WEEK 8

P51-72
THE ASIAN GROWTH MIRACLE
Introduction:
The pace of economic growth and structural change in many Asian countries in the past thirty to
forty years ranks as one of the most outstanding features of recent world economic history It has been
termed the “Asian growth miracle.” Why have the Asian economies flourished whilst other developing
countries and regions have not? Incomes in developing Asia have grown much faster for a sustained
period of time-up to four decades-than they have anywhere else in the world. These economies were able
to move from a very low level of economic activity in the late 1950s and early 1960s, to fairly high levels of
per-capita income, much faster than most of the industrial countries outside Japan were able to do during
their rapid growth phases.
What were some of the characteristics of this spectacular growth performance in Asia and what were the
policies that contributed to it and supported it?

Lesson Proper: THE ASIAN GROWTH MIRACLE

Many aspects of the growth theories described do apply to the Asian experience, though each is
not fully sufficient to adequately explain the ‘miracle?’ In the following section, we look at the various
aspects that may have supported such rapid growth.

In what follows, we adopt the approach suggested by Quibria (2002), grouping the explanations
for the Asian “miracle” into primary and secondary factors. The primary factors were present in all
the “miracle” economies at the time of their economic takeoff. The World Bank (1993) study identified
the countries falling into this classification to be Japan, the NIEs (Singapore, Hong Kong, Taiwan, and
Korea),
Indonesia, Malaysia, Thailand, and China. The primary factors in these countries form the common
denominator of the Asian growth experience and they are the fundamental determinants of sustained
rapid growth during the period. They are mutually reinforcing and therefore constitute a bundle of
characteristics or factors that cannot be easily separated.

In addition, there were secondary factors that were sometimes present and sometimes not. They
contributed to the “miracle” of rapid growth but they varied from country to country. They added
richness and variety to the growth experience. In analyzing the growth experience of the “miracle”
economies, it is important to distinguish the policy environment that existed during the early stage of the
economic takeoff to sustained high growth and the economic performance that resulted from the mix of
policies. To do this, it is useful to describe the dynamics of the growth process that resulted in such
outstanding growth performance.

PRIMARY FACTORS

First Primary Factor: Importance of Outward Looking Policies and the Emphasis on
Exports and Foreign Direct Investment
As with other developing countries, the economies of East and Southeast Asia started the industrialization
process by developing import-substituting industries. They included industries that were natural
complements to the agricultural base that already existed, such as food processing, textiles and apparel,
and footwear. There was also a push toward medium and heavy industries in several countries, including
Korea and India. During the 1960s, development economists and policymakers stressed the importance of
developing a wide range of domestic industries that could supplant imports. This line of reasoning was
termed “bootstrap” development. It was also popularly believed that the developing countries would
need large inflows of development assistance to supplement domestic saving in order to accomplish this
transformation of the production structure. India took on board these suggestions and began to develop
a wide range of domestic industries with the help of the Soviet Union.

Other countries in Asia were more reluctant to follow this model completely. Instead, they turned to
Japan as an example of how to industrialize. Japan in the 1960s was building a strong industrial economy
based on exports. It had achieved industrial maturity in the 1930s and it returned to this model of
development after World War II, with the difference being that it targeted much of its production at foreign
markets. Korea, Taiwan, China and later, the major economies of Southeast Asia, followed this model.
Soon after developing some industrial capacity in importsubstituting industries, they turned their attention
to external markets. In Korea, the model was followed most closely as the industrial conglomerates, called
chaebol, were modeled on the Japanese industrial giant kareitsu, such as Mitsubishi and later, Sony and
Honda. In Taiwan, the model was adjusted to stress the development of small and medium industries and
the network of overseas Chinese in the rest of Southeast Asia, particularly Hong Kong and Singapore, but
also in Europe and North America. The emphasis was initially on apparel, which shifted quickly to
electronics.
In the Southeast Asian countries of Malaysia, the Philippines, and Thailand, the initial emphasis
was on agriculture-based exports such as rubber, sugar, coconut and palm-oil products, and textile
fabrics, such as silk. In Malaysia, large rural estates were mobilized to increase production, together with
research to increase productivity. Slowly, the emphasis on agriculture-based industry gave way to the
development of labor-intensive industries, including apparel and footwear and later, electronics assembly.
The emphasis on exports was facilitated by government policies, which varied from country to country.
One of the common threads of these policies was that there was initial protection of these
industries through a combination of import restrictions and tariffs so that resources would be allocated to
them by the private sector in anticipation of good profit potential. However, these taxes were lower in East
and Southeast Asia than they were in South Asia and other developing regions. More importantly, they
were reduced over time to minimize the distortions in the allocation of resources that were created. In
South Asia, tariffs were also reduced but it took a longer period of time to do so, resulting in a much
slower transition to export promotion from import-substitution, leading to waste and misallocation of
resources.
Tax rates and trade distortions are shown in Table 3.3 where two measures of trade taxes are
reported. The first, taxes as a percentage of exports and imports, may understate the degree of protection,
particularly if taxes are high since there will be less trade in these products. On the other hand, the
average tariff rates may overstate the degree of protection for the same reason since most trade occurs in
products that are taxed at low rates. Nevertheless, both sets of figures show that there has been a
deceleration in the level of taxation, particularly since 1990. Even in South Asia where rates were high in
1980 and 1990, the rates fell in the decade of the 1990s and 2000s. The challenge in South Asia is not
only to reduce the rates of taxation, but also to find other revenue sources to replace the tax on trade and
also to reduce the level of nontariff barriers, which are not only difficult to measure but also restrict trade.
Here we are speaking of bureaucratic procedures and slow processing that increase costs and reduce
efficiency.
 The transformation to labor-intensive industrialization with an emphasis on exports was supported
by the inflow of foreign direct investment, initially in small amounts from Japan and the United States, and
later in greater volume, particularly from Japan as it accelerated the movement of its labor-intensive
industries offshore when the yen appreciated in value in the second half of the 1980s and early 1990s.

The combination of a shift toward export promotion policies combined with reductions in tariff rates
and complemented by the inflow of foreign direct investment and supportive macroeconomic policies
produced an export boom that lasted more than twenty years, unprecedented in economic history. The
ratio of exports to GDP increased by leaps and bounds. The proportion of exports derived from
manufacturing also increased dramatically and employment shifted from agriculture to industry, as did
value added (see Table 3.4). By 2000, more than 50 percent of GDP was generated by the export sector
in all the East and Southeast Asian countries except Korea, Indonesia, and the Philippines (see Table 3.5).
Hong Kong and Singapore have had the highest GDP percentage share of exports in the region
historically and currently; it went up to 207 and 231 percent respectively, in 2007. Indonesia, which was
slow to start industrializing because of its earlier dependence on oil, and China. which was also late in
starting and is a very large economy with a huge domestic market, were exporting less than 50 percent of
GDP.

In South Asia, on the other hand, the rate of export expansion was modest until the 1990s when
trade liberalization policies were adopted' in several countries. Figures in Table 3.5 show that by 2000,
exports of India, Pakistan, and Sri Lanka were generally only one-third (around 15 percent of GDP) of
most countries in East and Southeast Asia, except for Sri Lanka which exhibited slightly higher export
figures of 40 percent.
In this region, Sri Lanka is an interesting case where agricultural exports, particularly tea, were
extremely important in the early years. However, despite more open export policies than its neighbors
(mean tariff rates are not significantly higher than those in Thailand or China), Sri Lanka has been unable
to develop a strong industrial base because of domestic constraints and a poor climate for foreign
investment as a result of civil unrest.

As suggested above, in the minds of the many economists, this surge in exports and the income
and technological transfers that accompanied it was the main reason that the Asian “miracles was able to
unfold with such vigor and dynamism.
THE ROLE OF TECHNOLOGY
Technology also played a crucial role as the “miracle” economies moved to higher levels of income and
development. Growth in income is a function of the growth in inputs and the TFP residual, and this residual is
largely a function of improvements in technology. The developing economies in Asia have been able to access
new technology in three major ways:

1. by buying it from foreign companies under license;

2. by copying it without license; and
3. by entering into a joint venture and importing the technology through foreign direct investment.

In recent years much of the transfer in technology has been through foreign direct investment.

FOREIGNTECHNOLOGY
Early on, the newly industrialized economies attracted and used foreign technology, but mostly through
license. Japan and Korea, in particular, did not encourage foreign direct investment in their economies. Instead,
they sent missions overseas to learn about the most up to date technology and then copied it. Much was spent
on research and development for the adoption of overseas technology in local industries and efficiency improved
as a result. Automobiles are a good example. Later, the countries of Southeast Asia bought technology from
other countries through the process of foreign direct investment. The amount of investment that flowed into the
Asian economies increased rapidly following the Plaza Accord when the industrial countries agreed to enter
foreign exchange markets to boost the value of the yen. This caused many industries in Japan to lose
competitiveness. As a result, these firms, mostly in labor-intensive manufacturing and electronics, moved
offshore to lower-cost locations in Southeast Asia and China. The amount of foreign direct investment increased
rapidly as a result (see Table 3.6).
Second Principal Factor: Macroeconomic Policies and the Role of Government
Unlike those countries that followed import- substituting industrial policies, the East and Southeast Asian
economies succeeded because their general policy thrust was to clear the way for markets, competition, and
contests for resources to play the lead role in the allocation process. Governments supported this market-led
development through the pursuit of prudent fiscal and monetary policies, including a low inflation environment, an
emphasis on human resource development, the provision of physical and social infrastructure, and the
maintenance of a legal framework, essential for a market system to function smoothly. The levels of government
financial deficits were generally low and government borrowing was held at prudent levels. In South Asia, budget
deficits tended to be higher. Nevertheless, inflation was generally not a problem that had to be addressed on an
ongoing basis as it was in Latin America (see T able 3.7).
The governments of the day in the Asian economies were thus also important players in the pursuit of
higher rates of growth and development. The success of these economies was not particularly sensitive to the
amount of government intervention in the microeconomic aspects of the economy. Government intervention in
the industrial and financial sectors was heavy in Japan, Korea, and Singapore, moderate in Malaysia and
Taiwan, and relatively weak in Hong Kong and Thailand. Yet all these economics grew rapidly. In the Philippines
and Sri Lanka, the policy environments were similar to the more successful economies but
growth was slowed by political uncertainty and domestic unrest. In Indonesia, growth was slowed by the early
reliance on oil and later by the demise of a single political regime that had been in place for more than thirty
years. The effectivity in achieving broad economic stability, export promotion, and tariff reduction and a neutral
position toward agriculture combined with outward-looking policies that attracted foreign direct investment and
technology transfer were more important than specific industrial, financial and trade policies in stimulating growth.

It is true that some policies, such as financial repression and directed government lending programs, were
not particularly beneficial and caused resources to be allocated inefficiently. However, the flow of resources
available for investment was quite substantial, but because of the high domestic saving rates and the inflow of
foreign capital, these shortcomings were not recognized until the growth bubble of the early and mid-1990s burst
in 1997.
What did seem to be important were incentives for the technocrats that ran the government bureaucracy.
The experiences of Singapore and Taiwan are notable. In both countries, civil-service wage levels are
comparable to those of the private sector so that the most qualified people can be recruited. Promotions are
based on merit, not patronage. Finally, there is a strong anti- corruption culture. Conversely in several other
countries, salaries for civil servants remain low. Such a system attracts those looking for rent-Seeking
opportunities and the environment creates a fertile seedbed for corruption and influence peddling. Even where
salaries are high, as in Japan, incentives to perform efficiently are eroded by a system where promotions are
made strictly on a seniority basis and rewards are made accordingly.

Third Principal Factor: Education, Labor-Force Growth, and Labor Productivity

Labor productivity in Asia increased rapidly as did total productivity. To a great extent, this was due to the
increase in the amount of capital per worker as a result of rapid investment growth and technological transfer.
Another significant factor that has influenced increased productivity in the region is the high level of investment
given to educating the workforce. Asia has a very literate workforce that makes them highly adaptable to
technological changes. In addition, high population growth, particularly in the labor force, was an important
source of economic development. Bloom and Williamson (1999) estimate that up to 25 percent of the increase in
Asia’s growth from the 1960s onwards can be attributed to high rates of expansion in the labor force. The
education and training of this rapidly growing workforce was, in turn, crucial to growth in productivity.

ROLE OF EDUCATION
Historically, the role of capital and saving to facilitate capital equipment purchases has been stressed as the
primary engine of economic growth. We see this in the models of Harrod and Domar (1939, 1946) and also in the
Solow and Swan (1956) models, even though the latter models emphasize the role of total factor productivity.
However, as discussed earlier, a number of economists have recently stressed the importance of education.
For example, the Nobel prize winner Robert Lucas (1990) and other proponents of the “new growth theory,”
including Mankiw and Romer (1991), and Mankiw, Romer, and Weil (1992) suggest that
education is even more important than physical capital in raising the rate of growth. Lucas argues that by
continuously shifting to products requiring higher skills, the Asian economies were able to raise productivity at a
very rapid rate. Countries that remained chained to a set technology, such as some countries in Africa, Latin
America, and South Asia, were not able to take advantage of increases in productivity as the NIEs and the
Southeast Asian countries did. These countries were very open and subject to the changing forces of
comparative advantage. This forced them to continuously adjust their product mix as wages rose and their
comparative advantage shifted. The secret was in the shifting mix of production, not in their having a better skill
or education mix than other developing countries, although skill development was a necessary condition for this
shift to be achieved.
For example, Table 3.8 shows that there has been a gradual increase in the human development index
(HDI) of countries in the Asian region, and it had reached a high level by the late 1980s. Even as early as 1980,
with the exception of China, the countries of East Asia had high literacy rates for both men and women (see
Table 3.9). Literacy rates were somewhat lower in Southeast Asia, although they were over 90 percent in
Singapore, the Philippines, and Thailand. In South Asia, literacy rates were much lower, with the exception of Sri
Lanka. During the next twenty years, there were further improvements in education as enrolment rates in
secondary and tertiary education increased. However, by the year 2000, some of the educational advantages
over comparable countries at the same level of income had eroded (this is partially reflected in Table 3.8 by the
declining HDI values relative to GDP in several Asian countries during the decade). There were two reasons for
this. First, the amount of public resources needed to boost the enrolment rates in secondary and tertiary
increased rapidly' because the cost per student was higher compared with primary education. Secondly, as the
incomes of the Asian economies rose, they had to face competition from a set of countries that also had high per-
capita incomes and a more educated workforce.

The decline in the ranking of the Asian economies in the HDI between the 1990 and 2000 rankings also suggests
that the rate of growth income tended to increase more rapidly for the Asian countries compared with the overall
HDI. This is particularly noticeable for China and Indonesia in East and Southeast Asia, and also for Sri Lanka in
South Asia, where the decline was quite precipitous (see Table 3.8). In the latter case, the lack of resources
devoted to education and other social sectors is understandable, given the civil disorder that occurred for much of
the decade.
Nevertheless, despite these favorable results, comparisons with other developing countries do not show that
the educational attainment in the Asian economies was significantly higher than that of other developing
countries. Behrrnan and Schneider (1994) note that the “miracle” economies had higher primary and
secondary school enrolments in 1965 than the international average after controls for per-capita income were
imposed. More than two decades later, only Korea and Indonesia had exemplary enrolment rates relative to
the international average. They conclude that the “miracle” economies as a group did not have an
unusually high schooling attainment despite many years of rapid growth.
This leads to the conclusion that education has to be taken together with labor-market flexibility and the mix of
skills developed to deal with a rapidly changing production schedule.

This aspect is illustrated by the case of the Philippines, which had a very high level of human capital
development in the 1950s and 1960s. However, because it was unable to put together a matching set of
development policies that could take advantage of this highly skilled workforce, it developed slowly and fitfully.
Political instability was reflected in the macroeconomic policies that were not conducive to attracting a large
inflow of foreign investment, and when they were able to maintain high growth rates for a time in the late 1960s
and 1970s, the government introduced a series of controls and agencies that squandered revenues.
Furthermore, the Philippines had difficulty overcoming a protectionist lobby that favored local big businesses.

Fourth Principal Factor: Labor-Market Flexibility

The “miracle” economies had very flexible labor markets at the beginning of their growth spurt and
this continued throughout the period of rapid growth almost unabated. According to the International Labor
Organization (ILO), the “miracle” economies are among the most flexible in the developing world. While there
can be disagreements about the desirability and extent of market interventions in the labor market to deal with
safety, health, norms for compensation, and child labor, there is little doubt that excessive labormarket
regulations have a negative impact on economic development and growth. Regulations raise the cost of labor,
diminish employment, and reduce the flexibility of firms to hire and fire. The result is that while those who are
employed benefit from the regulations, there are negative impacts on the rest of the labor force, including the
poor. The “miracle” economies were able to achieve rapid growth in real wages without protective labor
legislation. Korea, for example, which joined the Organization for Economic Cooperation and Development
(OECD) in the late 1990s, did not have a minimum wage policy until 1988.

The bundle of these four policies resulted in a number of important macroeconomic developments,
including rapid growth and reduction in poverty. These factors, particularly high saving and investment, and
increasing productivity, are discussed in the next two sections.
 SECONDARY FACTORS

Initial Secondary Factor: Difference in Initial Conditions

Several other factors have been discussed in the literature as possible explanations for the growth of the
“miracle” economies and they also deserve mention. They include initial conditions and sector policies.

Initial conditions played an important role in providing a fertile seedbed for development to germinate. The
successful East Asian economies differed substantially from other deve10ping economies of Asia in the 1960s in
two fundamental respects. First, the subsequently successful countries were by and large better endowed than
others in Asia in terms of the quality of their human resources. Secondly. income, wealth, and land were also
more evenly distributed in these Asian economies in the early 1960s than they were in other Asian countries. In
the aftermath of the Korean War and following the migration of large numbers of people fleeing the Chinese
mainland, land reforms were undertaken in these two countries that brought about greater equality in the
distribution of land and capital resources. At the same time, both of these economies had benefited from strong
educational policies in earlier years that resulted in higher levels of human resource development, including
nearly 100 percent literacy, a high completion rate in elementary school, and high enrolment rates in secondary
school (see Tables 3.9). In China, there was also strong emphasis on education and equality of opportunities so
that when the economy opened up to Western ideas in the 1980s, it had a strong and well educated labor force.
In Southeast Asia, the Philippines had been the beneficiary of assistance from the United States that
strengthened the education system in the colonial period, and this emphasis on education continued after
independence. In Thailand, the monarch controlled some land but there had historically been a policy of relatively
even land distribution. As the urban elites made more money in the 1980s and 1990s they bought up land and
the distribution of resources became more unequal. This was exacerbated by the lack of secure title and land
tenure laws that required tenants of cleared land to work the land or else risk confiscation.

Another Secondary Factor: Importance of Sector Policies

AGRICULTURAL SECTOR POLICIES

In general,as industrialization proceeds, there is a tendency to pursue policies that favor the industrial sector at
the expense of agriculture. This is only natural since in the initial stages of industrialization, taxes on agriculture
make up the major source of revenue for the government. The risk in following such a policy of taxing agricultural
exports and the agricultural sector in general, is that it is not a sustainable long-term strategy because it results in
the eventual strangulation of that sector, a reduction in output growth, and stagnation of the rural economy.
Because the growth in industrial sector employment is never enough to offset such a loss in income and
employment, this type of policy will eventually result in the collapse of aggregate demand and industrial
stagnation, even if there is a viable export market. In this case of the Asian economies, there was first a gradual
and then more rapid increase in the rate of saving and private investment. This provided resources to fund
industrial development and reduced the necessity for taxing the agricultural sector excessively. While an anti-
export bias did exist for traditional exports from Malaysia, Thailand, and other East and Southeast Asian
economies it was modest. In the case of Thailand, the tax on rice exports created incentives for diversification of
the agricultural base to crops with greater profit potential. Furthermore, the Green Revolution was instrumental in
raising rural incomes. It was also supported by large amounts of public investment, particularly to extend the
amount of irrigated areas.

INDUSTRIAL POLICIES
The term “industrial policy” in the context of the development of the “miracle” economies is taken to mean
government policies that were designed to promote particular subsectors, usually capital-intensive industries.
These industrial policies included subsidized credit and other policies designed to promote these industries so
that they could compete effectively in international markets. These policies became an integral part of the policy
apparatus.
Only Korea and Taiwan adopted comprehensive industrial policies. In the other economies, industrial
policy was not adopted in a systematic way nor was it particularly important in influencing the evolution of
industrial growth and concentration. There was government intervention in most of the other economies but they
were sporadic and not well coordinated over time. In Malaysia, there was an effort to support heavy industry in the
19805 and a high-tech push sponsored by the Minister of Industry, Dr. Habibi, in the early 1990s. However, these
efforts did not increase international competitiveness and were interpreted by observers as political favors to
supporters and, as a result, arbitrary without any well formulated economic objective. In Thailand,
Christensen et al. (1997, p. 346) Observed that Thai
sector policies “were not guided by a strategy of picking winners and have often been marked by patronage
and rent-seeking.
The policies in Korea and Taiwan were, on the other hand, systematically thought out. Subsidies were
withdrawn if certain performance criteria were not met and there was a vigorous effort to keep the favored
industries on track to become competitive in external markets.
Whether these industrial policies in Korea and Taiwan were successful or not has been the subject of
considerable research. There is still no uniform agreement on the subject. Little (1996) concluded that it was
most plausible that Korea grew despite its industrial policies, while Pack (2000) concluded that industrial policies
played a minor role in stimulating growth and should be viewed cautiously, particularly in light of the adverse
effects of such policies on the financial sector (see also Chapter 8) and other sectors that had been neglected.

ASPECTS OF ECONOMIC PERFORMANCE IN THE ”MIRACLE” ECONOMIES

1. High Growth Rates of Saving and Investment
Rates of saving and investment increased dramatically in many countries in Asia, from paltry levels of 10 percent
or less in Korea and Singapore, and somewhat higher levels elsewhere in 1960, to over 30 percent by the 1990s.
This achievement is unprecedented in the annals of economic history. To give some idea of the magnitude of this
accomplishment, consider the average saving rates for the OECD countries and other developing economies
(see Table 3.10). Hong Kong and Malaysia had high saving rates in 1960. Other countries in Asia, for which data
are available, recorded saving rates below 20 percent, and often, below 15 percent. By 1970, saving rates had
risen, but were still below 20 percent in all but six developing economies shown in Table 3.10. By 1990, all
economies in East and Southeast Asia had saving rates of over 30 percent except Taiwan and the Philippines. In
South Asia, the record was less spectacular but still impressive. Bangladesh, India, and Nepal all raised their
saving rates over the period of four decades. By contrast, the saving rate in the United States was never more
than 20 percent and was on a declining trend throughout the period, while Japan’s saving rate was relatively
stable, although it also began to fall in the 1990s.

Apart from the issue of efficiency, the rapidly growing rate of saving was instrumental in providing the
resources for the high growth rates achieved in the Asian region in the past few decades. As investment rates
were also high, the resource gap among the Asian countries was insignificant. In East Asia, China, Hong Kong,
and Taiwan have had an excess of saving over investment since 1980 (see Table 3.11), with the exception of
Korea whose saving-investment gap moved from a deficit to a surplus by 2000. In Southeast Asia, Singapore and
Thailand moved to a surplus in 2000, while Indonesia and Malaysia had surpluses for all the available years
displayed in Table 3.11. The Philippines had deficits in 1980, 1990, and 2000. In South Asia, India has moved
between small surpluses and deficits while Bangladesh, Pakistan, and Sri Lanka had substantial deficits in 2007.

2. Increased Productivity
Beyond the increases in saving and investment, it is likely that improvements in the efficiency with which these
resources were used also contributed significantly to the growth in the Asian nations. For comparison purposes,
we will first examine estimates of total factor production (TFP) for the industrialized nations. We begin with a
caveat that the estimates are sensitive to the accuracy of the variable inputs measured. If the contributions of
labor and capital to the growth process are underestimated, then the value of TFP will be overestimated.
 The initial estimates of TFP made by Solow and others for the industrial countries were very large, (that is,
the inputs of labor, capital, and land, measured in a simple fashion, grew much more slowly than, output). The
TFP component accounted for as much as 60 percent of total output growth. Conventional factors of production
accounted for the remaining 40 percent.
Initial work on TFP in the late 1980s led to tension between the World Banks view and that of the wider
academic community, as represented by Alwyn Young (1992, 1995), Lawrence Lau (1996), and others. The
World Bank made a case for a high level of TFP in Asia. Young and Lau disagreed with this, saying that growth in
Asia was primarily due to the rapid accumulation of physical capital and labor.

Recent research suggests that many of the differences in opinion can be reconciled by looking at
assumptions about the shares of capital and labor in income. Lower assumptions of capital shares result in
higher estimates of TFP. Moreover, estimates of TFP have been rising over time as the region opened its
borders to foreign investors and the rate of technological transfer increased. This has been reinforced by the
rapid growth of the region between 1985 and 1997. This period, the beginning of which coincided with the Plaza
Accord, where the Group of Seven (G7) industrial countries agreed to support a yen appreciation, also
corresponded to a period of rapid inflow of foreign direct investment and rates of technological transfer.
Sarel (1997) shows that the average rate of productivity growth in the late 1980s and early 1990s was 3.2
percent for the MRS. This is considerably higher than the rate of just over 2 percent for the period 1970-
1985. Similar results were recorded by Bosworth and Collins (1996), who found a “U shaped” pattern of
productivity growth for the three periods 1960-1973, 1973-1984, and 1984-1994. In the last period, TFP
contributed a substantial fraction of total output growth in all the Asian economies. While not as high as the TFP
figures obtained for the industrial countries, they are still quite high when compared with the estimates
reported by Young (1992, 1995), and Kim and Lau (1994). They are in excess of 45 percent of the overall
growth in output per worker in Taiwan, Singapore, and Thailand, and between 30 and 45 percent in Malaysia
and Korea.
 THE POLICY MATRIX AND ECONOMIC PERFORMANCE IN SOUTH ASIA

Growth in South Asia was considerably slower than in the “miracle” economies during the postwar period.
There are a number of reasons for this and we can only speculate what might have happened if they had
adopted open and outward-looking policies at an early stage in their development. In terms of the bundle of four
primary policies that were responsible for the rapid growth of the miracle economies, there are obvious
differences between these policies and those pursued in South Asia.

The South Asian economies were generally not open to trade and to the inflow of foreign direct
investment. Sabhs and Warner (1995) developed an openness index based on four aspects of trade policy,
classifying an economy as open if it had import duties that were less than 40 percent, quotas covering less than
40 percent of imports, a black market exchange premium of less than 20 percent, and an absence of a state
monopoly for major exports. They also defined an open economy as one without a socialist government.
According to this categorization, none of the South Asian economies was open during the postwar period apart
from Sri Lanka and Nepal in 1992. Conversely, all the “miracle” economies were open throughout the period
between 1950 and the early 1990s, when Sachs and Warner ended their data series. Because the South Asian
countries were not open to trade, there were also very limited inflows of foreign direct investment until very
recently.

South Asia had generally inflexible labor markets even though there were high levels of unemployment.
This was particularly true in the formal sector. For example, according to the Global Competitiveness Report of
1998, although India ranked high in terms of the quality of its labor force as reflected by the number of engineers,
scientists, and others with technological backgrounds, it ranked near the bottom in terms of labor-market
flexibility. Labor unions were strong and job security was high, particularly given the level of economic
development. This situation was generally true in the other countries in South Asia too. As a result, they were not
able to respond quickly to shifts in demand according to the change in skill mix required when demand shifted to
higher-skilled occupations.

The educational attainment of the workforce in South Asia was, until recently, much lower than in the
“miracle” economies (such as Hong Kong and Singapore). This is evident from comparisons of literacy and
school enrolment rates in the two economies (see Table 3.12). In South Asia, there has been some improvement
in recent years, particularly in the 1990s. Nevertheless, these countries generally lag behind the “miracle”
economies and East and Southeast Asia in both educational attainment at the secondary and tertiary levels,
and in labor-market skills and rates of literacy.
 Macroeconomic policies in South Asia were generally stable-inflation rates were not high and variable and
government deficits were not excessive. There were exceptions, including the fiscal crisis in India in the early
1990s. But the record was generally good and certainly better than in other developing regions such as Latin
America, where high rates of inflation and macroeconomic instability have been endemic.

Industrial policies were adopted that gave subsidies to several industries but these policies were generally
unsuccessful in promoting rapid growth, neither in exports nor in achieving economic efficiency. This was
because the subsidized industries did not have to meet the market test of competing in international markets.
Furthermore, they were not sanctioned if they did not meet production and efficiency targets. As a result, a large
but relatively inefficient industry sector developed. In addition, the mix of subsidies and directed credit in South
Asia also weakened the competitiveness and allocative efficiency of the financial system.

CONVERGENCE OF INCOME
We conclude this section on the Asian growth experience of income. Whether countries from the lower end of the
development spectrum will ever catch up with the development levels of the more advanced and more
industrialized economies at the high end of the spectrum is often a question of interest to both theoretical and
applied economics. The answer to this question holds the key to determining which economic development and
growth strategies are most appropriate at particular points in time. From the review of the Asian “miracle” in
the previous section, it seems that the prospects for convergence within this group of countries are good.
However, for other regions this may not be the case.

In order to understand the issue of convergence better, we shall discuss some basic concepts relating to
the convergence of income.

1. Absolute Convergence
The hypothesis that poor countries tend to grow faster per capita than rich countries-without conditioning on any
other characteristic of the economies-is referred to as absolute convergence. The Solow model says that all
economies will converge to the same level of per capita capital and per-capita income irrespective of where they
started out. This would be true even with technical progress, since the technical progress coefficient is assumed
to be constant across all countries.
Is this realistic? Has there been this kind of convergence either within countries or across countries. Let us
look at the evidence;
First, if this kind of convergence is to take place, then the poorer countries with lower levels of capital per
capita will grow faster. They are closer to the origin of the phase diagram in Figure 3.4.

Using this inference from the Solow model, we can test whether such a relationship exists, that is, is there a
relationship between per-capita income in an initial period and growth over an extended period from that initial
date. Most studies have worked with logarithmic functions. This is done so that a linear relationship between
levels and growth rates can be established and tested through regression analysis.
However, the convergence hypothesis does seem to hold if a more homogenous set of countries is
considered. In the OECD after 1950, the poorer countries (those in the bottom half of the distribution in 1950)
grew by over 1 percent faster than the rich countries in the top half. Those in the bottom quarter grew more than
2 percent faster than those in the top quarter. The dispersion of income fell dramatically
 2. Conditional Convergence
A more general approach than absolute convergence is called conditional convergence. In conditional
convergence, various parameters are allowed to change between different countries or groups of countries. If
saving rates, depreciation rates, and population growth rates differ among countries, the levels of income may
differ, although the Solow theory would still predict that there would be a convergence in growth rates of income.
Nevertheless, the steady state levels of income would differ.
There have been many studies on conditional convergence but we will not go into them in detail here.
Suffice it to say that they cannot completely explain the differences in growth rates among a wide set of
countries. One difficulty is that heterogeneity in the data set would require the use of different regression models
for different subsamples (see Ardic, 2002). On the plus side, variations in the saving and population growth rates
can explain more than half of the variations in per-capita income across countries. However, the magnitude of the
coefficients on these variables is too large to be consistent with the Solow model. This result implies that the
effect of diminishing returns is very small. It takes many decades for the effect of diminishing returns to set in.

For all intents and purposes, the Harrod-Domar (1939, 1946) model seems to be a better predictor of the
actual evolution of income growth. Yet we know that the Harrod-Domar model is much too simple. What is more
likely is that several countervailing factors are working simultaneously to make it appear as if the saving rate and
the capital-output ratio alone determine income. There may be a steady state but it is continually being shocked
by changes in some of the variables. One thing that could be happening is that shifts in technology have the
effect of boosting returns to scale, offsetting the tendency for diminishing returns to set in. Furthermore, if
technical progress does not spread uniformly across countries, then the rich countries will continue to have an
ever widening edge over the not so rich. A branch of the new growth theory explores these issues in more depth.