Robert Wade, Governing the Market, 1990, pp. 22-33 and Chs. 2, 10, 11
Wade reviews theories of East Asian (meant to include Japan, Taiwan, South Korea, Hong Kong and Singapore) economic success. He categorizes the various earlier interpretations as Free Market theory and Simulated Free Market theory and proposes what he calls the Governed Market theory.
The FM and SM Theories: The Free Market (FM) theory (Friedman and others) attributes the success to operation of free markets. The Simulated Free Market (SM) theory (Bhagavathi and others) theorizes that the government acted to positively reduce market distortions, such as absence of complete information and inflated prices of products and factors. The later differs from the former in the distinction between a free trade regime (former) and a neutral trade regime (later). The later is sought to be achieved by offering export subsidies and tax credits to offset the import premium resulting from tariffs and quantitative restrictions.
The GM Theory: The Governed Market theory (Wade) ascribes the East Asian success to three proximate causes that are traced to two broader causes. The three proximate causes are very high levels of productive investment, relatively more investment in certain key industries and exposure of many industries to international competition. Wade believes that these were the result of economic policies – incentives, controls and risk spreading mechanisms – which produced different production and investment outcomes than would have resulted under FM or SM policies. Secondly, he also attributes it to a certain kind of organization of the state and the private sector.
Redistribution of agricultural land in the early post war period
Controlling financial system and making financial capital subordinate to industrial capital
Maintaining stability in economic parameters that affect long term investment – exchange rate, interest rate and general price level.
Modulating impact of foreign competition and prioritizing use of scarce foreign exchange.
Wade asserts that these actions were not insignificant to claim that markets would have behaved as it did even in their absence. He summarizes the difference between the FM/SM and GM theories in that while the former emphasize resource allocation as the principal source of growth, the latter emphasizes capital accumulation and the level and composition of investment. Further the resulting level and composition of investment was different from what would have resulted in a FM/SM scenario and also under that of the interventionist policies of other LDCs.
The Organization of the State and Private Sector: Wade calls the arrangement in the East Asian Countries as the authoritarian (soft authoritarian in Japan) and corporatist. The distinctions he uses are for the process of choice of governance and space for interest groups. In the former, he makes the distinction of democratic vs authoritarian and in the latter, pluralistic vs corporatist. The distinction in space for interest groups is contrasted between the freedom of interest groups to organize and assert influence over the government (pluralistic) and that of the state chartering or creating the interest groups and giving them monopoly of representation of occupational interests in return for the right to monitor them. The USA is the ideal democratic-pluralistic, Switzerland and Austria the democratic-corporatist, and Korea and Taiwan the authoritarian – corporatist. Japan is termed soft authoritarian-corporatist.
The question of Evidence: This section discusses the difficulty of establishing causative relation between economic growth and government steerage. The difficulty is broadly two fold – non-availability of a counter factual and the difficulty in isolating the impact of industrial policy from that of other policies such as macro-economic, public goods and distributional. Within industrial policy, effect of functional and sectoral policies need to be separated. Many difficulties of isolation and measurement within the sectoral policies are discussed. It is also significant that optimality within industry caused by an intervention does not establish national welfare optimality. The approach adopted by Wade to establish the GM theory encompasses the following.
Assess the extent of price distortion (since FM/SM attributes economic success to absence of price distortion)
Find existence of effective instruments of intervention/control
Identify institutional locus of the instruments and evidence of national goal setting, to the level not found in laissez-faire economies
See if these instruments have been effective when political power is unified and unified under people committed to industrialization.
Chapter 2: The Rise of East Asia This chapter gives evidence of the dramatic economic and development success of five East Asian countries – Taiwan, South Korea, Japan, Hong Kong and Singapore. Taiwan and South Korea are discussed in detail. All the five countries have jumped their positions in per capita GNP rankings between 1962 and 1986. The increase in per capita GNP has been more than 20 times for Japan, South Korea and Taiwan and around 15 times for the other two. All of these countries currently have a trade surplus with the US. The share of these countries in the world GDP, manufactured exports, refined copper consumption (a basic industrial ingredient ) and integrated circuits production have all gone up.
Taiwan and South Korea are described in more detail. The information given is tabulated below.
In case of Taiwan, the composition of exports changed from 85% agricultural goods in 1955 to more than 90 % industrial goods in late 80s. Balance of Payments has been consistently positive since 1970 with exception of 2 years and Debt service ratio consistently 5 % or less. The Foreign Exchange reserves are the 2nd highest in the world after Japan.
The industrial transformation achieved by these countries has been over much lesser time than that taken by the developed countries earlier. Taiwan and Korea have achieved in 15 years what took Japan 25 years and Great Britain took 50. Wade also gives information on the shares of heavy and light industries to manufactured production, and export mix to prove the depth of industrial production.
(It is interesting to note that the level of gross domestic investment as percentage of GNP has fell from 33% to 18 % in the early 80s. It will be interesting to see whether this has affected the economic performance in the years hence.)
Development Styles: This is depicted beautifully by what Wade calls Kite drawings that give information on four dimensions – consumption pattern (passengers cars per 1000 population), income inequality (ratio of income of lower 40% of population to richest 10%), industrial competitiveness (ratio of exports in metal and machinery products) and long-term dynamism (average annual growth of per capita GDP). The kites show a similar pattern for Japan, Korea and Taiwan – high dynamism, high international competitiveness, low inequality and austere consumption that is in contrast to that of US and the Latin American countries.
Two variations of the market supremacy interpretation:
Free market theory (FM): markets for goods and factors of production were freer in East Asia countries than in other countries.
Simulated free market theory (SM): recognizes the existence of market distortions and industrial policies in East Asia, but ways that industrial policies merely offset existing market distortions, creating overall neutrality in resource allocation
Political economy approach:
Governed market theory (GM): East Asian success resulted from government action to constrain and accelerate the competitive process.
Policies include: maintenance of a post-land reform ceiling, control of domestic and cross-border sources of credit, stabilization of the main macroeconomic parameters of investment choice, export promotion, investment in technology
Legitimacy of government depends on the economy.
Risk-taking by associating itself with successes and blaming the private sector for failures.
Directed foreign investment into industries with high potential linkages.
Korea vs. Taiwan:
Taiwan: FM/SM, only a small-scale segment had free markets
Korea: authoritarian political institutions, FM/SM and GM, aggressively pushed exports, exercised leadership in selected industries, similar to Taiwan but government encouraged the growth of huge conglomerate firms (chaebol), dynamic economic policy
Korea had an underlying reciprocity between government and large private firms which helped to sustain a well-developed policy network. Korea had a more centralized management structure (Ministry of Trade and Industry and the Economic Planning Board). T
Taiwan was less centralized with power over industrial policy issues spread out among more ministries and agencies.
Taiwan supported weaker authority structures than Korea. They government the market to a similar extent, but using a different strategy.
Invested more heavily than Taiwan and Korea
Governed market elements, redistributivist land reform, bank-based financial system, direct foreign investment controls, selective government leadership in investment and technology.
MITI provided a model for its counterparts in Taiwan and Korea. Zaibatsu were similar to Korean chaebols.
Greater emphasis on consensus in state-society relations
Its small size meant that full employment and wide diffusion of the benefits of economic growth were possible.
Wealthier than Taiwan or Korea, but as a former British territory, it is hard to compare.
Economy managed by informal coalition of peak private economic organizations and the government.
Picking winners; hard states are able to resist private demands and actively shape the economy and society.
Factors associated with hard states = massive social coercion, serious military threat from outside, support from the international state system, social grouping with people sufficiently independent, skillful leaders.
So in this concluding chapter, Wade sets up (once again) the debate among “neoclassical” theorists and “political economists”—the former convinced that East Asian (Taiwan, Japan and Korea) success was merely a function of restraining state intervention in the market, and the political economists giving much more credence to public policy intervention. Wade chooses political economy (or GM: governed market) over neoclassicism (or FM/SM: free market/simulated free market).
Wade then launches into the question of whether GM is therefore an appropriate strategy to achieve East Asia’s results elsewhere. First, history, geography and some other unique circumstances led to the success of GM. He then refers to the way capital “ricochets” around the world, making investment decisions difficult and inefficient.
He then jumps into a statement that GM is still probably the best strategy internationally, and that the neoclassical model is not borne out outside of East Asia either. Wade then, after a couple disclaimers, launches into ten “prescriptions for micro- and mesoeconomic interventions…and state effectiveness.” which he says are “consistent with [that of] governments of very successful countries.”
Create a policy climate which stimulates domestic industrial development.
Cost curves: Industrialized countries are likely to have decreasing returns to scale if they grow industry, but most developing countries will see increased returns.
“Use protection to help create an internationally competitive set of industries.”
In the context of highly integrated international trade, promote exports.
“Welcome multinational companies, but direct them towards exports” and local suppliers.
Employ a government-controlled bank-based financial system rather than leave investment decisions to changing public preferences.
But: a) the public sector must devise a way to detect market signals dulled by government intervention, and b) financial flows must be regulated so as to prevent massive outflow of domestic wealth.
Do trade and economic liberalization incrementally (slowly):
Get “substantial external financial assistance” in order to transfer from macroeconomic stabilization to liberalization
Free up export-input imports, and wait for exports growth, before liberalizing imports that will compete with domestic goods
Public sector should promote exports
Financial liberalization should come at the end
Establish a ‘pilot agency’ or ‘economic general staff’ to lead growth.
Consolidate efficient political authority and institutions before democratizing. (structure before justice.)
Develop corporatist institutions before democratizing—that is, create industry groups, separate from the state, to set policy, rather than the U.S. and British system which “tolerates raw adversarial outcomes between economic interest groups.”
Even soft states should begin building institutions capable of coherent industrial policies.
Finally, Wade widens the lens and implores the developing world to not follow the U.S. example of ad hoc policy, and suggests that history will show that the next “Wealth of Nations” (Adam Smith) will trumpet the GM (intervention) model.