How Asia Works

1. Land reform and household farming drive initial agricultural productivity

Household farming was the archetypal land reform success story.

Maximizing agricultural output. In poor countries, where the majority of the population is employed in agriculture, land reform that promotes small-scale, labor-intensive household farming can dramatically increase productivity. This approach, which resembles large-scale gardening, makes use of all available labor and pushes up yields to the highest possible levels.

Historical examples. Japan, South Korea, and Taiwan implemented successful land reforms after World War II, redistributing land to small farmers and providing support through agricultural extension services, credit, and marketing assistance. This led to rapid increases in agricultural output, creating a surplus that primed demand for goods and services and supported overall economic transformation.

• Key elements of successful land reform:
  • Equitable distribution of land to farming families
  • Government support through extension services and infrastructure
  • Focus on maximizing yields rather than profits per hectare
  • Creation of rural markets for manufactured goods

2. Export-oriented manufacturing is key to rapid economic development

Export discipline was Korea's financial get-out-of-jail card.

Manufacturing and trade. The quickest path to economic development for poor countries is through export-oriented manufacturing. This allows countries to leverage their abundant, low-cost labor while acquiring technological skills and accessing global markets.

Export discipline. Successful East Asian countries implemented policies that forced domestic manufacturers to compete globally. This "export discipline" provided a clear benchmark for success and pushed companies to continuously improve their products and processes. Governments used various tools to encourage exports:

• Subsidies and protection for infant industries
• Access to credit tied to export performance
• Creation of export-oriented industrial zones
• Support for technological acquisition and upgrading

By focusing on exports, countries like Japan, South Korea, and Taiwan were able to rapidly increase their manufacturing capabilities and move up the value chain, producing increasingly sophisticated goods over time.

3. Financial policies must support agricultural and industrial objectives

The state never stops disciplining companies by providing the moral framework in which they operate – whether in the more dirigiste or more free market phase of economic development.

Aligned financial system. Successful developing countries ensure their financial systems support key development objectives in agriculture and manufacturing. This often involves:

• Maintaining capital controls to prevent disruptive international capital flows
• Directing bank lending towards priority sectors and export-oriented firms
• Limiting consumer lending and speculative investments
• Keeping interest rates low to support industrial investment

Developmental finance. The financial system in developing countries should prioritize long-term technological learning over short-term profitability. This may involve sacrificing some financial sector efficiency in the short term to achieve broader developmental gains.

• Examples of developmental finance policies:
  • State-owned or state-directed banks
  • Preferential lending rates for priority sectors
  • Restrictions on capital outflows
  • Limited development of stock markets and other speculative financial instruments

4. Government direction of entrepreneurs is crucial for technological upgrading

Rents are the bait with which the successful developing state catches and controls its entrepreneurs.

State-led industrialization. Successful developing countries actively shape the behavior of private entrepreneurs to align with national development goals. This involves creating incentives and pressures for businesses to invest in technological upgrading and compete internationally.

Tools for directing entrepreneurs:

• Selective protection of domestic markets
• Subsidies tied to export performance
• Access to credit and foreign exchange based on meeting development targets
• Creation of state-owned enterprises in strategic sectors
• Forced mergers or restructuring of underperforming firms

Balancing act. Governments must strike a balance between supporting domestic firms and exposing them to international competition. Too much protection can lead to inefficiency, while too little support can prevent firms from developing the capabilities needed to compete globally.

5. Premature financial deregulation hinders economic development

The case for deregulation strengthens as an economy evolves, but the risks of premature deregulation are greater than those of tardy deregulation, especially in our world of globalised financial flows.

Dangers of early liberalization. Many developing countries, particularly in Southeast Asia, liberalized their financial sectors too early under pressure from international institutions like the IMF and World Bank. This led to:

• Increased speculative investments, especially in real estate
• Greater vulnerability to international capital flows
• Reduced ability to direct credit towards productive sectors
• Financial crises, as seen in the 1997 Asian Financial Crisis

Gradual approach. Successful countries like Japan, South Korea, and Taiwan maintained tight control over their financial systems until they had achieved substantial industrial development. They only gradually liberalized as their economies matured and domestic firms became internationally competitive.

• Key aspects of financial control:
  • Restrictions on international capital flows
  • State influence over bank lending decisions
  • Limited development of stock markets and other speculative financial instruments
  • Gradual liberalization only after achieving industrial competitiveness

6. North-East Asian countries succeeded through effective development policies

North-east Asian states gave themselves the best possible start in their economic development by the attention they paid to agriculture.

Comprehensive strategy. Japan, South Korea, and Taiwan implemented a coherent set of policies that supported rapid economic development:

1. Land reform and support for small-scale farming
2. Export-oriented industrialization with state support and guidance
3. Financial policies aligned with development objectives
4. Gradual liberalization only after achieving industrial competitiveness

Results. These policies led to:

• Rapid increases in agricultural productivity
• Development of world-class manufacturing industries
• High rates of economic growth sustained over decades
• Relatively equitable distribution of economic gains

Key factors:

• Strong, developmentally-oriented states
• Willingness to go against prevailing economic orthodoxy
• Focus on technological learning and upgrading
• Effective use of both market forces and state intervention

7. South-East Asian countries struggled due to misguided economic strategies

Finance bulks up

Policy failures. Countries like the Philippines, Indonesia, Malaysia, and Thailand failed to implement effective development policies, leading to slower and less equitable growth:

• Incomplete or ineffective land reform
• Lack of export discipline for domestic manufacturers
• Premature financial liberalization
• Overreliance on foreign direct investment without developing domestic capabilities

Consequences:

• Persistent rural poverty and inequality
• Limited development of domestic manufacturing capabilities
• Vulnerability to financial crises and external shocks
• Slower overall economic growth compared to Northeast Asian countries

Missed opportunities. Despite abundant natural resources and favorable initial conditions, Southeast Asian countries failed to achieve the rapid, sustained economic development seen in Northeast Asia due to policy missteps and the influence of entrenched elites.

8. China's development combines elements of both success and potential pitfalls

China can be benchmarked against the three basic structural insights brought about by economic development elsewhere in the region.

Mixed approach. China's development strategy since 1978 has incorporated elements of both successful Northeast Asian policies and potentially problematic Southeast Asian approaches:

Successes:

• Return to household farming in the 1980s, leading to rapid agricultural productivity growth
• Focus on export-oriented manufacturing and technological upgrading
• Maintenance of capital controls and state direction of the financial system

Potential issues:

• Growing rural-urban inequality and land insecurity for farmers
• Dominance of state-owned enterprises in key sectors
• Limited support for private sector manufacturing firms

Future challenges. China's continued development will depend on its ability to:

1. Address growing rural-urban disparities
2. Foster innovation and upgrading in private sector firms
3. Manage the transition to a more market-oriented economy without losing developmental focus
4. Navigate international pressures for faster liberalization and market opening

The outcome of these challenges will determine whether China can fully join the ranks of developed economies or face the "middle-income trap" experienced by many Southeast Asian countries.

Last updated: October 1, 2024