Three sources of

growth of an economy
1. Increase in tangible inputs such as
capital, labor, and human capital.
2. Increase in efficiency, both technical and
allocative.
3. Increase in intangible inputs such as R &
D.
Functional approach: examine all of the functions that a
government can or should fulfill in development economy.

Positive approach:
What have these government done (or not done)?
How have their policies worked?
Under what circumstances?
• The GDP of Hong Kong and Taiwan over the postwar period and
China since it began its process of economic reform in 1979 grew at
an average annual rate of approximately 9 per cent.
• The amount of investable funds and the quality and quantity of human
resources in the economy are also relevant considerations in
determining the appropriate role of the government.
• Potential size of the domestic market also makes a big difference.
• The larger the effective size of the economy, the less non market
coordination will be required.
 AUGMENTING THE INPUTS
How do the governments of the three economies attempt to augment their inputs
of products, such as capital, labor, and human capital?
 CAPITAL
In order for the fixed capital stock to increase, there must be fixed
investment.

Fixed investment is financed from saving, both domestic and

foreign.
 Increasing Savings
• All 3 economies achieved very high saving rates, of between 35 and 40
per cent.

• 1979 this high saving rate was partially achieved by China through a
restriction of consumption opportunities.

• Saving ( and investment) is encouraged by the macroeconomic stability

maintained by the different gov’ts in their respective economies.
• Monetary Policy in Taiwan is targeted on a positive real rate of
interest.

• Real wages in all three economies are somewhat repressed- the labor
unions have been, until recently, kept weak.
Increasing Investments
• Aggregate Saving is not necessarily equal to aggregate investment
• Hong Kong and China: Fixed investment is promoted by special tax
incentives, such as tax holidays.
• China: traditionally hard large excess demand for fixed investment.
• Fixed investment is also promoted by microeconomic stability.
Labor
• The rates of growth of the labor force in China, Hong Kong, and Taiwan
have been quite rapid.
• Both HK and Taiwan have experienced labor shortages and rising wages
since the 1980s.
• The use of foreign contract labor has become common in HK and
Taiwan.
• In the year 2020, the proportion of the Chinese labor force employed in
the agricultural sector will still be 33 per cent.
• The female labor force participation rates in all the 3 economies are
high.
Human Capital
• Universal compulsory primary education, financed by the government,
was achieved in Taiwan sometime in the early 1960s.
• Universal Secondary Education was mostly achieved in Hong Kong.
• There is a potential deficiency in the supply of human capital in China.
• Illiteracy is still a serious and increasingly important problem in the
poorer rural areas of China.
• Tertiary education are still relatively scarce in China.
• HK and Taiwan’s public educational system is supplemented by
private institutions.
ALLOCATING RESOURCES
EFFICIENTLY
• Allocation of resources is said to be efficient if not additional output
can be produced without increasing at least one input, and no input can
be decreased w/o decreasing at least one output.

• Welfare Theorem breaks down if there are increasing returns to scale,

other nonconvexities, informational asymmetry, or other externalities,
and/or significant market power on either the supply side or the
demand side of the economy.
• The role of the government is to help achieve an efficient allocation of
resources.
• There is a distinction between a permanent (one-time) allocation of ret
and a repeated allocation of rent.
• Under repeated allocation, some care has to be taken to assure that
there will be actual competition in the market.
The Structure of Ownership
• Hong Kong and Taiwan’s predominant mode of ownership of enterprises is
private (family owned).
• In China, it is the nonstate sector that has been the most dynamic and
successful over the past 15 years.
• Hong Kong has always operated as a private-enterprise economy: its public
utilities- electricity, gas, and transportation.
• Taiwan’s reliance on the private sector was by no means inevitable- the
share of the public sector in terms of the value of industrial assets in the early
1950s was almost 90 per cent.
• The choice of private over public ownership for enterprises other than
public utilities turned out to have enormous economic significant.

• First, the effectively family-owned nature of these private enterprises

implies that they are owner managed.
• The transition of Chinese agriculture from a collective system to an
essentially private individual household system resulted in large gains
in efficiency of the order of between 30 and 40 per cent from 1979 to
1985.
The Market Environment
• Hong Kong has always been a private-enterprise and a free market
economy.
• Taiwan’s government has been more activist or interventionist.
• China is the least marketized of the three.
• The government must also assure that there is the transportation and
communication infrastructure to make the one market a reality.

• The government must also assure that there is sufficient meaningful

competition.

• The government also needs to provide services for standardization,

inspection, and certification.
• In Hong Kong, a free port, the market works the best of the three
economies.

• The market in Taiwan is becoming more open.

• China is still far from being a competitive market, both because of

infrastructural bottlenecks and because of significant monopolistic
elements in the economy.
• In the three economies, commercial banks are not relied upon as a primary source
of equity capital.

• Hong Kong’s financial market is one of the most competitive in the world.

• In Taiwan, financial repression is practically absent.

• China is the only economy with bank lending rates significantly below the market.

• Financial repression and credit rationing may be viewed as a reallocation of rents

between lenders and borrowers, savers, and investors.
Coordination Externalities

• Multiple economic equilibria can arise from “nonconvexities,”

complementarity, information asymmetry, or the lack of credible
commitments.

• One useful role of the government is to create conditions that are conductive
to the achievement of the efficient economic outcome that otherwise is not
achievement and to guarantee its implementation through its powers of
enforcement.
• Coordination means using or sharing the same information among economic
agents, so that the adverse effects of information asymmetry can be overcome.

• Coordination is much more important for investment decisions than for current
production decisions.

• Nonmarket coordination does not necessarily need to involved the government.

• Coordination, whether public or private, can lead to either private or social

benefit, or both.

• Another role is to reduce transaction costs.

Achieving Technical Efficiency
• Red tape is a relic of the days when the government had to provide
employment to a large number of people and carve up to make work
for them.

• China and Taiwan have made special provisions to expedite foreign

investment applications.
• Also relevant is whether the style of the government is discretion
based or rule based.
• Discretion based system is open to “rent-seeking” and corruption
• Hong Kong has already put in place a rule-based system.

• Transition from a discretion-based system to rule-based system,

kinship and long-term friendship rooted in shared cultural norms can
provide the bases for the implicit contracts necessary to support
economic transactions in the absence of explicit rules and regulations
or established customs.
Creating New Institutions and Drafting New
Laws
• The government can make new laws and create new institutions that
facilitate and support economic development. These can be laws with
regard to property rights.
• 2 developments in the 1950s:
-Hong Kong abolished rent control on new residential buildings.
-The gov’t perfected the laws governing condominium ownership to
separate units in a bldg. making it possible for individuals to own their
individual units.
Social Safety Net, Income Distribution, and
Social Welfare Programs
• It is the responsibility of the government to provide a social safety
net.
• Social Safety Net reduces risks to workers and the population in
general.
• The government should also pay attention to the distribution of
income to make sure that the gap between the rich and the poor does
not become so excessive that it may breed social and political
instability, and to the equality of access to opportunities to make sure
that sufficient social mobility, and hence hope, exists in society.
Social Welfare Programs

• Traditionally provided only for very low-income households in HK

and Taiwan.

• Social welfare programs must be carefully designed.

• One important aspect of these programs is that in order for them to

work, they must be compulsory to everyone.
Infrastructural Investment
• The social overheard capital such as electric utilities, transportation and
communication facilities, and industrial parks all require a huge amount of
investment, which cannot be afforded by individual private enterprises, especially
in the early stage of economic development.

• Infrastructural projects are usually undertaken by the government rather than by

private investors because of factors such as nonappropriability, lack of sufficient
capital position.

• Infrastructure should be an area of primary focus of government investment.

Examples of successful infrastructural projects :
• Hsinchu Science-Based Industrial Park in Taiwan- modeled after the Stanford
Industrial Park

• China is trying to do the same thing in an area located adjacent to the Chinese
Academy of Science in Zhongguaneun, a suburb of Beijing.

• Export processing zone in Kaohsiung

• Special Economic Zones of Chuna

• Suzhou project run by Singapore

• Infrastructural Investment projects also act as signals for coordinated
expansion in an industry, a cluster of industries, or a geographical
area as well as a tangible demonstration of a government
commitment.

• The existence of complementarities is a major reason for

coordination.
Consumer and Environmental Protection

• The area of consumer and environmental protection is one where the

government must take a leading role.

• China still lags far behind in both consumer and environmental

protection.

• New measures of real GDP or GNP are required in order to reflect the
benefits of a cleaner, healthier, and safer environment.
Efficient Allocation across Industries

• A necessary condition for overall efficiency of the economy is an

efficient allocation of resources, including fixed investment and
capital, across industries.

• The selection, or targeting, of industries for favored treatment in order

to promote investment in them by the government is often referred to
as an industrial policy.
• In China, prior to 1984, the entire industrial sector was state owned.

• Industrial policy in Hong Kong is rather limited.

• In Taiwan, credit rationing is definitely used to support industries that the

government wants to start- these are referred to a pioneering industries.

• Protection in the form of tariffs, quotas, and import permits is used to favor
certain industries.

• One notable failure of industrial policy in Taiwan is an attempt to promote

Taiwanese large trading firms along the lines of the Japanese firms of Marubeni,
Mitsubishi, and Mitsui.
• Direct Investment by the government, or by government development banks, in
favored industries in the form of a state-owned or controlled enterprise, is also done.

• Example:

China Steel Corporation , established in the mid 1970s was majority owned by the
government of Taiwan.

The export industries and enterprises have been favored in the early phase of Taiwan’s
industrialization and China’s economic reform.

In Taiwan, it is done through preferential interest rates for the finance of production for
exports.
• Miscellaneous advantages: rebating of import duties on inputs used in
production for exports and reduction of port fees.

• There is no explicit government support for exports in Hong Kong.

Efficient Allocation across Enterprises

• The government has to take into account the existence of increasing

returns to scale which render the usual market allocation inefficient.

• The government must be able to identify and enlist promising

entrepreneurs/ enterprises to undertake selected industrial projects in
the early stage of its industrial development.
• The government has the ability to create, as well as allocate rents,
through taxation and subsidies, franchising, preferential loans, and
land grants.

Performance based rents: investment tax credits, accelerated

depreciation, and tax holidays for new enterprises.
Transition-facilitating rent: used to compensate vested interests so as
to obtain their support for reforms that enhance the overall efficiency of
the economy.
• Two-track price system with one price market determined and the
other one fixed, is a major factor in the relatively smooth transition of
the Chinese economy from a centrally planned one to a mostly market
one.

• Under this system, efficiency is immediately achieved because, on the

margin, everything is bought and sold at the free-market price.
Efficient Allocation through Government
Coordination
• One important role of the government is to enforce contracts and commitments
that are not “self-enforcing.”
• Governments of Hong Kong and Taiwan tend to be less interventionist than those
of Japan and South Korea.
• The key to successful government coordination lies in the credibility of its
commitments, including the commitments to enforce explicit and implicit
agreements among independent contracting parties.
• The government must therefore use its credibility wisely and in particular should
avoid engaging in predatory behavior that undermines its future credibility.
Shifting the Production Possibility Frontier

To the extent that technical progress is embodied, any policy that

increase the quantity of gross domestic fixed investment shifts the
production possibility frontier upward. Other measures that shift the
production possibility frontier include R & D investments and
reorganizations.
R & D Technology

• In the 1970s, Taiwan avoided an industrial policy and set up a number

of national research institutes and dramatically increased its funding of
large-scale industrial R & D projects.
• Hong Kong is relatively late to this game although it recently set up a
new Hong Kong University of Science and Technology which has a R
& D arm that works closely with industry.
• China has a strong scientific and technological capabilities in the
Chinese Academy of Sciences.
• Industrial policy is not infrequently linked to R & D and science and
technology policies.
• The personal computer industry in Taiwan provides a successful example of
government-financed R & D and industrial policy.

• Appropriability has long been recognized that the basic issue in the financing
of R & D.
• Government investment in R & D: through government laboratories or
indirectly by financially supporting R & D projects at universities and in
private industry, can also be viewed as an attempt to create comparative
advantage.
Technology Transfer
• Foreign Direct investment can also bring in new technology, and in
principle can shift the production possibility frontier.

• While foreign direct investment and the use of imported new capital
equipment and technology increase gross output, they do not
necessarily increase added value above a normal return to the capital,
and thus there is no ‘’excess” returns to be measure.
Strategic R & D
• R &D can be used strategically.
• The standard practice in the technology transfer world to cross-license.
In order to cross-license, an enterprise must have an invention, a patent,
something to cross-license to another enterprise.
• Indigenous R & D
-often has the effect of coaxing a reluctant technology to transfer the
technology.
• As long as a country does R&D itself and is in the business of cross-
licensing, it will have the incentive to enforce intellectual property
rights.
Reorganization
• Reorganization and the introduction of new modes of production are also
measures that can shift the production possibility frontier.
• HK and Taiwan- whatever changes there have been are more evolutionary.
• China- the changes have been more radical.
• Contract responsibility system was the foundation of decentralization effort.
• Contract responsibility system- coupled with the agricultural price and market
reforms, was immediately and immensely successful, generating huge increases
in productivity in agriculture of the order of 30-40 per cent within a few years.
CONCLUSION:
• The role of government in the economic development of China, Hong Kong, and Taiwan has
been diverse and multifaceted.
• Many similar policies and measure have been adopted in different economies, albeit at
different times, reflecting the differences in their relative stages of economic development.
• Major differences across three economies:
The relative lack of support for tertiary education and for R & D by the government in HK has
resulted in the superiority that Taiwan has in high technology industries.
Freedom Capital Movement, low tax rate, and the adherence of the law, with a relaxed
regulatory system have contributed to HK’s success as leading financial center in East Asia.
• The free trade policy in HK has resulted to more development than the
economies of China and Taiwan which are characterized by dualism.
• Taiwan is producing and exporting what Japan was producing and
exporting a decade ago.
• China is producing what Taiwan was producing a decade ago.
• Shanghai will be looking to replace or at least supplant HK’s role as a
financial center serving the Chinese economy within the next couple
of decades.
• What distinguishes China, Taiwan, and Hong Kong on the other is the
role of ideology and the East Asian tradition of a high degree of
personalization of government.