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Economic Development in Asia
Chapter 2 – Introduction and Overview
Economic Development in Asia
• East Asian miracle, a showcase of
development up until the Asian
crisis.
• Asian crisis created a number of
questions about the continued
viability of a rapid growth profile for
the region.
• Economies have begun to rebound.
The enormous interest in the economic
development of postwar East Asia has
continued into the new millennium. The
regions recent economic history has been
marked by an “economic miracle” that
spanned several decades followed by a
severe financial and economic crisis.
Problems of widespread poverty and
economic inequality remain despite
significant economic progress.
The development process began in
Japan when it opened its economy to
increased trade and investment. The rapid
industrialization that followed quickly spread
to the neighboring economies of South
Korea, Singapore, Taiwan and Hong
Kong. Economic growth in these newly
industrialized economies (NIEs),
sometimes called the Asian “tigers” ,
averaged 8 percent per year in the three
decades prior to Asian financial crisis in
1997.
After the sharp economic contraction in
1998, the region rebounded rapidly. In
south korea, for example year-on-year
industrial production and gross domestic
product (GDP) increased dramatically in
1999 while stock market value doubled in
Thailand and Malaysia.
• Social impact of the crisis has been
substantial.
• Future development will depend
upon many factors, including public
policy and developments in industrial
countries.
• This course looks at both the history
and the future outlook for the region
The financial crisis also hampered progress
in reducing poverty and addressing other
social issues. The human development
gains in health, education, poverty and
equality and the distribution of income
achieved by East Asia in the two decades
prior to the crises was eroded to some
degree resulting in slower growth.
There is no doubt, however, that the
economies of East Asia are in the process
of recovering from the crisis and the region,
as a whole, will play a major role in the
global, high tech world economy that we are
moving towards in this new millennium.
In South Asia, where the impact of the
financial crisis on the region was not as
severe, economic progress has accelerated
following a shift in policy in the late 1980s
and early 1990s . Nevertheless, this region
faces a number of challenges, including
further progress in reducing poverty and the
resolution of political disputes that have
drawn resources away from economic
development.
Difference between development
economics and other branches of
economics
• It looks at all of the other branches
of economics within the context of
economic development.
• It uses the tools developed in
other branches of economics to
analyze the problems and
challenges of economic
development.
Measuring Growth & Development
• Use of GDP and GNP and
exchange rate comparisons lead
to patterns of growth over time.
• Other methods such as purchasing
power parity can also be used to
compare standards of living.
Other Measures
• Human development index (HDI)
• Healthy life expectancy
• Green GNP
- assesses the impact of environmental
• degradation in the development
• experience.
Human Development Index (HDI)
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The United Nations Development Program
(UNDP) developed the HDI in the late
1980s and has been publishing it since
1990. This index has three components:
per-capita income and two additional
measures-life expectancy at birth, and
level of educational attainment that
combines adult literacy and educational
enrolment rates. These are added to per-
capita income, which is adjusted to reflect
the diminishing marginal use of money to
obtain HDI.
GREEN GNP
One of the more recent approaches
developed to address the inherent
shortcomings of GDP and GNP as growth
and development measures is based on
what is known as the “green” system of
national accounting. Green GNP is the
informal name given to national income
measures that are adjusted to take into
account the depletion of natural resources
(both renewable and non-renewable) and
environmental degradation.
EXCHANGE RATE METHOD
The exchange rate method between the
local currency and the U.S. dollar to convert
the currency into its U.S. dollar equivalent.
A country’s GDP and GDP per capital would
then be valued accordingly, in U.S. dollars.
PPP METHOD
The purchasing power parity method
develops a cost index for comparable
baskets of consumption goods in the local
currency and then compares this with prices
in the United States for the same set of
commodities. A country’s PPP is defined
as the number of units of the country’s
currency required to buy the same amount
of goods and services that a dollar would
buy in the United States.
Summary
• Uniqueness of the Asian
development progress (Asian
Miracle Economies).
• Indicators of economic growth and
development.
Chapter 4 – The Asian Crisis and Recent
Developments
Start of the Asian Crisis
June 1997, after a sustained attack on the
currency led by currency hedge funds, the
Thai baht sustained a large devaluation.
Currency devaluations in Malaysia,
Indonesia and the Philippines followed in
July.
The currency weakness extended to
Australia, Hong Kong and Korea
currencies in October.
Hedge Fund- a limited partnership of
investors that uses high risk methods, such
as investing with borrowed money, in hopes
of realizing large capital gains.
Hedge Fund-is an alternative investment
that is designed to protect investment
portfolios from market uncertainty, while
generating positive returns in both up and
down markets.
A hedge fund can basically invest in
anything – land, real estate, derivatives,
currencies, and other alternative assets.
Malaysian ringgit, the Indonesian rupiah,
and the Philippine peso.
While the currency parity with the u.s. dollar
was maintained, the stock market fell by
about 30 percent of its value in a week.
• By early 1998, currencies fell by
35% to 55% for Korea, Philippines,
Malaysia and Thailand, and more
than 15% for Singapore and Taiwan.
• Indonesia suffered greatest fall of
80%.
• Equity prices also fell as a result of
investor uncertainty and currency
volatility (Table 3.1).
• Price of Equity. The amount of
money for which one may buy or sell
a share of common stock. The price
of equity changes throughout a
trading day, especially in times of
high trading volume.
• Volatility – is a statistical measure
of the dispersion of returns for a
given security or market index. In
most cases, the higher the
volatility, the riskier the security.
Volatility can either be measured by
using the standard deviation or
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variance between returns from that
same security or market index.
The Asian Crisis
• Thin and restricted equity markets
exaggerated the decline.
• Lack of hedging facilities forced
investors to reduce holdings
dramatically.
• Interest rates were raised to help
stabilize currencies and liquidity
was reduced.
• The result was a sharp decline in
aggregate economic activity in late
1997 and in 1998.
Thin – slender, slim, slight
Restricted – limited in extent number,
scope or action.
Stabilize – make or become unlikely to give
way or overturn.
Explanations for the Asian Crisis
• There are three broad explanations,
none of them alone completely
satisfactory.
• First, a speculative bubble in the
housing and equity markets arose
which was funded and sustained by
excessive lending by the banking
system.
Speculative bubble or asset bubble is a
situation in which asset prices appear to be
based on implausible or inconsistent views
about the future.
• Second, external sector difficulties
emerged including slow export
growth, loss of external
competitiveness and rapid growth in
current account deficits.
• Third, capital flight and investor
panic spread across the region
through a contagion mechanism
as a result of globalization.
External sector – is the portion of a
country’s economy that interacts with the
economies of other countries.
Contagion – spillover effects are also
known as fundamental based contagion.
Capital flight is a large-scale exodus of
financial assets and capital from nation due
to events such as political or economic
instability, currency devaluation or the
imposition of capital controls
The Asian Crisis –
The Bubble Economy (1)
• First, the bubble economy was the
result of interaction between lenders
(mostly banks) that borrowed
offshore at high interest rates and
relend at higher rates to domestic
investors.
• The domestic investors borrowed
extensively to finance speculative
investments in the housing and
equity markets.
• This created a speculative bubble
that depended on a stable exchange
rate and high profits.
• High profits became more
improbable as the boom reached
its peak, which was further
undermined by the successive
devaluations in all the economies
as the crisis unfolded.
• Banking weakness was reinforced
by a lack of competition and
unsound lending practices.
• These included risky long term
lending in local currency using short
term dollar loans from overseas
lenders.
• When these borrowers defaulted it
resulted in the inability of the banks
to repay these short term dollar
obligations.
• This banking crisis was also
influenced by moral hazard
• Moral hazard occurs when an
agent takes more risk because
they are insured against the
negative consequence of such
actions.
• In the case of the Asian financial
crisis banks thoughts that
governments would insure a stable
exchange rate.
• They also might have thought that
the government would bail them out
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if they found themselves in financial
trouble
The Asian Crisis –
External Sector Difficulties (2)
• Second, as the bubble of the early
1990s progressed, current account
deficits also grew as offshore
borrowing increased.
• While exports were growing rapidly,
this was viewed as a sign of strong
investment and growth enhancing
capital expansion.
Current account deficit is a measurement of
a country’s trade where the value of the
goods and services it imports exceeds the
value of the products it exports.
• However, when export growth began
to sag in 1996 this large current
account deficits became a growing
liability and worry for international
investors.
• Exchange rates were tied to the
dollar and exports were hurt in
international markets as the dollar
appreciated in the mid 1990s.
The Asian Crisis
Contagion Effects (3)
• Third, there was a strong
contagion effect as the financial
crisis spread across the region.
• Countries that had strong currencies
and economies, such as Hong Kong,
Singapore and Taiwan were also
adversely affected.
Contagion effect – explains the possibility of
spread of economic crisis or boom across
countries or regions. This phenomenon may
occur both at a domestic level as well as at
an international level.
As the foreign exchange crisis unfolded,
there was a dramatic turn around in net
private capital flows to the region – from a
$97 billion inflow in 1996 to a $12 billion
outflow in 1997.
There was also a dramatic reversal in bank
credit which also amounted to about 10
percent of GDP.
Together, the reversal of capital flows and
bank credit created a liquidity crisis that led
to a sharp fall in income and output.
Indonesia, which had been a model of
probity and sensible policies was hardest hit
by the crisis as its exchange rate fell by over
50 percent and aggregate incomes fell
dramatically.
This contagion effect was the result of
investors pulling out of many economies
simultaneously.
Indonesia, which had been a model of
probity and sensible policies was hardest hit
by the crisis as its exchange rate fell by over
50 percent and aggregate incomes fell
dramatically.
This contagion effect was the result of
investors pulling out of many economies
simultaneously.
Competitive Devaluation – also as currency
war, is a condition in international affairs
where countries seek to gain a trade
advantage over other countries by causing
the exchange rate of their currency to fall in
relation to other currencies.
Post-Crisis Experience
• The impact of the crisis was fully felt
in 1998 when all the crisis countries
and most other countries had
negative or very small rates of
positive growth.
PRC and Taiwan were the only exceptions.
Equity prices also fell across the region in
1998.
• Korea and Malaysia have been
particularly successful in reducing
NPLs, enabling the banking system
to begin to extend new loans.
• Thailand and Indonesia have been
only moderately successful while in
the Philippines, the level of NPLs,
though small during the crisis, has
crept up in recent years.
Social Impact of the Crisis
• The fall in output and employment
created hardships for many
segments of the society in the
affected countries.
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• There was significant reverse
migration to rural from urban areas
as job opportunities dried up.
• Poverty levels increased between
1997 and 1998.
The Recovery Part 2
• The region has grown much richer in
the decade since the Asian crisis.
• China has emerged as a regional
economic powerhouse.
• Half the GDP of the region and one
third of exports originates in China
• China is now the largest trader in
Asia overtaking Japan.
• China joined WTO several years
ago.
• Import GDP ratio is 34% in China
versus 9% for Japan.
• Shows Japan is still somewhat
protectionist.
• Middle income countries are being
squeezed by China.
• In Southeast Asia in particular.
Agenda for Reform
In the wake of the Asian crisis, there were a
number of reforms
Continuation of the debt restructuring
process with help of AMCs.
Arrangements of credit lines with the private
sector.
Reform of exchange rate regimes to reduce
the chance of abrupt currency devaluation.
Chapter 5 – Agriculture
Agriculture & Economic Growth
Plays a key role in the process of economic
development.
Rich source of factor inputs to feed the
growing labor force in the industrial sector
and other modern sectors.
Major source of investment and capital
formation.
Provides foreign exchange for acquisition of
foreign technology.
Finally, agriculture provides a rich market
for the output of the modern urban sector.
The transition from a primarily rural based
economy to an industrial economy requires
a strong agricultural sector.
This is because a surplus from agriculture is
needed to fuel investment in industry.
Decline of the Agriculture Sector
• Experience of a broad range of
countries indicates that the relative
importance of the agricultural sector
to the economy diminishes with
growth over time.
• As income increases, share of
agricultural value-added in GDP and
as a source of unemployment
declines.
Productivity in Agriculture
• In contrast, the growth of per capita
food production in Asia shows a
steady increase over time,
increasing by nearly 40 percent by
the end of the period.
• The largest increments were
achieved in the late 80s and early
90s.
• Hence, its astounding agricultural
productivity presents a key link to
the chain of developments that led to
Asia’s economic success.
Agricultural Development in Monsoon
Asia
• Monsoon agriculture requires
extensive labor input during planting
and harvesting.
• Most agriculture was rain fed in the
early part of the 20th century.
• Farms were small and population
densities high, conditions that were
ideal for rice cultivation.
• Traditional agriculture was quite
efficient, given its limitations.
• Irrigation and higher yielding
varieties were the keys to
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transforming traditional agriculture
and raising productivity.
• This transformation was required to
lift savings and to provide labor and
investment for the growing industrial
sector.
Lessons and Policy Issues in Asian
Agriculture
• Genetically modified organisms
(GMOs) are becoming more
important despite objections from
EU countries.
• Zero tillage an important new
development
• Shift away from primary grains
toward tree crops, horticulture,
fishing and secondary food crops
should be encouraged.
Chapter 6 - Industrialization and
Structural Change
Industrialization
Rapid industrial development is the key
element of structural transformation from an
agrarian based rural economy to a modern
state.
In the Lewis-Fei-Ranis (LFR) model,
capital accumulation fuels the development
of the industrial sector.There is a dramatic
shift from agriculture to industry.
Labor removed from agriculture does not
affect output much since there is a surplus
of labor in the rural sector.
As labor moves from the traditional sector to
industry, overall labor productivity
increases.
Wages in industry are higher than they are
in agriculture resulting in labor migration.
• A delicate balance is necessary to
keep agriculture viable yet allow for
investment in industry.
• Linkages between the two sectors
are important as backward
linkages with suppliers in the rural
sector help both sectors to grow as
industry flourishes.
• Forward linkages help countries to
upgrade their industrial bases.
Linkages
• Backward linkages are strong in
industries such as leather, clothing,
textiles, food and beverages and
paper products.
• Forward linkages are strong in
industries such as petroleum and
chemical and some heavy industries
and also in some labor intensive
electronics.
Economic Efficiency
• Despite economies of scale, overall
economic efficiency depends on a
number of other factors including
management, marketing and
distribution. Technology is also
important.
• To become efficient, it is often
argued that new industries need to
be protected from competition until
they grow to be efficient enough to
compete internationally.
Infant Industry Protection
• Such infant industry protection
has been used to erect tariff barriers
and import restrictions in a number
of countries. [Refer Supplementary
Article 5a]
• Generally, the evidence from a
number of developing countries
suggests that such protection
increases inefficiency rather than
reduce it.
• There are some exceptions in Asia,
including Korea and Taiwan.
Small Scale Industrial Development
• Small and medium scale industries
(SMEs) are generally more labor
intensive.
• Given a good policy environment,
SMEs can thrive, particularly where
large scale economies are not
necessary. Taiwan is a good
example, where outsourcing and
international networking were used
to build up the industrial base.
Openness and Foreign Trade
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• Foreign direct investment (FDI) can
be an important source of capital
and expertise, particularly for export
oriented industries in the early
stages of development.
• The issues of FDI and international
trade will be taken up more
systematically in the next chapter.
The Asian Experience with
Industrialization
Unprecedented in economic history.
Per capita income increased by about 7%
per year in the NIEs for 30 years.
At the end of this period, incomes were four
times higher than in the base period.
Industry’s share of income increased
dramatically.
Some countries had high savings
rates and medium to rapid labor
force growth (Russia and Spain) but
they didn’t grow as fast.
There was more to the Asian miracle
than the brute force of high
investment and rapid growth in the
labor force.
Innovation, better industrial
organization, growing globalization
all contributed. [Refer
Supplementary Article 5b]
This process of innovation and
structural change resulted in a
dramatic shift in the composition of
industrial output.
The share of manufactured goods
increased as did the share of
exports (Table 5.2).
Exports shifted quickly to light and
heavy industry from primary industry
(Table 5.3).
There was also a shift, from the
1980s, to more “science” based
industries such as electronics,
pharmeceuticals and biotechnology.
The electronics sector began to
feature prominently in the exports
and production of the NIEs and in
Southeast Asia.
Growth followed an ‘S’ shape, accelerating
rapidly in the 1970s and 1980s.
Technological Transfer
There were different patterns of
technological transfer.
Korea and Taiwan followed a pattern of
producing locally for foreign firms to the
foreign firms’ specifications or a
combination of local and foreign designs
and specification. They did not form joint
venture or encourage foreign firms to set up
independent operations.
Singapore and Hong Kong welcomed
foreign direct investment. Singapore had a
more hands on industrial policy by training
and provision of infrastructure.
Despite differences, four factors
were common.
1. Low inflation and interest
rates and high saving rates.
2. Outward looking trade
policies.
3. Forward looking human
resources strategy.
4. Appropriate (for local
conditions) government
industrial strategy.
Comparative Advantage and
Industrialization
The Asian industrial experience can
be further analyzed by looking at
revealed comparative advantage or
by comparisons with best practice
firms in industrial countries.
Such comparisons allow us to draw
several inferences. Some of them
reinforce previous observations.
The share of manufactured goods in
total exports increased dramatically.
This shift in production
corresponded closely with a similar
shift in production taking place in the
world economy.
The export push began in labor
intensive goods and moved to
electronics and other science based
exports.
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The pattern was more pronounced in
East Asia and Southeast Asia but
was also observed in South Asia.
Because of this shift, Asian countries
were able to gain market share of
world exports over a twenty year
period
Role of Innovation
If we break down the composition of output
growth in the NIEs and SE Asia:
- About 20% is due to labor force
growth.
- As much as 25% or more is
attributed to educational improvements of
the labor force.
Innovation requires the active involvement
of labor since it requires a destruction of
old ways of doing things and creation of
new methods and processes.
Entry and exit of firms have to be
facilitated in order for innovation to
take place efficiently and smoothly
Costs of entry and exit are high for
larger firms and are particularly high
when large firms have a special
relationship with the government.
In PRC, India, Vietnam and Indonesia, large
firms are kept in business because of the
feared adverse effects on employment.
One method of facilitating entry into new
business and of attracting overseas FDI is
through the set up of Special Economic
Zones (SEZs).
Many countries in Asia have set them up.
3 main kinds of industrial clusters are large
metropolitan agglomerations, small groups
of firms with similar interests and clusters
with a few main producers and their
suppliers.
Much innovation in Southeast Asia has
been the result of spending by MNCs.
Innovation and technology transfer takes
place most often when capital equipment
and components are imported by export
oriented manufacturing firms
In East Asia, it has been generated
internally and with the help of strategic
alliances with foreign firms.
Innovation, Education and Growth
Convergence
There was growth convergence between
Asian NIEs and industrial countries.
This resulted from synergies created by
technology, education, openness and
competitiveness.
It is important that appropriate technology
be employed at each stage of the
industrialization process.
Employment Growth and Industrialization
Flexible wages and appropriate technology
are needed to absorb labor into industry
quickly and effectively.
This enables employment to grow with
output without inflation.
Most East and Southeast Asian economies
were fully or nearly fully employed for most
of their growth spurt.
South Asia was not as fortunate as income
growth was not sufficient to reduce
unemployment dramatically.
Rural to Urban migration
As industrialization proceeded, so
did the movement of labor from
rural to urban areas.
Harris-Todaro model predicts that
unemployment can coexist with
rapid labor movement to the city.
Rural to Urban Migration
It is also possible that the lure of the city
and the stories told by their relatives that
had just migrated were enough to induce
the young workers to migrate.
The move would have appealed to the risk
takers in the countryside – likely to be the
young and adventurous rather than the
secure and middle aged.
Workers also migrate in order to
provide remittance income for their
families at home.