Introduction: Middle Income Traps and Other Forms of Economic Stagnation

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1 1 Policy Mimicry, Institutional Isomorphism, and Middle Income Traps: Lessons For and From Thailand, Korea and China M Ramesh and M. Howlett National University of Singapore Paper Presented at IPSA Congress, Poznan, July 2016 RUDIMENTARY DRAFT. PLEASE DO NOT CITE. Introduction: Middle Income Traps and Other Forms of Economic Stagnation As Agenor, Canuto and Jelinic (2012) define it, a middle income trap (MIT) refers to a situation in a country whereby there develops a stable, low growth economic equilibria where talent is misallocated and innovation stagnates. (p. 1) 1 Many studies have focused on the phenomena of stagnation. Aiyar et al for example identify several factors that determine economic growth such as institutions, demography, infrastructure, macroeconomic environment, economic structure, trade structure, and other factors. Thus, La Porta, Lopez de Silanes, Shleifer, and Vishny (1997, 1998) have argued that the quality of a country s legal institutions such as legal protection of outside investors could affect the extent of rent seeking by corporate insiders and thereby promote financial development. [1] Another strand of the literature has emphasized the advantage of limited government (Buchanan and Tullock, 1963; North, 1981 and 1990; and DeLong and Shleifer, 1993), [1] while Mauro (1995) finds that corruption lowers investments, thereby retarding economic growth, although Mironov (2005) cautions that this is true of only certain kinds of corruption. Knack and Keefer (1997) have also provided evidence that formal institutions that promote property rights and contract enforcement help build social capital, which in turn is related to better economic performance and growth. [1] It is important to recognize that the MIT is not the only type of stable stagnating equilibria and many low income and also high income countries (Japan, for example) have also developed relatively stable trajectories in which their growth has levelled off or stagnated. And neither is MIT a new phenomenon. There are many countries in Latin America and some in Africa that have been in the middle income bracket for decades [33] Separating what is new about the middle income trap and other kinds of traps and trajectories is therefore important both in terms of understanding whether such traps exist and are unique in any way, and, secondly, how they are to be overcome. This is the purpose of this paper. The available evidence shows that income traps are real but may be overcome with appropriate policy measures. Emulating other countries with successful record in this regard offers considerable scope for improvement for all countries except those already at high level. However, new economic and demographic challenges are emerging for which there is little precedence and call for policy ingenuity. These issues are discussed below in reference to Thailand, South Korea, and China. Issues in Identifying Middle Income Trap In general it is not unusual for a country to become mired at a middle income level. The chart below compares a country s per capita income (relative to United States, adjusted for purchasing power) in 1960 with its income in Only 13 countries are said to have moved into a high income bracket over this half century including Hong Kong, Japan, South Korea, Singapore, and Taiwan. Many other high income countries simply began as wealthy and stayed that way while others began and stayed poor.

2 2 Source: Screenshot from The Economist (2012) The middle income trap, however, refers to more than just the process of attaining a stable but stagnating equilibrium. As Aiyar et al have put it The middle income trap is the phenomenon of rapidly growing economies stagnating at middle income levels 2 and failing to graduate into the ranks of high income countries. 3 [1] That is, a MIT is a specific two stage pattern of development in which some progress in incomes occurred which allowed a country to climb out of low income status but was then followed by failure to continue to climb into the ranks of high income countries. Unlike simply stagnating at some given level, this particular kind of trajectory is a challenge to some orthodox economic thinking which generally assumes that once the appropriate conditions are present to allow a transition from low to medium levels of income and a country has transitioned to middle income status, these same conditions will continue in place or lead to a virtuous path of development towards a high income status. 4 Typically, according to the World Bank, MIT countries have the following characteristics: low investment ratios, slow manufacturing growth, limited industrial diversification, and poor labour market conditions. Eichengreen, Park, and Shin (2012), define a growth slowdown episode as one in which three conditions are satisfied: i) growth in the preceding period is greater than or equal to 3.5 percent per annum; ii) the difference in growth between the current and preceding period is greater than or equal to 2 percentage points per annum, and iii) the country s per capita income exceeds US$ 10,000 in 2005 constant international prices. [1] But the MIT phenomenon raises crucial conceptual, empirical and methodological issues, such as when to determine the start of a trajectory, what should be considered as the defining features of a trap be it GDP growth, environmental deterioration, or stagnant or declining well being, what triggers the trap, and how the trap can be avoided. Several preliminary insights are available in the literature as to why such traps occur. Arthur Lewis, for example, argued as far back as the 1950s that productivity gains in most countries were achieved as labour shifted from low productivity agriculture to more productive manufacturing, a process that could be expedited by appropriate policy measures 5. Following his insight, The migration of labour from agriculture to manufacturing, and

3 3 the corresponding structural transformation of the economy have come to be viewed as the engine of economic development and growth (Harris and Todaro, 1970; Lewis, 1979). [1] While helpful in explaining the initial development situation in many countries, such economistic explanations did not explain why the newly productive industrializing countries would then stagnate. Other work in dependency theory (Wallerstein, Amin et al CITES) 1 blamed unfair terms of trade and protectionism while others (A. G. Frank CITES) 2 blamed neo colonial investment practices and political conditions in many countries favoring large land owners and commericial practices rather than manufacturing. And some transitions in income did occur in countries lin the 1960s and 1970s as world trade and investment opened up and countries engaged in different divisions of labour internationally (CITES ON WTO AND 1970s and 1980s Developments Hellenier et al). 3 However, such explanations do not explain why stagnation would occur once trading conditions equalized and countries were governed by governments seeking productivity and trade enhancement and general improvements in wages and working conditions rather than self enrichment the specific phenomena associated with the middle income trap. Some explanations focus on changes in demographic factors as key variables. Several papers, for example, document a positive impact of the working age ratio on economic growth in a cross section of countries (e.g. Bloom and Williamson, 1998; Bloom and Canning, 2004). Others find that national savings rates are strongly connected to demographic structure (Higgins, 1998; Kelley and Schmidt, 1996). Another approach is to focus on particular countries or regions. Aiyar and Mody (2011) use data on the heterogeneous evolution of the age structure of Indian states to conclude that much of the country s growthh acceleration since the 1980s can be attributed to the demographic transition. Bloom, Canning, and Malaney (2000) and Mason (2001) find that East Asia s economic miracle was associated with a major transition in age structure. Other studies have suggested that demographic variable of interest include the sex ratio, a measure of gender bias. Sen (1992) and others have argued that the phenomenon of missing women reflects the cumulative effect of gender discrimination against all cohorts of females alive today. Gender bias could impact economic growth through higher child mortality, increased fertility rates, and greater malnutrition (Abu Ghaida and Klasens, 2004). In their study of Indian states, Aiyar and Mody (2011) find that a more equal sex ratio is robustly associated with higher economic growth. [1] While it has long been recognized that economic growth does not necessarily lead to equal distribution of income, recent findings increasingly point to evidence that equality supports growth and, conversely, inequality stymies it. This poses new challenges for countries with high and growing inequality which had been harbouring the view, fostered by Kuznetz hypothesis, that inequality will decline when economic development reaches middle income levels. The phenomenon of population ageing as a result of declining birth and increasing life span with rise in income has been recognized since the 1970s. What was less recognized that some countries, particularly in Asia, will turn old before they become rich, posing new development challenges. Aged population imposes additional costs on public finance which may diminish resources available for development if not addressed effectively. It is now increasingly recognized that the level of income inequality is a significant determinant of economic growth. First, large inequalities foster political and social instability as more people engage in activities, such as crime and violent protests, which deter investments. Second, large inequality with credit market imperfection results in under investment in human capital. Finally, countries with high inequality redistribute more, which creates distortions and lowers growth. [35] 6 However, other studies focus on changes in investment activity and especially infrastructure investment. This conveys beneficial externalities to a gamut of productive activities, and in some instances has characteristics of a public good (e.g. a road network might be non rivalrous at least up to some congestion threshold). For this reason, it 1 Amin, S. Accumulation on a World Scale. New York: Monthly Review, 1974; Arrighi, Giovanni. The Long Twentieth Century: Money, Power, and the Origins of Our Times. London; New York: Verso, Frank, A. G. Latin America: Underdevelopment or Revolution. London, 1970; Wallerstein, Immanuel Maurice. World-Systems Analysis: An Introduction. Durham: Duke University Press, Fröbel, Folker, Jürgen Heinrichs, and Otto Kreye. The New International Division of Labour: Structural Unemployment in Industrialised Countries and Industrialisation in Developing Countries. Cambridge; New York; Paris: Cambridge University Press ; Editions de la Maison des Sciences de l Homme, Helleiner, Eric, and Andreas Pickel. Economic Nationalism in a Globalizing World. Ithaca, N.Y.: Cornell University Press, 2005.

4 4 has been uncontroversially viewed as positively related to economic growth, at least up to a point. Nonetheless, a survey by Romp and De Hann (2007) shows that the empirical literature has found mixed results, especially when proxies such as public investment are used to measure infrastructure development. There is also a long tradition of literature pointing to the perils of over investment (Schumpeter, 1912; Minsky, 1986, 1992). For example, Hori (2007) argues that the investment slump after the Asian Financial Crisis of the late 1990s was at least partly due to overinvestment prior to the investment booms have often been associated with excessive borrowing and rapid accumulation of public and/or external debt. Inflation has also been associated with negative growth outcomes (Fischer, 1993), although Bruno and Easterly (1998) and subsequent contributions emphasize that the relationship is ambiguous when inflation is low to moderate. [1] More recent contributions, and studies using more direct measures of infrastructure, have generally found a more positive impact of public capital on growth (Demetriades and Mamuneas, 2000; Roller and Waverman, 2001; Calderon and Serven, 2004; Erget, Kozluk, and Sutherland, 2009). [1] While this work is interesting and suggestive, the orthodox explanation for the MIT is still that the cost advantages in manufactured exports that once drove growth start to decline as unionization and cost of living spurs wage increases in newly industrialized countries in comparison with lower wage countries which then become the new targets for investment and production. Middle income countries are then faced with new challenges, including problems with social cohesion if wealth and poverty effects are not borne equally by all sections of the populace, a large pool of urbanized young people in search of jobs, as well as millions who may still live in misery and poverty, particularly in lagging regions which have not yet transitioned from agricultural pursuits.[14] However this does not explain how some countries have been able to continue or even accelerate their growth trajectory and make the transition to high income status. There is a large literature on the relationship between financial openness and growth (e.g. Grilli and Millesi Feretti, 1195; Quinn, 1997; Edwards, 2001) for example, but there is more going on than just the adjustment of the cost of factors of production given changes in the international division of labour and labour cost adjustments across countries and regions. As X&X have argued We view today s development problem as one of how to accumulate productive capabilities and to be able to express them in 1) a more diversified export basket and; 2) in products that require more capabilities (i.e. more complex). [33] This suggests that a significant part of the MIT story lies in education 7 and human resource capabilities linked to technological change and advanced consumer and production industries and processes. This is at least in part a story about learning and the specific mechanisms such as mimicry and institutional isomorphism which have brought countries into the midddle income ranks but which are not capable of bringing them further into the ranks of the high income nations. The Role of Innovation and Learning in Creating, and Overcoming, the MIT In understanding why one middle income country might succeed while another might fail to transition, it is necessary to remember what MIT is: a stable, low growth economic equilibria where talent is misallocated and innovation stagnates. (Agenor, Canuto and Jelinic s 2012, p. 1) 8 This shifts the analysis away from simple factors of production arguments about the nature and origins of the MIT to those linked to learning and innovation. Searching for the reasons why some countries fail to learn and innovate is a more promising direction to follow than focussing on trade or investment relations and patterns in a more or less open world economic system or upon the demographic aspects of what are more often effects of MIT rather than causes. One way the MIT literature seeks to explain this phenomena, for example, is to argue that middle income is a development stage that characterizes countries that are squeezed between low wage producers and highly skilled and fast moving innovators. Many middle income countries tend to make two common mistakes: either they cling too long to past successful policies, or they exit prematurely from the industries that could have served as the basis for their specialization process (Agénor and Canuto 2012; Aiyar et al. 2013; Eichengreen, Park, and Shin 2013; Felipe 2012; Gill and Kharas 2007; Nungsari and Zeufack 2009; OECD 2007). In this view timing and smooth transitions between industries and specializations are two keys to success. [14]

5 5 This is a powerful explanation, as for instance, it underscores the significance of events such as wars or crises which prevent such transitions from occurring and sometimes result in a lagged or stepped pattern of development (for example Korea after the Korean war, or other countries after years of non innovating dictatorships e.g. Spain, Portugal or Greece). Capital inflows, for example, have classically been regarded as conducive to growth, allowing capital to be allocated to wherever its marginal product is highest, besides facilitating consumption smoothing and diversification of idiosyncratic income risk. But the sudden stops literature pioneered by Calvo (1998) has emphasized that periods of surging capital inflows are sometimes followed by a cessation or even reversal of the flow, with often severe repercussions. Recent evidence from the global financial crisis suggests high domestic spillovers from reliance on cross border banking flows (Cetorelli and Goldberg, 2011; Aiyar, 2011, 2012). This is consistent with the twin crises literature emphasizing that banking crises and sudden stops are often joined at the hip (Kaminsky and Reinhart, 1999; Glick and Hutchinson, 2001). Such shocks, however, may not affect long term growth, they have been found to lower potential output levels permanently, consistent with persistent albeit temporary impact on potential growth (Cerra and Saxena, 2008). Such explanations require refinement if the reasons for growth, and stagnation, in innovative behaviour are to be clearly understood. Here it is useful to look at endogenous growth theory and problems with developing and applying technology in national and regional innovation systems (ADD MANY CITES HERE, such as Soete, Edquist, Nelson, Lunvall, Gibbins etc.). 4 Such theories focus attention in explaining the MIT on understanding why innovation would occur up to one point and then stall. Most endogenous growth theory focuses on the role played by government, industry and university linkages in creating regional, national and trans national innovation systems (NIS) which serve to create, mobilize and utilize knowledge in production processes (CITES ETZKOWITZ). 5 Productivity increases are not expected to simply occur by magic or automatically but crucially depend on the nature, type and effectiveness of the innovation system in place in 4 Clark, N., C. Juma, G. Dosi, C. Freeman, R. Nelson, G. Silverberg, and L. Soete. Evolutionary Theories in Economic Thought. In Technical Change and Economic Theory, London: Pinter, Dosi, G., C. Freeman, R. Nelson, G. Silverberg, and L. Soete. Technical Change and Economic Theory. London: Pinter, The Nature of the Innovative Process. In Technical Change and Economic Theory, London: Pinter, Dosi, G., L. Soete, and J. Niosi. Technological Innovation and International Competitiveness. In Technology and National Competitiveness: Oligopoly, Technological Innovation and International Competition, Montreal: McGill-Queen s Press, Freeman, C., J. Clark, and L. Soete. Unemployment and Technical Innovation: A Study of Long Waves and Economic Development. London: Frances Pinter, Freeman, C., C. Perez, G. Dosi, R. Nelson, G. Silverberg, and L. Soete. Structural Crises of Adjustment: Business Cycles and Investment Behaviour. In Technical Change and Economic Theory, London: Pinter, Lundvall, B., G. Dosi, C. Freeman, R. Nelson, G. Silverberg, and L. Soete. Innovation as an Interactive Rpocess: From User- Producer Interaction to the National System of Innovation. In Technical Change and Economic Theory, London: Pinter, Soete, L. The Impact of Technological Innovation on International Trade Patterns: The Evidence Reconsidered. Research Policy 16 (1987): Nelson, R. R. High Technology Policies: A Five Nation Comparison. Washington: American Enterprise Institute, Neoclassical vs. Evolutionary Theories of Economic Growth: Critique and Prospectus. The Economic Journal, no. December (1974): Nelson, R. R., and S. Winter. An Evolutionary Theory of Economic Change. Cambridge: Harvard University Press, Nelson, R. R., S. G. Winter, and H. L. Schuette. Technical Change in an Evolutionary Model. Institute of Public Policy Studies discussion Paper no. 45, Leydesdorff, L. The Triple Helix: An Evolutionary Model of Innovations. Research Policy 29 (2000): Etzkowitz, H., and L. Leydesdorff. A Sociological Paradigm for Economic Development. In New Developments in Technology Studies: Evolutionary Economics and Chaos Theory. London: Pinter, 1994.

6 6 a jurisdiction and its ability to either create or adapt knowledge towards product and process innovation and enhanced productivity (WOLFE AND GERTLER, Neo Schumpeterian growth theory) 6. Governments can play a critical role in steering or directing such activity or even undertaking relevant R&D on its own or as part of a public private innovation system. 7 AS X&X argued, if we compare the exports of countries in the middle income trap with those of countries that graduated. The results indicate that: 1) countries that made it into the upper middle income group had a more diversified, sophisticated, and non standard export basket at the time they were about to jump than those in the lower middle income trap today; 2) countries that have attained upper middle income status had more opportunities for structural transformation at the time of the transition than countries that are today in the lower middle income trap; 3) countries in the upper middle income trap are less diversified, are exporters of more standard products, and had fewer opportunities for further structural transformation than the countries that made it into the high income group. [33] This focuses attention on how countries learn and utilize knowledge in their production and consumption processes. Not all knowledge has to be produced internally, of course, but can be imported subject to barriers such as copyright protection, patents and other forms of intellectual property rights. These serve as barriers to entry of middle income countries to high income status and several routes exist through which they may be overcome. 1. Developing own knowledge (Germany, USA) 6 Mytelka, Lynn K., Haeli Goertzen, David A. Wolfe, and Matthew Lucas. Learning, Innovation and Cluster Growth: A Study of Two Inherited Organizations in the Niagara Peninsula Wine Cluster. In Clusters in a Cold Climate, Montreal: McGill Queens University Press, Wolfe, David A., Charles Davis, Matthew Lucas, D. Wolfe, and M. Lucas. Global Networks and Local Linkages: An Intoduction. In Global Networks and Local Linkages: The Paradox of Cluster Development in an Open Economy, Montreal: McGill Queens University Press, Wolfe, David A., and Matthew Lucas. Introduction: Clusters in a Cold Climate. In Clusters in a Cold Climate, Montreal: McGill Queens University Press, Niosi, J. Complexity and Path Dependence in Biotechnology Innovation Systems. Industrial and Corporate Change 20, no. 6 (December 1, 2011): doi: /icc/dtr065.. Technology and National Competitiveness: Oligopoly, Technological Innovation and International Competition. Montreal: McGill-Queen s Press, Edquist, C. Systems of Innovation: Technologies, Institutions and Organizations. London: Pinter, Lundvall, B. National Systems of Innovation: Towards a Theory of Inovation and Interactive Learning. London: PinterLundvall, B, Nelson, R. R. National Innovation Systems: A Comparative Analysis. Oxford: Oxford University Press, Nelson, R. R., and N. Rosenberg. Technical Innovation and National Systems. In National Innovation Systems: A Comparative Analysis, Oxford: Oxford University Press, Padmore, Tim, and Hervey Gibson. Modelling Systems of Innovation: II. A Framework for Industrial Cluster Analysis in Regions. Research Policy 26 (1998): Niosi, J., and B. Bellon. The Global Interdependence of National Innovation Systems. Technology in Society 16, no. 2 (1994): Niosi, J., P. Saviotti, B. Bellon, and M. Crow. National Systems of Innovation: In Search of a Workable Concept. Technology in Society 15 (1993):

7 7 2. Buying your way to the top a middle income country which can afford to purchase or attract the latest and best (Singapore?) 3. Adopting older free or less expensive technologies and knowledge and improving upon it 4. Cheating and stealing. These strategies are ordered roughly by cost. Developing your own knowledge is a very expensive and very time consuming project, requiring for example the development and staffing of university systems which can take many generations to flourish. Buying leading edge knowledge means paying premium prices. And cheating and stealing invokes penalties and restrictions which many countries cannot withstand. That leaves no. 3 as the only practical course open to many countries and it is the arguments of this paper that it is this strategy which leaves many countries trapped at the middle income level and unable to make the transition to a higher level. This thesis is explored below in the cases of Thailand, Korea and China, examples of three countries which followed different learning paths. Comparative Economic Performance: Thailand, Korea, China Thailand, South Korea and China (along with Hong Kong, Indonesia, Japan, Malaysia, Singapore, and Taiwan) are the miracle Asian economies of the late nineteenth century. Source: Screenshot from Rajan (2011) Of the countries in the list, it is the four NIEs Hong Kong, Singapore, Taiwan and Thailand that stand out for sustained economic growth over five decades (Japan s growth is less remarkable because it was already a developed economy that had been battered by War). The above graph shows that Indonesia, Malaysia, and Thailand have not fared well since the outbreak of the economic crisis in An important factor explaining the economic miracle was the heavy interventionist role of the government in guiding economic development. While the details varied substantially, most of these governments used a combination of industrial policies throughout their development process; first with import industrialization

8 8 substitution that protected domestic firms and promoted infant industries, and second, export promotion that provided financial incentives to firms that actively sold their products in foreign markets. Thailand s per capita GDP was similar to South Korea s during the 1960s but the latter had pulled far ahead by the 1970s and the difference deepened in the following decade. The difference became particularly pronounced in the 2000s, when Korea emerged from the crisis stronger while Thailand lagged. China s growth was even more spectacular: its per capital income was less than 1/4 th the Thai level in 1980 but had caught up with the latter by Per Capita Economic Growth Rate GDP Per Capita, Current US$ GNI per capita, PPP (current intl. $) China ,350 7,470 9,040 Korea ,340 7,950 17,110 28,650 30,970 Thailand ,070 2,850 4,880 8,410 9,280 High income 8,512 16,302 24,463 35,647 38,325 Middle income 1,039 1,820 3,017 6,278 7,172 Low income ,231 1,375 Source: World Development Indicators Korea s vastly superior performance is further confirmed by growth rates measured in terms of per capita in constant $, as shown in the following graph. Thailand, on the other hand, grew at rate about average for the middle income group. 30,010 GNI per capita, PPP (constant ), Constant 2005 Intl $ 25,010 20,010 15,010 10,010 5,010, China Korea Middle income Thailand Source: World Bank Development Indicators The following graph confirms that while many Asian have grown rapidly in recent decades, the rate was exceptional in the case of China, which took about 10 years to raise its per capita GDP from PPP$3,000 to PPP$8,000, while the same took Taiwan and Korea about twice as much. It entered the 1980s well behind Thailand but its per capita income surpassed its southern neighbour within three decades.

9 9 Source: Screenshot from Aiyar et al (2013) The following graph on expenditures on research and development is revealing in that offers insights into the different levels of resources being devoted to technological advancement. South Korea is now the fourth largest spender on R&D, a remarkable achievement for a country that was known for imitation products only a few decades ago. China s performance is no less remarkable, having more than tripled the share of GDP (which itself grew at a dizzying rate) it devotes to R&D and now ranks 24 th in the world. Thailand s performance is middling, ranking 68 th among all the countries in the world. R&D Expenditures, % of GDP 2009 Rank Israel Finland Sweden Korea Japan Denmark United States European Union China Middle income Thailand Source: World Bank Development Indicators. China s education indicators at the primary and secondary levels are superior to middle income countries counterparts but are below the levels of developed countries. However, China is a diverse country with vast areas for sub par performance which is not captured in this nation wide data. The different levels of preparation for the modern economy is evident in these countries education performance as well. Thus, public spending on education as percentage of GDP is 5 percentin Korea, 4 percent in China and 3.8 in Thailand. While Korea s public spending is lower than the average for High Income countries, its total (public and private) education expenditure of 8.0 of GDP is higher than the OECD average of 6.2 percent.

10 10 %20Country%20note%20 %20Korea.pdf In terms of enrolment, however, both China and Thailand fare poorly at secondary and tertiary levels. Korea, on the other hand, is a league of its own, with universal enrolment. Education Statistics, % Public spending on education, total (% of GDP) School enrolment, primary (% gross)thus School enrolment, secondary (% gross) School enrolment, tertiary (% gross) China * High income Korea Middle income Thailand China High income Korea Middle income Thailand China High income Korea Middle income Thailand China High income Korea Middle income Thailand Source: World Bank Development Indicators * /08/c_ htm If income distribution affects economic performance at higher levels of development, then China and Thailand have a difficult challenge facing them. China has climbed from being a reasonably equal country in the 1990s to one highly unequal within a decade. Thailand currently has one of the most unequal distribution of income in the world and the trends indicate further deterioration. Korea, on the other hand, is rather equal, though its gini of 31 is considerably higher than the world leader Sweden at 31. Gini Index late 1990s late 2000s Recent Equality rank (out of 139) Sweden Korea China Thailand worldfactbook/rankorder/2172rank.html

11 11 Thailand: The Failure to Move Beyond Isomorphism and Emulation Thailand entered the modern age following the overthrow of monarchy in The new government, led by the People s Party, sought to distinguish itself from the ancien regime by appealing to economic nationalism. Criticizing the monarchy for giving away the country to foreigners, the new government started to assert control over the economy by requiring businesses to register and to use the Siamese language in their signboards and accounts (Coughlin, 1952). [3; 93] In 1938, Phibun Songkram, who was heavily influenced by the German and Japanese modernization models, took over the reins of power and aggressively launched the Thai ification campaign. By the end of the 1940s, the newly created Ministry of Industry had taken over the textile and paper factories, previously run by the military, while other agencies began to operate sugar mills, tobacco factories, and distilleries. By the mid 1950s, the government had launched 100 manufacturing firms, producing glass, chemicals, cement, iron and steel, and other products (Ingram, 1971; Hewison, 1989). [3; 93] Domestic banks also grew during this period under heavy government protection. By the end of the 1950s, Thailand s industrialization strategy began to change for several reasons. After grabbing power from Phibun in 1957 and imposing dictatorial rule, Sarit was casting around for a new development model that would distinguish his government from its predecessor. Towards this end, the newly installed Revolutionary Party guaranteed the private sector freedom from government competition and expropriation. It also prohibited government guarantees for private sector loans, as was the practice under Phibun. [3; 95] The Sarit government ushered in a new era of emulation and isomorphism of development policies and institutions that had worked elsewhere and were being pursued in other countries at the time, notably the NIEs. The new government pursued an explicit strategy of supporting export led industrialization. It passed the Promotion of Investment Act of 1960 and Promotion of Industrial Investment Act of 1962, which expanded fiscal incentives for manufacturing activities while retaining the import bans and surcharges on competing imports (Atchaka 1986; 12). [3; 96] The new set of industrial development policies also reflected the Sarit s regime s more open attitude toward foreign investments. To attract foreign investors, it enacted policies such as guarantees against nationalization, the repeal of the 1956 Labour Act, and the imposition of a ban on strikes and union organizing. [3; 96] The economy in the 1960s grew quite rapidly. The share of value added in manufacturing rose from 10 percent in 1951 to 15 percent in 1968, with the largest increase coming from food processing and rice milling. Agriculture, still the biggest industry at that time, added new exports such as maize and cassava, while consumer goods industries were led by beverages, tobacco, textiles, and apparel. Morever, the structure of imports also began to shift away from consumer durables (food, beverage, tobacco) and towards intermediate and capital manufacturing inputs. Calculating the impact of ISI based on the product s degree of dependence on imported inputs, one study found that ISI took place in almost all durable and non durable consumer goods industries, especially in footwear, leather products, textile goods, and wearing apparel manufacturing (Narongchai, 1975; 261). [3; 97] Studies (Atchaka, 1986; Samart 1989; Mounier et al. 994) point to the early 1970s as the start of exportoriented industrialization. Nevertheless, export expansion began long before the Thai government made it its main development thrust. From 1960 to 1972, manufactured exports increased five times, with processed food, beverages, sugar, textile goods, cement, and basic industrial chemical among the growth industries (Narongchai, 1975; 264). What demarcated this earlier period from 1972 and beyond was the shift in the direction of Board of Investment (BOI) promotional activities toward export manufacturing activities and the development of more liberal incentives for domestic and foreign investors. [3; 97] In the fifth 5 year plan introduced in 1983, the government specially emphasized FDI and allowed export companies to be fully owned by foreign investors. The Industrial Estate Authority of Thailand constructed industrial estates and the first EPZ was established at Bangchan near Bangkok in The Lab Krabang Industrial Estate was completed in 1979 as an EPZ and was filled up by In addition, the government divided the country into three regions and encouraged investment in specific areas. [8] From 1987, Thailand began achieving high economic growth rates of 9.5 percent, 13.3 percent, 12.3 percent, and 11.6 percent respectively. However, the high rates of economic growth exposed various problems in the Thai

12 12 economy, including infrastructure deficiencies, human resource shortages, an income gap between urban and rural villages and the need to promote small businesses. [8] The steady economic growth of the past two decades came to an abrupt halt in June 1997 with the outbreak of the Baht crisis that rapidly engulfed the entire region. GDP shrunk by 10 percent while unemployment tripled, causing widespread economic and social hardship. While economic growth recovered in the following years, it never recovered to the levels experienced in the early 1990s. Two main economic hypotheses explaining the crisis emerged in the aftermath of the Financial Crisis. According to one view, sudden shifts in market expectations and overconfidence were the key sources of the financial turmoil. [9] According to the other view, the crisis reflected structural and policy distortions in the countries of the region. Fundamental imbalances triggered the crisis in 1997, even if, once the crisis started, market overreaction and herding caused the plunge of exchange rates, asset prices, and economic activity to be more severe than warranted by the initial weak economic conditions. [9] Regardless of the actual causes that triggered the 1997 crisis, recent commentators have pointed to politicaleconomic reasons for explaining the sluggish growth rate in the fifteen years following the crisis. The strength of political institutions and stability of the government are key conditions for rising above middle income level. In the case of Thailand, political turmoil has robbed the country of policy direction and stable conditions necessary for economic growth. The massive election victory of Thaksin in 2001 and again in 2005 briefly suggested a new era of stable politics in Thailand. But it did not last, following military coup in 2006 and internecine political conflicts since. All this means that state driven investments and economic overhauls have become more important for Thailand s ability to shore up growth and preserve its competitive edge. Plans to roll out anti flooding projects and spend 2 trillion baht on high speed rail lines and other infrastructure projects were approved by Parliament last year but the political standoff means that there will be long delays. [19] NEED TO LINK THIS TO LEARNING BY EMULATION AND ITS LIMITS South Korea: The Transitions to a High Level NIS After a decade of turmoil and policy drift during the 1950s, Korea embarked on a determined export led development during the 1960s. The strategy used a combination of tariffs and import quotas to protect infant industries and export subsidies, preferential loans, tariff reductions on product inputs, low exchange rates, and export processing zones to support domestic industries grow, then become competitive on the global market. [5] The government sought to reduce anti export bias not via import liberalization (the orthodoxy) but through selective subsidizations of exports. [6] It was influenced by Japan s growth strategy of state led economic development. Included: 1) Economic Planning Board, which created 5 year plans; 2) Nationalized commercial banks; 3) Bank of Korea placed under the control of the Ministry of Finance; [6] There was also heavy investments in infrastructure road, rail, ports, and power generation; [6] The government followed a careful sequencing of development policies: First 5 year plan ( ) placed priority on simple consumer exports Second 5 yer plan ( ) consumer exports and replacement of intermediate goods imports with domestic goods Third ( ) industrialization centred on heavy and chemical industries Fourth ( ) development of knowledge and information intensive industries [8] The ROK economy boomed through much of 1960s and 1970s but experienced negative growth in The downturn came as a result of a combination of events, including political turmoil after the assassination of former President Park, the second oil shock of 1979, a bad rice harvest and rising foreign debt due to overdependence on

13 13 foreign loans. To improve the current account balance, the government implemented measures to cool down excessive consumption resulting in a relatively low average annual growth rate of 8.4 percent in the 1980s. [8] In the next period ( ), the ROK enjoyed an economic boom due to the three lows : a low won, low oil prices, and low international interests rates. The depreciated won strengthened the competitiveness of exports and the fall of crude oil prices sharply reduced the cost of imports. In addition, low international interest rates reduced the burden of interest payments on foreign debt, which stood at $48.8 billion at the end of 1985 (see Okuda, 1993). The external current account balance jumped from a $900 million deficit in 1985 to a $14.1 billion surplus in 1988 and the economy averaged annual growth of more than 12 percent. [8] A major characteristic of the ROK s industrial policy was that there was little foreign investment, in part because several domestic business groups (Chaebols) were providing the necessary entrepreneurship, while the country used foreign loans to fund industrial development. Korean firms licenced and emulated foreign technology rather than invite FDI. [8] Although the ROK economy grew under heavy intervention and regulation, deregulation has driven the policy discourse since 1993 (see Ishizaki, 1994). However, in view of the economy s overdependence on a group centred structure, the administration of President Kim Ybung sam judged that if deregulation were implemented under existing conditions, chaebol domination would strengthen and other companies would be put at greater disadvantage. So the administration devised a plan to open up corporate stock ownership wider and spread out ownership of the Chaebols, as well as to limit inheritance and gift giving, to mitigate corporations dependency on borrowing, to limit mutual financial guarantees and to limit investment in affiliated companies (Mizuno, 1993). [8] South Korea has gone some way to dismantle the developmental state. This dismantling began in the late 1980s, with the democratization and the discrediting of military rule and by the same token, discrediting of bureaucratic rule. Many Korean economists and public officials converted to neoliberal thinking. In fact even Chaebols became champions of liberalization, as by the late 1980s they had reached the point of organizational and technological sophistication where they saw the state as more of an obstacle than a help. [7] Similar to Thailand, Korea was hit hard by the 1997 economic crisis. Deep economic and social policy reforms were undertaken in the aftermath of the crisis. By 2001 the economy was back on track and there was a spectacular growth in the following years, interrupted only by the Global Financial crisis of Only nine countries with a population of more than 10 million have successfully overcome the middleincome trap and realized a per capita income of $40,000: the United States, Japan, Australia, the Netherlands, Belgium, France, Canada, Germany and Sweden. Italy, Spain and Greece are other countries that remain stuck in the middle income trap. Their growth rate fell after they realized the $30,000 per capita income threshold because of many factors, including a weak manufacturing base; bad fiscal health; higher imports than exports; and a birth rate and transparency index below the OECD average. [To succeed, Korea] needs to improve its service sector productivity, which is less than half of manufacturing productivity, according to the OECD. It also needs to raise the birth rate to at least 1.8. The country should also increase transparency in doing business. Finally, it needs to increase the current employment to population ratio the proportion of the working age population that is employed from 64 percent to greater than 70 percent. Hiking growth potential is also necessary. [29] China: Alternative Practices in NIS Development In 1978, China was one of the poorest countries in the world. The real per capita GDP in China was only one fortieth of the US level and one tenth the Brazilian level. Since then, China s real per capita GDP has grown at an average rate exceeding 8 percent per year. As a result, China s real per capital GDP is now almost one fifth the US level and at the same level as Brazil. [32] The average growth rate of real per capita GDP was a modest 3 percent a year before 1978 and an average of over 8 percent in following decades [32] Deep economic trends suggest that China s income will continue to rise in the near and medium future.

14 14 After the People s Republic of China was established, the CCP government thought the most effective way to speed up industrialization was by increasing investment in heavy industries such as steel, concrete, and heavy machinery. China s government mobilized the resources for investment by limiting household consumption and setting low prices for agricultural goods so that forced savings and surpluses extracted from the agricultural sector could be sued for investments in such industries. [32] This strategy of extensive growth based so heavily on capital accumulation was not sustainable and had grave welfare consequences. The big push towards industrialization during the Great Leap Forward ( ) not only failed to raise the GDP growth rate, it also had such a disruptive effect on agricultural production that a severe famine occurred when China was hit by adverse weather shocks in 1959 (Li and Yang 2005). [32] When the Cultural Revolution ended after the death of the Communist Party chairman Mao Zedong in 1976, the Chinese government under the leadership of Deng Xiaoping sought to increase its legitimacy by improving aggregate economic performance and raising living standards. In December 1978, the government decided on a general policy of Gaige Kaifang, or reform and opening up. [32] There were two important reforms. First, the government increased prices for agricultural goods. Second, the previous collective farming system was shifted to the household responsibility system. Under the new system, each farm household was assigned a fixed quota of grains that the household had to sell to the government at official prices. However, any extra grain the household produced could be sold at market prices. [32] As a result, total factor productivity in the agricultural sector grew by 5.62 percent per year between 1978 and 1984 and China s agricultural output increased by 47 percent during this period. The increase in food availability alleviated China s subsistence food constraint and started a structural transformation that reallocated a large amount of labor from agriculture to industry. From 1978 to 1984, agriculture s share of total employment fell from 69 percent to 50 percent: that is, in just six years, 19 percent of China s labor force more than 49 million workers reallocated out of the agricultural sector. [32] In the early 1980s, encouraged by the successes of the rural reforms, the Chinese government started two market reforms in the non agricultural sector. First, a dual track system was introduced. State owned enterprises were still given quotas on both production inputs and output that transacted at official prices, but they were also allowed to buy inputs and sell output beyond quotas as market prices. Second, the central government also devolved economic decision making powers to lower level governments and provided them with fiscal incentives. Starting in 1980, a fiscal contracting system was implemented that effectively made local governments the residual claimants of the enterprises under their control. [32] Under these reforms, the township and village enterprises based on the old rural collective flourished and led the way to an expansion of the non state sector. The number of township and village enterprises increase from 1,520,000 in 1978 to 18,880,000 in 1988 (NSB China 1999). The reforms did less for state owned enterprises. Local governments at county level and above south to improve the economic performance of the state owned enterprises under their control by implementing a managerial responsibility system that linked managers and workers income to financial outcomes of the enterprises. The reforms did have some positive effect on productivity. Li (1997) estimates that their TFP on average grew at 4.68 percent per year between 1980 and 1989, and that most of the productivity growth could be attributed to stronger incentives, increased market competition, and better allocation of production inputs. [32] The reform without losers strategy (letting the non state sector grow without downsizing the state sector) posed tradeoffs. In the absence of hard budget constraints and market discipline, the state owned enterprises continued to be outperformed by the non state sector. Between 1988 and 1998, the average annual growth rate of TFP in the state sector was only 0.27 percent, while the comparable growth rate of the non state sector was 2.17 percent. Faced with increasing competition from the more efficient non state firms and without significant productivity growth, the financial condition of the state owned firms deteriorated. By 1994, it had become clear that the strategy of reform without losers could no longer be sustained. In 1995, the Chinese government reduced its commitment to stable employment in the state sector. Many small scale state owned enterprises were allowed to go bankrupt or be privatized through management buyouts. [32]

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