Growth and the Asian

Experience
 Concerns of Economic Development
• Why do economies grow?
• Why should they grow?
• Why do we want them to grow faster?

Important Concepts to Understand the Theory

of Economic Growth
• Components of Income and Output
• Total Factor Productivity
• Economic Efficiency
• Technical Progress or Innovation
The Law of Diminishing Marginal Returns
• A concept in economics that if one factor of
production (eg: number of workers) is increased
while other factors (eg: machines, factories,
workspace) are held constant, the output per unit
of the variable factor will eventually diminish.
 Components of Income and Output

• Traditionally labor and capital were introduced as the only

variables determining the level and the growth of output.
Y = f (K,L). Land was assumed to be included within capital.
• Other factors were not considered until it was noted by Solow
that there was a large residual factor that was unexplained.
• Substantial time has been spent explaining this residual.
• This residual has been called total factor productivity (TFP)
or sometimes multifactor productivity.
• TFP is very large in industrial countries, explaining as much
or more than 50 percent of economic growth in the postwar
era.

http://www.freeimages.co.uk/
 Total Factor Productivity
• It pertains to the efficiency with which the inputs are combined
to produce outputs

Question: What factors are contained in the residual? Y = f (K, L, A)

• Such a list might include:
– the adoption of new technology,
– better educated workers,
– better management,
– better coordination within the organization,
– more efficient production techniques,
– better inventory management,
– better and cheaper distribution and marketing skills and organization.

• G(Y) = g(K) W(K) + g(L) W(L) + A

 Testing Different Growth Theories
• Many different approaches have been devised to test these
alternatives. In doing this, it is useful to distinguish between
embodied and disembodied technical progress (TFP).
• Embodied TFP can be measured by adjusting the factor inputs
of labor and capital. Disembodied TFP cannot – it has to go
into the residual.

Total Factor Productivity

• A country has a growth rate of income of 6%, a growth rate of
capital (net of depreciation) of 10%, and capital’s share of income
is 30%. If labor grows at 1%, how much is total factor
productivity?
 Economic Efficiency
• Static Efficiency
• Happens if firms move from inside the production possibility frontier
• Dynamic Efficiency
• Takes place when there is economic growth and the scale of
production increases or production shifts from a low productivity
sector to a more productive sector
• Represented by an outward shift of the PPF curve
 Technical Progress or Innovation
• Embodied Technical Progress
• Deals with the changing nature of the inputs into the production
process.
• Includes more highly skilled and computer-literate workers or less
stressed and more congenial workers
• Installation of new innovations in capital equipment
• Disembodied technical progress
• Relates to the way factors are combined together in the workplace,
such as management or organizational innovation.
• This type of technical progress would be contained in the residual A
and would arise from the way in which factors are combined together
within the industry.

Growth accounting is a shorthand method for assessing technical

progress and does not require a production function.
 Growth Theories
• Keynesian Theory or Harrod-Domar Model

• Solow or Neoclassical Model

• Power -Balance Theory

• Structuralist Approaches or Structural Theory

• New Growth Theory

 Keynesian Theory
• An economic theory developed by the British economist John
Maynard Keynes during the 1930s in order to understand the
Great Depression.
• Keynesian economics is an economic theory of total spending
in an economy and its effects on output and inflation.
• It believes that the government should increase demand to
boost growth and stresses the accumulation of capital.
• Includes Rostow’s stages of growth model and the Harrod-
Domar growth model.
• Do not explicitly consider the law of diminishing returns to
capital and because of this, is not particularly realistic.
Rostow’s Stages of Growth
 The Harrod-Domar Model
• The simplest macroeconomic model
• Dynamic version of a simple Keynesian model.
s
g*    

• Growth of income is a function of the depreciation rate of capital,
the saving rate, and the capital-output ratio.
• Population growth can be added and it reduces the rate of growth,
ceteris paribus. Therefore, this model specifically suggests that
countries with low population growth will be better off, other
things being equal.
• Weakness: incorporates the restrictive assumption about constant
returns to scale and the constancy of the saving rate, and failure
to consider that population growth may be endogenous,
depending on the stage of economic development.
 The Solow (Neoclassical) Model
• Developed by Solow and Swan in 1956.
• Growth model which incorporates the law of diminishing returns to
factors of production. Exogeneous technological change generates
long-term economic growth.
• It differs from the Harrod-Domar model by adding a second factor,
labor, and introducing an third independent variable, technology,
to the growth equation.
• Technological progress is the residual factor explaining long-term
growth and its level is assumed by Solow and other theorists to be
determined exogeneously (independent of all the factors in the
model)
• Fundamental Solow equation: (1+ ) k (t+1) = (1- ) k (t) + s y (t)
• With technological progress: (1+ ) (1 + π) k(t+1) = (1- ) k (t) + s y (t)
 Power Balance Theory
• Assumes and emphasizes that the poor “southern”
economies were being exploited by the rich industrial
“northern” economies.
• Assumes that when incomes are low, countries will not be able
to save much, and therefore, savings depend on income.
• Deterioration of terms of trade of agricultural products in
poor economies further aggravates the situation.
• The theory has generally been discredited because we can
see that there is development of industrial capacity in East and
Southeast Asia and in some Latin American countries.
• There are elements of truth in this paradigm in Africa where
raw materials are still the main exports.
A busy street in India
 Structuralist Approach
• The structural approach was developed in the 1960s and 1970s by the
American economist and engineer Hollis Chenery.
• This Approach models economic growth as a process of shifts in
resources among sectors. It stresses the rigidities that hinder this shift
in resources and studies how the shift in output among different sectors
takes place over time as development progresses.
• A shifting balance between the three major sectors of the economy –
agriculture, industry and services.
• Agriculture diminishes over time and industry increases. Productivity is
higher in industry so higher growth depends upon this shift. Industrial
output will reach a point when it declines and finally see an increase in
the component of services in the GDP
• A stereotypical pattern of economic growth which has been observed in
many countries.: Initially, agriculture has a large share of output when the
economy is at a low level of development. Share of industry and services
are small. As industrialization takes place, the share of agriculture
declines and that of industry and services grow.
Share of Income by Sector (Philippines) 2019
 Share of Income by Sector (Philippines)
2000-2018
60.0
50.0
40.0
30.0
20.0
10.0
0.0
2000
2001
2002
2003

2005
2006
2007
2008
2009
2010

2012
2013
2014
2015
2016
2017
2004

2011

2018
Agriculture Industry Services
 Two Sector Model of Growth
• The Lewis-Fei-Ranis model (LFR), named after the three
economists (Arthur Lewis, John Fei, Gustav Ranis) that
developed it, is a two sector model – a modern and a
traditional sector.
• Also known as the Surplus Labor Model.
• Resources move from the traditional to the modern sector
and this spurs growth.
• The LFR model is that it describes many of the
characteristics of the Asian economies when they were just
beginning on the path to rapid development in the 1960s
and 1970s.
• That is why it has become so popular among development
economists studying Asia.
 New Growth Theories

• New growth theories that go beyond Solow-Swan model have

been developed in the past decade.
• They stress the importance of externalities (external
economies and spillovers) and the possibility of increasing
returns to scale rather than the decreasing returns to scale of
the Solow model.
• The key to this is human capital formation.
• Higher per capita incomes tend to slow growth because of
diminishing returns but higher endowments of human capital
tend to speed up growth.
• Returns to such investments may be increasing.
 The Asian Growth Miracle
• For the last forty years, a group of countries in East and
Southeast Asia have grown at remarkably high rates.
• Japan led the way, beginning right after World War II.
• It was joined by Thailand, Taiwan, Korea, Singapore and
Korea in the 1960s.
• Southeast Asia followed in the 1970s.
• Although individual experiences vary, South Asia did not
generally begin to grow more rapidly until the late 1980s
and early 1990s, when government policy shifted toward
supporting a more open and competitive environment.
 GDP Growth Rates for selected Asian Countries
1970 1980 1990 2000 2010
Singapore 13.94225 10.11338 9.820972 9.039196 14.52565
China 19.3 7.806691 3.907114 8.491508 10.63614
Myanmar 4.979331 7.938538 2.816933 13.74593 9.634439
Lao PDR .. .. 6.704579 5.798782 8.526906
India 5.15723 6.735822 5.533455 3.840991 8.497585
Philippines 3.764605 5.148911 3.036966 4.411222 7.632265
Thailand 11.40795 5.173541 11.16716 4.455676 7.513591
Malaysia 5.986539 7.441827 9.008527 8.858868 7.424847
Korea, Rep. 9.997317 -1.70128 9.81123 8.924426 6.496794
Vietnam .. .. 5.100918 6.787316 6.423238
Indonesia 7.554635 9.880078 7.242132 4.920068 6.223854
Cambodia .. .. .. 10.71199 5.963079
Japan 0.399051 2.817591 4.892713 2.779633 4.191739
Brunei Darussalam .. -6.9967 1.089421 2.849422 2.598966

Data from database: World Development Indicators

 Policy Environment Before the Transition to
Rapid Growth
• The policy environment in most developing countries throughout the
world stressed import substitution policies for industry.
• The theory was that developing countries had a comparative advantage
in primary products and so they should export these products.
• The import substitution theory also argued that since incomes were
low, savings rates were also low. Inflows of investment and
financial aid were needed to lift growth.
• To minimize on foreign exchange outflows, industries that substituted for
some imports were promoted by government policy.
• Such a strategy, which was followed for several decades after World War
II in many developing countries, simply perpetuated the cycle of North-
South trade and reinforced protectionist policies that contributed to
a lack of competition and economic inefficiency.
 Policy Environment
• What Japan and later the countries of East Asia did was to
begin to develop an environment that stressed outward
looking trade policies and the acquisition of foreign
technology.
• In the case of Japan, many believe it was an attempt to
develop a mercantilist strategy to help it recover its influence
after the defeat in World War II.
 The Asian Growth Miracle
• Primary factors
- Openness
- Macroeconomic Stability
- Education Policies
- Labor Market Flexibility (Labor Productivity)
• Secondary factors
- Initial Conditions
- Sector Policies
Primary Factors
1. Openness
• The first factor in the primary strategy was outward looking
policies and emphasis on exports and acquisition of
foreign technology.
• First, some industrial capability was built up by focusing on
import substitution in industries with ties to agriculture -
footwear, food processing and textiles.
• Second, after some years, industrial policy shifted to
promoting external markets.
• Initially, this focused on extending the scope of the industries
that were producing for the domestic markets such as textiles
and apparel, leather products and footwear and food
processing.
Primary Factors
1. Openness
• In Southeast Asia, the focus was also put on rubber, sugar,
coconut and palm oil products as well as some specialized
textile products such as silk.
• Slowly the emphasis shifted toward labor intensive industries
that were not necessarily tied to the agricultural base such as
electronics assembly and apparel.
• The shift from import substitution to export promotion was led
by a shift in the trade regime so that there were lower tariff
rates on exports and imports.
• Non-tariff barriers, including bureaucratic procedures and
graft/corruption as well as import bans on some items, were
also reduced.

Silk Factory, China

Tariff rate, applied, weighted mean, all products (%)
for selected regions and the world

Data from database: World Development Indicators

Last updated: December 20, 2019
Primary Factors
1. Openness
• Transformation to labor intensive export oriented industry
was supported by flow of foreign direct investment – initially
from Japan and the US, particularly in Korea, Taiwan and the
Philippines.
• Later the volume increased and more flows began coming in
from Europe.
• A virtuous cycle of growth was created by this shift in
emphasis from import substitution to export promotion.
• In South Asia, on the other hand, the shift occurred much more
slowly.
• Technological transfer served to reinforce the shift in export
emphasis.
Exports of goods and services (% of GDP) of selected
Asian countries

Data from database: World Development Indicators

Last updated: December 20, 2019
Exports of goods and services (annual % growth) for
selected regions and the world

Data from database: World Development Indicators

Last updated: December 20, 2019
Primary Factors
1. Openness
• Foreign technology acquired by buying from foreign companies
under license.
• By copying it without license – sometimes legally and
sometimes not.
• By entering into joint ventures (FDI).
• East Asia (Korea, Japan, Taiwan) by and large followed the first
route while Southeast Asia followed the second.
• The flow of FDI increased following the Plaza accord in 1985
when the yen appreciated and Japan began to move some of
its labor intensive industries offshore.
Primary Factors
2. Macroeconomic Stability
• The second set of primary factors focused on the importance of
macroeconomic policies and the role of the government.
• Governments generally followed policies that created and supported
a competitive environment for export oriented industries but not
necessarily for the domestic market. Japan is a good example of
the latter.
• The amount of government intervention didn’t seem to have a
direct effect on performance.
• There was a lot of government intervention in the industrial and
financial sectors in some countries and little in others.
• In Korea, Japan and Singapore, there was a lot while there was less
in Malaysia and Taiwan. In Hong Kong and Thailand, on the other
hand, there was virtually no intervention.
• What was important was the efficiency and incorruptibility of the
bureaucracy.
Primary Factors
2. Macroeconomic Stability
• In the Philippines and Sri Lanka, policy environments were similar
to those in the successful countries but growth was slowed by
other factors such as corruption, lack of political will, corruption
and domestic unrest.
• The efficiency of government as well as policies followed were
important. Taiwan and Singapore are good examples.
• Efficient governments are characterized by little rent seeking,
salaries are competitive and promotions are based on
performance not on seniority, patronage or crony connections.
• Some policies such as financial repression and directed government
lending programs were wasteful.
• But the flow of resources for investment were substantial and the
wastefulness and distortions created by these policies didn’t
surface until the 1990s bubble broke.
 Corruption Perceptions Index 2019 – 1

Source: Transparency International

 Corruption Perceptions Index 2019 – 2

Source: Transparency International

 Salary of Government Leaders (Top 20 as of 2019)
RANK COUNTRY WORLD LEADER ANNUAL SALARY (IN USD) CORRUPTION PERCEPTIONS INDEX
1 Singapore Prime Minister Lee Hsien Loong 1,610,000.00 85
2 Hongkong Chief Executive Carrie Lam 568,400.00 76
3 Switzerland President Ueli Maurer 482,958.00 85
4 USA President Donald Trump 400,000.00 69
5 Australia Prime Minister Scott Morrison 378,415.00 77
6 Germany Chancellor Angela Merkel 369,727.00 80
7 New Zealand Prime Minister Jacinda Ardern 339,862.00 87
8 Mauritania President Mohamed Ould Abdel Aziz 330,000.00 28
9 Austria Chancellor Sebastian Kurz 328,584.00 77
10 Luxembourg Prime Minister Xavier Bettel 278,035.00 80
11 South Africa President Cyril Ramaphosa 273,470.00 44
12 Canada Prime Minister Justin Trudeau 267,041.00 77
13 Belgium Prime Minister Charles Michel 262,964.00 75
14 Liechtenstein Prime Minister Adrian Hasler 254,660.00 -
15 Denmark Prime Minister Lars Lokke Rasmussen 249,774.00 87
16 Sweden Prime Minister Stefan Lofven 244,615.00 85
17 Iceland Prime Minister Katrin Jakobsdottir 242,619.00 78
18 Ireland Taoiseach Leo Varadkar 234,447.00 74
19 Guatemala President Jimmy Morales 227,099.00 26
20 France Prime Minister Edouard Philippe 220,505.00 69
 Salary of Government Leaders (Selected Asian
Countries as of 2019)
COUNTRY WORLD LEADER ANNUAL SALARY (IN USD) CORRUPTION PERCEPTIONS INDEX
Brunei Darussalam Sultan Hassanal Bolkiah 1,986,768,000 (from oil) 60
Singapore Prime Minister Lee Hsien Loong 1,610,000.00 85
South Korea President Moon Jae-in 211,320.00 59
Japan Prime Minister Shinzo Abe 202,700.00 73
Philippines President Rodrigo Duterte 95,554.00 34
India Prime Minister Narendra Modi 66,000.00 41
Malaysia Prime Minister Mahathir bin Mohamad 61,844.00 53
Thailand Prime Minister Prayut Chan-o-cha 49,728.00 36
Myanmar President Win Myint 40,980.00 29
Cambodia Prime Minister Hunsen 30,000.00 20
Indonesia President Joko Widodo 27,400.00 40
China President Xi Jinping 22,000.00 41
Vietnam President Nguyen Phu Trong 8,320.00 37
Lao PDR President Bounnhang Vorachith 1,630.00 29
Primary Factors

3. Education and 4. Labor Productivity

• The third and fourth set of primary factors focused on
education and labor productivity.
• As stressed by the new growth theories, education played a
critical role in both the transition to an export led growth
strategy and to the ability to sustain it
• By 2000, some of the educational advantages of Asia had
began to erode. There were two reasons for this:
– diminishing returns since more resources had to be
devoted to secondary and tertiary education.
– rapid rate of income growth that tended to outstrip the
corresponding growth in human development.
Primary Factors
3. Education and 4. Labor Productivity

• Behrman and Schneider concludes that schooling attainment in

miracles economies was not particularly outstanding.
• The conclusion is that labor market flexibility has to be
considered along with education.
• The miracles economies did not have strong unions until
recently (Korea) and weak minimum wage legislation.
• The International Labor Organization (ILO) rates the miracle
economies as among those with the most flexible labor
markets.
• Mobility from rural to urban is also high.
Secondary Factors

1. Differences in Initial Conditions

• Initial conditions played a part in the success of the
miracle conditions.
• Land, income and wealth distribution in the miracle
economies were generally more even than in other
countries and regions.
• Average educational attainment was high at the
beginning of the high growth period.
Secondary Factors
2. Sector Policy
• Sector policies were influential to the growth of the miracle
economies.
• Agricultural sector policies were not particularly onerous. There
were taxes on agriculture but sector was still viable.
• Industrial policies were benign and competition flourished in
most countries.
• In Korea and Taiwan, “infant industry” protection policies were
strictly enforced and favored export industries were monitored
for efficiency and export performance. Subsidies were
withdrawn if performance was below expectations.
• There is considerable debate about whether industrial policy in these
two countries was beneficial or not. Whatever the outcome of these
discussions, it is a fact that growth was rapid in both countries.
 Aspects of Economic Performance
• High levels and growth rates of savings and investment in
miracle economies, and both of these variables increased
dramatically as a percent of income.
• Furthermore, the saving-investment gap was small or even
negative for some countries.
• Increased productivity in miracle economies.
• Measures of total factor productivity (TFP) show a modest
contribution to output growth until the middle of the 1980
and an acceleration afterwards.
• The latter is the combined result of previous transfer of
technology and more rapid FDI following the Plaza accord.
 Convergence of Income
Question:

The Solow model tells us that incomes will converge to a steady

state irrespective of where they started out.

This assumes that the technical progress coefficient, , remains

constant across all countries.

Is this a realistic inference?

 Convergence of Income
• To test this hypothesis of absolute convergence, we can see if
there is a relationship between per capita income in an initial
period and the growth in income in successive periods.
• Using logs to denote growth we have, for the period 1960 to
1990,

log[Y (1990 )  Y (1960 )]  a  b log Y (1960 )

 Convergence of Income
• Tests of this model for several sets of countries shows that it doesn’t
hold for a heterogeneous group of countries around the world.
• It does hold for OECD countries and for OECD and Asian
countries together.
• It does not hold for developing countries in general.
• A less restrictive form of convergence is called conditional
convergence.
• In this form of the model, we allow the various parameters of the
growth equations to change between different countries or groups of
countries
• There would still be a convergence in growth rates of income but the
level of income in the steady state would differ.
• This level would depend upon saving rates, population growth
rates and depreciation rates of capital.
 Convergence of Income
• Tests of this model show that there is still a lot of unexplained
variation in per capita income, although variations in
population growth rates and saving rates did explain about
half of the variation in per capita income across countries.
• However these results imply that the rate of convergence is
very slow.
• What is likely is that a number of other factors are involved
aside from the saving and population growth rates, such as the
spread of technology and the role of education.
 Is there Convergence?
• There is evidence that there is convergence within groups of countries
with similar geographic and economic similarities such as the
European Union or countries in East Asia.
• However there is less evidence that there is convergence between
rich and poor countries.
• For example globally there is strong evidence for divergence.
• Rich countries get richer and poor countries get poorer.
• This does not hold within countries although the convergence is slow.
• German states and Japanese prefectures and states of the US are
converging.