Some of this inequality is simply due to the law of supply and demand.

Because unskilled labor is abundant and skilled labor and entrepreneurs are scarce, unskilled wages are low and those who have skills prosper. Indeed, earlier theories suggested that inequality contributed to economic growth. Sir Arthur Lewis, who received the Nobel Prize for his work on development economics, argued that what he called the surplus of labor kept wages low and profits high. Workers earning subsistence wages could not save, but capitalists could; thus higher profits contributed to a higher saving rate. In this view, there is a trade-off between growth and equality. Current views are different. Today, many economists believe that growth and equality are in fact complementary, as evidenced by the East Asian miracle.

Wrap-Up

SOURCES OF PROBLEMS IN LESS-DEVELOPED COUNTRIES

A lack of resources, both human and physical, and high population growth, which makes raising educational levels difficult The lack of financial markets and inadequate legal systems A high level of income inequality

THE SUCCESS OF EAST ASIA

The most successful efforts at development, anywhere at any time, have been in East Asia in the decades after World War II. Sustained growth over three to four decades has led to eightfold or greater increases in per capita income. There are several ingredients to this success: Macroeconomic stabilityavoiding for the most part high inflation or high levels of unemployment. As part of this strategy, governments maintained a high level of fiscal responsibility, eschewing the huge budget deficits that characterize many LDCs. High saving rates. With saving rates of 25 percent or more, the countries could invest heavily. Smart investment of savings. As important as the high level of saving is the fact that the savings were invested well; in other countries with high saving rates (either forced, as in the communist countries, or the result of a natural resource bonanza, as in Venezuela), they were not. Heavy investment in education, including the education of women. This investment resulted in a highly skilled labor force that was able to absorb new technologies. Heavy investment in technology. What separates developed from lessdeveloped countries is not only a shortage of capital but also a gap in knowledge. East Asian countries developed technology policies aimed at
DEVELOPMENT

799

closing this gap, with remarkable success. Some countries, like Singapore, encouraged foreign firms to invest directly, bringing with them access to foreign markets as well as new technology. Other countries, like Korea, focused on licensing new technologies from the more advanced countries. Political and social stability, which provides an environment conducive to investment. So impressive have the outcomes in East Asia been that many refer to them as the East Asian miracle. Some economists, however, find nothing miraculous in them the growth can be explained largely by standard economics of the kind that we have studied in this text (see Chapter 27). High saving rates, high investment in both capital and education, and knowledge are part of the standard recipe. Still, one point argues for a miracle: no other set of countries has been able to achieve similar outcomes. Underlying these successes were both good policies (such as those that led to macroeconomic stability) and strong institutions (such as newly created financial institutions that allocated the capital well). Three features of East Asias development strategy deserve special attention: the roles of government, exports, and egalitarian policies.

The Role of Government Perhaps the most distinctive feature of the East
Asia model was the balance the countries achieved between the role of the state and the role of the market. Their governments pursued market-oriented policies that encouraged development of the private sector. They sought to augment and govern the market, not to replace it. They also fostered high saving ratesoften in excess of 25 percent. In Japan, more than a third of these savings went into accounts at the postal savings banks established by the government. In Singapore, the government established a provident fund, to which all workers were required to contribute 40 percent of their income. These governments also influenced the allocation of capital in myriad ways. Banks were discouraged from making real estate loans and loans for durable consumer goods. This action helped to increase private saving rates and to discourage real estate speculation, which often serves to destabilize the economy. As a result, more funds were available for investment in growth-oriented activities like purchasing new equipment. In addition, governments established development banks to promote long-term investment in sectors such as shipbuilding, steel mills, and the chemical industry. These interventions have been more controversial, and their success has been mixed. On the positive side, the steel firms in Taiwan and Korea are among the most efficient in the world. With more mixed results, the Japanese and Korean governments took a variety of initiatives to promote certain industries, including the computer chip industry. By the early 1980s, Japan seemed poised to completely dominate that market. During the late 1980s and early 1990s, a series of agreements reached between Japan and the United States lowered tariffs on semiconductors and allowed U.S. manufactures access to the Japanese market. These

800

CHAPTER 36 DEVELOPMENT AND TRANSITION

changes served to level the playing field, enabling American producers such as Intel to draw on Americas comparative advantage in chip production and reassert leadership in the industry. The dangers of government intervention are often symbolized by the Japanese governments failed attempt to discourage Honda (originally a manufacturer of motorcycles) from entering the auto market, arguing that there were already too many producers.

Export-Led Growth A second factor that distinguished the countries of

East Asia from less successful LDCs was their emphasis on exports. A growth strategy focusing on exports is called export-led growth. Firms were given a variety of encouragements to export, including increased access to credit, often at subsidized rates. Export-led growth enables firms to produce according to their long-term comparative advantage. This is not current comparative advantage, based on current resources and knowledge. It is dynamic comparative advantage, which relies on acquired skills and technology, and on recognition of the importance of learning by doingthat skills and productivity improve with production experience. When an LDC emphasizes exports, demand for the goods it produces is not limited by the low income of its citizens. The world is its market. Advocates of export-led growth also believe that the competition provided by the export market is an important stimulus to efficiency and modernization. The only way for a firm to succeed in the face of keen international competition is to produce what consumers want, at the quality they want, and at the lowest possible cost. This keen competition forces specialization in areas where low-wage LDCs have a comparative advantage, such as in the production of labor-intensive products. Finally, export-led growth has facilitated the transfer of advanced technology. Producers exporting to developed countries not only come into contact with efficient producers within those countries but also learn to adopt their standards and production techniques.

Fostering Equality Another distinctive aspect of East Asias development strategy was its emphasis on equality. Examples of these egalitarian policies include Singapores home ownership program; the almost universal provision of elementary and secondary education, extended to girls as well as boys; and the land redistribution programs that were the precursor of growth in several of the countries, including Taiwan and Japan. In many of these countries, the governments also tried to curb excessive wage inequality and to discourage conspicuous consumption by the rich. Their experience has shown that high saving rates are possible without either the oppressiveness of Soviet-style governments or vast inequalities. The equality measures have actually promoted economic growth. The land reforms have resulted in increased agricultural production, and the high educational levels have directly increased productivity and facilitated the transfer and adoption of more advanced technology. More education for women is associated with smaller families, and thus with declining rates of population growth.

DEVELOPMENT

801

Wrap-Up

EAST ASIAS SUCCESS

Key ingredients to East Asias success include macroeconomic stability, high saving rates to finance investment, investment in education and in technology, and political and social stability. Governments pursued market-oriented policies that encouraged saving and investment. Growth strategies emphasized export-led growth. Income equality was fostered.

ALTERNATIVE DEVELOPMENT STRATEGIES

The development strategies pursued by East Asia stood in marked contrast to those followed in much of the rest of the world, and many economists attribute, at least in part, the differences in performance to differences in strategies. As the developing countries first experienced independence, many came under the sway of socialism and government took a central role in planning development. Having been dominated by foreign governments, they worried that opening themselves up to foreign investment would lead to a new form of dominationdomination by large multinational firms. Some countries, trying to reduce their reliance on imports, focused on import substitution policies, and a few, like Brazil, had a short period of success following that strategy. But by and large, the countries following these strategies stagnated or grew very slowly. Even before the end of the cold war seemed to provide convincing proof that the socialist or planning model was badly flawed, its weaknesses as implemented in the developing countries seemed apparent. Governments did not do a good job of planning, often managing and allocating resources inefficiently. White elephants such as huge and inefficient steel mills dotted the landscape. Protectionist barriers were erected, nominally to help support domestic industries but all too often to allow friends of the government to enjoy high profits insulated from outside competition. In some cases, the inefficiencies were so extreme that the value of the inputs imported for use in production was greater than the value of the output, had it been sold at international prices. Protection had been granted using the infant industry argumentthe argument that new industries had to be protected until they could establish themselves sufficiently to meet the competition. But in many of the developing countries, the infants seemed never to grow up: protection became permanent. In the early 1980s a new development strategy emerged. Recognizing the limits of a state-dominated economy, many countries swung to the other extreme, arguing for a minimal role for government. Governments were urged to privatize and liberalize, to sell off state companies and eliminate government intervention. These

802

CHAPTER 36 DEVELOPMENT AND TRANSITION