The East Asia miracle---achieving high growth with equity---is due to a combination of fundamentally sound development policies, tailored interventions, and an unusually rapid accumulation of physical and human capital. Making the miracle was no simple matter, as the World Bank's policy research report The East Asian Miracle: Economic Growth and Public Policy makes clear. Numerous ingredients went into the recipes for success in Hong Kong, Indonesia, Japan, Malaysia, the Republic of Korea, Singapore, Taiwan (China), and Thailand. Nonetheless, the market-oriented aspects of the experience of these eight high-performing East Asian economies (HPAEs) can be recommended with few reservations. Whether interventions should be attempted everywhere is another matter.
East Asia has a remarkable record of high and sustained economic growth. From 1965 to 1990 the 23 economies of East Asia grew faster than all other regions of the world (figure 1). Most of this achievement is attributable to seemingly miraculous growth in the eight economies studied.
The HPAEs have also been unusually successful at sharing the fruits of growth. Figure 2 shows the relationship between the growth of gross domestic product (GDP) per capita between 1965 and 1990 and changes in the Gini coefficient, a statistical measure of the inequality of income distribution. The HPAEs enjoyed much higher per capita income growth at the same time that income distribution improved as much as or more than it did in other developing economies, with the exception of Korea and Taiwan (China), which began with highly equal income distributions. The HPAEs are the only economies that have high growth and declining inequality. Moreover, some of the fastest-growing East Asian economies---such as Japan, Hong Kong, and Singapore---are the most equal.
As a result of the rapid, shared growth, human welfare has improved dramatically. Life expectancy in the developing HPAEs increased from 56 years in 1960 to 71 years in 1990. In the HPAEs, the proportion of people living in absolute poverty, lacking such basic necessities as clean water, food, and shelter, dropped---from 58 percent in 1960 to 17 percent in 1990 in Indonesia, for example, and from 37 percent to less than 5 percent in Malaysia during the same period. Absolute poverty declined in other developing economies, but much less steeply. A host of other social and economic indicators, from education to appliance ownership, have also improved rapidly in the HPAEs and are now at levels that sometimes surpass those in industrial economies.
What caused East Asia's success? In large measure the HPAEs achieved high growth by getting the basics right. Private domestic investment and rapidly growing human capital were the principal engines of growth. High levels of domestic financial savings sustained the HPAEs' high investment levels. Agriculture, while declining in relative importance, experienced rapid growth and productivity improvement. Population growth rates declined more rapidly in the HPAEs than in other parts of the developing world. And some of these economies also got a head start because they had a better-educated labor force and a more effective system of public administration.
Fundamentally sound development policy was a major ingredient in achieving rapid growth. Macroeconomic management was unusually good and macroeconomic performance unusually stable, providing the essential framework for private investment. Policies to increase the integrity of the banking system and to make it more accessible to nontraditional savers raised the levels of financial savings. Education policies that focused on primary and secondary schools generated rapid increases in labor force skills. Agricultural policies stressed productivity and did not tax the rural economy excessively.
But these fundamental policies do not tell the entire story. In most of these economies the government intervened---systematically and through multiple channels---to foster development, and in some cases the development of specific industries. Policy interventions took many forms. Policies to bolster savings, build strong financial markets, and promote investment with equity included keeping deposit rates low and maintaining ceilings on borrowing rates to increase profits and retained earnings, establishing and financially supporting government banks, and sharing information widely between public and private sectors. Policies to bolster industry included targeting and subsidizing credit to selected industries, protecting domestic import substitutes, supporting declining industries, and establishing firm- and industry-specific export targets.
In assessing whether selective interventions were good for growth, the researchers of The East Asian Miracle conclude that in a few economies, mainly in northeast Asia, government interventions sometimes resulted in higher and more evenly distributed growth than otherwise would have occurred. The prerequisites for success were so rigorous, however, that policymakers seeking to follow similar paths in other developing economies have often met with failure. First, governments in northeast Asia developed institutional mechanisms that allowed them to establish clear performance criteria for selective interventions and to monitor performance. Intervention has occurred in an unusually disciplined and performance-based manner. Second, the costs of interventions, both explicit and implicit, did not become excessive. When fiscal costs threatened the macroeconomic stability of Korea and Malaysia during their heavy and chemical industries drives, governments pulled back. In Japan the Ministry of Finance acted as a check on the ability of the Ministry of International Trade and Industry to carry out subsidy policies, and in Indonesia and Thailand balanced budget laws and legislative procedures constrained the scope for subsidies. Indeed, when selective interventions have threatened macroeconomic stability, HPAE governments have consistently come down on the side of prudent macroeconomic management. Price distortions arising from selective interventions were also less extreme than in many developing economies.
In the newly industrializing economies (NIEs) of southeast Asia---Indonesia, Malaysia, and Thailand---government interventions played a much less prominent and frequently less constructive role in economic success, while adherence to policy fundamentals remained important. These economies' capacity to administer and implement specific interventions may have been less than in northeast Asia. Their rapid growth has occurred in a very different international economic environment from the one that Japan, Korea, and Taiwan (China) encountered during their most rapid growth. Thus the challenge is not only to try to understand which specific policies may have contributed to growth, but to understand the institutional and economic circumstances that made them viable. The experience of these NIEs, whose initial conditions parallel those of many developing economies today, may prove to have more relevance outside the region than that of northeast Asia.
Aside from the ability to sustain rapid growth with fairly equal income distributions, the HPAEs also differ from other developing economies in three factors traditionally associated with economic growth. Elevated rates of investment, exceeding 20 percent of GDP on average between 1960 and 1990, including remarkably high rates of private investment, combined with rising endowments of human capital because of universal basic education, tell a large part of the growth story. These factors "account" for roughly two-thirds of the growth in the HPAEs. The remainder is attributable to productivity growth. In fact, productivity growth in the HPAEs exceeds that of most other developing and industrial economies. This superior performance comes from the combination of success at allocating capital to high-yielding investments and success at catching up technologically to the industrial economies.
What was the role of public policy in helping the HPAEs to rapidly accumulate human and physical capital and to allocate those resources to high-yielding investments?
To attempt to answer this question, The East Asian Miracle develops a framework that links rapid growth to the attainment of three functions---accumulation, efficient allocation, and rapid technological catch-up.
Policy choices are classified into two broad groups, fundamentals and selective interventions. Among the most important fundamental policies are macroeconomic stability, high investments in human capital, stable and secure financial systems, limited price distortions, and openness to foreign technology. Selective interventions include mild financial repression, directed credit, selective industrial promotion, and export-push trade policies.
To succeed, interventions intended to guide resource allocations must address failures in the working of markets. If not, markets can perform the allocation function more efficiently. The researchers focus on a class of economic problems---coordination failures---that can lead markets to fail, especially in early stages of development. They interpret some of the interventionist policies in East Asia in terms of responses to these coordination problems---responses that emphasized cooperative behavior among private firms and clear performance-based standards of success.
Some HPAEs have gone a step further, creating "contests" that combined competition with the benefits of cooperation, among firms and between government and the private sector. The key feature of each contest is that the government distributes rewards such as access to credit or foreign exchange, based on performance, which the government and competing firms monitor.
The HPAE governments did not set out with the singular goal of achieving the functions of growth. Rather, they used multiple, shifting policy instruments in pursuit of more straightforward economic objectives such as macroeconomic stability, rapid export growth, and high savings. Pragmatic flexibility in the pursuit of such objectives---the capacity and willingness to change policies---is as much a hallmark of the HPAEs as any single policy instrument. This is well illustrated by the variety of ways in which the HPAEs achieved two important objectives: macroeconomic stability and rapid export growth.
HPAE governments attacked the problems of missing capital markets (and imperfect banking systems characterized by asymmetric information) through a three-pronged approach. Many HPAEs created specialized development banks that were important sources of long-term financing for investment at early stages of development. And during selected periods, some HPAEs used financial repression to aid the banking system or to bolster ailing industries. They worked to create the institutional foundations of bond and equity markets. Finally, with the recognition that most investment would come from retained earnings, HPAE governments encouraged the retention and reinvestment of corporate earnings.
East Asian governments created a wide range of financial institutions to fill perceived gaps in the types of credit provided by private entities. They met the need for long-term credit for industry by creating development banks. Most of the governments have also created specialized institutions that provide credit to agriculture and small firms.
Industrial development banks have been substantial long-term lenders in Indonesia, Japan, Korea, and Taiwan (China), but not in the other HPAEs. And in all the other HPAEs except Hong Kong and Singapore, development finance institutions helped expand financial markets.
Many other developing economies have also attempted to remedy the perceived failure in long-term capital markets. Nearly all have been unsuccessful in creating development banks.
Development banks have performed relatively better in the HPAEs, especially those banks in the northern-tier economies concentrating on industrial finance. But failures have occurred, as in the 1950s, when insolvent development banks were closed in Japan and Thailand. Likewise, development banks lending to small and medium-size enterprises in Indonesia and Malaysia have reported difficulties because of growing arrears. On the positive side, successful development banks in East Asia, particularly in Japan and Singapore, have applied commercial criteria in selecting and monitoring projects and firms, even within the constraints set by government priority activities, and they have contributed to the region's financial deepening.
HPAE governments have encouraged private investment with a wide array of mechanisms. These included low capital goods prices, subsidized interest rates for corporate investment, and limited risk for private investors.
Tax, tariff, and exchange rate policies, which kept the relative price of investment goods in the HPAEs below that in other low- and middle-income economies, undoubtedly contributed to growth. Since the same volume of nominal investment bought more real capital goods in these economies, output was increased and returns on nominal investments were higher.
Most HPAE governments have at one time or another held interest rates below market-clearing levels while nonetheless achieving high and growing rates of aggregate and financial savings and output growth. The HPAEs have not, however, used financial repression as a consistent and deliberate policy over time to secure resources to finance the budget or resource transfers to selected economic sectors. Financial repression has been used in selected periods, however, usually after an external shock, as in Korea. Korea averted a recessionary crisis in the early 1980s by sharply lowering real interest rates on deposits and loans---thus engineering a massive transfer of wealth from savers (mostly households) to borrowers (mostly firms). Because strict foreign exchange controls prevented households from converting their savings, households temporarily accepted negative real interest rates. The intervention lasted only from 1980 to 1982, when real interest rates became positive again.
The HPAEs' equity and bond markets were not responsible for the Asian miracle. The HPAEs nevertheless recognize the value of these markets.
The Asian stock market boom is a relatively recent phenomenon, however, and its takeoff in the late 1980s suggests that it is a result rather than a cause of East Asia's rapid growth.
The HPAEs all benefited from doing the fundamentals well---encouraging macroeconomic stability, basic education, sound and solvent financial institutions, secure property rights and complementary public investments in infrastructure, and low relative prices of investment goods. Efforts to improve the institutional framework for capital market development came later in the process and were not responsible for the takeoff. In some cases (as in Japan), well-functioning development banks were a positive but not a determining factor.
Drawn from World Bank, The East Asian Miracle: Economic Growth and Public Policy (New York: Oxford University Press, 1993). Prepared by a team led by John Page and comprising Nancy Birdsall, Ed Campos, W. Max Corden, Chang-Shik Kim, Howard Pack, Richard Sabot, Joseph Stiglitz, and Marilou Uy.