East Asian Growth - Case Study Example

East Asian Growth Introduction Paul Krugman's (2000) study on the economy starts with the study on the Russian economic growth and the later incidents that led to the increase in the growth of East Asia and the Asian Tigers. The East Asian countries showed remarkable growth rates to catch up with the western nations that are far ahead, only to come down on their growth rate before slowly climbing back again to meet a steady state growth rate. The data related to tracing this performance of the Asian nations is analysed. The performance of these countries seem to be closer to the Solow's (1956) model for steady state economic growth derived and based out of Cobb-Douglas Production function. In this paper, we discuss the growth rate that was seen in the East Asian countries and the causes for this economic growth and compare that with the Russian as well as the current growth in the Asian Region. We will also look at the slow down of the Japanese and the Russian economy. The growth in the East Asian economy has peaked after reaching specific levels; the reasoning behind this will be analysed and the oscillation of growth about this peak before settling down to a standard and uniform growth rate is suggested. While the countries try to reach the required GDP for a developed nation at the earliest, they also would like to take the shortest possible route to this rapid growth. Three basic factors have been identified by economists that influence economic growth. These are the capital, labour and the technological progress. Factors that influence Growth Capital Capital infusion has been a major contributor to growth in industry and the overall economic growth of the country or society. This has happened in Europe during the industrial revolution as well as in US when it switched gears with massive investments to surpass the European nations in the first fifty years of the twentieth century. The capital investment that the countries could mobilise will become a necessity in the early stages of economic growth particularly, when the country is trying to reach the performance levels of the other developed countries. This is not a period of innovation but a period of emulating the other's efficiencies. This is necessary to ensure that the country does not lag behind the other too much. Influence of capital is very well known in the economic growth of a country. This has been repeatedly proved by the Russians and by the Japanese and now by the Chinese. The Chinese tourism industry has taken in foreign investments and capital to such an extent that today China is in the top five tourist destinations in the world. This has been made possible mostly by the capital investments that have been pumped into the country both by Chinese entrepreneurs as well as by foreign direct investors. Similarly, capital investments from the US played a very important role in the initial growth in Japan. This was repeated in Singapore and in other Eastern economies as much as with the Russian and Eastern bloc countries in Europe. There was a large capital inflow into these countries which spearheaded the growth in these countries. This is in line with both Paul Krugman's view as well as that of the classical economists advocating Solow Model. In line with the model, the countries in the East Asia displayed rapid and more than normal growth in their economic structure due to the sudden influx of capital. Labour Labour is the other major contributor to production. Production or output per worker is enhanced by capital. But production itself is brought in by labour in association with capital. Labour has the role of increasing the production using the invested capital. This has happened in Russia as pointed out by Paul Krugman when large scale movement of labour was carried out from the villages to the production centres. This resulted in a massive growth rate that was misconstrued by the media as a continuing phenomenon. Labour would increase the production directly. However, unskilled or labour that does not maximise production systems and employ efficient methods would result in lower production rates in due course of time. The formula of more the merrier does not apply here. Large scale increase in labour and capital has been displayed by the East Asian countries as well, viz., China, Singapore, Japan and Taiwan. Every one of them had an equal amount of capital also getting pumped in by foreign investors primarily from West. This ensured a combination that could bring about roaring changes in the economic growth. The increase in labour has happened not only in the number of people available for the job but also an increase in their skill levels from secondary graders to PhDs. Larger increase in the skill level has resulted in stupendous growth. This was made possible by either allowing migrant settlers who are technically qualified into the country and by increasing the educational institutions in the country. The East Asian countries continued to educate their people from non-value adding labourers to value adding skilled workers which could turn the country's limited resources into assets that could be exported out. The Government acted as a catalyst in the change by augmenting educational institutions and appropriate support to provide education to the existing citizens of the country. This improved the working class in these countries and production increased. Many of these countries were also having a service oriented structure which ensured that it was not just the materials that were getting exported but also the services rendered by their companies and businesses. This is valid in the case of Hong Kong and Singapore. Though the nature of electronic industry growth in Japan and South Korea, later also in China, are all attributed to the availability of cheap labour in that country. Paul Krugman and other economists argue that this availability of cheap labour is not something that would exist forever. As the businesses integrate across the globe, the 'cheap'-ness of the labour force will vanish as the companies would vie to meet the salary levels resulting in rising salaries and therefore increases the cost of the labour. The competitiveness of these countries will be lost once this cheap labour ceases to exist. This will form the peaking of the labour in that specific country. They need to have clear foundations in manufacturing and supporting markets to sustain themselves beyond this period. Improving on labour supply could also result from value addition to the labour force which is done over a period of time. Labour supply is related to population increase as well. It should be noted that the Production per worker is inversely proportional to the population. The effect of a population increase in the short term will result in a declining production per worker whereas over a longer period it would result in an increased production per worker. This is possibly the reason why we find the countries in the northern Europe promote larger families since a declining population over a longer run could cause a fall in their production levels. It is a balance that the country has to realise between the growth in population and the existing production capability. This is very much important for the East Asian countries. They find a rapid growth happening because of the large population intensity that they have already. This is very true of all the Asian Tigers. Japan had and continues to have, one of the highest population intensities in the world. China and India have high population densities and they are growing still (PRB, 2006). Though China has slowed down on this front, the growth rate in India will push it to become the largest populated country before the end of this century. However, labour is a restricted resource and would reach a peak in due course limiting the chances to grow further on. Innovations Technology is another major contributor to the growth in production output. The Cobb-Douglas Production function connects all these parameters into one empirical formula. Output Y=AKL Where A is the technology component of the production output, K is the capital input and L is the labour. The and are constants again related to technological growth of the country. The three parameters in the equation are decided by the technological progress the country achieves. While A is directly related to the technology growth and is a measure of the technology growth, alpha and beta are the measures by which the available capital and the labour is utilised by employing appropriate technology. In other words, as Paul Krugman refers, this can be visualised as the efficiency of production. Efficiency of usage of labour and the efficiency of usage of capital both contribute to the production output of the country. This in turn would contribute to the growth rate of the country. Industrial development saw the major change in the world trade balances over the eighteenth and nineteenth centuries moving it away from the Asian countries to the Western nations. This was made possible only because of the massive industrialisation that happened resulting in economic superiority. Under many conditions this superiority has gone hand in hand with political domination obtained, again out of innovation and technological advancement. Continuing growth in technology and innovation will open new territories to master which would help the countries realise GDP growth. Most of the countries in the west that have a sustained growth rate, viz., UK and US, have a continuing and ongoing plans to encourage new ideas and entrepreneurship that would take them further heights. Innovation and technological advances made by the people in the country would ensure that the companies thrive and therefore the countries continue to grow. Solow Model talks about the technology advances and the way they influence the growth in the country. But the changes in Japan for instance, does not forbear any proof to this statement. Japan had a host of inventions and cutting edge technology products that were invented right in Japan. For example, the Sony Company, brought in the walkman, Epson the specialist printers and many more firsts to the credit of Japan, including bullet trains and the innumerable cars. But all this, could not stop Japan from recession nor take them to further growth. Japan not only invented new products; they also brought in new methodologies for efficient operation in factories, viz., the Just In Time management, 5S, Deming Awards and many others which have been replicated and used by the western corporate bodies as well. Japan's debacle is a clear example that innovation is a key factor for sustained growth; but innovation or technological advances alone do not guarantee growth, unlike what is propounded by Paul Krugman (2000). Solow Model The Solow neo classical model of the growth of nations has been defined using the Cobb-Douglas Production form to explain the relationship between the factors that affect the growth of the nations. While the model is directly dependent on the factors like capital and labour, technology takes the form of increase in efficiency of operation and usage of capital and labour. It is also important that variations in capital could occur in a limited context to the variations in the savings in the country. From the Cobb Douglas form, we can derive the per capita production and capital intensity. Output Y=AKL Cobb Douglas form Dividing both the sides by L, the labour available in the country, we get the per capita output and the per capita capital established on the capital intensity. y = AK .. per capital production form Applying the differential and logarithms to the Cobb-Douglas form of the model, it is found that the growth rate of output per worker is a function of the technological progress and capital deepening which happens when there is an increase in capital resulting from savings in the country (Karl Whelan, 2005). When we apply this model to the eastern economies, we find that the countries have been largely funded by foreign investments. Foreign investment China has exceeded USD 270 billion dollars in 2004-05 (UNCTAD, 2005). In Malaysia, it was USD 50 billion dollars. All this mean that it was not a savings driven economy but driven by investors elsewhere. Secondly, the model also assumes a condition where the market for the products produced by the factory caters to the internal requirements of the country which is not true in most of the east Asian economies. All the Asian Tigers had an export driven economy that saw the doom during the Asian crisis of 1998. In case of Singapore, the country adapted to the change in the world trade by moving out of export oriented business to an industry centred one, by promoting a number of industries in the country. It resulted in large employment generation, utilising the skills available in the country and in roping in people from other neighbouring states to augment and sustain growth. But still the strength of the nation will lie with internal consumption and marketability within. This might not be possible for smaller nations. On closer look, we find that the East Asian economies are not clear fit to the Solow model though of course, the principles of the model may be applied on this region to identify the changes and to decipher information out of it. They do display the tendency to move towards the developed nations in terms of economical growth. But their thrust results in rapid growth followed by the peaking of GDP which seems to slide down subsequently towards the steady state. Growth and its limitations Peaking of Capital Capital investment in a country which is under a closed environment is limited to the savings in the country. Assuming that the country does not have foreign investments into it, then the Capital available for usage is limited to the savings s. sY = Y - C Where Y is the capital available and the C is the cost incurred. These results in savings and the change in capital or increase in capital will be figure by which the production will also increase. The increase in capital can be looked at as the rate of change of savings in the country or the rate of growth of savings in the country would result in the growth of capital which in turn would increase the production output. A saving s of the output Y is saved every period under consideration. The rate of rise of capital will depend on the rate at which savings will increase in the country. Over a period of time, it is quite possible that the increase in capital or savings stabilises around specific values and more or less uniform savings is obtained. This will be realised if we assume that the savings itself is a function of the requirements and the purchasing power or the salaries of the people. Assuming that this displays a stable growth rate which is quite possible, there can be relatively much stable savings growth resulting from the steady growth in individual income. In cases were the country is dependent on the foreign investment, the investor interest is retained as long as there is a favourable monetary policy in the country. Due to this reason, the governments of these countries ensured that their currency is adequately under valued so that investors get a better return for their investments. This brought in more investors into the country. This has happened repeatedly with the Chinese Yuan when it was deliberately devalued to ensure profitable balance of trade for its internal businesses who are exporting and for foreign investors. Moreover, these economies try to create a protected environment for their businesses in their country without opening up free trade with partner countries. Such investor 'friendly' climates can not exist for too long. This would at one point of time, create a sealing in the capital generated and might eventually depend on savings from the internal population rather than on the funding overseas. The final and steady state rate of capital growth will be proportional to the rate of growth of the savings in the country. Peaking of Labour The availability of labour is certainly a limited resource, limited only by the population of the country. Though the countries like China or India, might have large populations which might show a larger growth rate when labour intensive jobs are brought into the country, would start slowing down once the labour growth rate peaks. There has always been a large question mark over the increase in the labour force in these countries. It is not possible for the labour force to increase exponentially or even linearly. There is a limit to the number of people the country could hold and over a period of time, there is a always a possibility that the country will not be able to sustain the same large growth rate in the labour force that was originally feasible. This peaking of the labour force would eventually force the countries to realise growth through other methods and not use the basic growth parameters like capital and / or labour. This has happened in the case of Japan when the rate of growth dropped seriously once the level of the skilled labourers and the pay packets started matching those in the west. Taking a closer look at the Cobb-Douglas form of the Production Function, we could see that the labour growth is a deciding parameter in calculating the overall production output of the country. If the rate of labour growth in the given period is n, then this may be taken as the parameter that influences the rate of growth of the production output. Though this has a direct contribution to the production output, it is naturally inversely proportional to the per person rate of growth. Peaking of Growth In line with the Solow Model, if the technological growth rate during similar period is taken as g, then these parameters would impact the rate of growth of the production output which would be an indirect measure of the GDP. In line with the Solow model, the growth itself tries to reach a steady state under specific assumptions of local trading and negligible or no governmental controls. However, in many of the East Asian countries, Government has acted as a catalyst to promote trade and industry in an attempt to catch up with the rest of the developed nations. The behaviour of the East Asian countries is more in line with the Solow model where the poorer countries tend to catch up with the rich. However, in line with the reasons explained earlier controlled by the capital availability and that of the labour in the country the growth is controlled or Solow's model is selectively applied. The conditional convergence concept much more closely explained by Mankiw, et al., (1992), describes the impact of the governmental policies, international trade and labour related parameters that modify the Solow model in its performance. This was further explained by Kieran McQuinn and Karl Whelan (Mar 2006), to take care of the changes that are wrought by the effects of foreign investments and external parameters that are not affecting all the countries. It also highlighted the effect of the service industry in the model. With the contribution of the service industry growing at a phenomenal pace in the GDP of every country, there has been change in the way the economic indicators are monitored. The dot com era introduced a new set of economic pointers that were not relevant for others. Service industries in developed countries contribute to nearly 70% of the GDP (Council for Science and Technology, Oct 2003). It has been happening the same way in the East Asian countries as well. The strong rise in the service industry contribution makes the capital investment needs a secondary priority while the need for a skilled labour becomes the most important factor. The model gets affected by this turn of industry to that extent. Econometric analysis of progress in Singapore and the other East Asian Tigers show that they do not match the Solow residual proportions in contrast to the swift rise in the output per worker. The per capita productivity has not been rising in line with the rise in the output per worker. They have very low Solow Residual. This implies that the countries capital stock growth was neither contributing to the changes that were witnessed in them. However, there are also the possibility that convergence was affected by the service sector growth which showed remarkable upswing in many of these countries. Hong Kong showed a large banking sector growth coupled with growth in trading services which catapulted the nation to large GDP growth. In line with Solow's model, the growth reaches a peak. The dynamics of growth might be not totally related to the proposals of the model. But the rapid growth as in the case of Russia and later in the case of Japan has led for a slackening / recession. This recession has been harder if it was not fully visualised and planned as the Perestroika chief experienced. On the contrary, in case of Singapore the shock became a mild tremor when the growth instead to skidding to a halt became a gradual slow down. South Korea and Taiwan had it hard whereas Singapore and Hong Kong felt the same impact in a milder way and they could recover faster. The other upcoming East Asian markets need to be looked under a different perspective. The Chinese and the Indian economies are more stable because they adopt and follow the Western methods in building their economies more relative to the local market rather than fully depending on the export market. Conclusion The East Asian nations during the post-war period have been vying to prosper with the Western nations and in their quest for rapid growth moves towards the methodologies that are proven methods for growth. They enhanced their capital investment and improved upon their existing and borrowed labour to ensure that the country was on the course for a rapid economic progress. In this venture, these countries have ignored that economies that have a export based economy and those that are only on the capital and on the labour addition without improving upon their efficiencies and on technological excellence will find themselves on a down swing sooner or later. This has been proved with the Asian Tigers and earlier with the Russian and east European economies. However, it should also be noted that rapid progress by itself is not anti to the country's progress. Countries planning for rapid industrialisation need to augment their capital and labour reserves at a fast pace and try to emulate the western nations to the extent possible. These countries need to adopt modified practices as in the case of Singapore when the countries reach their peak in growth and start slowing down. These phases need to be carefully administered by the government and the agencies in charge to ensure that the transition from the large growth sector to the steady state growth is smooth and the shock of the transition is not felt excessively causing slides as in the case of the Japan and South Korea. A detailed study of the economic growth and slow down of Japan and such countries offer greater insight that would help in planning the strategies to adopt during such a recession if it occurs. In case of East Asian countries, the development though was fast is not something that can be rejected as a shot in the air. But it is something that is a precursor to the future growth which would eventually happen. For equality among all the people and countries is the steady state for the world peace as well. References 1. Cobb C W and Douglas P H, 1928, A Theory of Production, American Economic Review, 18 (Supplement), 139-165. 2. Council for Science and Technology, Oct 2003, Links between Knowledge Intensive Services and the Science Base, available at: http://www.cst.gov.uk/cst/reports/files/knowledge-intensive-services/services-report.doc 3. Karl Whelan, 2005, The Solow Model of Economic Growth, EC4010 Notes available at http://www.tcd.ie/Economics/staff/whelanka/topic1.pdf 4. Mankiw, N. Gregory, David Romer, and David Weil, 1992, A Contribution to the Empirics of Economic Growth," Quarterly Journal of Economics, 107, 407-437. 5. Paul Krugman, 2000, The Myth of Asia's Miracle, MIT Press, available at: http://web.mit.edu/krugman/www/myth.html 6. Peter Stearns, Fall 2000, The Industrial Revolution: A teaching Challenge, OAH Magazine of History, ISSN: 0882-228X 7. PRB, 2006, Population Reference Bureau Publications, available at: http://www.prb.org 8. Solow, Robert, 1956, A Contribution to the Theory of Economic Growth, Quarterly Journal of Economics, 70, 65-94. 9. UNCTAD, 2005, Foreign Direct Investments Statistical Table, available at: http://stats.unctad.org/Handbook/TableViewer/tableView.aspxReportId=142 Read More