The three stages of industrialization

These three stages of industrialization are evident in the paths traced by Taiwan and South Korea. (See Table 7.3.) In Taiwan, industrialization fo- cused initially on light manufacturing, textiles in particular. By the mid-1950s, textiles were Taiwan’s most important export. The government also encour- aged production of simple consumer durable goods such as television sets. In the late 1950s, the Taiwanese government began to emphasize heavy indus- tries. A joint venture between several Taiwanese firms and an American firm was formed in 1954 to produce synthetic fibers (Wade 1990, 80). In 1957, a plant to produce polyvinyl chloride was constructed under government su- pervision and then was handed to a private entrepreneur, Y. C. Wang (Wade 1990, 79). The government created state-owned enterprises in the steel, ship- building, and petrochemical industries. During the 1970s, attention shifted to skill-intensive industries, with particular emphasis on machine tools, semicon- ductors, computers, telecommunications, robotics, and biotechnology (Wade 1990, 94). By the mid-1980s, electrical and electronic goods had replaced textiles as Taiwan’s largest export (Wade 1990, 93).

The South Korean government adopted similar policies (Amsden 1989). In the 1950s, the government emphasized textile production, and textiles be- came South Korea’s first important manufacturing export. During the late 1960s, the South Korean state initiated the development of the chemical and heavy-machinery industries. It created the Pohang Iron and Steel Company, known as POSCO, which subsequently became one of the world’s leading



142 CHAPTER 7 Trade and Development II: Economic Reform

steel producers. The government also provided extensive support to Hyundai Heavy Industry, a shipbuilder that subsequently became a world leader in this industry. Then in the late 1970s, the South Korean government began to give priority to skill- and R&D-intensive sectors, and it is during this period that the South Korean electronics and automobile industries began to emerge (Amsden 1989).

In the East Asian model of development therefore, government policy drives industrialization from low-skilled, labor-intensive production to capital-intensive forms of production and from there to industries that rely on high-skilled labor and technology-intensive production. Each stage is associ- ated with particular types of government policies, and as each stage reaches the limits of rapid growth, emphasis shifts to the next stage in the sequence (Wade 1994, 71). Moreover, at each stage, governments stress the need to develop internationally competitive industries.

East Asian governments relied heavily on industrial policies. They used industrial policy to achieve four policy goals: reduce the cost of invest- ment funds in targeted industries, create incentives to export, protect infant


Stages of Industrialization in Taiwan and South Korea, 1880–1968

Commodity Exports

1880–1930 Primary ISI * 1930–1955

Primary Export- Oriented Industries


Main Industries

Taiwan: Sugar, rice

South Korea: Rice, beans

Taiwan and South Korea: Food, beverages, tobacco, textiles, clothing, cement, light manufactures (wood, leather, rubber, and paper products)

Taiwan and South Korea: Textiles and apparel, electronics, plywood, plastics (Taiwan), wigs (South Korea), intermediate goods (chemicals, petroleum, paper, and steel products)

Major Economic Actors

Taiwan and South Korea: Local producers (colonial Japan)

Taiwan and South Korea: Private national firms

Taiwan and South Korea: National private firms, multinational corporations, state- owned enterprises

Orientation of the Economy

External markets Internal market External markets

*ISI, import substitution industrialization. Source: Gereffi 1990, 19.



The East Asian Model 143

industries, and promote the acquisition and application of skills. Taiwan and South Korea created incentives to invest in industries that state officials identi- fied as critical to development. To do so, governments in both countries pro- vided firms investing in these industries with preferential access to low-cost credit. In South Korea, the government nationalized the banks in the early 1960s and in the ensuing years fully controlled investment capital. Control of the banks allowed the government to provide targeted sectors with access to long-term investment capital at below-market rates of interest (Haggard 1990, 132). Although the banking sector was not nationalized in Taiwan, the gov- ernment did influence banks’ lending decisions. During the 1960s, banks were provided with government-formulated lists of industries that were to receive preferential access to bank loans. During the 1970s, the banks themselves were required to select five or six industries to target in the coming year. As a result, about 75 percent of investment capital was channeled to the govern- ment’s targeted industries (Wade 1990, 166).

Asian governments also implemented policies that encouraged exports. One method linked access to investment funds at low interest rates to export performance. In Taiwan, for example, firms that exported paid interest rates of only 6–12 percent, whereas other borrowers paid 20–22 percent (Haggard 1990, 94). In South Korea, short-term loans were extended “without limit” to firms with confirmed export orders (Haggard 1990, 65). Credit was also made available to exporters’ input suppliers and to these suppliers’ suppliers (Haggard 1990, 65–66). In addition, “deliberately undervalued exchange rates” improved the competitiveness of exports in international markets (World Bank 1993, 125). Finally, a variety of measures ensured that domestic firms could purchase their intermediate inputs at world prices. These measures often entailed the creation of free-trade zones and export-processing zones— areas of the country into which intermediate goods could be imported duty free as long as the finished goods were exported. Export-processing zones al- lowed domestic producers to avoid paying tariff duties that would raise the final cost of the goods they produced.

The Taiwanese and South Korean governments also protected infant indus- tries at each stage. In some instances, the measures they used were straightfor- ward forms of protection. The South Korean government, for example, enacted legislation in 1983 that “prohibited the import of most microcomputers, some minicomputers, and selected models of disk drives,” in order to protect domestic producers in the computer industry (Amsden 1989, 82). POSCO ini- tially produced steel behind high import barriers. In other instances, protection was less transparent. Hyundai Heavy Industry, for instance, was protected in part through a government policy that required Korean oil imports to be car- ried in ships operated by a merchant marine that Hyundai Heavy Industry had itself created (Amsden 1989, 273). Taiwan adopted similar policies.

Finally, the Taiwanese and South Korean governments put in place policies that raised skill levels. Investments in education were made to improve labor skills. In Taiwan, enrollment in secondary schools had reached 75 percent of the eligible age group by 1980. Enrollment increases were accompanied by



144 CHAPTER 7 Trade and Development II: Economic Reform

rising expenditures on education; per pupil expenditures increased eightfold in primary schools, threefold in secondary schools, and twofold at the university level between the early 1960s and 1980s (Liu 1992, 369). Similar patterns are evident in South Korea, where enrollment in secondary schools increased from 35 percent in 1965 to 88 percent in 1987 and “real expenditures per pupil at the primary level rose by 355 percent” (World Bank 1993, 43, 45).

Governments also invested in scientific infrastructure to facilitate the application of skills to R&D activities. In Taiwan, the Industrial Technology Research Institute was formed in 1973, and nonprofit organizations were created during the 1970s to perform research and disseminate the results to firms in the private sector. A science-based industrial park designed to realize agglomeration effects was created in 1980 (Haggard 1990, 142). In South Korea, tax incentives were used to induce chaebols, the large South Korean firms, to create laboratories for R&D purposes. An industrial estate for computer and semiconductor production was created, and the Electronics and Telecommunications Research Institute, a government-funded institute oriented toward product development was formed in the industrial estate (Amsden 1989, 82). These policies raised skill levels and created an infrastructure that allowed the more highly skilled labor force to work to its full potential. This skill upgrading was critical to the transition to the third stage of the industrialization process.

The two explanations discussed thus present different arguments for East Asia’s success. One suggests that East Asia succeeded because governments allowed markets to work. The other suggests that East Asia succeeded be- cause governments used industrial policy to promote economic outcomes that the market could not produce. Which argument is correct? Although we lack definitive answers, we may conclude that both explanations have value. By “getting prices right,” the export orientation and the stable macroeconomic environment encouraged investments in industries in which East Asian coun- tries had or could develop comparative advantage. By targeting sectors where comparative advantage could be created, by reducing the costs of firms oper- ating in those sectors, by encouraging firms to export, and by upgrading skills, industrial policy encouraged investments in areas that could yield high returns. As Stephan Haggard (1990, 67) has summarized, macroeconomic “and trade policies established a permissive framework for the realization of comparative advantage, and more targeted policies pushed firms to exploit it.”

Although the relative importance of the state and the market in account- ing for East Asia’s success remains in dispute, what is clear is that the experi- ence of the East Asian NICs was vastly different from the experience of Latin America and sub-Saharan Africa. East Asian governments adopted develop- ment strategies that emphasized exports rather than the domestic market, and they realized substantial improvements in per capita income. The development strategies adopted by governments in other developing countries emphasized the domestic market over exports and generated economic imbalances and modest improvements in per capita incomes. Consequently, when economic crises forced governments to adopt reforms, the East Asian example provided a powerful guide for the kind of reforms that would be implemented.

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