How did East Asia's contest-based competition work? Through public-private cooperation and sound rules and rewards
Cooperation between the government and the private sector has worked well for some HPAEs, but a few caveats apply. First, cooperative behavior may become collusion if firms act together to raise prices. Second, cooperation may inhibit competition, leading to managerial slack or a more general loss of efficiency. Third, business-government cooperation may encourage firms to seek favors from government.
How did the East Asian economies that encouraged cooperation avoid these problems? They combined cooperative behavior---including sharing of information among firms and between the private and public sectors, coordination of investment plans, and promotion of interdependent investments---with competition by firms to meet well-defined economic performance criteria.[1] They developed institutional structures in which firms competed for valued economic prizes---such as access to credit---in some dimensions while actively cooperating in others; in short, they created contests.
Market-based competition and contest-based competition both included prohibition of monopolies, although the number of competing firms was sometimes small. Even though Japan and Korea have tended to have high levels of concentration in their manufacturing sector, domestic competition has usually been vigorous. The Japanese government has proceeded on the assumption that competition among fewer, more evenly matched firms is preferable to having one large firm competing with many smaller rivals.
Contest-based competition included clear, well-enforced rules and prizes for winners. The simplest and most widely used were export contests for access to credit and sometimes foreign exchange. While export credit schemes varied widely, all made credit available to firms with confirmed export orders. For many small and medium-scale enterprises, export credits were their only access to the formal financial sector. Monitoring performance was simple; firms were required to show evidence of export orders to receive credit.
In Korea and Taiwan (China), not only did export projects get easier access to funds, but firms that exported successfully had an easier time getting future loans. Because such credit was fungible and credit generally was tight, firms sometimes diverted export financing to higher-yielding nonexport investments.
A second approach used the power of government to grant licenses. The Bank of Japan, for example, induced commercial banks to compete to provide financial services in line with government policy---for example, by opening rural branches---in hopes of winning highly sought-after urban branch licenses. The contest also gave banks a strong incentive to comply with technically nonbinding administrative guidance of their lending: banks that failed to comply with guidance about the spread between deposit and lending rates were not permitted to expand their branch network.
During the 1950s Japan's Ministry of International Trade and Industry licensed capacity expansion in several key industries----mainly heavy and chemical industries. In the 1950s and 1960s, the ministry limited entry and restricted competing imports. Firms in the protected industries were required to coordinate investments to prevent excessive expansion of capacity, but they were also required to compete. Firms that received "extra profits due to regulation" (quasi-rents) were required to reinvest these profits in activities that would result in economies of scale or learning. These in turn contributed to declining real product prices and increasing market shares. Thus, firms competed for domestic market share within a framework of "orderly capacity expansion." Success was further judged by the extent to which economies of scale or learning permitted industries to expand export market shares.
The final example is Korea's heavy and chemical industries drive of 1973-79, which combined licensing of capacity, access to credit, and protection against competing imports with physical and economic targets for performance.
At the heart of the drive was the goal of changing the industrial structure toward more capital- and knowledge-intensive industries by coordinating public and private investments. Large private companies, the chaebol, bid on large-scale investments---for example, electronics, shipbuilding, and machinery---for which they received exclusive licenses combined with generous access to credit. The rewards were quasi-rents due to import restrictions and restrictions on entry, access to credit in a highly credit-constrained system, and government support during business cycle downturns.
These incentives have been the source of disastrous economic performance in other economies and have not been an unmitigated success in Korea. Interventions were so pervasive that bottlenecks emerged, large-scale debts were incurred, and labor-intensive industries were starved of credit. The eventual check on poor performance in Korea was the result of two performance-based rules. First, the government established a timetable for the attainment of international competitiveness in each industrial sector. Firms that failed to maintain the pace of cost reductions in line with the international norms faced both political and economic sanctions. Second, because access to credit, even at early, nonexporting stages of the development of heavy and chemical industries investments, was linked to the export performance of other products produced by the chaebol, efforts to maintain export competitiveness across a wide range of products were encouraged.
In most of the HPAE examples, using exports as a performance yardstick generated substantial economic benefits. A firm's success in the export market is a good indicator of economic efficiency---a much better indicator, in fact, than success in a domestic market. Export markets are likely to be much more competitive than domestic markets. Even if the firm's success is based on finding a niche in a foreign market, its contribution to the domestic economy is still as large as if it had succeeded by developing new production processes or otherwise boosting efficiency.
There are, of course, other advantages associated with exports. There are spillovers related both to marketing know-how and to production know-how. For instance, success in the production of intermediate goods requires producing to standards that are typically higher than those that prevail in developing economies. The contacts made when exporting may also be of value when a firm decides to enter related markets or to acquire advanced technology.
In creating contests, HPAE governments were less heavy-handed than some others that have attempted selective interventions. Though the architects of these contests made some mistakes, they generally did not force decisions on others who had their capital at risk. (The creation of the Mitsubishi Automobile Company in 1965, despite the Ministry of International Trade and Industry's guidance to refrain from entering the automobile production market, is a case in point.)
Contests in northeast Asian economies have succeeded partly because the prerequisites were right. Preferential access to credit and foreign exchange has been an extremely attractive reward. Rules have centered on economic performance, primarily a well-understood imperative to export. The government "referees" who designed and supervised the contests have been generally competent and fair.
Contests won't work everywhere, however, as the preponderance of unproductive subsidies in developing economies that proffer rewards but lack adequate rules and referees makes clear. Moreover, even in economies with strong government institutions, running contests becomes more difficult as firms grow and their power increases vis-à-vis that of the bureaucracy. As Japanese officials, who are now moving away from contests toward a more functional approach to incentives, have discovered, running a party game for children is one thing, and doing it for professional wrestlers is quite another.