Tuesday 5 November 2013

Book Review: Joe Studwell: How Asia Works

Over the weekend I read an excellent book titled: How Asia Works: Success and Failure in the World's Most Dynamic Region by Joe Studwell. In it, the author walks us through the economic development of Japan, Taiwan, and South Korea. Outlining what worked in these countries, and why economic development plans in comparable southeast Asian countries like Thailand, Indonesia, Malaysia, and the Philippines didn't.

To climb from the extreme third world poverty that afflicted these northeast Asian countries to the first world countries that they have become, Studwell prescribes three key features:

1. Agricultural Reform: Maximizing yield via small scale 'gardening' on individual or family sized plots of land. He presents a convincing case for using yield maximization rather then labor productivity or scale profitability at very low levels of development. This creates a rural surplus that provides a solid based to fund the more capital intensive manufacturing development. It also best utilizes the available input; an abundance of manual labor.

2. Manufacturing Development: Studwell emphasizes the need to push industry to evolve as quickly to the technological frontier as possible; and that 'free markets' are generally not up to the task. First, facilitate arrangements/partnerships that will enable technological transfer and learning, rather then processing and assembling. Next, learn the heck out of that product and figure out how to fill the backward and forward linkages of each supply chain. Then, export, export, export.

None of this seems terribly surprising, but what was novel, and the two key items that Studwell emphasized were a). Encourage multiple domestic firms to undertake this process, and b). Measure their viability using their ability to sell into more developed export markets. Markets provide a ton of information, selling a car into the north american market requires a level of quality and innovation that isn't required in undeveloped domestic markets. Nurturing the survival of the fittest element domestically requires losers to cull. This is key. Avoid the "national champion" label from inception. Instead, wait until you can hop on a winning band wagon.

3. Financial Repression: Now, the Financial Repression bit should accompany the first two steps and should be used to accomplish them. Finding the right timing and policy mixture to both subsidize industrialization (at the expense of savers) and guide the subsidized industrialization towards 'socially optimal' development, is the difficult part.

As separate issues, funding industrialization on the backs of savers is not difficult. Devalue currency, cap deposit interest rates, limit capital flows (domestically and internationally), are a few tools that are often utilized. All things equal, these policies are sub-optimal at any given static level of development. This book argues that they become productive when the return on these 'subsidized funds' can be employed in a manner that increases future income sufficiently to offset the short term welfare losses. In gamblers parlance, the expected value (EV) of the policy mix that represses is greater then the mix that does not repress.

Think of it as you would the economic returns to education, it's hard to justify university while actually attending it. You could make more money, you could spend more money, you'd have more economic freedom if you just dropped out and joined the workforce (especially in Alberta!). But that university degree gives you a range of options that is much wider, and it gives you a higher entrance points into many of the same companies (impacting your future income streams). Essentially, you've created a new set of equilibrium points that were not previously available and are typically more desirable (on average of course, this being Alberta and all). Or, by not investing in education you limit your potential equilibrium points.

Studwell finds that by rewarding firms via favorable loan repos for export success (ala South Korea) the government can steer their policy in a market informed manner where the EV justifies the gamble. Studwell shows how countries like Malaysia, Indonesia, Thailand and the Philippines fell of his path at varying stages and found themselves in stagnating economies that were unable to weather the '97 Asian financial crisis.

What does this mean for China?

China would be somewhere in that financial repression/climb up the technological ladder phase. It is so much more difficult to interpret China's results due to her scale. What I glean from Studwell's analysis (confirmation bias alert!) is that China should continue to work it's way down the path it's currently on. Export informed protectionism should probably continue as China aims to create globally recognized brand names like Hyundai and Samsung that operate on the technological frontier.

Perhaps the inland provinces can follow this same approach and leverage the more developed markets on the eastern coast as the build up their technological base.

The key insight I took from this book was that dogmatic centralization of control is still the ultimate enemy. Markets need to inform policy choices in the protectionist development stages of an economy. Since domestic markets are not yet able to adequately support products on the technological edge globally, export markets are key.

Think of a complete liberalization in exchange rate, deposit rate, and capital flows policy. Perhaps even rural land reform similar to those in Japan or South Korea (where rural peasants were able to own and sell their property to urban developers), undoubtedly (in my mind) the Chinese consumer would be better off in the short term. I haven't heard any convincing arguments against that.

But at these early stages of development I find it entirely plausible that the steps outlined by Studwell play an important factor in determining whether a country can fight it's way through the middle income trap. It just seems like the downside risk of premature liberalization outweighs the risk of continuing down this slow and steady reform process that has still yielded excellent and real welfare results.

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