9:51 AM Mar 8, 1996


Kuala Lumpur Mar (Martin Khor) -- A new paradigm, based on experience of East Asia, of analysis and strategies for successful development in developing countries, appears to be emerging in challenging the current orthodox, and dominant paradigm of reliance on the "free market" is best for economic growth.

Several economic and trade experts taking part in a research project on East Asian development have come to the conclusion that successful development requires an active role for the state, particularly in mobilising resources and giving direction for industrialisation.

Without this critical intervention role, merely relying on market forces through economic liberalisation and "getting prices right" -- the World Bank 'market-friendly' model -- would not get poorer countries into a sustainable development path, and indeed is likely to get them stuck in a poverty cycle.

A complex set of conclusions, rich with important policy implications, emerged from a Conference on "East Asian Development: Lessons for a new global environment", held here on 29 February and 1 March.

Organised by UNCTAD, and hosted by the Institute for Strategic and International Studies (Malaysia), the seminar brought together about a hundred scholars and policy makers to examine what it was that made East Asian countries succeed in getting high growth, whilst growth and development in many other developing countries failed to take off.

The seminar reached the following core conclusions:

* The success of East Asian economies was due, not to following free market policies, but to strong state intervention in the economy and government policies to foster industrialisation;

* East Asian economies have very high savings rates, which are converted into high investments that in turn explain the high growth rates;

* There is a unique relation between public and private sectors, where governments facilitated high savings and profits, whilst corporations invested a large part of profits instead of distributing them as dividend;

* Foreign investments play an important initial role, but for sustained growth, it is essential that the capacity of domestic firms be built up;

* Whilst the initial phase of industrialisation can be fired by exports of labour-intensive, low-skilled manufactured exports, a country must quickly move on to higher stages based on higher value-added and higher-skilled activities.

Also discussed at the Seminar were the following issues:

* Can the East Asian experience be replicated in a changing global environment where new World Trade Organisation rules restrict industrial growth in the South?

* What can African countries learn from the East Asian model, and can they put into practice some of these lessons?

The seminar had the benefit of several background papers prepared by development experts under a UNCTAD-managed research project on East Asian development that was funded by the Japanese government.

At the final session, senior UNCTAD officials gave a cogent summing up of the implications of both the research findings and the seminar.

Mr Yilmaz Akyuz, head of UNCTAD's Global Interdependence Division and leader of the research project, said that the key question the research team had sought to answer was what made the East Asian countries grow, when others failed to do so.

"We thought that the explanation of rapid growth provided by other researchers were inadequate," he said. "We didn't think that East Asian growth and capital accumulation had been properly explained."

Akyuz said the conventional view was that these countries were efficient because they got their "prices right" and that they had high investment because they got their policies right. "Missing from this view was a good theory of accumulation in East Asia."

Finding a theory for growth was the team's starting point. "Delinking technology from investment is bad economics," explained Akuyz. "So we linked them. Investment is a condition for productivity growth, and output per head is related to capital per head. So we looked at investment as a key factor."

The team found that East Asian countries raised their savings rate from 10% to 40% of GDP in the context of fast growth. They discounted the possibility that fast growth itself raised the savings rate, as there were other countries with high growth but low savings.

Thus, high savings was a key factor explaining East Asian growth. But how did the savings get transformed into high investment rates that led to growth?

Akyuz found the answer in what he calls the "profit-investment nexus". The East Asian countries had a government-business relationship in which government created the conditions for higher business profits (than would otherwise have been possible under normal market conditions), whilst the companies delivered by investing a large part of their profits, instead of distributing the dividends.

This combination of factors resulted in high investment and accumulation, which in turn led to high GDP growth rates.

Akyuz found that this was the real key to East Asian growth; the exports for which East Asia is famous were "secondary" as a factor.

A crucial conclusion of the team was that "without a strong government policy and role, that growth would have been impossible to achieve."

The role of the state, said Akyuz, included not only investment policy (such as directing funds to certain sectors) but also a combination of other policies, such as reducing the level of conspicuous consumption and policies that got corporations to retain profit for new investment rather than to distribute as dividend.

The team then examined what Akuyz calls the "export-investment nexus." The East Asian countries tried to generate their own technology, using the strategy of adaptation and imitation. They also channelled a significant part of production to exports, whose earnings in turn contributed to investment.

"There was thus a link between the profit-investment nexus and the export-investment nexus", said Akyuz.

He added that an important lesson that was almost negated in previous studies on East Asia was that the evolution of the export-oriented sector was not a spontaneous development but involved state policies.

For example, when South Korea first industrialised, it relied on cheap labour and natural resources as the basis of its comparative advantage. But foreseeing future difficulties due to wage pressures and growing competition from lower-cos t countries, the country built up for the next industrialisation phase.

The research team also faced a puzzle at the start, said Akyuz: in these countries, profits were 40 to 50 per cent of value-added, yet the income distribution pattern was good.

The answer lay in the fact that a large part of the profits was retained and invested, and this profit-investment nexus ensured that income distribution remained more equitable.

"The social justification in placing a large part of value-added in a small part of the population is found in the retention and investment of profit which led to growth," Akyuz said.

He stressed that this process would not have taken place without active government intervention.

In a concluding speech, Roger Lawrence, Deputy to the UNCTAD Secretary-General, summed up the seminar's overall conclusions.

The first lesson, he said, was that there is a leadership role for government in the development process. Everyone agrees on the state's role in creating an enabling environment that includes legal and regulatory frameworks and good infrastructure.

The East Asian experience however also shows up a new dimension: the role of government in promoting development activities, especially in industrialisation.

"The lesson we draw is that successful development patterns do not emerge through spontaneous market forces, and this is a very important conclusion," Lawrence said.

UNCTAD's work confirms conventional view that outward orientation is essential for developing countries.

"Looking to labour intensive products, involving low skills, especially for exports, is a good starting point for industrialisation, since cheap labour is what a developing country has to offer," said Lawrence. This, he added, can secure a country a position in a regional context as neighbouring countries that are fast developing could pass on the lower-skill industries to it.

There was however the need for such countries to manage their resources well and take care that easy export of natural resources do not stand in the way of developing manufactured exports.

Another lesson however was that reliance on cheap labour in unskilled activities was only an initial phase and an industrialising country should get through this phase quickly if it was to get into the real dynamics of development. Steps needed to move on to the next stage of industrialisation should start immediately.

On the issue of investment, Lawrence said the seminar had concluded that "policies to direct investments to particular sectors and activities (including exports) are important."

The role of foreign investment in East Asia was varied. In the second tier NICs, the role of FDI has been especially important.

"There is a general agreement that FDI has been an important element for Asian countries at the first stage as it allows a country to jump-start the process of industrialisation and into markets for manufactured exports.

"But an important point made is that the development of national capital and national firms is absolutely essential for the development process to mature. FDI should be seen as a step in that direction and not as a substitute. An important question thus is how, and how rapidly, is FDI moving the economy as a whole into capacity building and establishing the capacity of domestic firms.

"The role of FDI is important in transferring skills and developing backward linkages by buying inputs from local firms. But domestic capacity building is absolutely key. Policies in this area, such as fostering local entrepreneurship, is important."

Lawrence then dwelt on another of the seminar's themes: how East Asia dealt with marginalised sectors.

"Even when growth is in place, not all parts of society move at the same pace," he said. "The seminar even used 'dualism' to describe the disconnection between parts of the economy that go forward and those that don't.

"The East Asian experience showed that policy-based directed credit schemes can play a role to improve the disadvantaged sectors. A major conclusion is that policies have to be taken to ensure that everyone comes along, or at least don't fall far behind, in the growth process."

Lawrence said the seminar also brought up another unique feature of East Asian development: how the private and public sectors interact. The government formulated policies together with the private sector.

"The private sector makes known its need of support from government. The government meets the private sector's needs, whilst the private sector meets the needs of national objectives."

Lawrence said it was recognised that the dynamics of this relationship are complex and difficult to bring about.

"The government must foster but at the same time discipline industry as well," he said. "Central to this discipline is the behaviour of the private sector in investing its profits. This profit-investment nexus is very central to the whole process."

There is also the need to realise possible pitfalls such as concentration of economic power and rent-collection mechanisms that could hinder development. To deal with these and soften the concentration of economic power, two instruments can be used: competition policy and the promotion of small and medium sized enterprises.

It was also necessary that policies be flexible and for mechanisms that can correct mistakes when they occur.

From a policy standpoint, Lawrence said, the most intriguing question is the applicability of the East Asian model to other countries. Here, the external and internal factors had to be considered. The first issue here was whether the external environment permitted or constrained the model's transfer.

"It is a fact that the Uruguay Round has reduced the scope for direct promotional activities by governments," Lawrence said. "But it is also clear that the room for manoeuvre has by no means disappeared. There is a large amount of grey area that can be exploited by developing countries. And for least developed countries there are exemptions and implementation delays permitted, giving additional room for manoeuvre."

On the second issue of the internal factor, Lawrence said that "the crux of the matter is whether the political and administrative capacity exists in other countries to emulate the East Asian experience."

Noting that the seminar had brought up that there is a great diversity of experience in East Asia itself, Lawrence said: "We don't want a new general paradigm to replace the old general paradigm.

"It shouldn't be said for instance that direct government promotion is the only way forward. Nor should it be said that the lessons of East Asia should be applied in toto. When countries are faced with limitations in administrative capacity, which is characteristic at the start of the industrialisation process, the tasks assigned to governments must be commensurate with their capacity to execute those tasks.

"I remain cautiously optimistic on the applicability of East Asia's experience to other countries, provided the approach is realistic, cautious and balanced."

Lawrence said that the seminar was part of the preparatory process for UNCTAD-9, and that the discussion would be carried over into the African context, and to explore if it would be useful for African countries to study the usefulness and applicability of the East Asian experience.

The research project and the Kuala Lumpur seminar have wide significance for development theory and policy.

For two decades, the World Bank and IMF have been advocating "free market" policies for developing countries under the structural adjustment policy (SAP) framework.

Underlying the policies is the belief that governments should divest themselves from economic activity and refrain from interventionist policies to direct the economy, to protect or promote local firms or to build up national capacity. It was assumed that if the state allowed the market to set the prices right (by removing subsidies and incentives), and companies were allowed to function without state interference or intervention, then the economy would become more efficient and growth would follow.

Despite following the SAP approach for a long period, many developing countries (especially in Africa) have failed to attain adequate growth and are still trapped in poverty.

The East Asia experience, depicted in the research project and seminar, shows that their high growth resulted from a central role by the state in mobilising savings, directing investment, disciplining and fostering the private sector, having an active industrial policy and devising mechanisms to deal with marginalised groups.

This is contrary to the orthodox SAP or free-market approach that preaches a minimalist role for the state and free rein to be given to the market.

The emerging paradigm's central message is that when national economic capacity is weak to begin with, the state's role is to actively help build up that capacity and not leave it to the market and private sector to do it themselves, for then it is possible or likely that there would be no development.

Thus, the larger East Asia lesson is that there are and can be successful alternatives to structural adjustment. The East Asian model is not the only possible one, nor should it be generalised to be appropriate or desirable for all developing countries.

It does prove however that the structural adjustment model is not the only one that works, that in fact East Asian countries attained high growth because they did not follow the SAP approach, and that therefore SAP cannot be taken as a model for each and every country (as its proponents have advocated).

Just as SAP is one model for development, so too should the East Asian experience be recognised as a different model, and one which arguably is much more successful than the SAP model.

The East Asian experience, and the UNCTAD-organised explanation of it, may well signal the beginning of the end of an era dominated by a single top-down and imposed socio-economic model.

It shows that there is a spectrum of different socio-economic models of development. SAP and East Asia are only some of the possible models. Allowing for a diversity of these models to co-exist, and to recognise that this is valid and even desirable, would free the developing world from the constraints of having to follow orthodoxy, ideology and economic fundamentalism.