Chapter 2:
Public Policy and Growth
Quan Longhua
The significance of geography and culture factor
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1. Regional linkages facilitated the adoption of imitative
strategies, in both public and private sector activity.
Policy imitation-specifically of Japan’s industrial strategy ( for
instance, Korean and Malaysia)
2. Geographical proximity has facilitated capital flows
Northeast Asian manufacturers of labor-intensive exports moved
their factories south to take advantage of lower wages.
3. East Asian economies may have benefited from positive
regional externalities
Through earlier trade with Japan, Western importers had become
familiar with Asian business, established networks for sourcing
East Asian products, and gained respect for East Asian quality.
Policy Explanations from different views
1
The Neoclassical View
2
The Revisionist View
3
The Market-Friendly View
4
Functional Approach View
The Neoclassical View
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The market takes center stage in economic life and governments
play a minor role. The East Asian economies greatly benefited
from decisions and policies that limit government’s role in
economic decision making, exercise a decisive role in determining
resource allocation.
Stable macroeconomic environment and limit the policy
distortions in the markets.
Factor markets have been roughly competitive, so positive real
rates of interest have prevailed.
The Revisionist View
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The East Asian countries didn’t rely solely on markets to allocate
savings, they repressed interest rates and directed credit in order
to guide investments. Governments in each of East Asian
economies at times intervened forcefully in markets.
The revisionist provide evidence that governments can foster
growth by “governing markets” and “getting prices wrong” and by
systematically distorting incentives in order to accelerate catching
up . Economic expansion depends on state intervention to create
price distortions that direct economic activity toward greater
investment.
The Market-Friendly View
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World Development Report 1991, in a comprehensive attempt to
describe the policies needed for rapid growth, falls in the middle
ground between the neoclassical and revisionist views.
The appropriate role of government in a market-friendly strategy
is to ensure adequate investments in people, provision of a
competitive climate for enterprise, openness to international
trade, and stable macroeconomic management. But beyond these
roles, government are likely to do harm than good.
Sustained growth results from the positive interaction of four
critical aspects of economic policy: macroeconomic stability,
human capital formation, openness to international trade, and an
environment that encourages private investment and competition.
Functional Approach View
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Understand how policy choices contributed to outcomes via
attainment of the three functions.
Link rapid growth to the three central functions:
• accumulation, efficient allocation, technological catch-up.
Understand how gov’t policies (either fundamental or
interventionist) contributed to the above three functions.
• Fundamental policy: macroeconomic stability, high investment in
human capital, limited price distortions, stable financial system, etc.
• Selective interventions: financial repression, industrial promotion
with directed credit, export promotion, etc.
• Institutions: technocratic insulation, high-quality civil service,
monitoring
Functional Approach View
Fundamentals
Market-based
Selective
interventions
Accumulation
Allocation
Contest-based
Institutions
Productivity
change
Functional Approach View
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The six fundamental policies are defined in the sense that they affect the
attainment of growth functions primarily through market-based
mechanisms of competitive discipline.
But the HPAEs also went beyond the fundamentals, intervening with
varying degrees of intensity to alter market incentives.
(1) incentives for manufactured exports. As part of this export push, all
the HPAEs permitted exporters automatic access to imported intermediate
inputs at international prices. Most also offered subsidized credit for
exporters.
(2) Most HPAEs also controlled interest rates on deposits and bank
lending.
(3) Some governments also directed credit to other activities, including
agriculture, small and medium-size enterprises.
(4) By intervening in credit markets, governments selectively promoted
industries, ownership groups, and , individual firms.
Some interventions went beyond helping markets perform better. Rather,
they guided and in some cases even bypassed markets.
Functional Approach View
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Market failure: the coordination problem.
a primary function of markets is coordination. The price system
is a mechanism by which the production decisions of the myriad
firms that make up the economy are coordinated. However, when
markets are incomplete or missing, they can not perform this
signaling function. Government intervention is necessary in the
early stages of development through create institutions and
facilitate coordination.
Functional Approach View
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Market failure:
Missing information and credit markets
In economies where equity markets are weak or absent, credit
mechanisms become the primary vehicle for raising capital and
diversifying and spreading risk. Capital is allocated by a screening
and evaluation process that is quite different from the idealized
market.
For that, governments intervened aggressively to address this
problem in the credit market, going beyond the normal regulatory
functions and prudential supervision that help ensure consumer
confidence.
Functional Approach View
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Market failure:
Scale Economies, Externalities, and Cooperation
Scale economies: Coordination may yield substantial benefits when
large indivisibilities in investment lead to economies of scale. The
market failure is due to incomplete markets, such as the absence
of capital and risk markets, no single entrepreneur could amass
the capital required for investment. Moreover, there are likely to
be large risks, and the market provides no mechanism by which
these risks can be divested.
Externalities: many of the externalities are related to learning:
spillovers associated with developing markets, discovering what
goods can be produced, and incomplete appropriability of
technological knowledge. It is precisely in situations where there
are many participants that markets are particularly useful and
where the absence of markets is particularly costly.
Functional Approach View
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Creating contests
Cooperation raises several problems:
(1) cooperative behavior may become collusion, if firms act
together to raise prices
(2) cooperation may inhibit competition, leading to managerial
slack or a more general loss of efficiency
(3) business government cooperation may encourage firms to
seek favors from government
The East Asian economies created contests to encourage
cooperation avoid these problems. They developed institutional
structures, such as access to credit, in some dimensions while
actively cooperating in others.
Functional Approach View
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Creating contests
Contest based competition included clear, well-enforced rules, and
prizes for winners.
(1)The simplest and most widely used were export contests for
access to credit and sometimes foreign exchange. Monitoring
performance was simple; firms were required to show evidence of
export orders to receive credit.
(2)Contest of using the power of government to grant licenses.
For instance, the coordination of investments in Korea under the
HCI drive. Large private companies, bid on individual, large scale
investments for which they received exclusive licenses combined
with generous access to credit in a highly credit-constrained
system, and government support during business cycle
downturns.
Functional Approach View
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The rules of the game: export as a yardstick
Exports, and especially manufactured, nontraditional exports,
were the yardstick against which the success of other allocation
decisions-for example, credit allocation, domestic content
requirements, and industrial licensing
Using export as a performance yardstick generated substantial
economic benefits. A firm’s success in the export market is a good
indicator of economic efficiency-a much better indicator than
success in a domestic market.
Functional Approach View
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Running the game: the role of referees
Referees play the role of enforce the rules, administer the
rewards, and discourage cheating. The referees are varied.
Banks monitor the export performance for execution of the export
order was essential to repayment.
Banking supervisors and customs authorities could also use their
coercive power to enforce the rules.
Functional Approach View
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The Limits and Constraints of Contests
What determines whether contests can be effectively used to promote
better allocation and faster growth?
(1) Benefits of coordinated behavior
In small, highly open economies with good entrepreneurial skills and
small nontraded goods sectors-the benefits of coordination of investment
decisions or sharing of information are likely to be small
Under kind of industrial structure with a large number of small and
medium-scale firms, the institutional costs of attempting to coordinate all
but the simplest activities were prohibitive
(2) The institutional costs of implementing nonmarket, contestbased competitive discipline
Civil services in these economies are not well insulated from political or
economic interference. So the efforts to coordinate economic activity
through selective interventions have been less successful.
These two factors may also explain why the reliance on contestbased competition may change over time in the same economy
Closing words for chapter 2
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The search for policy explanations for East Asia’s success has not been
completely successful.
neoclassical, revisionist, and market-friendly-adds important elements
to our understanding, however, none fully captures the complexity of
public policy and rapid growth in the HPAEs.
We have proposed using a functional approach to understanding the
relationship between policies and growth. The fundamental policies were
widely used by all the HPAEs and more interventionist policies have the
potential to contribute to growth when they address the coordination
problems. However, they must combine the benefits of cooperation with
contests.
Effective implementation of contests depended on two sets of factors
almost unique to the northern HPAEs:
(1) the competence, insulation, and relative lack of corruptibility of the
public administration
(2) pragmatism and flexibility of governments in the HPAEs where
contests were tried and abandoned or continued depending on their
results.