Hiding in plain sight — How did South Korea (and others) develop so fast?
As a young man in 1990s, I looked up to Japan, South Korea and Taiwan. These were the Asian ‘miracle economies.’ Countries that became developed in the twentieth century while starting from scratch. In 1960s, the per capita Gross Domestic Product (GDP) of India and South Korea was similar. Today the per capita GDP of South Korea is 15 times that of India. Taiwan has a similar story. Why did these countries develop so fast? Joe Studwell answers this question in the book How Asia Works. According to Studwell, all three “North East” Asian countries and China followed the same development template. Other countries like Philippines, Malaysia, Thailand and Indonesia — the South East Asian group — followed a different development strategy and hence remained poor or got stuck at a middle-income level. Studwell’s analysis is intriguing and I want to discuss it in detail. In this post, I will first layout Studwell’s hypothesis and then briefly apply it to India.
The core argument
The core argument of Studwell is as follows.
Countries at different stages of development require very different economic thinking. At a minimum, there are two kinds of economics.
· Economics of development: This is applicable in early stages of development when a country needs to learn how to be more productive. Countries need a lot of assistance in this stage. This is similar to how a young person attending school or college needs help.
· Economics of efficiency: Applicable to a country at a later stage of development.
There are three critical steps in the economics of development
I. Land and agricultural policy: The key first step is land redistribution. In addition to land redistribution, the country should support the small landholder farmers with credit, marketing assistance, technology transfers and with inputs such as seeds, fertilizers, etc.
II. Manufacturing with export discipline: Manufacturing is critical to increasing the productivity of an unskilled population. It is also the primary source of better paid employment. However, in initial stages, the manufacturing in a country needs support before it can compete with countries that are already developed. This support can be in form of subsidies and credit and in form of tariff and non-tariff barriers to imports. Such support however, could lead to the local manufacturing becoming inefficient. So, the governments should ensure that there is competition and the losers in such competition are weeded out. The government should also ensure that the manufacturing companies are obliged to export and compete in the world markets.
III. Control of financial sector: Banks and other financial institutions should lend as per the development priority of the country. This means lending to small farmers and also to companies which may not initially have too much experience of manufacturing. Banks usually resist such pressure and may have more profitable and perhaps safer lending options such as retail and real estate lending. The government would need to force the banks to lend as per the development priorities of the state.
Let us look at each of these in detail.
Land and agriculture policy
In early parts of development, most of the population in a country is engaged in agriculture. Market forces, if left to themselves, lead to stagnation or even fall in agricultural yield. This is because the demand for land is much greater than supply and this imbalance leads to a very high land lease rate. The land lessee (or the share cropper) has very little incentive or spare money to invest in the land. The lessor (or the land lord) also has no incentive for investing in the land preferring instead, to maximize his revenues by increasing the rent. The first critical step of a good agriculture policy is land redistribution.
When land is redistributed, a family of five or six people may get to own a small area — say around a Hectare. The family would do every little thing that needs to be done to increase yield. For example, they could start with planting seeds in trays indoors and transplant the small shoots later to the ground. Or they would apply fruit and vegetable compost plant by plant. Or they could target watering, with taller plants getting more water. The list of such tasks is endless and Studwell calls this large-scale gardening. These tasks are back breaking and the marginal return to labor would be very low. The return on cash invested might also be low. The yield per unit of land however, would be very high. For a society with very few employment options, this is the unit of efficiency that matters.
The land reforms need to be supported by measures such as easy availability of fertilizers, good quality seeds, knowledge creation and dissemination and marketing support. When done well, these measures and the consequent yield increase has many benefits for the society.
· At the most fundamental level, the increase in income of small farmers is a good thing by itself.
· This increase in incomes leads to an increase in demand for manufactured goods. This demand, at least in the beginning, is not very sophisticated and that is great for the nascent manufacturing industry in these countries.
· The increased yield also means that the country would not need to use its precious foreign exchange for food imports.
· The income surplus, parked in banks, could be used by the country to lend to manufacturing companies.
· Finally, there is a psychological impact of these changes. The small farmers, who increase their prosperity through hard work, become more confident. In countries where land reforms were executed well, many capable political leaders and businessmen come from an agricultural background.
Across Asia, land was very unevenly distributed in the early part of twentieth century. For example, in 1928 in undivided Korea, 4 per cent of households owned 55 percent of agricultural land. In Taiwan only a little over 30% land was farmed by owner cultivators and rents reached 70% of output for some high-quality land. In Java in 1960, 60% of rural population was landless with the average holding of those fortunate enough to have land being under half a Hectare. In passing, I must note that there seems to be something structural about agriculture that leads to such land holding patterns. I would love to explore this triumph of Pareto in a future post.
Countries in the North East Asia group — Japan, Taiwan and South Korea and later China — had a meaningful land redistribution followed by effective support to small farmers that lead to a sharp increase in crop yields. Countries in South East Asia group — Philippines, Indonesia, Malaysia and Thailand — did a halfhearted land redistribution. In the South East Asian group, the land redistribution was mainly on paper and rich and influential landowners never relinquished control of their land. If somehow, they were forced to let go of parts of their land, they immediately re-leased it from the new landowners at very low rates either because the small landowner did not have money to grow crops or because he was intimidated by his former landowner or both. Of all the countries in South East Asia group, Studwell has the harshest words for Philippines.
Studwell takes the example of Eduardo ‘Danding’ Cojuanco or ‘Boss Danding’ of Philippines. Even after the supposed land redistribution, Boss Danding owned more than 6,000 hectares. Boss Danding was Ferdinand Marcos’s crony and under him was the governor of Development bank of the Philippines and ran a coconut marketing monopoly. He lived in Negros Occidental and controlled most of local mayors and congressmen. His power allowed him a lifestyle of living in a mansion — called the White House — and indulging in his passion for vintage luxury cars, big motorbikes and fighting cocks. When the law forced him to redistribute his land, he formed a joint venture with his tenants but retained management control. The workers were paid wages and 35% of profits but Danding’s costs in the joint venture are not open to audit. This story repeats itself across South East Asia. The rich and politically connected can subvert land reforms unless they are done exceedingly well. And when they are implemented well, the difference is obvious.
In the North East Asian countries, the yields went up significantly. As per the book
“In the first ten to fifteen years following the shift to small scale household agriculture in successive east Asian states, gross output of foodstuffs increased by somewhere between half (in Japan, which was the most productive country) and three-quarters (Taiwan).”
Incidentally, this worked even for cash crops. For example,
“… the sugar yield on small household farms in Taiwan or China has traditionally been 50 percent more than on pre- or post-colonial plantations in the Philippines or Indonesia.”
This increase in yields improved income for a large part of population and helped jump start manufacturing. However, there is an expiry date for the benefit of these policies and as a country starts becoming rich, it needs to start tapering the support given to farmers. As can be expected, it is easier to institute policies that help farmers, then to remove them. Japan for example, has not been able to do it. However, the benefits of good land policies in the initial years of development far outweigh the costs to government finances and to consumers in the later years.
Once land redistribution and other agricultural policies have helped jumpstart manufacturing, they have achieved their biggest development role. Let us look at manufacturing policies next.
Manufacturing / Industrial policy
Manufacturing is very important for the development of a country. Most of the workforce in an underdeveloped country is not very skilled and machines used in manufacturing can scale their capabilities. Such scaling is not easy in services and therefore manufacturing is crucial for the development of any large country [1].
Studwell argues that at the beginning of the development process, a country has very limited capacity in manufacturing. He says that such a country needs support from the government in the shape of subsidies and protection. He further says that every developed country has seen such protection in its history [1].
Britain had such protections when it started industrializing. For example, only British flagged ships were allowed in British and British Colonial ports. Britain also taxed export of raw wool and the import of wool clothing in order to promote its wool textile industry. Then there is the example of East India Company. The support this company got from the British government would take multiple books to list out.
Another prominent example of protection of nascent industry is United States. Alexander Hamilton, the Treasury Secretary responsible for the early manufacturing policy of United States coined the expression ‘Infant Industry’. And an infant — whether a human or an industry — needs protection. The US government provided a lot of it.
Why does a country at the beginning of its industrialization need protection? It is because manufacturing techniques cannot be learnt by reading theory. Learning by doing is the only way for a country to acquire this capability and the companies engaged in such learning are bound to make mistakes. If they are not protected from experienced competitors, they would be wiped out.
Of course, such protection can lead to the companies becoming inefficient. Studwell says that two measures would keep such tendencies in check. The first measure is competition and ruthlessness in culling out the losers. The second is export obligation. Studwell believes that this is where the North East Asian countries executed well and the South East Asian economies did badly.
He takes an in-depth look at South Korea. General Park Chung Hee took over the country in a coup in 1961. He decided that businessmen would work according to development priorities set by him. He literally jailed many of them and the community got the message that they had to get into manufacturing and succeed. Businessmen were forced to enter into technical tie-ups and get into fertilizers, synthetic fibers, cement, iron and steel, etc. without any previous experience of manufacturing those products. At that time, Hyundai was one of the five big construction companies in the country. The founder of Hyundai, Chung Ju Yung, had never manufactured or exported anything. Chung started with manufacturing cement and quickly started exporting it. Then, he also started making and exporting cement plants. In 1968, he had the permission to import and assemble Complete Knock Down (CKD) car kits in a joint venture with Ford. The state policy forced car assemblers to quickly increase the local content. Soon access to bank finance was progressively conditioned on building a truly Korean car and exporting it.
The Korean car market in 1973 was only 30,000 cars but still three manufacturers were licensed. In spite of the controlled prices, the market was too small for any company to make profits. Hyundai Motor Company (HMC) made losses every year from 1972 to 1978. The earliest market leader was the Shinjin Chaebol which took too much debt and the government forced it out of business. As the market grew, other entrepreneurs wanted to manufacture cars and the government licensed them but made sure to ruthlessly weed out the losers. After a few decades of competition and the financial crisis, HMC was the clear winner by 2000.
HMC entered the US market with a small car — Excel. It managed to sell 260,000 units in 1987 and 1988 on the back of aggressive pricing and advertising. The company made huge losses on these exports. The company cut costs and volumes fell but by mid 1990s the volumes stabilized and HMC started making profits in the US. By 2010, HMC along with Kia which it had purchased, was tied with Ford as the fourth biggest global auto group.
In contrast, the South East Asian countries did a very poor job of persuading big entrepreneurs to get into manufacturing. The biggest businessman in Malaysia, Lim Goh Tong who began in construction, got government concessions in oil and gas and has since become very wealthy due to monopoly in gambling. In Indonesia and Thailand, the biggest businessmen are not into manufacturing. Studwell has the harshest words for Philippines again. According to him, landowning families dominate the business scene in the country. They do the minimum assembly work required and are protected by high tariff walls. None of these countries has a manufacturing brand to match a Hyundai or a Toyota or even an Acer.
I think that what kind of business makes money for a country’s largest businessmen is a very important Indicator. If the largest businesses men are in commodities and / or government granted monopolies, then it is a bad sign. These large businesses would squeeze the margins of downstream manufacturers. Low margin for manufacturing would mean that those businesses do not have money to invest in technological development and increasing productivity. If the productivity in a country is low, then by definition its GDP per capita cannot be too high. The largest businessmen usually have the most political power. They can use this power to make sure that their commodity and / or concession businesses are protected. This imposes a large cost on the economy.
Both, small farmers and nascent manufacturing companies, need support from banking in initial stages. This may not be very easy in a financial system that is totally free to do what it wants. Let us look at this next.
Keep banks on a short leash
The author argues that an appropriate land and manufacturing policy can succeed only if financial institutions lend as per development policy. A bank may reasonably prefer to lend to a large plantation rather than to many small farmers. However, that would cause land reforms to fail. So, banks may need to be coerced to lend to small farmers practicing large-scale gardening. Similarly, it takes time for a society to learn manufacturing. And companies need funding support during this time. Again, a bank may reasonably prefer to lend to real estate companies or to make individual or retail loans. Governments in North East Asia forced banks not to make such decisions.
Bank depositors paid the costs of such policies. A generation of savers in South Korea for example, put their savings in banks and got a meagre interest rate. In a sense these savers financed the development of the country.
Conglomerates used profits from one business to fund another. For example, Hyundai’s ship building business became profitable much before its automobile business. Profits from the former were poured into the latter. There were many such examples. Minority shareholders, if any, of the profitable businesses were hurt by such moves. In the intense development phase of South Korea, retail investors in both debt and equity got a raw deal. Then there is the question of macroeconomic policies.
Studwell argues that there was almost no correlation between what are considered prudent macroeconomic policies and success in becoming a developed economy. In South Korea, rediscounting of export loans was unlimited. There was also unlimited rediscounting to other government favored projects. One of the consequences of these policies was an inflation rate of between 15 and 20%. Additionally, General Park Chung Hee nationalized all the banks. Taiwan was much more conservative comparatively. The interest and savings rate were comparatively higher and the inflation lower. Taiwan also did not face the balance of payment and banking crisis that South Korea did. However, both of them succeeded in transforming their economies. In the not so successful South East Asian group, you have the opposite extremes of Thailand and Philippines.
Thailand has followed most of the prudential financial policies prescribed by IMF and World Bank and yet it remains a middle income country. There are no internationally competitive Thai firms. Philippines on the other hand has been the most fiscally profligate. It is economically in worse shape than Thailand and all other South East Asian countries. However, all countries in this group — whether conservative or not — are much worse off than the North East Asian cohort.
The difference between the North East Asian group and the South Asian group is not their macroeconomic policies but how well they implemented their agriculture and manufacturing polices. The not so successful countries followed the prescription of World Bank type economists and the successful economies relied on economic history. In fact, this debate between economists and economic historians is a running theme through the book.
Economist versus Historian
As I mentioned in the beginning, Studwell says that there are at least two economics. One for the developing countries and another for developed countries. He calls the latter efficiency economics — a broad umbrella term for a wide range of thought that generally believes the government interference is wrong in all circumstances. Studwell criticizes the efficiency economist of not understanding history. He believes that everycountry in the world protected its manufacturing in the early stages. Countries have no other choice. When manufacturing skills are low, competition from sophisticated global companies would destroy the ‘infant’ industry. Just like how an experienced professional boxer would destroy a child or a teenager, no matter how talented. Studwell believes that efficiency economists do not understand this because they have very little understanding of economics history.
Studwell claims the Germany followed the prescription of Fredrich List and the so-called Historian school when it was developing. Japan learnt from Germany and South Korea learnt from Japan. List believed that the free-market evangelism emanating from Britain was opportunistically based on that country’s technological leadership. Here is List
‘Any nation which by means of protective duties and restrictions on navigation has raised her manufacturing power and her navigation to such a degree of development that no other nation can sustain free competition with her can do nothing wiser than to throw away these ladder of her greatness and, to preach to other nations the benefits of free trade, and to declare in penitent tones that she has hitherto wandered in the paths or error, and has now for the first time succeeded in discovering the truth.’
Studwell has an interesting anecdote on the relative influence of List in South Korea and in the United States.
‘The Korea and Taiwan scholar Robert Wade observed when he was teaching in Korea in the late 1970s that ‘whole shelves’ of List’s books could be found in the university bookshops of Seoul. When he moved to the Massachusetts Institute of Technology, Wade found that a solitary copy of List’s main work had been last taken out of the library in 1966.’
The efficiency economists can be very influential as they dominate academia and such institutions as World Bank and International Monetary Fund (IMF). Studwell’s recommendation is that a developing country have a clear plan based on teaching of Fredrich List and counter the influential efficiency economist by lying. According to him, the Chinese government has taken a lot of project specific technical support and financing from World Bank but has never entertained its prescriptions for prematurely deregulating its economy. IMF was prevented from seconding officers in its ministries as it has done in other countries. As he says
‘The standard Chinese response to IMF efforts to get inside the bureaucracy over the years has been: ‘Do us a seminar.’
As I read the book, I kept wondering about how India and China fare on the prescriptions of Studwell. The book has a chapter on China and is worth reading even though much has changed in the country since the publication of the book (2014). India is mentioned off hand a few times — mainly as a country that has failed in its development. I have tried to put some summary thoughts on where India is on Studwell’s framework in the next section. Unlike this article till now, the next two sections are not from the book.
What about India?
How does India compare on the three-pronged development recommendation of Studwell? A deep dive is beyond the scope of this already long essay but here are my quick observations. Let us start with land reforms.
Land reform in India is complex as it is a state subject. As I discussed earlier, making rules is not enough. The rules have to be implemented well on ground otherwise the landlords can undo all the land redistribution. Hence, land reforms have to be evaluated state by state and from what I can make out from a little bit of research, the three states that did a good job of land redistribution in India are West Bengal, Kerala and Jammu and Kashmir. This probably led to a better life for the small farmers in those states but certainly did not help in developing manufacturing. None of the three states is known for its industrial dynamism.
India has a history of helping farmers through other measures such as credit, cheap fertilizers and procurement support. However, the implementation of all these policies has been criticized. For example, as I have analyzed here, the benefit of procurement under Minimum Support Price (MSP) goes to very few farmers.
Even with these shortcomings, India may be now anyway getting at least some of the benefits of a good land and agriculture policy. Recall, the benefits to the society we discussed earlier. One was increase in rural demand for manufactured goods. In India of today, a lot of support from the Union budget goes to rural areas as I have explained here. This support — especially MNREGA — has raised the minimum wages and has increased the rural demand. Another benefit of a good land policy is reduced need for precious foreign exchange for food imports. Food sufficiency plus exports, led by software services, have made the exchange situation in the fairly comfortable.
There is no doubting that we still lag in manufacturing which results in lack of meaningful employment for large sections of the population. This also makes India a low productivity country. This lack of manufacturing capabilities is a result of our policies for the first many decades since independence.
A lot of what needed to be done to promote manufacturing is under the central government and while the government did set up companies for manufacturing of chemicals, fertilizers, heavy machinery, etc. it is clear that there was a lacuna in our policy. First of all, due to industrial licensing and due to reserving of many sectors for Public Sector, there was very little competition for manufacturers, both in public and private sector. More importantly, in India there was no export obligation and companies had very little pressure too improve. Most crucially, there was no penalty for failure. The country has got a working bankruptcy system only in the last few years. For the first few decades, companies were monopolies or oligopolies in their field which could sell their substandard products to customers at a very high rate because the customer had no choice. The companies had no pressure to improve technologically. And if a company failed even in this easy task, its existence was never threatened. Precious capital was locked in such bloated and inefficient producers. Indian companies took advantage of protection and credit and delivered almost nothing in return. We have started seeing some changes in the manufacturing policy in the last few decades but clearly a lot more can be done.
One surprising revelation of the book is that the ownership of the banks did not matter. General Park nationalized all banks in South Korea. That did not prevent it from becoming a manufacturing powerhouse and a developed country in a very short time. I have
always felt that the bank nationalization in India in 1969 was a very bad move. Now, I am not so sure. The bad part of the move was the banks were directed to lend to companies that had no incentives to improve. Like Korea, deposit holders in India too subsidized companies. However, unlike in Korea, we got very few world class manufacturers in return.
India has not managed to come up with any globally known manufacturing companies such as Hyundai, Samsung or Huawei.
Summary and general discussion
Redistribute land and support your farmers. Encourage your entrepreneurs to get into manufacturing and support them while making sure that they do not become inefficient. Make sure that your banks support these policies. Is development really this easy?
The first thing to note is that a simple articulation of a process does not make it easy. Each of the above sentences has many implementation challenges on ground and tackling them is nowhere near easy. Redistribution of land is incredibly tough. Rich landlords are politically very powerful. They have all kinds of ways to subvert any land redistribution process. Similarly, big businessmen are economically and politically powerful. They resist being put under conditions like export targets when they can make much more money from trading in commodities or state sanctioned monopolies or from real estate projects. Their political power means that they can price their commodities high making it difficult for manufacturers to prosper.
Also there is the question of what is true in social science. In general, I believe in empirical evidence rather than in a theory even if the theory is mathematically elegant. However, empirical evidence is not easy to interpret. If a country did follow Studwell’s prescriptions, is it guaranteed to succeed? Or would it be that if the country fails, we would say that it did not do a good job in implementation? Reminds me of discussions on cricket. Why did Virat Kohli succeed? Because he was assertive. Why did Hardik Pandya fail? Because he was reckless. My assertiveness is assertiveness and yours is recklessness. Or as Hindi films and a Big Boss participant have respectively said,
Tumhara khoon khoon, humara khoon pani?
Sada kutta kutta, tuada kutta Tommy?
Such questions are way above my paygrade. But it makes sense to me that efficiency economics is great for a society to reach the local maxima. However, if it wishes to search for a global maxima, it needs help in changing its trajectory. We see this in groups of people all the time. We also see it in countries which are stuck in low income or middle-income traps. There is of course the risk that any policy attempt to change trajectory can be captured by vested interests as it was done with manufacturing in India in the past.
To end this already very long post, I will very briefly describe some things that India could do. Do remember that we are in way above my pay grade territory.
· Land redistribution is very unlikely in most parts of India right now. However, some of the benefits of land redistribution are already occurring due to budgetary transfers to rural areas and other developments.
· Rural India is very diverse. An apple orchard owner in Shimla is very different from a tribal farmer in Palghar. The latter needs the support that the former is probably getting. It is crucial that we retarget support to farmers that need it although this is very tough politically.
· India has no choice but to increase its manufacturing. Manufacturing should be thought of at least at two levels. Low-tech labor-intensive manufacturing that creates a lot of employment and relatively technology intensive manufacturing. Both are needed but may require different policy prescriptions. Low tech manufacturing needs little protection. It does need all help possible in terms of Real Ease of Doing Business. Competition between states would be a good tool for both keeping manufacturers honest and for increasing Real Ease of Doing Business.
· This may be the perfect time for India to make a sustained effort to get its manufacturing right. Changed global geopolitical scenario creates a window of opportunity for us. As does the fact that manufacturing itself will change significantly in coming years due to impact of Artificial Intelligence, Robotics and Internet of things. Software is critical component of these technologies and India has some strength in software.
· What does ‘sustained effort to get manufacturing right’ mean? A lot of things. Focusing on Real Ease of Doing Business as have been talking about in our series on this topic. Getting bankruptcy right and making sure that it stays right. Ensuring that there is money for firms that want to get into manufacturing, especially technologically intensive manufacturing. This even when most of the ‘risk capital’ goes into relatively easier areas such as food delivery.
This list of what needs to be done is incomplete and more importantly, as we know, implementation is very different from announcements. So how would we know if the country is actually making progress? One indicator would be if more of our richest and most influential businessmen are into manufacturing and less in commodities or concession-based businesses or in food delivery. Another indicator would be when India based consumer good manufacturing companies become household names in the developed markets in the world.
I look forward to that day.
[1] With the exception of port financial havens such as Hong Kong and Singapore and super specialized agricultural exporters such as Denmark and New Zealand.
I have forgotten who recommended the book, How Asia Works, to me. My heartfelt thanks to them — I enjoyed it and learnt a lot.
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