this late-comer goose.  However, India has not industrialized according to the "Flying Goose Model," which looks at the flow of primary to secondary to tertiary industrialization. Still severely lacking in necessary infrastructure and education, India has skirted this issue by leveraging its relatively small highly-educated population (and its yet underutilized, and much larger, un-educated population) to establish competitive advantage in business process outsourcing and technology services. Through call centers, remote computer coding, and other services, Indian businesses do not need to rely on poor infrastructure to export value to the rest of the world. They have established external economies of scale in areas such as Hyderabad and Bangalore, and some of that investment is now spilling into the manufacturing sector, for example establishing competitive advantage in producing car parts, although the manufacturing base is still far below potential.

India has leveraged the liquidity available to begin their own nascent services industry as opposed to manufacturing.  By doing this, they have attracted much FDI in the form of outsourcing directly from the United States.  This has lead to fast fortunes by many Indian entrepreneurs, though the nation still lacks a wholistic path to development, and while some sectors are booming, many regions and industries have been left in the dust. 

The demographic emerging from India's educational system is also an issue that must be solved. Governments and institutions have not given proper support to the primary education system in India. However, the much stronger higher education system, as established by the Indian Technical Universities, produce highly-skilled workers, albeit a smaller proportion of the population due to poor turnout from primary education. These highly skilled workers, when given the choice between working in the successful, lucrative services sector or working as management or R&D in the industrial sector—long stunted due to poor infrastructure and strict labor laws—often will choose services. This education cycle has cannibalized the manufacturing sector from establishing a critical mass of talent.  A lack of a strong manufacturing sector, which would employ large numbers of the low-education population, leads to a further disparity between the opportunities of the highly-skilled and low-skilled demographics.  There is the potential for a virtuous cycle to be started if young entrepreneurs go into manufacturing and utilize the large labor pool, though due to poor institutional support, bad business laws, and outdated infrastructure, these talented youth are going into services instead.  Likewise, by strengthening India's primary education system, it will increase both the number of entrepreneurs available, as well as the number of low-skill labourers needed to feed both the services and manufacturing sectors.

Additionally, government and institutions have been slow to reform liberal land ownership laws, allowing just one small private owner to put large industrial projects on hold. This is ironic, considering most growth models consider strong private ownership laws essential for development.  In the case of Inida, it is the lack of state power to properly allocate land resources which is the largest obstacle. Cities where governments have been able to establish the large industrial clusters, such as Bangalore, have experienced considerable success because of it.

However, high levels of investment, an enormous, relatively young population, and the inspiration of rapidly developing neighbors may provide the coaxing India needs to begin institutional reform. This could position India as the up-and-coming star in the Asian Miracle, the fourth wave, hitting mid-way through the 21st century.  India's well-developed services industry could even play a key role in the knowledge spillover to the other East Asian Nations. Industrialization in Asia is not a zero-sum game of development. To the contrary, countries' growth and successful ascension of the development ladder has shifted the global industrial map, allowing for their neighbors to follow in their progress.

 

1It should be noted that ISI manifested itself in many ways, and did not always match up with Washington Consensus Policies. Take the examples of the socialized, centrally planned economies of South America, such as Argentina, which also worked to establish infant industries to supplant imported goods.

2He also interestingly mentions Germany as another example of rapid development through EOI post WWII.

3I feel that this figure is quite misleading by the author of the paper however, as many hong Kong residents run factories in the Pearl River Delta region, making GNP a much more accurate description of wealth in HK.

4Much of the productivity growth came from the massive stimulus and investment during the 2008 global financial crisis. State-owned banks funneled much of the investment to important cities and sectors, thereby stimulating huge capital growth and urbanizing more of the populace.

5There is also much skepticism on whether Chinese State Owned Enterprises (SOE) are flexible enough to upgrade their managerial techniques. The exiting government of Hu Jintao is expected to release a plan this december detailing their mitigation of the state-owned monopolies. http://www.reuters.com/article/2012/10/21/us-china-economy-reforms-idUSBRE89K0GS20121021