Facing economic imbalances

Facing economic imbalances, unable and unwilling to change policy, many governments sustained ISI by borrowing from abroad. Yet foreign loans could provide only a temporary solution; foreign lenders would eventually question whether loans could be repaid. When they concluded that they couldn’t, they would be unwilling to lend more, and governments would be forced to cor- rect budget and current-account deficits. This point arrived in the early 1980s and ushered in a period of crisis and reform. Before we examine this period, however, we must look at economic developments in East Asia, as these devel- opments played a critical role in shaping the content of the reforms adopted throughout the developing world after 1985.

THE EAST ASIAN MODEL Whereas ISI was generating imbalances in Latin America and sub-Saharan Africa, four East Asian economies—Hong Kong, Singapore, South Korea, and Taiwan—were realizing dramatic gains on the basis of a very different devel- opment strategy. The dramatic performance gap is evident in three economic indicators. (See Table 7.1.)

� Per capita income in East Asia grew almost three times faster than in Latin America and South Asia and more than twenty-six times higher than in sub-Saharan Africa.

� Manufacturing output grew by 10.3 percent per year between 1965 and 1990. No other developing country came close to this growth for the period as a whole

� Exports from East Asia grew 8.5 percent per year between 1965 and 1990 while exports from Latin America shrank by 1 percent per year.

As a consequence, manufacturing grew in importance in East Asia, while the importance of agriculture diminished. This differed substantially from ISI countries, where agriculture’s importance fell but manufacturing failed to grow. (See Table 6.1.) The growing manufacturing sector transformed the composition of East Asia’s exports. (See Table 6.2.) By the mid-1990s, manu- factured goods accounted for more than 80 percent of East Asian exports. By contrast, only in Brazil, Mexico, India, and Pakistan did manufactured goods account for more than 50 percent of total exports by the 1990s, and most of these gains were realized after 1980. Finally, per capita incomes in East



138 CHAPTER 7 Trade and Development II: Economic Reform


Comparative Economic Performance, Selected Developing Countries (Average Annual Rates of Change)*

1965–1990 1985–1995

Growth of per Capita GNP East Asia and the Pacific 5.3 7.2 Sub-Saharan Africa 0.2 1.1 South Asia 1.9 2.9 Latin America and the Caribbean 1.8 0.3 Growth of Manufacturing East Asia and the Pacific 10.3 15.0 Sub-Saharan Africa n.a. 0.2 South Asia 4.5 5.3 Latin America and the Caribbean 8.3 2.5 Growth of Exports East Asia and the Pacific 8.5 9.3 Sub-Saharan Africa 6.1 0.9 South Asia 1.8 6.6 Latin America and the Caribbean 2.1 5.2

*n.a., not available; GNP, gross national product. Source: World Bank, World Development Report, various issues.

Asia soared above those in other developing countries ( Table 7.2). In 1960, per capita incomes in East Asia were lower than per capita incomes in Latin America; by 1990, East Asian incomes were higher than—in some cases twice as large as—per capita incomes in Latin America.

Why did East Asian countries outperform other developing countries by such a large margin? Most who study East Asian development agree that the countries in the region distinguished themselves from other developing coun- tries by pursuing export-oriented development. In an export-oriented strat- egy, emphasis is placed on producing manufactured goods that can be sold in international markets. Scholars disagree about the relative importance of the market and the state in creating export-oriented industries. One position, the neoliberal interpretation, is articulated most forcefully by the IMF and the World Bank. This thesis argues that East Asia’s success was a consequence of market-friendly development strategies. In contrast, the state-oriented inter- pretation, advanced by many specialists in East Asian political economy ar- gues that East Asia’s success is due in large part to state-led industrial policies.

The IMF and the World Bank contend that East Asia’s economic success derived from the adoption of a neoliberal approach to development. This in- terpretation places particular emphasis on the willingness of East Asian gov- ernments to embrace of international markets and their ability to maintain



The East Asian Model 139


Gross National Product per Capita, Selected Developing Countries (1996 U.S. Dollars)

1960 1990 2000 Percent Change 1960–2000

Hong Kong 3,090 20,827 26,699 764 Singapore 2,161 17,933 24,939* 1,054 Taiwan 1,430 10,981 17,056** 1,093 South Korea 1,495 9,952 15,876 962 Mexico 3,980 7,334 8,762 120 Malaysia 2,119 6,525 9,919 368 Argentina 7,371 7,219 11,006 49 Chile 3,853 6,148 9,926 158 Brazil 2,371 6,218 7,190 203 Thailand 1,091 4,833 6,857 528 Zaire/Congo 980 572 281*** – 71 Indonesia 936 2,851 3,642 289 Pakistan 633 1,747 2,008 217 India 847 1,675 2,479 193 Nigeria 1,033 1,095 707 – 32 Kenya 796 1,336 1,244 56 Zambia 1,207 1,021 892 – 26 Tanzania 382 494 482 26

*Data for 1996; **data for 1998; ***data for 1997. Source: Penn World Tables.

stable macroeconomic environments. (See World Bank 1989, 1991, 1993; Little 1982; Lal 1983; for critiques, see Toye 1994 and Rodrik 1999.) Most East Asian governments adopted ISI strategies in the immediate postwar period. Unlike governments in Latin America and Africa, however, East Asian governments shifted to export-oriented substitution once they had exhausted the gains from easy ISI. In Taiwan, for example, the government shifted in 1958 from production for the domestic market to a strategy that emphasized production for export markets. South Korea adopted similar reforms in the early 1960s. A second wave of newly industrializing countries (NICs)—a group that includes Indonesia, Malaysia, and Thailand—followed the same path starting in the late 1960s (World Bank 1993). The emphasis on exports forced Asian manufacturing firms to worry about international competitive- ness. As a result, the World Bank and the IMF argue, Asian societies invested their resources in domestic industries profitable in world markets.

The shift to export-oriented strategies was followed by selective import liberalization. Asian governments did not engage in wholesale import liber- alization. The Taiwanese and South Korean governments continued to rely heavily on tariff and nontariff barriers to protect domestic markets. In Taiwan,



140 CHAPTER 7 Trade and Development II: Economic Reform

for example, approximately two-thirds of imports were subject to some form of tariff or nontariff barrier greater than 30 percent, and as late as 1980 more than 40 percent of imports faced protection greater than 30 percent (World Bank 1993, 297). A similar pattern appeared in South Korea, where, as late as 1983, “most sectors were still protected by some combination of tariffs and nontariff barriers” (World Bank 1993, 297). However, selective liberalization helped promote exports by reducing the cost of critical inputs. Reducing tar- iffs on key intermediate goods, such as looms and yarn in the textile industry, enabled domestic producers to acquire inputs at world prices. This kept ex- ports competitive in international markets.

East Asian governments also maintained stable macroeconomic environ- ments. Three elements of the macroeconomic environment were particularly important. First, inflation was much lower in East Asia than in other devel- oping countries. Between 1961 and 1991, inflation averaged only 7.5 percent in the East Asian economies. By contrast, annual inflation rates in the rest of the developing world averaged 62 percent (World Bank 1993, 110). Second, because governments kept inflation under control, they could maintain appro- priately valued exchange rates. In many developing countries, high inflation caused the domestic currency to rise in value against foreign currencies, making exporting difficult. In the East Asian countries, by contrast, governments were able to maintain exchange rates that allowed domestic firms to remain compet- itive in foreign markets. Third, East Asian governments pursued relatively con- servative fiscal policies. They borrowed little, and when they did borrow, they tapped domestic savings rather than turning to international financial markets. This approach was in stark contrast to Latin American governments, which ac- cumulated large public-sector deficits financed with foreign capital.

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