08 August 2014
Asia's economy -- no miracle!

Asia's economy -- no miracle!

Asia's dramatic economic development has not been a miracle. It has been the result of sound policies. But can Asia succeed in innovation-driven development?

Asia's dramatic economic development has not been a miracle. It has been the result of sound policies. But can Asia succeed in innovation-driven development?

A strong economy is necessary for national development, despite what some idealist dreamers might say. The economy provides us with goods and services which are essential for our lives -- food, clothing, shelter, i-Phones, Facebook, even Lady Gaga -- all these things are part of the economy.

But the economy by itself is not sufficient for national development. We need the government to provide us with infrastructure like water, sanitation, roads, bridges and so on. We also need the government to provide at least basic health and education services.

There are four main sources of growth for our economy -- labor, capital investment, human capital (education and health) and productivity (which is driven by technology, innovation and efficiency improvements). Poor countries typically have lots of labor, but much less capital investment and human capital, and low levels of productivity. So the challenge of economic development is fostering investment, human capital and productivity. The case of Japan is quite the reverse, with its declining labor force and population, and high levels of investment, human capital and productivity.

As countries like Japan and Korea have demonstrated, all countries have the ability to achieve their economic potential -- through a process of economic catchup or convergence towards world leaders.

Asia's economic development is often described as a miracle. But it is not! It is the result of sound policies to foster investment, human capital and productivity. What is curious is that much of Africa and Latin America have not seized the opportunity of economic catchup.

Everyone is astounded that China was able to achieve annual economic growth of 10% for some three decades. This is not astonishing at all! Countries at the bottom of the development ladder have the potential for rapid growth. This is known as the "benefit of backwardness". China opened to foreign trade and investment, liberalized parts of its economy, built good infrastructure and provided human capital to its citizens. With so much pent-up potential, the economy just took off.

Many are now worried that China's economic growth has now slowed to about 7%. This is also not surprising. As economies make progress towards the global technological frontier (global best practice), their rates of economic growth will tend to slow down.

While Asia's economic record may not be a miracle, it is unique. The World Bank's Growth Commission identified only 13 countries which have experienced annual economic growth rates of 7 per cent for 25 years or longer in the post World War II period (at this pace, an economy doubles in size every decade). These economies are Botswana, Brazil, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Malta, Oman, Singapore, Taiwan and Thailand -- 9 of which come from Asia.

How did these economies achieve such a good performance? It was a simple recipe of sound macroeconomic management (low inflation and debt), infrastructure, education, competitive market economies and promoting exports.

But perhaps the key factor was sound leadership. The comparison of North and South Korea is instructive. North Korea's elite, based in Pyonyang, has basically ripped off the country, and repressed much of the population through "extractive" institutions. This means that the elite lives a life of privilege. But the whole country is left poor and vulnerable. And it has to use political blackmail of the West and China to survive politically.

South Korea, though not a democracy after the Korean war, employed a fundamentally different approach. At the time, South Korea was surrounded by three communist countries -- China, the former USSR and North Korea -- and thus felt vulnerable. It decided, with help of its American ally, to become a strong country through "inclusive" economic institutions and policies. So it invested in its people (human capital) and infrastructure, and it promoted market-based development. Ultimately, South Korea became a democracy, and is now a wealthy advanced country.

For all countries, a key driver of economic development is absorbing knowledge and technology from the rest of the world. This fosters human capital and productivity growth.

There are a number of ways to absorb knowledge and technology from the rest of the world. Education should be straightforward, since basic knowledge is freely available, especially thanks to the Internet. China and some other Asian countries have wisely sent students overseas to undertake studies -- Japan has been less active in this area.

Some countries like Japan and Korea bought or licensed technology. Foreign direct investment is another way to acquire knowledge and technology. Local citizens and enterprises which work with foreign companies are exposed to much knowledge and technology. The most controverial means of acquiring foreign technology today is intellectual property theft or cyber industrial esiponage.

Climbing the economic ladder from the bottom to the top is a long journey. Policies must become increasingly sophisticated along the way. There is a risk that countries may get stuck along the way -- fall into a "middle income trap".

As countries near the top of the economic development ladder, they must become more innovation driven. But even at lower levels of development, countries like India have been undertaking "frugal innovation", developing low cost products and services to improve the lives of their citizens.

While Japan's economic development has been outstanding, neither its GDP per capita nor labor productivity have caught up with the US. It remains 25-30% behind. And there is no sign of it closing this gap.

Japanese companies have been very successful at "incremental innovation", making small improvements in production and other processes. This is known as "kaizen" or continuous improvement in Japanese. But Japan has been much less successful in "disruptive innovation" or "major breakthroughs".

Why? A group of students at Tokyo's Sophia University offered the following possible reasons.

Japanese education emphasizes rote learning and passing tests, more than critical thinking and analysis. Japan's group or collectivist, rather than individualist, culture does not lend itself to generating bold new ideas. Japan also has less of a "risk-taking" culture. There is a greater tendency to conform. Indeed, there seems to be much less of a celebration of "passion" than in the US.

Japanese companies are very hierarchical, and promotion and pay scales are based on seniority. This means that the best ideas do not always make it up to decisionmakers.

Big Japanese companies and banks are very conservative. This means that new entrepreneurs like Softbank's Masayoshi Son or Rakuten's Hiroshi Mikitani can be treated like outsiders -- rather than being treated as national heros, as in the cases of Steve Jobs or Bill Gates. Japanese companies lack the multiculturalism that can make US companies, especially in Silicon Valley, creative and innovative. It is much harder for a startup to find capital.

Japan is well aware of these issues and it is working to change. But change comes slowly. Most other Asian countries are behind Japan in the economic ladder. Many will encounter challenges like these.

Looking ahead for China, also reveals many challenges. Some of its most innovative and creative people like Ai Weiwei are artists that oppose the Communist Party regime. Continuing to repress such people will entail great costs for China innovation and creativity future, in addition to the terrible human rights abuses.


John West
Executive Director
Asian Century Institute
Tags: asia, economic convergence, economic catchup, frugal innovation, incremental innovation, kaizen, cyber espionage, ai weiwei

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