Catch-Up Problem in Developing Countries - Essay Example

Catch-Up Problem in Developing Countries The Asian crisis of the late 1990s altered the fortunes of those stricken countries overnight, turning the much-ballyhooed economic miracle into chaos. Japan too became (and still is) trapped in a banking crisis of its own making after the bubble of 1987-1990. A supposedly distinctive East Asian, or Japanese, model of economic growth suddenly lost its lustre, and the American model of free-market capitalism came to triumph. The Asian economies were then compelled to reform their regulatory and institutional structures by adopting more market-oriented approaches. Those that had to depend on bailouts from the IMF were forced to accept a wide-ranging reform program as obligatory conditions for the rescue loans. The themes of this paper are (1) that the Asian crises were the inevitable outcomes of the dirigiste development policies the Asian economies pursued in their successful catch-up growth, (2) that such an institutional regime, however, finally met its match in the form of free-market global capitalism, especially in terms of unbridled capital flows, and (3) that East Asia's present trend of deregulation and marketization is all the more pushed by the institutional requirements of the Internet revolution as the region struggles to catch up in the digital age. Into the "McLuhan" Stage of Growth Any successfully developing economy climbs a ladder of growth. Until the arrival of a New Economy, all the advanced economies had, in the past, trodden a path of industrial structural transformation from the "Heckscher-Ohlin" labour-intensive industries (typified by textiles) to the "nondifferentiated Smithian" scale-driven industries (steel, basic chemicals, and heavy machinery), to the "differentiated Smithian" assembly-based industries (automobiles and electric/electronics goods), and finally to the "Schumpeterian" R&D-intensive industries (specialty chips, biotechnology, and new materials) (Ozawa 1992). This conceptualization of stages-based process of industrialization is in line with a "leading sector" theory of growth a la Joseph Schumpeter, which envisages a sequence of stages in each of which breakthrough innovations (new technologies) create a certain new dominant industry as the main engine of growth. This stage-demarcated sequence of growth can be clearly seen in the history of industrial capitalism. Great Britain was the first country that introduced the Industrial Revolution and quickly moved from textiles to steel and heavy machinery. Continental Europe and the United States then followed in Britain's footsteps by borrowing from the latter, a process which Clarence Ayres (1952) called "cultural borrowing"--that is, borrowing of an industrial culture from the more advanced. Japan, too, joined the Western powers in this game of cultural borrowing, quickly going through the Hecksher-Ohlin ("textiles") and nondifferentiated Smithian stages (steel) in the pre-World War II period. It then successfully climbed the ladder to the differentiated Smithian (automobiles) in the post-war period and most recently to the Schumpeterian (specialty microchips) stage. And Japan's success has prompted other East Asian countries to follow the Japanese model of growth. In this respect, what the World Bank (1993) called the “East Asian miracle" is nothing but the successful outcome of "cultural borrowing" in industrial technology. Where each East Asian economy is situated in terms of its borrowing and catching-up efforts. Japan is the first Asian economy that has gone through the four stages of growth and is now on the threshold of a brand-new stage, which can be identified as the "McLuhan" stage (named after the media guru, Marshall McLuhan) led--and driven--by the information technology (IT) revolution (Ozawa 2000). If we accept the notion of a New Economy, this brand new industrial structure has so far been most successfully introduced in the United States. The Asian NIEs (Hong Kong, Singapore, Taiwan, and South Korea) have swiftly caught up with Japan, although they are still somewhat behind the latter in R&D-intensive Schumpeterian industries. But now they are stepping up their efforts in R&D activities. For example, Korea's R&D expenditure-to-GDP ratio moved up from 1.9 percent in 1990 to 2.7 percent in 2000, compared with Japan's 3.2 percent (Business Week, November 27, 2000). ASEAN-4 (Thailand, Malaysia, Indonesia, and the Philippines) are still largely at the "nondifferentiated Smithian" stage, although they have successfully entered the labour-intensive, standardized low-end segments of the assembly-based "differentiated Smithian industries"(e.g., chip assembly and low-end consumer electronics). They have difficulty climbing the ladder of growth mainly because of a dearth of high-skilled human resources. (Amoore, 2000) In the meantime, their most formidable competitor, China, has made great strides in catching up and overtaking the ASEAN-4. China is well on its way to entering the assembly-based industries, especially automobiles and consumer electronics, taking advantage of its huge domestic markets that can attract foreign multinationals and technologies. And the arrival of the Internet has all of a sudden altered the dynamics of catch-up among the East Asian economies. The NIEs, notably South Korea, are moving into the Web world more decisively than Japan, which is in fact worried about falling behind in Asia's online rush. Hong Kong and Singapore have sharply reduced telecommunications costs through drastic deregulation of the market. Both enjoy the advantages of their advanced information infrastructure and English skills. Hong Kong has built an IT business center, "Cyberport." Singapore is busily wiring up the buildings in that island city with high-speed Internet networks with an aim to cover one quarter of them by 2005. Taiwan's cable television networks now cover 80 percent of the island's households; these will soon offer cheap and fast online connections. 60 percent of Korean households are PC-equipped, and they are active online traders, accounting for nearly 70 percent of all securities transactions. Given these rapidly emerging Net economies in it s neighbours, Japan fears that it may be left behind unless it too quickly adapts to the imperatives of the New Economy. The Internet Revolution The Internet revolution, still in its nascence, is already exerting an enormous impact on culture and the way we live, just as the telegraph--and later the telephone--did in the previous communications revolutions (Phillips 2000). The McLuhan industries produce "abstract goods" or "conceptual goods" which may not be fully captured in the conventional national income accounting. But Internet artifacts ("physical goods") such as PCs, cellular phones, and handheld computers are manufactured in the differentiated Smithian industries, just as many inputs (such as steel plates and plastics) for automobiles are produced in the nondifferentiated Smithian industries. The McLuhan phase of growth is currently in the making by the ongoing development of information technologies into a coherent whole. Unlike the previous linear and sector-differentiating progression of structural upgrading in which a new independent industry (say, automobiles) becomes dominant as a leading sector without much affecting yesteryear's leading sector (say, textiles), the McLuhan industries impact all the "older generation" (Old Economy) industries in the areas of management, production, procurement, distribution, and customer services. In fact, the non-manufacturing, transactions-intensive sectors such as finance, telecommunications, distribution, and government services are the ones most dramatically impacted. Shared Growth, Bank-Based Finance, and Industrial Conglomerates East Asia's successful catch-up has been accomplished not because they adopted free-market capitalism but because they pursued a state-directed brand of capitalism or dirigiste capitalism by way of "governing the market" (Wade 1990) and often by even "getting the prices wrong" (Amsden 1989). The domestic industries, especially during their infancies, were heavily protected under import-substitution policy and made open only when they become competitive enough to export, with the help of export-promotion measures. This Asian-style dirigiste capitalism was actually tolerated by the United States during the Cold War. It is well known that the United States as the leader of the Free World opted for a foreign policy in favour of security, even at some cost to its own economic interests, and ensured Asia's "continuing orientation toward Washington" (Cumings 1984). It is now widely accepted that the East Asian miracle (rapid growth in the pre-crisis period) occurred because dirigisme or authoritarianism was tempered by the principle of "shared growth" (World Bank 1993), in which the benefits of economic development were to be shared widely by the public. Shared growth gave a political legitimacy to Asia's growth-focused dirigisme. A variety of measures were instituted to alleviate the short-term costs of rapid growth such as subsidies on housing, food, fuels, and other basic necessities--and strong job security in the workplace (e.g., life-time employment in Japan). All this came to constitute implicit social contracts. How did East Asia finance its once miraculous growth? At lower stages of economic development, bank loans are the predominant source of investment money. There is no limit to the availability of credit in the aggregate when the central bank is involved in creating credit. Schumpeter (1935) called banks "the headquarters of the capitalist system." Ayres (1952) similarly argued that investment funds can be "created, quite literally, out of thin air" through the banking system. Japan--and then Korea, in particular--used central bank-based finance very effectively as an instrument of finance without causing serious inflation during its high catch-up growth period (Ozawa 1999). Another institutional device for catch-up growth is the formation of industrial groups or conglomerates. Japan's keiretsu, South Korea's chaebol, and Indonesia's konglomerat are the prime examples. These industrial groups are an effective institution to reduce "coordination failures" and capture business externalities of industrial development, an institution which provides an economic environment where even absolutely "weak" (initially) and/or small-medium firms could participate--and are assisted by large "strong" ones--in group-coordinated endeavours. In short, three dimensions of rapid catch-up growth existed: socio-political, financial, and industrial. The social contract of shared growth was maintained to achieve political stability and legitimacy for sometimes authoritarian measures; financial credit was created through the banking sector and strategically channelled to key industrial development mostly under government direction; and the private sector was courted and supported by the government to build a dynamic and modem industrial capability by way of learning (technological absorption) from the advanced countries. The Irony of Fast Catch-Up The triple-faceted institutional arrangement proved to be quite effective in inducing rapid catch-up growth. But the irony is that the more successfully the East Asian economies climbed up the ladder of growth, the less compatible the existing institutions became; their success made themselves increasingly incongruous and inappropriate for the newly emerged environments. In fact, institutions are very slow to adapt to changes and become even more rigidified (Olson 1982). The state-managed banking sector, in particular, has fallen victim to institutional rigidification. Because of heavy involvement by the government in protecting the sector not only from foreign competition but also from potential business failure, moral hazard (high-risk-taking in the belief that the government would always come to the rescue) was inevitably created. Coupled with subsidized lending, state-managed finance eventually caused over borrowing, over diversification, overcapacity, and overstaffing, especially in capital-intensive scale-driven industries, as evidenced in electronics and automobiles throughout East Asia (Zhan and Ozawa 2001). These outcomes lay the ground for the Asian financial crisis of 1997-1998. The very success of the above institutional setup for rapid growth thus eventually culminated in creating the susceptible conditions for the financial crises to occur when dirigisme was confronted with the forces of global free-market capitalism under the pressure of the Pax Americana which was no longer tolerant of wide-spread government involvement in economic affairs in the post-Cold War era. The financial market in particular had to be liberalized--and consequently became open to capital flows. East Asia as a whole, but those crisis-stricken economies in particular, began to deregulate and liberalize their economies partly under the pressure of the bailout conditionalities imposed by the IMF but more importantly because of the rising incompatibilities of the obsolescing old regime institutions at home. The Imperatives of the New Economy In addition, the Asian crises occurred during the period when Internet technology began to suddenly proliferate at an accelerating pace to create a New Economy in the United States. This coincidence provided an additional, more decisive and autonomous momentum for the Asian economies to deregulate their business environments so as to promote entrepreneurial Internet ventures. Because the emergence of a New Economy owes to drastic deregulations and free-market plays in the United States, its spread to East Asia has already had a significant impact on the region's dirigiste regime, especially in the areas of telecommunications and finance. In particular, capital markets (venture capital, equities, IPOs, and M&As) have been an indispensable financial ingredient of the unprecedented US economic boom. In short, the Internet revolution is not really a technological revolution per se but an institutional revolution involving both the real and financial sectors of the economy. Asia's New Round of Catch-Up Growth? Most interestingly, the IT revolution will have its greatest impact on East Asia's erstwhile heavily protected sectors, notably finance, telecommunications, and distribution, for two important reasons: first, a successful IT revolution requires deregulation and free-market transactions and, second, an application of information technology enhances transactional efficiency and productivity. Therefore, the more archaic, distorted, and inefficient an industry is, the greater the potential gains from the IT revolution, hence the faster the potential productivity growth. And East Asia has a huge backwater of hitherto regulated and protected industries which are now beginning to open up for global competition in trade and foreign direct investment. One prime example in this regard is Japan's suddenly growing cellular phone market, which now boasts the world's largest number of subscribers (around 20 million at the end of 2000) to the mobile-Internet services delivered over the i-mode of cellular phones. This domestic advantage puts Japan far ahead in the race to commercialize this fast-growing technology into third-generation (3G) cellular services. What is surprisingly little known, however, is that the United States forced Japan to deregulate the cellular phone market in 1994. Until then, Japanese citizens were not even permitted to own cellular phones. Besides, once the market was to be deregulated, their local companies were scared of losing business to American rivals like Motorola, which had introduced cellular phones much earlier. Thanks to the gaiatsu (outside pressure) for deregulation exerted by the United States, Japan finally opened up the market and serendipitously leapfrogged to the front of the global race to the wireless Internet and in-commerce. East Asia has been an excellent emulator. Japan's such capacity in particular has long been known, as is described in the Veblenian paradigm of "Old Japan" (Ozawa and Phillips 1994). And the advent of the New Economy is providing another unique opportunity to play catch-up. Wireless Web may be the future of the digital economy rather than fixed-line Web. The former has a great promise of leapfrogging for developing countries where fixed-line infrastructure is poor but satellites are available. Sensing this godsend opportunity, for example, Japan has just begun to mobilize itself once again as it did previously in its successful catch-up efforts. In September 2000, its newly formed twenty-member IT Strategy Council, chaired by Sony's president and composed of other notable leading companies such as Softbank, Toyota Motor Corp., and IBM (Japan), announced an ambitious goal to surpass the United States in the Internet economy in five years. To achieve this national goal, the Council urges the government to dism antle institutional obstacles (i.e., business-hampering regulations) to the growth of a New Economy. Japan has a solid production base of Internet artifacts, including telecommunications equipment, fibre optics, and digital goods. Another round of catch-up has just begun. Indeed, the Japanese who are frustrated by a lost decade of growth (the whole 1990s) see a promise of revitalizing their economy in deregulations, and criticize the government for its slow pace of implementation. But there is a big question: Will Japan and the rest of Asia wholeheartedly embrace the American model of a New Economy? How far will they be really able to reform its ossified Old Economy system of institutions? The American model of an IT-driven growth rests on a circular sequence of an "IT revolution[right arrow] investment[right arrow] stock market gains[right arrow] wealth effect[right arrow] consumption and investment[right arrow] economic boom"--namely the "virtuous" circle of real and financial developments. This New Economy model has recently resulted in skill shortages, ever-rising trade deficits, debt overhang, and a rising income gap. And already a high-tech bubble burst has occurred. The "virtuous" circle may easily turn into a vicious circle. Be that it may, as noted in figure 2, East Asia now has to reform its erstwhile Old Economy regime toward a more market-oriented one. In other words, "institutional borrowing" (or "cultural borrowing" in the true sense of the term) is required. 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