Why East Asian countries have fared better than other LDCs
Developing market economies of East Asia have survived the turbulent international decade since the 1973 oil price increase better than most other developing countries. Nevertheless, the deep international recession of 1982-83, the steep rise in international interest rates, and the further increase in energy prices after 1979 have hit many economies in the region extremely hard. For the group as a whole, GDP growth declined to less than 5 percent per annum during 1980-83. But its average of 7 percent over the past decade was still markedly better than the 4 percent average annual growth achieved by all developing countries. Even though the external debt burden has increased in East Asia, the increases have been less than elsewhere and borrowing capacity will be generally less of a constraint on future growth.
During the last two decades most East Asian countries have experienced outstanding social and economic progress. GNP per capita growth during 1960-82 was distinctly above average, except in the Philippines. At the same time, food supplies have improved, and the incidence of absolute poverty has fallen in almost all countries. Impressive gains in welfare, measured by increased life expectancy, reduced infant mortality rates, and higher adult literacy rates, have been made. Finally, East Asian countries have been relatively more successful in transforming the structure of their economies, in developing human capital, and building up institutions.
The seeds of this successful adjustment can be traced to the very policies that promoted rapid growth in the 1960s. This article discusses these policies in the large market economies of East Asia (Indonesia, Korea, Malaysia, the Philippines, and Thailand), outlines the external shocks they have faced, and analyzes their generally successful pursuit of economic adjustment.
Factors in rapid growth
Development results from the complex interaction of a number of historical, political, cultural, economic, and social factors and is unique to each country. However, there are a number of common elements in the dynamic growth of the East Asian economies. First and most important is political continuity and generally strong government commitment to development; second is their strong emphasis on education; third, their export orientation; fourth, their concern with agriculture; and, fifth, their mobilization of large volumes of domestic and foreign savings. These have been associated with a pragmatic economic management that has relied considerably on market forces, used selective and relatively effective state interventions, and has been flexible and, on the whole, responsive to changing international conditions. Finally, knowledgeable and sustained technocratic leadership has been available to design and implement desired economic policies.
There has, of course, been considerable diversity among the countries in terms of the speed and level of their development and the effectiveness of their policies. Some of the current economic difficulties being faced by the Philippines, for instance, are due not only to political factors and a very difficult international economic environment but also to less-than-firm economic management under which resource mobilization needs have been neglected, consumption growth maintained notwithstanding a sharp deterioration in terms of trade, and a growing investment program financed by relatively short-term borrowing. Still in the overall perspective of developing countries and in terms of macro-economic indicators, the performance of the Philippines during the last decade has been, if anything, somewhat above average.
Foreign trade orientation
Almost all East Asian economies have been more open than either an average middle-income country or a typical industrial market economy, and the rapid growth of their foreign trade sectors is perhaps the most well-known feature of their development. Many factors have contributed to this vigorous export expansion, but the growth in their manufactured exports has emerged as the most dynamic, and will crucially influence whether or not exports will continue to grow faster than national product. The outstanding success of Korea in exporting manufactured goods is recognized. But exports of manufactured goods from the Philippines, Malaysia, and Thailand have also risen—at rates averaging 20-30 percent per annum for a decade. Even in Malaysia, where exports of petroleum, timber, rubber, and palm oil have also risen dramatically, manufactured exports have accounted for over 35 percent of incremental export earnings over the past decade. As a result, the structure of exports has undergone a major change in all these countries.
In expanding their exports of manufactured goods, the East Asian countries have taken advantage, first of all, of favorable international developments. World economic activity has shown sustained growth during the last two decades, and world trade has grown substantially faster than output, greatly facilitated by liberalization in the industrial countries. In addition, these countries have been able to increase their market share by export promotion policies—such as the maintenance of realistic exchange rates, the avoidance of discrimination against exports, or the compensation of exporters for a bias in favor of domestic industry.
These countries have also benefited from wider markets and technology transfer. International trade has been an important source of information on new products, new designs, and new production processes. For capital-scarce countries, the concentration on labor-intensive manufactured exports with low capital/output ratios has provided important opportunities for maximizing output and employment per unit of investment. Finally, the discipline of international markets has been generally beneficial for economic policies.
Although manufacturing has clearly been the leading sector, the contribution made by high agricultural growth in these countries—sustaining overall growth, direct and indirect job creation, strengthening the balance of payments, and poverty alleviation—is not fully appreciated. The home market for manufactured goods has been crucial, and the rate of growth of agricultural production and incomes has been an important determinant of the rate of expansion of this market.
The agricultural performance of many East Asian countries has been truly outstanding. Over the last two decades, agriculture in Korea and Indonesia has grown by almost 4 percent per annum. In Malaysia, the Philippines, and Thailand, annual growth rates have been close to 5 percent. Increased irrigation, improved crop varieties, and greater use of fertilizer have typically been the most important sources of agricultural growth. Government agricultural programs and policies, emphasizing incentives and investments, have in most cases combined with responsive and dynamic private sectors to offset the effect of increasing population pressure on land resources.
Crop diversification (as in Thailand, Malaysia, and the Philippines) and improved productivity in existing crops in response to less favorable price prospects (like rubber in Malaysia) have been vital for sustaining agricultural growth. This needed policies that permitted output to adjust relatively quickly to shifting comparative advantage and new economic opportunities.
The surge in investments, which resulted in a tremendous expansion of physical and social infrastructure and human and industrial capital has, on the one hand, fueled the high GNP growth rates and, on the other, has itself been financed by rapidly rising incomes. Whereas in developing countries as a whole, the investment rate as a percentage of GNP rose from around 20 percent in 1960 to 24 percent in 1982, the corresponding increase in the market economies of East Asia was from 12 to 27 percent. Foreign capital inflows have been an important source of financing, but 80-85 percent of gross investment in recent years has been met from domestic savings. Typically, at least a quarter of the incomes arising out of the growth process have been saved. The most dramatic rises in domestic saving rates have been in Korea (from 1 to 22 percent between 1960 and 1982) and in Indonesia (8 to 23 percent). Maintenance of attractive returns to savers through positive real interest rates, developed financial institutions, and attractive opportunities for private investment have been among the factors responsible for the excellent record of domestic resource mobilization.
|Middle income countries||3.61||5.41||3.02||6.52||2.62||12.82|
Role of economic policies
In the final analysis, the huge success of these countries is the result of effective economic policies. By and large, they have placed considerable reliance on market forces. This has two aspects. First, the state enterprise sector is, and has remained, relatively small, and has been largely confined to energy-related activities. Second, price distortions have been relatively limited.
In developing countries, there is a growing body of evidence on the benefits of using prices to reflect scarcities and encourage growth. The issue of price distortions has been widely researched and was a special focus of the World Bank’s 1983 World Development Report. Thailand, Korea, Malaysia, and, somewhat surprisingly, the Philippines were among the relatively few countries where key economic prices (the exchange rate, wages, interest rates, and power rates) were not too out of line with opportunity costs, where protection of manufacturing or export taxation on agriculture was generally moderate, and where inflation was kept within limits. These countries were notable for keeping exchange rates competitive, which contributed significantly to their export success.
While prices do matter for growth, the Bank’s analysis suggested that price distortions explained only a part of the variation in growth performance among countries in the 1970s. The rest was the result of other economic, social, political, and institutional factors. It is not the absence of state interventions but rather the selectivity and effectiveness of their use that distinguished the market economies of East Asia from many other developing countries. The strong policy and investment support provided for agricultural systems, human resource development, and export zones was the key factor in accelerated economic development. In Korea, the Government was also successful, at least until the mid-1970s, in encouraging the development of heavy industries such as shipbuilding, and it has provided an important stimulus for technology-based development by promoting research and development institutions.
Macroeconomic management in East Asia has also been characterized by (1) a basic stability and predictability of major policies; (2) given these, a high degree of policy flexibility and a quick responsiveness to changing economic circumstances; and (3) very close attention to the integration of economic policies, leading to a considerable cohesion in overall development strategies. These, in turn, have been influenced by continuity of political and economic leadership.
These factors have enabled East Asia to cope with a series of external shocks since 1973 relatively well. The 1973 oil price increase meant a loss of GNP of 5.8 percent, 4.4 percent, and 3.4 percent, respectively, for Korea, Thailand, and the Philippines, the three major oil importing developing countries in the region. New oil price increases during 1979-80 added a further burden—ranging from 6 percent of GNP in Korea to 3.7 percent in the Philippines—to the balance of payments. For all three countries, the additional rise in oil prices in 1979 came at a time of weakening international demand for their exports, and—for all countries except Korea—of a sharp deterioration in the non-oil commodity terms of trade. Last but not least, real interest rates shot up sharply in 1981-83, as nominal interest rates rose and international inflation declined; these imposed an additional debt burden of 3 percent of GNP per annum in Korea and around 2 percent in the Philippines.
Indonesia has been faced with an adjustment problem of a different kind. Higher oil prices after 1973 meant a gain of 9 percent of GNP over 1973-75; from 1978-80, the terms of trade gain, arising mainly out of higher oil prices, was equivalent to 14 percent of GNP. But since 1981 net oil and gas revenues, after an increase of over $6 billion between 1978 and 1980, fell by $4 billion in 1983 and will rise very little during 1984 and 1985. Malaysia, which has an export-to-GNP ratio of over 50 percent, has witnessed great instability in exports, whose purchasing power expanded at an average annual rate of 9 percent during 1973-80 but dropped by 6 percent per annum during 1980-82. The reduction in the real value of exports amounted to a decline in GNP of over 10 percent over the three-year period.
These huge swings were a consequence of openness, and reflected the recent great volatility in the international prices of raw materials and energy and in interest rates. In contrast, industrial countries suffered a loss of 2 percent of GNP with each of the oil shocks. The surprise is not that growth in these East Asian countries slowed to 3 percent per annum during 1982-83, but that it continued at all. The great resilience of their economies in the face of sudden and unexpected changes can be traced to their determined pursuit of structural adjustment policies related to energy prices and production, investment, and exports over the last decade.
Energy. Korea, Thailand, and the Philippines are heavily dependent on imported oil; in 1980, energy imports accounted for the great bulk of their commercial energy consumption and for about one third of total imports in each. Before 1973, dependence on imported energy was growing rapidly. It is hardly surprising, therefore, that the fivefold rise in real petroleum prices during the last decade has entailed major domestic adjustments in these countries. Reducing dependence on imported energy is now an important objective of national policy in all three countries, and reduced dependence on imported oil a secondary objective. To achieve these, actions have been taken to reduce the growth of demand, increase the supply of domestic energy, and diversify the sources of energy imports.
Considerable progress has already been made, especially since 1979. The volume of oil imports has decreased somewhat during the last few years, only partly because of the overall economic slowdown. Pricing policies, particularly in Korea and the Philippines, have been the most powerful instrument in reducing domestic demand for energy. In Indonesia, where domestic oil prices have historically been low, average prices have been raised over threefold since January 1982. Energy prices not only affect the final demand but strongly influence the pattern of future output and expenditures, including the structure of transport. Scaling down or eliminating energy-intensive industries has been an important corollary of sharply increasing domestic energy prices.
Energy conservation and demand management have been combined with major efforts to increase domestic production of energy, particularly in Korea (through its nuclear program), the Philippines, (through the development of geothermal, coal, and hydro resources), and Thailand (through the expansion of natural gas, lignite, and hydroelectric power).
The programs for expanding domestic energy production are generally well-conceived. But investment requirements of energy development remain very large, notwithstanding the recent general downward revision of power investment programs, and will put a major strain on resources. Net import substitution in energy should have higher priority than reduction in dependence on imported oil, particularly if switching between imported fuels requires heavy capital outlays.
Trade. Despite being faced with more difficult balance of payments positions and sluggish growth in international trade since 1980, the market economies of East Asia have not turned inward. All have continued to emphasize export development and have strengthened export incentives.
Some countries have initiated efforts to reduce protection for domestic industry through tariff reductions and import liberalization. The Korean government, for instance, has decided to carry out a major reform of the import tariff system to promote further the competitiveness of Korean industries. Korea has also liberalized foreign investment to promote industrial efficiency to accelerate technological development. In the Philippines a major program of tariff reductions, import liberalization, and reform of the industrial incentive system was initiated in 1980, though it has suffered a setback in the last year due to the debt crisis.
The push to increase the attractiveness of exports and to reduce the domestic protection of industry has not been easy politically, in light of the sluggish world trade. In East Asia, as elsewhere, there is genuine internal debate on the extent of state support required for industrialization. Further, liberalization of imports and reduced protection for industry, while essential for improving efficiency, could meet increasing resistance even in East Asian countries if the protectionist pressures in the developed world continue to grow and if world trade does not resume its healthy growth. Efforts to liberalize imports have also implied additional risks as foreign exchange resources have become scarcer. Fortunately, manufactured exports from these East Asian countries have held up relatively well during the recent deep recession, expanding at an average annual rate of 13 percent during 1980-83, compared with 5 percent for developing countries as a whole. This suggests that its better domestic policy environment governing exports continues to be a significant factor in East Asia’s greater success in exporting. Needless to add, this pay-off to export-oriented policies serves to reinforce these policies themselves.
Investment. The speed and flexibility in policy implementation have also been demonstrated through major downward adjustments in the investment program in almost all East Asian countries during the last few years. Two examples illustrate the common approach.
In Indonesia, a weaker demand for oil, the lower oil prices of early 1983, and a sharp decline in non-oil exports as a result of the deep international recession produced a fundamentally changed resource outlook. The Government acted swiftly. In addition to allowing sharp increases in the prices of domestic oil and fertilizer in early 1983, it devalued the exchange rate in March 1983. A comprehensive reassessment of the public investment program was initiated, and imports of capital goods were reduced by postponing a number of major projects with a high foreign exchange content. At the same time, high priority continued to be attached to projects that created employment, supported agricultural development, and promoted human resource development through the expansion of social services. These measures have had a remarkable effect on the balance of payments; the current account deficit fell from $7.1 billion in 1982-83 to $4.2 billion in 1983-84. To reduce the deficit further, only a limited increase in total investment is forecast for 1982-85.
Malaysia, traditionally a resource-rich country, has in recent years faced large public sector and balance of payments deficits. These are partly cyclical but have also been related to a tremendous expansion of public sector activities in recent years in support of important social and economic goals. In 1983, concerned with the growing burden of domestic and external debt, the government initiated actions that may reduce real federal government spending by perhaps as much as 20 percent by 1985. Thus, in Malaysia as in other countries, the focus has shifted from the sheer size of public sector expenditures to their efficiency and effectiveness.
Adjustment costs. These adjustments were necessary but have not been without cost. In Korea, where the adjustment has already proceeded quite successfully, there was little growth in per capita consumption over 1979-82, and real wages declined by 8 percent during 1980-81. In the Philippines, average per capita consumption is likely to be no higher in 1985 than in 1980. In Indonesia, average per capita consumption, after very rapid growth during 1975-82 (which was nearly 7 percent per annum), will show a small decline over two years, 1983 and 1984. Managing adjustment in these circumstances in such a way that employment and incomes of the poorer groups are not seriously affected presents a tremendous further challenge to the skill and ingenuity of policymakers in these countries. Even in Thailand, where consumption has continued to expand, no significant progress has been made in poverty eradication since the mid-1970s.
If the difficult and delicate process of structural adjustment is to succeed, the domestic efforts of developing countries require strong international support. World Bank forecasts indicate that the annual growth in the industrial countries over the next decade will be nearly 3 percent, substantially below the 4.9 percent of 1960-73, but much higher than the average annual rate of the last ten years (a little over 2 percent), which included two serious recessions. A sustained recovery in trend growth cannot, however, be taken for granted. It will require continued control of the growth in demand for energy and of fiscal deficits, reduced international interest rates, and greater coordination of monetary and exchange rate policies among the major countries. Moreover, recovery in the industrial countries will assist, but not ensure, good access to their markets by developing countries; resistance to protectionist pressures will also be necessary. Last, but not least, a continued expansion of net commercial bank lending to the developing world will also be crucial.
External debt management issues will require especially careful handling by both borrowers and lenders. The total external debt of East Asian economies is less than one sixth of the total debt outstanding of developing countries. The burden of debt—measured by the ratio of either total debt or annual debt-service payments to exports of goods and services—is also clearly lower in East Asia than in some of the heavily indebted Latin American countries. But this burden has nonetheless grown, notwithstanding a more than fivefold growth in the nominal export earnings of this group of countries in the last decade, and reflects mainly hardening of the terms of debt. For Indonesia, Korea, Malaysia, the Philippines, and Thailand, debt-service payments, including interest on short-term debt, rose from 14 percent of export earnings in 1973 to 20 percent in 1983. The relative decline in the reliance on flows of official assistance is in itself not undesirable for countries that show increasing capacity for self-sustained growth. But this shift has been too sudden and has coincided with a period when real interest rates on borrowing from financial markets have been very high.
At least in East Asia, the high level of real interest rates—and not any failure of exports or real waste of investment resources—is the primary factor behind the growth in their burden of external debt. The very high real interest rates on private lending, estimated at over 14 percent per annum during 1981-83, emerged because inflation has decelerated suddenly but inflationary expectations have not changed. The sharp rise in the value of the dollar has also added to the real interest burden, since most of the debt is denominated in dollars. Without a very substantial decline in real interest rates, the debt problem could totally disrupt the development process, even with sustained international recovery. It is simply not within the debt-carrying capacity of developing nations to pay real interest rates of say 9-10 percent for any length of time. Indeed, the wisdom of large additional borrowing at such interest rates can be questioned.
But even with lower real interest rates, the net capital requirements of developing countries, including those of East Asia, will remain sizable. The Bank has lent over $10 billion to the East Asian countries (excluding China) during the last four years (fiscal years 1981-84). This lending has been directed especially toward support of structural adjustment programs and policies. The Bank’s dialogue with governments on economic issues has been extremely active and there has generally been agreement on broad directions of policy change and reform. It is hoped that this dialogue will continue, and the real volume of lending at least maintained for the next several years. But the bulk of external capital needs in East Asia will have to be met from commercial sources. Provided the international economic trend remains reasonably favorable and international interest rates drop from the very high current levels, debt servicing will not pose serious difficulties in East Asia.
For other Third World countries, the developing market economies of East Asia may be seen as providing a powerful “demonstration effect” through the outward orientation of their economic policies, their reliance on market signals, the stability and predictability of their macroeconomic policies, and their avoidance of confrontation between government and business.