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1 Introduction
Timo Henckel1
For several decades, East Asia, with its rapid economic growth and continuous rise in living standards, has been the envy of the developing world. Commentators referred to the âAsian tigersâ and the âEast Asian miracleâ to signal just how exceptional the economic performance of the Asian high flyers has been.
The âmiracleâ was seriously called into question during and after the 1997â98 Asian financial crisis, which pushed numerous countries deep into recession and engendered a policy response that still reverberates today. While the crisis was undoubtedly severe, remarkably, most countries in the affected region rebounded swiftly and strongly. Nevertheless, the crisis revealed some ugly cracks in the economic and financial fabric of the affected countries, reflected, for example, in investment rates that have not fully recovered to the levels seen before the crisis.
During the 2008â09 global financial (and economic) crisis (GFC), eyes were again on East Asia to see what policy lessons had been learnt from the previous decade, how decoupled the region had become from the rest of the world, and how resilient these economies were in coping with external shocks such as the precipitous fall in international trade. Once again, East Asia held up well but remains vulnerable.
This volume brings together ten chapters, each one examining an important issue related to growth and development in East Asia. The authors, well-respected experts on the region's economies, turn over many stones in their quest to understand what made East Asia successful and what its remaining failures are. Their insights will prove invaluable to those with a keen interest in the region's economic fortunes. The second chapter, âOutward-looking growth strategies in East Asia: rationale and successâ recalls the driving force that led to the extraordinary economic success of East Asia since the 1970s: international trade. Trade barriers were removed, trade and export growth soared and living standards rose dramatically. The âEast Asian miracleâ serves as a potent example of what is possible when the right economic policies are adopted.
The author, Stephen Schwartz, distils three theoretical benefits of openness and outward orientation: enhanced competition, increased employment and a larger flow of technical knowledge. These benefits typically far outweigh the costs associated with free trade. A summary of the literature and a weighing-up of the evidence provide strong support to the theory. In most of East Asia, trade liberalization raised total factor productivity, reduced poverty and generated spillover effects on the overall economic reform process. While it is not a magic bullet, trade liberalization is a vital ingredient in a country's policy mix that allows its living standards to rise appreciably and sustainably.
The 1997â98 Asian financial crisis rattled the region and temporarily undermined confidence in the East Asian growth model. But in retrospect this episode serves only to further strengthen the case for a growth strategy that embraces openness. The remarkable feature of the Asian crisis was not how much the affected economies suffered during and after the crisis but how quickly they rebounded. The crisis taught another useful lesson, namely that rapid growth in production and trade needs to be buttressed by sound monetary and fiscal policy and a healthy, resilient financial sector.
That this lesson was learned is evident from the resilience with which East Asia was able to navigate through the 2008â09 global financial crisis. While East Asia did suffer from the drastic reduction in international trade flows that followed the tremors in the global financial markets, most countries were able to prevent serious, lasting economic downturns. This is testimony to the economic strength of the region and the increased wisdom of local policy-makers.
The political efforts to open East Asian economies to international trade have followed a multi-pronged approach. In some cases, multilateral negotiations were conducted but there has also been a proliferation of bilateral preferential trade agreements (PTAs). Schwartz argues that they have been, on balance, positive, leading to trade creation rather than diversion and acting as catalysts for broader integration. In the future, these PTAs will either have to become considerably more flexible and open or be succeeded by multilateral agreements if further gains from international trade are to be reaped.
The East Asian growth miracle did not visit every country in the region: some countries were unable to board the growth train. Identifying the reasons that prevented them from emulating their more successful neighbours is the task Ponciano Intal, Alfredo Poyal and Maricar Garde set themselves in Chapter 3, âFacilitating domestic investment and growthâ. The authors apply to their native country, the Philippines, the growth diagnostics suggested by Hausmann, Rodrik and Velasco (HRV) (Hausmann et al. 2005), a kind of troubleshooting manual for policy-makers. The HRV framework, following a sequential diagnostic tree, allows the authors to identify the binding constraints in an economy and to deliver a practical and efficient policy prescription based on this diagnosis.
The starting point for this diagnostic exercise is the observation that the Philippines, compared with its fast-growing neighbours, has been suffering from low levels of private investment. The key question is: What is responsible for these low investment levels? The diagnosis considers, in turn, weak financial markets, lack of human capital, excessive taxation, political uncertainty and weak institutions as causes for low investment. None of these do the trick. Instead, the authors identify as the main culprits instability of the macro-economy and the protracted fiscal crisis that began in the mid 1990s and ran through to the mid 2000s. A persistent decline in tax revenues meant that the debt-to-GDP ratio grew substantially and the cost of servicing this debt became prohibitive. A downgrading of its creditworthiness by the international rating agencies and a rise in risk premiums was the inevitable consequence, with the memory of the country's economy's collapse in 1983â85 still fresh.
Intal, Poyal and Garde emphasize that other factors, particularly political uncertainty and weak institutions, share responsibility for the Philippines' lacklustre growth record. Nevertheless, fiscal imprudence is the one feature that sets the Philippines apart from its fast-growing neighbours and, following the spirit of the HRV framework, this deficiency was the most pressing one. The Filipino government successfully consolidated the national budget and put the fiscal house in order. The economic statistics from the mid 2000s suggest that domestic and international investors rewarded this policy reversal.
The overall lesson from this study, one echoed in many other chapters of this volume, is that there is no off-the-shelf panacea for treating an economy's ills. Sustained growth depends on a host of factorsâgood governance, sound institutions, adequate human capital, reliable financial markets, prudent fiscal and monetary policyâand the key bottlenecks to investment and growth vary between countries and over time. It is, in the authors' words, âprobably not surprising that virtually all successful economies have followed largely heterodox economic policiesâ.
Chapter 4 changes tack and examines the extraordinary increase in trade flows that Asia has witnessed throughout the past 20 years. In âGlobal production networks in electronics and intra-Asian tradeâ, Byron Gangnes and Ari van Assche point out that growth in East Asia's intraregional trade is driven mostly by increased component trade within global electronics production networks, which expanded exponentially as communication and transportation costs shrank, electronic goods became more modular and production processes fragmented. While the expansion of global production networks has benefited all East Asian countries, development paths across countries have been uneven, giving possible cause for concern.
Using an extensive dataset, Gangnes and van Assche reveal a pattern of specialization in which upper- and middle-income countries produce sophisticated components while lower income countries assemble final goods with less value-adding. These patterns are not immutable, however, as countries move up the value chain. Within the electronics sector the newly industrialized economies, and to a lesser extent the countries of the Association of Southeast Asian Nations (ASEAN), are becoming more sophisticated.
The marked increase in intraregional trade might reflect an increase in East Asian autonomyâindeed, an increasing number of commentators have argued that Asia's fortunes are decoupling from the rest of the world'sâbut developing East Asian countries remain heavily dependent on developed-country markets. This was clearly visible during the 2008â09 global economic crisis when declining incomes in Western countries led to a stunning contraction of East Asia's exports.
The authors end with two important questions that call for further investigation into the complex web of trade interactions. First, what are the mechanisms through which countries are able to move up the value chain? Second, how sustainable are global production networks in the post-crisis era in light of rising transportation costs, weak final demand and the threat of trade and investment barriers?
Shujiro Urata, in âDynamic gains of trade and foreign direct investment in East Asiaâ (Chapter 5), provides a good overview of the extent to which foreign trade and foreign direct investment (FDI) have contributed to economic growth in East Asia. Foreign trade has been beneficial because the East Asian countries were able to sell to large foreign markets products for which they have a comparative advantage. FDI became increasingly important as a driver of growth, bringing numerous benefits, including funds for fixed investment, technology and management know-how.
The speed with which export-to-GDP ratios and FDI flows to East Asia grew was truly remarkable, as was the rapid change in patterns of FDI. Whereas initial FDI funds were largely sourced from Japan and other industrialized countries, FDI flows became increasingly intraregional. The changing sectoral patterns of FDI flows reveal that the share of the electronics industry as a proportion of total FDI has been increasing steadily.
Urata sees the increase in foreign trade and FDI as mutually reinforcing. He refers to a âtradeâFDI nexusâ. The main reason is the emergence of complex networks that allowed a fragmentation of the production of many goods, particularly personal computers and other consumer electronic goods. FDI transferred the necessary technological and managerial know-how to the host countries to enable them to specialize in one link of the production chain; this specialization then led to large trade flows of components. Production fragmentation may take place within a single firm that operates in several countries or across different firms. In both cases, technology transfer has been shown to increase the total factor productivity of the host country.
If East Asia wishes to expand trade and FDI further, the region needs to lower or remove the barriers that remain. Urata regards a region-wide free trade agreement as the key to maintaining high economic growth, but realizes that there exist formidable political constraints to the achievement of such.
The benefits of openness are by no means restricted to static gains from trade. Perhaps even more valuable are the (dynamic) gains derived from FDI. Such investment can fill existing investment-savings gaps by sourcing relatively stable capital from abroad and it creates substantial transfers of technological and managerial know-how from the multinational corporations to the host country.
These benefits are emphasized by Shandre Thangavelu, Yong Yik Wei and Aekapol Chongvilaivan in Chapter 6, âPost-crisis investment performance of ASEAN countries: importance of FDIâ. The authors argue that the region's competitiveness and strong export performance were a direct result of the FDI inflows, which generated knowledge spillovers in high-tech industries and allowed the beneficiaries to build upward and downward linkages within the complex global production network.
Thangavelu, Wei and Chongvilaivan ask if the 1997â98 Asian crisis has substantially and enduringly altered the incentives to invest in the region. Output growth in the ASEAN countries rebounded strongly after the crisis but it was more volatile and accompanied by growing budget deficits and higher unemployment. Much of the volatility can be attributed to external shocks such as the September 11 terrorist attacks and the SARS epidemic, but the rise in structural unemployment raises the question of whether the economies are able to keep up with the pace of technological change. A fall in FDI might explain a growing gap between the global technology frontier and the domestic level of technology.
Indeed, the authors find that average FDI flows into Southeast Asia, as a proportion of global FDI flows, dropped from 7.66 per cent to 2.92 per cent during 1999â2005. Flows into East Asia also fell in the same period, while South Asia experienced a slight increase.
Regression analysis based on a panel of five ASEAN and four East Asian countries offers some formal evidence on the importance of FDI for economic growth and on the possible consequences of the 1997â98 Asian crisis. Growth in FDI inflows is clearly associated with growth in output. Unsurprisingly, output growth suffered after the Asian crisis. What is less obvious is that this slowdown can be attributed, at least in part, to the pronounced drop in FDI inflows that followed the crisis. Thangavelu, Wei and Chongvilaivan conclude that the decline in FDI may have induced further structural shifts in the host countries' fundamentals that lessened their productive capacity.
According to the authors, the declining share of FDI flows into Southeast Asia raises several serious concerns; in particular, whether large FDI flows are necessary to maintain economic growth in the region. For the authors, FDI remains an important driving force for growth, and Asian governments should continue to adopt policies that raise the incentives for multinational corporations to invest in their countries.
One pillar of this pro-growth policy mix is infrastructure investment, a theme taken up in Chapter 7, âInfrastructure investment in East Asia: learning from crisisâ, by Hongjoo Hahm, John Holdaway and William Wallace. The chapter offers some background information and statistics in support of the well-established link between infrastructure investment and economic growth and poverty reduction. The authors review the patterns of infrastructure provision in East Asia before and after the Asian financial crisis and discuss whether the current investment model is appropriate for the region following the global financial crisis.
Rapid rates of growth, urbanization and decentralization strain the existing infrastructure, and the perception among many business people in the region is that the level and quality of infrastructure is not keeping pace with economic growth. The demographic, socio-economic, geographic and cultural changes that developing countries are undergoing demand a different kind of infrastructure, with different modes of planning, financing and delivery. For example, decentralized decision-making and implementation of investment would probably deliver efficiency gains. And the funds to fill the infrastructure gap need to come from a variety of sources, including higher usage charges, more public spending, international capital markets and deeper, more sophisticated domestic capital markets.
The challenge is for each country to find its own best policy mix. Times have changed and what worked well for the region's leading countries 20 years ago may not be appropriate for the laggards. The Asian and global financial crises provide some important lessons that Hahm, Holdaway and Wallace draw on to offer the following recommendations to the region's policy-makers:
- Recognize infrastructure expenditure as a top priority for growth.
- Improve planning and coordination.
- Ensure value for money in public infrastructure expenditures by reducing poorly targeted subsidies.
- Continue to promote good governance through transparent regulatory frameworks, healthy competition and civil society oversight.
These recommendations, which developed countries should also heed, require foresight, long-term planning and sensitivity towards the everchanging socio-economic landscape. According to the authors, the most significant change in the landscape is the âenhanced civil society oversight given East Asiaâs embrace of the information age. The citizens of East Asia are demanding accountability and transparencyâ, meaning that the centralized nanny state will have to give way to the agile, decentralized âservice stateâ. The resilience with which the East Asian countries weathered the storm of the 2007â08 global financial crisis gives reason for hope that this ambitious transition is achievable.
Hahm, Holdaway and Wallace are, of course, aware that large public infrastructure projects can seriously jeopardize a country's fiscal position. In â(Some) fiscal priorities for developmentâ, the chapter following theirs, Richard Hemming and Greetje Everaert highlight the benefits of fiscal discipline and discuss the difficulties of achieving it. They, like the previous authors, acknowledge that there is a pressing need to increase public infrastructure investment in the Asia...
