The Economic Playbook Used By Asia’s Fastest Growing Countries

Joe Studwell’s HOW ASIA WORKS lays out why Northeast Asian countries far outperformed their Southeast Asian counterparts (namely through better agricultural, manufacturing and financial policies).

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1. Step #1: Agricultural & Land Reform Lays the Groundwork
2. Step #2: Manufacturing Takes Off From a Stable Agricultural Base
3. Step #3: Countries “Pick” Industrial Winners with Financial Reforms
4. Southeast Asian Countries Did NOT Follow the Playbook
5. China Has Implemented the First Two Steps…
6. …But is Having Difficulty with the Final Step (Financial Reform)

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Joe Studwell’s How Asia Works: Success and Failure in the World’s Most Dynamic Region is a perfect primer for understanding Asia’s economy.

As the title suggests, Studwell meticulously lays out the post-World War II stages of economic development for:

• Northeast Asia (Japan, South Korea and Taiwan)
• Southeast Asia (Thailand, Malaysia, Indonesia and the Philippines)
• China. 1 As primarily financial centers with few natural resources and non-descript agricultural histories, Studwell leaves Hong Kong and Singapore out of the mix.

In teasing out the development paths, he shows that the Northeast Asian countries have achieved much greater growth due to:

1. Superior agricultural and land reform programs
2. State-lead manufacturing
3. More effective financial reforms

As shown below, these decisions have made a significant difference in national wealth (on a GDP per capita basis).

1. Step #1: Agricultural & Land Reform Lays the Groundwork

According to Studwell, Asian economic development in the second half of the 20th century (1945-2000) went three distinct phases:

1. Agricultural and land reform focused on based on “garden-sized” plots
2. Manufacturing defined by state-guided industrial policy
3. Financial reforms to support local industry and exports

Post WW-II, land reform in Northeast Asia was pursued to equitably spread land among the population in the form of “garden-sized” plots.

Compared to centralized large-scale plantations, this “garden-sized” approach was superior on two fronts:

1. Put people to work. It solved the post-war issue of mass employment by putting as many people to work as possible.
2. Improved agriculture. Crop yields were higher as more hands were put to use in this labor-intensive sector.

Mass employment and higher crop yield had the trickle-down effect of providing adequate food for the population and increased wealth from the crop surplus.

The surplus supported exports and boosted each country’s balance of trade as Taiwan, Korea and Japan depended less on food imports. 

2. Step #2: Manufacturing Takes Off From a Stable Agricultural Base

Building from agricultural strength, these countries pursued manufacturing more aggressively with chaebols of Korea (eg. Hyundai, Samsung) and zaibatzus of Japan (eg. Sony, Mitsui) leading the way.

While these conglomerates received massive state subsidies and operated in protected industries, both the Korean and Japanese governments set the stage for innovation by fostering in-country competition and export discipline targeting productive sectors (eg. steel, autos).

These conglomerates would be protected as infants but had to eventually make their own way against international competition.

For every Hyundai that succeeded globally, there was a Daewoo (which declared bankruptcy in 1999 with $50B in debt).

3. Step #3: Countries “Pick” Industrial Winners with Financial Reforms

Finally, financial reforms – namely interest rates, capital controls, foreign investment and exchange rate policies – were used to support agriculture and industry.

Whether this meant transferring wealth from households to industry through low interest rates or boosting exports through artificially low exchange rates, financial policies through the 60s, 70s and 80s supported Japanese, Korean and Taiwanese development at the expense of “free markets”.

 By controlling the financing spigot, these governments diverted cash to large projects and heavy industries that required long-term investments in lieu of quarterly earnings.

The efficacy of financial reforms met its limits in each country, though, as the seeds that sowed financial growth also sowed imbalances. 

4. Southeast Asian Countries Did NOT Follow the Playbook

In contrast to the development track that Northeast Asia took, the Southeast Asian nations Studwell follows whiffed at each stage of development.

In the Philippines, which came out of World War II as the second richest nation in Asia, land reform was concentrated towards large-centralized plantations known as haciendas. 

Instead of mass employment and crop surplus for staples such as rice, these haciendas produced cash crops (eg. sugar) that saw money flow into very few hands. This framework set the stage for the orgy of kleptocracy under Ferdinand Marcus which plagues the Philippines to this day. 

In terms of manufacturing, the Southeast Asian nations did not force export discipline onto its entrepreneurs. To take Malaysia as an example, the government did not prioritize investments in heavy industry.

Instead, entrepreneurs such as Lim Goh Tong were able to make his billions from unproductive but high-margin businesses such as real estate and gambling.

While Malaysia ventured into auto making, its lack of export discipline is reflected in the fact that few in the West have ever heard of (let alone ever bought) a Proton – the national carmaker. 

Southeast Asia’s record of financial reform is…shaky to put it lightly. Poor financial policies in the region culminated in the devastating 1997 financial crisis.

While South Korea was badly harmed in the crisis, it was the Southeast countries (Thailand, Indonesia, Philippines, Malaysia) that saw the biggest percentage declines in gross national product (GNP) over the following years.

5. China Has Implemented the First Two Steps…

When Deng Xiaoping became China’s “paramount leader” in 1978, he soon spearheaded land reform that encouraged “garden-sized” agriculture, which stood in stark contrast to the large collectivized agriculture under Mao Zedong.

As in Japan, Korea and Taiwan before, the household farming initiative provided employment and food for the masses.

Surpluses supported a burgeoning countryside market place and laid the groundwork for one of the most rapid periods of industrialization (1978-2008) the world has ever seen. 

In the place of chaebols and zaibatsus, China nurtured massive state-owned enterprises in oligopolistic settings.

The Chinese government has set economic and trade policies to protect its own, including in:

• Banking: Industrial and Commercial Bank of China, Agricultural Bank of China, Bank of China and China Construction Bank
• Oil & Gas: Sinopec, CNOOC, PetroChina
• Network Equipment Huawei, ZTE
• Telecoms: Chinese Mobile, Chinese Telecom

By keeping wages low, interests rates low and foreign exchange low, China orchestrated a massive transfer of wealth from the households into industry, which has driven its export-investment growth machine.

…But is Having Difficulty with the Final Step (Financial Reform)

The first two steps in Asian development – agricultural/land reform and manufacturing reform – have produced clear winners (Northeast Asia) and losers (Southeast Asia).

China has followed in the track of the winners.

It is the third aspect – financial reform – that has tripped up every country.

Clearly, financial reform is only one part of the equation. But with China’s large shadow banking sector and seemingly never-ending credit growth, it is a big part.

Studwell gives kudos to China’s performance over the past three decades but is not ready to crown them champions.

In addition to financial reforms, he adds to the challenges of income inequality, an unfavorable demographic shift, democracy, institutional deficiencies and social unrest born from slowing growth. 

Japan was in practically the same shoes 25 years ago. The island nation’s financial reforms in the 80s, which supported an export-investment directed industry, ultimately lead to a massive asset bubble and crash.

Abenomics and the three arrows for reflation and growth are only the latest effort to turn back the tide that crashed onto Japan two decades ago. 

With Japan as a key proxy, there is no clear blueprint from Asia’s recent economic history to suggest China can manage this situation. Xi Jinping and the new leadership will be under great pressure to show it can.

With the world watching, China should be able to manage the façade through 2014, but cracks are showing. Cracks that could set the country on a downward path in the decade to come.