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Is the World Banks market friendly approach a satisfactory explanation for the East
Asian miracle?

Stiglitz (1996) considers the miracle in terms of the Solow (1957) model and defines
it as growth unexplainable in terms of inputs reflected in the Solow residual. The market
friendly approach must therefore explain why growth in East Asian countries exhibited a
positive Solow residual. The World Bank in their publication the East Asian Miracle
attributes this growth to a market friendly approach. The market friendly approach is
defined as government industrial and competition policy to ensure adequate investment in
people, provision of a competitive climate for enterprise, openness to international trade and
stable macroeconomic management. (EAM 1993) Distinct from the pure free-market
approach the market friendly approach is derived from recognition of imperfections in
markets. Arrow and Debreau (1954) show that if perfect markets do not prevail intervention
may be effective in reaching optimal outcomes. Stiglitz (1989) argues series of imperfections
occur in the East Asia pre miracle. However, the differentiation between a market friendly
approach envisioned by the World Bank and that of a government controlled system in
response to a realization of the existence of imperfections in developing economies (Stiglitz
(1989)) stems from the confinement and manner of the role of government (Yanagihara
1994).
In short, the World Bank attributes East Asias growth to getting the basics right and
that intervention should only occur to allow these fundamentals to be pursued as an
acknowledgment of only few cases of market failure . According to the World Bank EAM
report, private domestic investment and rapidly growing human capital were the principal
engines of growth. HPAEs developed an infrastructure that was complimentary to private
investment. Tax incentives and policies that kept the relative prices of capital goods low also
helped to create an investment friendly environment (EAM Report, 1993). Furthermore
HPAE governments focused their education spending on universal primary education (EAM
Report, 1993). Focusing on primary education as opposed to tertiary education not only
prevented a the brain drain and had higher returns to investment but also led to a more
equitable income distribution. High levels of domestic financial savings sustained the
HPAEs' high investment levels. East Asian countries had in common a high savings rate with
an average savings rate of c. 37% of GDP in 1990 (World Bank Data) some 20 percentage
points higher than the Latin American average. Some HPAEs have also used more
interventionist policies to increase the saving rate. For example China and Taiwan imposed
high interest rates on loans for consumer items and imposed high taxes on luxury items
(EAM Report, 1993). Furthermore the World bank cite agricultural and population trends;
agriculture, while declining in relative importance, experienced rapid growth and productivity
improvement and population growth rates declined more rapidly in the HPAEs than in other
parts of the developing world.
In this sense then, according to the World Bank EAM report there is little that is nothing
miraculous out the HPAEs' superior record of growth; it is largely due to superior
accumulation of physical and human capital. However other than these policies to promote
the basics, it argues that intervention is unnecessary. In reality, governments actually pursued
a variety of Industrial policies to address market failures, which have surely had a profound
effect on their economies as result of the scale and scope of the interventions.

In the case of East Asia, capital markets were particularly weak and institutions such
as postal banks were created to encourage saving (Stiglitz, 1996). Such institutions also
meant that capital allocation wasnt left to the markets and was actually decided by the
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government. This ensured that firstly no capital left the country and those investments were
based on long term social returns as opposed to short term profits (EAM Report, 1993). Strict
performance criteria based on a range of factors ensured this and mitigated the opportunity
for rent seeking. Yet, the extent of state control over capital allocation varied within East
Asia however. For example, in Malaysia, Singapore, Thailand and Indonesia, banks are
privately owned and exercise independent authority lending whereas China, Korea and
Taiwan exercised tight control over capital allocation (EAM report, 1993). While the World
bank acknowledged these policies they argued that the distortions were not as severe as those
in other developing econimes, e.g. Brazilian directed funds attractive negative real interest
rates of -23% v.s. S. Korean of -2.7 for industry. Development banks which monitored much
of this capital have also been criticised as ineffective. Critics point to statistics that show the
small percentage of overall loans made by such institutions. Stiglitz and Uy (1996) believe
that such statistics are unconvincing as a loan by a development bank may be far more
significant than the actual number of dollars lent due to its signalling or risk sharing effects.
Moreover, East Asian countries recognised that the inadequate incentive system in place for
R&D and marketing activities meant that firms who invested in such activities were actually
at a disadvantage (Stiglitz, 1996). HPAE governments have therefore implemented a number
of programmes to address such issues and the region has since benefited from marketing and
technological spillovers.
Capital market imperfections can also prevent a firm from increasing production and hence
benefiting from increasing returns. Such a scenario calls for strategic trade intervention. This
has also been implemented in East Asia and allowed infant industries to benefit from Arrows
learning by doing and production costs have lowered as a result (Stiglitz, 1996). Strategic
trade intervention was heavily implemented in Japan during the 1960s. The government
helped targeted firms to grow so that they could benefit from increasing returns to scale. The
argument behind this was no intervention would result in more firms and lower industry
profits therefore (Stiglitz, 1996). The HPAEs also supported specific, key industries that
had growth potential. For example, Japan and Korea used capital subsidization and import
protection policies to promote heavy industry (Stiglitz, 1996). Whilst some argue that such
policies can lead to rent seeking, in the case of Japan and Korea, in the case of Hyundai it has
lead to formation of a world leading shipbuilder.
Critics cite industrial policys inability to pick winners. For example the EAM Report (1993)
tells of how Japanese Government discouraged Honda from starting up in the automobile
industry. However strict performance criteria ensured that errors like this were few and far
between. This protection was based on conditioning that denied benefits to firms that failed to
reach export targets (for example in South Korea) so that global competitiveness was
incentivised and thus placing an emphasis on productivity. It must also be realised that
industrial policy was not geared towards picking winners in the narrow sense of the term.
Policies were instead focused on supporting winning industries and banks seemed to have
discretion to select which firms within that industry to support (Stiglitz, 1996). Moreover
such critics ignore the wider role government played in spearheading the expansion of
certain manufacturing sectors (Stiglitz, 1996). By increasing the technological and marketing
knowledge, it has been able to create an entrepreneurial environment that has stimulated
further economic growth. The World Bank also finds evidence that targeted industries have
lower growth rates than other industries. Kwon (1994) however questions the economic data
analysis used in coming to this controversial conclusion. Having re-estimated the model,
Kwon (1994) shows that targeted industries in Korea performed well.
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As discussed, the World Bank dismisses industrial policies of the nature HPEAs enacted as
ineffective and finds little evidence that supports changing the structure of industry. It
justifies this by concluding that industrial policy produced market conforming results
despite evidence in each case that the interventions as demonstrate had beneficial effects in
many cases. Their conclusion flies in the face of much of the evidence; however likely a
function of its inherently ideological foundations derived from the radical neoclassical
Washington consensus (Amsden, 1994 & Harrison, 2001), the way the test has been
formulated means that the results were probably a forgone conclusion.
Whilst the fundamentals listed by the World Bank were obviously very influential in East
Asias success story, Amsden (1994) argues that the market friendly view fails to take into
account the micro foundations embodied in the macro basics and hence its model for growth
has been oversimplified. For example, the neo liberal approach by the World Bank assumes
that export growth was simply a result of a pro export orientated policy. In reality, such
export growth wouldnt have been able to occur if it were not for firms international price
competitiveness brought about by selective industry targeting policies.
Moreover, Perkins (1994) criticizes the World Bank (1993) for it wrongly suggesting that a
one size fits all policy could have been used in the eight East Asian countries to the same
effect therefore rejecting epistemological universalism of development a la Kenny and
Williamson (2000). He asserts that in reality there were at least three models of East Asian
development. Individual countrys policies were tailored to their natural resource
endowments as well as their political and cultural values. For example, Chinas approach to
growth was far more interventionist than Hong Kong, reflecting its communist past.
In conclusion, the market friendly approach is able to provide a good description of the
main macro determinants of East Asias growth. However, its failure to recognise the
important role that supporting institutions have played in this growth miracle, has resulted in
an over simplified model that cannot be rolled out in other developing nations as the World
Bank (1993) wrongly suggests. A more suitable explanation to East Asias growth is that
HPAEs implemented similar but country specific policies, in a way that best complemented
their resource endowments, culture and political institutions in order to get the basics right.
While at times these may have appeared minimal, they dramatically improved performance
(like a catalyst in a chemical reaction, see (Stiglitz, 2001).