Thoughts on The Role of Government in Developing Economies
Looking to fill the gap in my knowledge regarding the development of Asian economies, I came upon How Asia Works by Joe Studwell. A fascinating case study of the drastic divergence in economic growth between Northeast Asia (South Korea, Japan, Taiwan, China) and Southeast Asia (Philippines, Thailand, Indonesia, and Malaysia), the book pins down prerequisites to growth for all major economies. More importantly, Studwell provides deep insight into how contrary to popular belief, developed economies are far from the products of free markets and limited government.
Studwell walks us through the economic transition, characteristic of all modern developed economies, of some of the most successful northeastern Asian countries (South Korea, Japan, Taiwan, China). The transition describes the stages an economy undertakes in its development lifecycle. The first stage is an economy that is primarily based in agriculture. The second stage is an offshoot of the first: agricultural surpluses and abundant exports allow individuals to move into urban centers and provide a strong manufacturing base. Finally, as an economy attains higher and higher levels of wealth through manufacturing exports, it can finally move into a service-based economy that is reliant on an educated population. The transition is intuitive and the logic is sound. Though in practice, the conditions necessary for an economy to move from one stage to the next cannot be satisfied without deliberate government intervention and strategic planning of the economy. Yet doesn’t this fact contradict mainstream neoclassical theories of growth which call for limited government? Not quite.
Neoclassical growth theory rests on a handful of key assumptions: a well-educated citizenry, free trade, political stability, enforceable property rights, public goods that support economic activity, abundant access to physical capital, and relative social mobility. If you look at any developed economy, all of these conditions are met and therefore neoclassical growth models can be applied. Yet if you steer an economy under the false assumption that these conditions have been met, then economic growth is unlikely and any efforts to advance a developing economy will be fruitless.
I cannot emphasize enough the importance of understanding the differences in growth dynamics between developing and developed countries. Throughout the 20th century, Western trained economists advised northeast Asian policymakers to deregulate, free their markets, and relax government control over their economies. They were so focused on preserving economic efficiency that they failed to recognize efficiency should have been the least concern of these developing countries. In actuality, arguments against tariffs, protectionism, subsidies, and state-funded enterprise had no bearing because these Asian economies were on a completely different plane of reference than those of the West. Here’s what happened, in a generalized sense across northeast Asia in the mid 20th century.
Governments stripped land rights from landlords and redistributed them to tenants who tended to the land, creating textbook levels of competition and incentives to innovate. Agricultural yields skyrocketed as farmers’ incomes were no longer crowded out by rent payments. Governments aggressively protected infant industries, giving companies the chance to ‘learn by doing’, rather than allowing them to get trampled by low global prices. Many of these firms became globally competitive and to this day command deep consumer loyalty (think Toyota, Samsung). By subsidizing important public investments, governments created those conditions that allow modern economists to theorize about the growth of developed economies. Strict export discipline enabled economic surpluses which were then invested into infrastructure and development. Government emphasis on the identification and dissolution of firms that could not compete freed up otherwise productive labor and capital resources. The regulation of financial institutions to encourage the flow of capital into projects that yielded higher long-term gains, rather than short-term profits created incentives for finance to make decisions that were socially optimal as well.
What I found extremely hypocritical was how Western economists so frequently demonized the role of government in economic development, while ignoring that their own countries — the U.S and Great Britain- had at some point used these exact same protectionist tactics (i.e. mercantilism, protectionist tariffs, state-run industrial operations) and worse (I’m talking about slavery, subjugation of natives, land clearing, etc.).
Had policymakers at the time listened to the advice of neoclassical economists that hailed from some of the most reputable academic institutions of the time, they could very well have handicapped their economies for decades to come. That they relied on the prudent insight of businessmen, engineers, and economists who studied the past failures and mistakes of developed countries at the time, was instrumental in creating the modern, globally competitive Asian economies of today.
