In 1960, South Korea was poorer than many sub- Saharan African countries and Taiwan not much richer. Since then, these two countries have experienced average annual increases in per capita income of 6.8% and 6.2% respectively, leaving far behind not only these African countries but also much richer countries, such as Mexico and Argentina. Most explanations of the East Asian `growth miracles' place heavy emphasis on export orientation. But, according to Dani Rodrik, speaking at a London discussion meeting on 18 January, a more plausible story focuses on the investment boom that took place in both countries. High levels of human capital and a relatively equal distribution of income created the conditions under which government intervention stimulated investment and led to growth, not rent-seeking. Rodrik is Professor of Economics and International Affairs at Columbia University and a Research Fellow in CEPR's International Trade programme. His talk was based on his article in Economic Policy 20, `Getting Interventions Right: How South Korea and Taiwan Grew Rich'.
The standard explanation of East Asian success is one of export-led growth. During the 1950s, the story goes, both of these countries engaged in traditional import-substitution policies, with multiple exchange rates, high levels of trade protection and repressed financial markets. By the late 1950s, each country had exhausted the `easy stage' of import substitution. Together with the impending reduction in US aid (which had been the main source of foreign exchange for both economies), this led policy-makers in the two countries to reverse their economic strategy and adopt export-oriented policies. These included the unification of exchange rates (accompanied by devaluations), other measures to stimulate exports (including, most significantly, duty-free access for exporters to imported inputs), higher interest rates and some liberalization of the import regime. As a consequence of these measures, as well as a broadly supportive policy environment, encompassing macroeconomic stability and public investment in infrastructure and human capital, exports took off in the mid-1960s. Export orientation led both economies to specialize according to comparative advantage, resulting in rising incomes, investment, savings and productivity.
The standard account recognizes that East Asian governments – save for Hong Kong – have played active roles in shaping the allocation of domestic resources. But the tendency is to downplay the significance or effectiveness of government interventions. A closer look at the evidence, however, suggests that the standard story is at best incomplete (and possibly misleading) because it attaches too much importance to the role of export orientation. First, the increase in the relative profitability of exports around the mid-1960s was relatively modest in both South Korea and Taiwan, and cannot account fully for either the initial jump in the export GDP ratio at that time nor the subsequent steady increase in this ratio. Second, neither export incentives nor the actual increase in exports can account for the phenomenal increase in investment that took place in both countries, which appears to be the proximate determinant of economic growth in the two countries. Third, since the export base was so small initially (less than 5% of GDP in Korea), the contribution of exports to output growth could not have been very high until the mid-1970s at the earliest. Fourth, there is no evidence that exports were associated with significant externalities or productivity spillovers to the rest of the economy. Lastly, the increasing outward orientation of the two economies can be explained by the sharp increase in investment: since capital goods had to be imported, an increase in investment demand necessarily rendered these economies more open to trade.
Rodrik believes that a much more plausible explanation for the economic take-off is the increase in investment that took place in the early 1960s. The reason for this investment boom is the key issue that must be addressed in any account of the East Asian experience. What seems to have happened is that in the early 1960s and thereafter the Korean and Taiwanese governments managed to engineer a significant increase in the private return to capital. They did so not only by removing a number of impediments to investment and establishing a sound investment climate, but more importantly by alleviating a coordination failure that had blocked economic take-off. The latter required a range of strategic interventions – including investment subsidies, administrative guidance and the use of public enterprise – which went considerably beyond those discussed in the standard growth story. That government intervention could play such a productive role was, in turn, determined by a set of advantageous initial conditions, namely a favourable human capital endowment (both economies had an extremely well-educated labour force relative to their physical capital stock, rendering the latent return to capital quite high) and a relatively equal distribution of income and wealth.
While this account helps us understand why government intervention could have played a productive role in these East Asian countries, it does not explain why pervasive intervention did not lead to rent-seeking and defeat the objectives of the policy-makers. Here again, initial conditions are likely to have played a very important role. A relatively equal distribution of income and wealth was critical. Compared with other developing countries in 1960, Korea and Taiwan stood out in having exceptionally equal distributions of income and wealth. This was due in part to history, and in part to the serious land reforms undertaken in both countries during the 1950s. The absence of large inequities meant several things. First, neither government had to contend with powerful industrial or landed interest groups. Governments could intervene effectively in Korea and Taiwan because they enjoyed an extraordinary degree of insulation from pressure groups and were able to exercise leadership over them. Second, governments did not feel an immediate need to undertake redistributive or populist policies. Third, the fact that the top political leaders were free to focus on economic goals meant that they could supervise the bureaucracy more closely.
This analysis helps to explain why so many other developing countries have failed miserably with government interventions that bear more than a passing resemblance to those employed by the East Asian countries. South Korea and Taiwan shared a number of special initial conditions – high levels of educational attainment relative to income, and equal distributions of income and wealth – that these other countries lack. Consequently, the Asian experience with government intervention is perhaps of limited relevance to other countries facing the growth challenge.