How the East Grew Rich

China Development Bank Financial Research Centre How the East Grew Rich by Lawrence J. Lau Working Paper No. 11 December 213 Institute of Global Economics and Finance The Chinese University of Hong Kong 13/F, Cheng Yu Tung Building, 12 Chak Cheung Street, Shatin, Hong Kong

How the East Grew Rich Lawrence J. Lau * December 213 1. Introduction East Asian economic growth has been led by the industrialization of Japan in the immediate post-world War II period, followed successively by Hong Kong, Taiwan and Singapore in the late 195s and early s; South Korea in the early s; and then Malaysia, Thailand and Indonesia; and then mainland China in the early s. Industrialization has also spread to Vietnam, Cambodia, Laos and even Myanmar since then. The centre of gravity of the world economy has been, and still is, in the process of gradually shifting from the United States and Europe towards East and South Asia. Within East Asia itself, the economic centre of gravity has also been shifting gradually from Japan towards China, which overtook Japan to become the second largest economy in the world in. East Asia is now home to both the second and third largest economies in the world. East Asian economic development has essentially followed the dual economy model of Professor W. Arthur Lewis, Nobel Laureate in Economic Sciences, based on the effective utilization of the surplus labor in the agricultural sector in an expanding non-agricultural (manufacturing, construction and service) sector. The openness of East Asian economies to international trade and investment as well as their active participation in the world economy are also critical factors in their success. * The author is Ralph and Claire Landau Professor of Economics, The Chinese University of Hong Kong and Kwoh-Ting Li Professor in Economic Development, Emeritus, Stanford University. This paper is a revised version of a lecture with the same title presented by the author as part of the CUHK Business School Global Leader Series, The Chinese University of Hong Kong, on 16 October 213. The author wishes to thank Mrs. Ayesha Macpherson LAU for her invaluable comments and suggestions, Dr. Masahiro KURODA, Professor Jung-Soo PARK and Professor Yanyan XIONG for their generous assistance with the relevant economic data, without which this paper would not have been possible. All opinions expressed herein are the author s own and do not necessarily reflect the views of any of the organizations with which he is affiliated. 1

As a whole, East Asia has made tremendous progress in terms of real GDP. Since, the rate of growth of East Asian real GDP has almost always exceeded those of the U.S. and the Euro Zone, except during the East Asian currency crisis of -. Note that the growth rates of Japan and the other four newly industrialized economies (Hong Kong, South Korea, Singapore and Taiwan), which have begun their economic development processes relatively earlier, have gradually declined over time, and those of the newly emerging economies of Cambodia, Laos, Myanmar and Vietnam are on an upward trend. Chinese real GDP has increased the most since amongst East Asian economies, whereas Brunei s real GDP has increased the least, followed by that of Japan. However, in terms of real GDP per capita, Brunei has fallen when compared to ; the Philippines and Japan have made relatively little progress; Macau, with a population of approximately half a million, has the highest real GDP per capita. Note that Chinese real GDP per capita still lags behind many East Asian economies and is ahead of only Cambodia, Indonesia, Laos, Myanmar, Philippines, Thailand and Vietnam. In, the United States and Western Europe together accounted for over 6% of world GDP. By comparison, East Asia accounted for just above % of world GDP. By, the share of the United States and Western Europe in world GDP has declined to approximately 45%, whereas the share of East Asia has risen to approximately 25%. The Japanese share of world GDP declined from a peak of 18% in the mid-s to 8% in, while the mainland Chinese share of world GDP rose from less than 2% in to over 11% in. 2

Figure 1: The Rates of Growth of Real GDP of East Asia, the U.S. and the Euro Zone 8. 7. The Rates of Growth of Real GDP of East Asia, the U.S. U.S. and and the the Euro Euro Zone Zone East Asia U.S. Euro Area 6. 5. 4. 3. 2. 1.. -1. -2. -3. -4. -5. Figure 2: Decade Average Annual Rates of Growth of Real GDP of East Asian Economies 3

Figure 3: The Growth of Real GDP in East Asian Economies in and (Part 1) 8 Real GDP of East Asian Economies in and, in USD trillions 7 6 5 USD trillions 4 3 2 1 Brunei Cambodia China Hong Kong Indonesia Japan Korea Laos Macao Malaysia Philippines Singapore Thailand Vietnam Taiwan, China Figure 4: The Growth of Real GDP in East Asian Economies in and (Part 2) 1,2 Real GDP of East Asian Economies in and, in USD billions 1, 8 6 4 2 Brunei Cambodia Hong Kong Indonesia Korea Laos Macao Malaysia Philippines Singapore Thailand Vietnam Taiwan, China USD billions 4

Figure 5: The Growth of Real GDP per Capita in East Asian Economies in and 8 Real GDP per Capita of East Asian Economies in and, in USD thousands 7 6 5 USD thousands 4 3 2 Brunei Cambodia China Hong Kong Indonesia Japan Korea Laos Macao Malaysia Philippines Singapore Thailand Vietnam Taiwan, China Figure 6: The Distribution of World GDP in, USD The Distribution of World GDP in, in USD Other Economies 24.5% United States 35.4% Korea, Rep. of.3% United Kingdom 4.3% Brazil 1.5% India 2.2% China 3.2% Japan 7.2% Euro Zone 21.5% 5

Figure 7: The Distribution of World GDP in, USD The Distribution of World GDP in, in USD Other Economies 27.% United States 21.6% Korea, Rep. of 1.6% United Kingdom 3.5% Euro Zone 18.7% Brazil 3.5% India 2.6% Russian Federation 2.7% China.4% Japan 8.4% Figure 8: China s and East Asia s Share of World GDP, -present (Current Prices) 26 24 22 East Asian Economies Mainland China China's and East Asia's Share of World GDP, -present 2 18 16 14 12 8 6 4 2 6

Figure 9: The Shares of East Asia, China, Japan and South Korea in World GDP, -present 26 The Shares of East Asia, China, Japan and South Korea in World GDP, -present 24 22 2 18 16 14 12 8 6 4 2 East Asian Economies China Japan Korea In, the United States and Western Europe together accounted for over 6% of world trade. By comparison, East Asia and South Asia combined accounted for less than % of world trade. In, the United States and Western Europe together still accounted for approximately 55% of world trade, while East Asia and South Asia combined accounted for just over % of world trade. By, the share of United States and Western Europe in world trade has declined to below 45%, whereas the share of East Asia and South Asia has risen to 3%. 7

Figure : The Distribution of Total International Trade in Goods and Services in The Distribution of Total International Trade in Goods and Services in Other Economies 37.8% United States 14.9% Korea, Rep. of.4% Euro Zone 32.4% United Kingdom 7.% Brazil.8% India.6% China.6% Japan 5.4% Figure 11: The Distribution of Total International Trade in Goods and Services in The Distribution of Total International Trade in Goods and Services in Euro Zone 22.8% Brunei.% Cambodia.% China 9.7% Hong Kong 2.5% Indonesia 1.% Japan 4.2% Korea 2.8% Lao.% Macao.1% Malaysia 1.1% United States.8% Other Economies 39.3% Philippines.3% Singapore 2.1% Taiwan, China 1.5% Vietnam.5% Thailand 1.2% The East Asian share of world trade rose from % in to just below 25% in. The mainland Chinese share of world trade rose from 1% in to % in. 8

Mainland Chinese international trade accounted for more than 4% of East Asian international trade in. Figure 12: The Rising Share of East Asian Trade in Total World Trade, -present 35 The Rising Share of East Asian Trade in Total World Trade, -present 3 25 2 15 Share of World Exports Share of World Imports Share of Total World Trade 5 Figure 13: The Share of China in Total World Trade, 195-present 12 11 9 The Share of Chinese Trade in Total World Trade, 195-present The ratio of Chinese Exports to World Exports The ratio of Chinese Imports to World Imports The ratio of Chinese Total Trade to World Total Trade 8 7 6 5 4 3 2 1 195 1951 9

Figure 14: The Share of China in Total East Asian Trade, -present 45 4 35 TheShare of Chinese Trade in Total East Asian Trade, -present The Ratio of Chinese Exports to East Asian Exports The Ratio of Chinese Imports to East Asian Imports The Ratio of Chinese Total Trade to East Asian Total Trade 3 25 2 15 5 2. The Commonalities among East Asian Economies The fast-growing East Asian economies have a few characteristics in common: a high domestic saving rate, the existence of surplus labor, active participation in the world economy and investment in basic education. 2.1 A High Domestic Saving Rate The saving rate of an East Asian economy typically started out low when its GDP per capita was low and near the subsistence level. However, the saving rate rose quickly as GDP per capita rose (see the following chart). It is, however, sometimes necessary to have a jump-start with an initial supply of savings to support the initial investment, for example, from a good agricultural harvest, land reform, foreign aid, credit or investment, and in mainland China s case, the agricultural reform and the introduction of special economic zones to attract foreign direct investment (FDI).

Figure 15: The Savings Rate and Real GDP per Capita: East Asian Economies 6 5 4 3 China Hong Kong Indonesia Japan Korea, Rep. Malaysia Philippines Singapore Taiwan Thailand National Savings Rate and Real GDP per Capita 2 Real GDP per 1, Capita, in US$,, With the possible exception of the Philippines, the saving rates of East Asian economies have been consistently high once their real GDP per capita exceeds the subsistence threshold. This is in contrast to Latin American economies, where the saving rates are typically low. The recent saving rates of Japan, Korea and Taiwan may appear low because of the statistical practice of expensing of educational and research and development (R&D) expenditures, which, properly speaking, should have been recognized as investment expenditures rather than current expenditures. These investments should be recognized as accumulations of intangible capital such as human capital and R&D capital. 11

Figure 16: Savings Rates of Selected Asian Economies, -present 6 5 China, Mainland India Japan Malaysia Singapore Thailand Savings Rates of Selected East Asian Economies Hong Kong Indonesia Korea Philippines Taiwan 4 3 2 Figure 17: Savings Rates of Selected Asian Economies, -present 6 55 5 45 China, Mainland India Japan Malaysia Singapore Thailand Savings Rates of Selected Asian Economies Hong Kong Indonesia Korea Philippines Taiwan 4 35 3 25 2 15 A high domestic saving rate means that the economy can maintain and sustain a high domestic investment rate without depending on the more fickle inflows of foreign aid, credits, 12

loans as well as direct and portfolio investment, enabling the tangible capital stock of the economy to grow continuously. 2.2 The Existence of Surplus Labor East Asian economic development has proceeded along the lines of Professor W. Arthur Lewis s celebrated model of surplus labor, first introduced in his article, Economic Development with Unlimited Supplies of Labour, published in the Manchester School. In almost every successfully developed East Asian economy, from Japan to Hong Kong, Taiwan, South Korea, mainland China and Southeast Asia, development began with the expanded employment of the surplus labor from the agricultural sector in the nonagricultural sector, enabled by the continuing investment in tangible capital in the nonagricultural sector. During this surplus labor phase, tangible capital was accumulated in the nonagricultural sector, and surplus labor moved from the agricultural sector to the nonagricultural sector as complementary tangible capital became available in the non-agricultural sector. For such movement of labor to be sustainable, a relatively high domestic saving rate would be needed, both as a source of wage goods (food) and as a source of investable funds in the non-agricultural sector, unless they could be supplemented by imports and inflows of foreign capital. It is important to realize that the principal source of economic growth during this phase is not the surplus labor itself, but the accumulation of tangible capital in the nonagricultural sector, which made it possible for the surplus labor to move from the agricultural to the non-agricultural sector to be productively employed. One important implication of economic development with surplus labor is that as the economy develops, the shares of GDP and employment originating from the non-agricultural sectors will rise, and the corresponding shares of the agricultural sector will fall. In addition, increased urbanization is likely to accompany the growth of the non-agricultural sectors. Of course, eventually the surplus labor in the economy will run out, and continuing economic growth will have to be driven by a rising tangible capital per unit labor ratio in the economy and also eventually by investment in intangible capital such as human capital and R&D capital. A high domestic saving rate continues to be important in providing dependably the resources necessary for these investments. 13

Figure 18: The Distribution of Japanese Employment by Sector Since % The Distribution of Japanese Employment by Sector 9% 8% 7% 6% 5% 4% 3% 2% % % Employment in agriculture Employment in industry Employment in services Figure 19: The Distribution of Japanese GDP by Sector Since % The Distribution of Japanese GDP by Sector 9% 8% 7% 6% 5% 4% 3% 2% % % Agriculture, value added (% of GDP) Industry, value added (% of GDP) Services, etc., value added (% of GDP) 14

Figure 2: The Distribution of Taiwan Employment by Sector Since 1951 % The Distribution of Taiwan Employment by Sector 9% 8% 7% 6% 5% 4% 3% 2% % % 1951 Employment in agriculture Employment in industry Employment in services Figure 21: The Distribution of Taiwan GDP by Sector Since 1951 % The Distribution of Taiwan GDP by Sector 9% 8% 7% 6% 5% 4% 3% 2% % % 1951 Agriculture, value added (% of GDP) Industry, value added (% of GDP) Services,etc., value added (% of GDP) 15

Figure 22: The Distribution of Korean Employment by Sector Since The Distribution of Korean Employment by Sector % 9% 8% 7% 6% 5% 4% 3% 2% % % Employment in agriculture Employment in industry Employment in services Figure 23: The Distribution of Korean GDP by Sector Since % The Distribution of Korean GDP by Sector 9% 8% 7% 6% 5% 4% 3% 2% % % Agriculture, value added (% of GDP) Industry, value added (% of GDP) Services, etc., value added (% of GDP) 16

Figure 24: The Distribution of Chinese Employment by Sector Since % The Distribution of Employment by Sector since 9% 8% 7% 6% 5% 4% 3% 2% % % Primary Sector Secondary Sector Tertiary Sector % Figure 25: The Distribution of Chinese GDP by Sector Since The Distribution of GDP by Sector 9% 8% 7% 6% 5% 4% 3% 2% % % Primary Sector Secondary Sector Tertiary Sector 17

2.3 Active Participation in the World Economy Economic growth in a typical East Asian economy is also accompanied by its increasing active participation in the world economy. Active participation in the world economy implies opening the domestic economy to FDI, foreign loans and often foreign portfolio investment as well. It also implies the promotion of exports, which often requires the relaxation of import restrictions so that the necessary equipment, raw materials, components and parts and other intermediate production inputs can be imported. Finally, it also implies the rationalization of the exchange rate so that it properly reflects the productivity of the domestic export sector compared to competitors and potential competitors in the rest of the world. 2.3.1 Foreign Investments and Loans Foreign aid, foreign investment and foreign loans can augment domestic savings. They are sometimes essential to jump-start the economic development process because the initial level of GDP per capita may be too low to provide sufficient domestic savings to finance the necessary investment. FDI brings with it not just capital, but also technology, know-how, markets, new business models and methods. FDI also directly augments aggregate demand and increases domestic employment. However, FDI and foreign loans are not sustainable as foreign direct investors and lenders must eventually repatriate their capital and profits, if any. 2.3.2 Export Promotion Most of the East Asian economies switched from a purely import substitution development strategy to an export promotion development strategy (while ensuring the sufficiency of the domestic food supply a priority) at the start of their successful economic development drive. Barriers to the imports of equipment, raw materials, components and parts and other intermediate inputs used in the export industries were removed, thus enabling the growth of exports. The export processing zone, pioneered by Taiwan, is an often used device to facilitate the imports of inputs critical to the export industries through bypassing the customs formalities, and hence also making unnecessary the rebating of customs duties and 18

value-added taxes paid on the imported contents of goods that are subsequently exported. A trade surplus augments the domestic aggregate demand and increases domestic employment. Exports also allow the expansion of the scale of production beyond the domestic market, and thus the realization of the economies of scale in manufacturing. The scale of the potential market is also essential for the maximization of the benefits of investment in intangible capital such as R&D capital and reputational capital (branding and goodwill). Exports can generate the foreign exchange revenue that can be used to import equipment, raw materials, components and parts and other intermediate inputs needed for production that are not available in the domestic economy. Exports and imports can generate readily collectible government revenue through export taxes and import duties that can be used to finance the construction of infrastructure and basic education. Exports can also generate the foreign exchange needed by foreign direct investors and lenders to repatriate their capital and profits eventually (the transfer problem). Thus, exports can enhance the ability of an economy to attract FDI and foreign loans. However, the macroeconomic benefits of international trade go beyond the stimulative effects of export surpluses. Even if international trade is balanced or in deficit, it still brings significant benefits, some of which are not adequately reflected in the conventional measurements of gross domestic product (GDP). It is therefore not an accident that the share of exports to GDP would rise significantly at the start of the economic development process of almost every East Asian economy. In most of the East Asian economies, the share of exports in GDP rose significantly, especially after the rationalization of the exchange rate. However, the export share is smaller when the size of the economy is larger. In addition, for East Asian economies that do not have a natural resource base (oil, minerals, cash crops such as palm oil and rubber), there would be significant trade deficits in the first few years after the adoption of an export promotion policy, reflecting the need to import equipment, as well as raw materials, components and parts and other intermediate inputs not produced domestically. 19

Figure 26: Exports of Goods and Services as a Share of GDP in East Asian Economies Figure 27: Exports of Goods as a of GDP: East Asian Economies 2 18 Exports of Goods as a Pecentage of GDP of Selected East Asian Economies Brunei Cambodia Hong Kong Macao Mainland Indonesia Japan Korea Lao Malaysia Myanmar Philippines Singapore Taiwan Thailand Vietnam 16 14 12 8 6 4 2 195 1951 2

Figure 28: Exports of Goods and Services as a of GDP: East Asian Economies 25 Exports of Goods as a Pecentage of GDP of Selected East Asian Economies Brunei Cambodia Hong Kong Macao Mainland Indonesia Japan Korea Lao Malaysia Myanmar Philippines Singapore Taiwan Thailand Vietnam 2 15 5 Figure 29: Exports of Goods as a of Japanese GDP since 195 18 Exports of Goods as a Pecentage of GDP 16 Japan 14 12 8 6 4 195 1951 21

Figure 3: Exports of Goods as a of GDP: Mainland China and Japan 4 Exports of Goods as a Pecentage of GDP 35 Mainland China Japan 3 25 2 15 5 195 1951 Figure 31: Exports of Goods as a of GDP: Mainland China, Japan, South Korea and Taiwan 7 Exports of Goods as a Pecentage of GDP of Selected East Asian Economies 6 Mainland China Japan South Korea Taiwan 5 4 3 2 195 1951 22

Figure 32: Exports of Goods as a of GDP: Four Newly Industrialized Economies 2 18 Exports of Goods as a Pecentage of GDP of Selected East Asian Economies Hong Kong South Korea Singapore Taiwan 16 14 12 8 6 4 2 195 1951 Figure 33: Exports of Goods as a of GDP: China, Indonesia, Malaysia and Thailand 12 Exports of Goods as a Pecentage of GDP of Selected East Asian Economies Mainland China Indonesia Malaysia Thailand 8 6 4 2 195 1951 23

Figure 34: Exports of Goods as a of GDP: Selected ASEAN Economies 9 Exports of Goods as a Pecentage of GDP of Selected East Asian Economies 8 7 6 5 4 Cambodia Laos Myanmar Philippines Vietnam 3 2 195 1951 Figure 35: Exports and Imports as a of Japanese GDP, -present 16.5 16. 15.5 15. 14.5 14. 13.5 13. 12.5 12. 11.5 11..5. 9.5 9. 8.5 8. 7.5 7. 6.5 6. 5.5 Exports and Imports as a of Japanese GDP, -present Exports as a percent of GDP Imports as a percent of GDP 24

Figure 36: Exports and Imports as a of Hong Kong GDP, -present 2 19 18 17 Exports and Imports as a of Hong Kong GDP, -present Exports as a percent of GDP Imports as a percent of GDP 16 15 14 13 12 1 9 8 7 6 5 4 Figure 37: Exports and Imports as a of Taiwan GDP, 1951-present 7 65 6 Exports as a percent of GDP Exports and Imports as a of Taiwan GDP, 1951-present Imports as a percent of GDP 55 5 45 4 35 3 25 2 15 5 1951 25

Figure 38: Exports and Imports as a of Singapore GDP, -present 2 2 19 Exports and Imports as a of Singapore GDP, -present Exports as a percent of GDP Imports as a percent of GDP 18 17 16 15 14 13 12 1 9 8 7 Figure 39: Exports and Imports as a of Korean GDP, -present 55. 5. Exports and Imports as a of Korean GDP, -present 195-present Exports as a percent of GDP Imports as a percent of GDP 45. 4. 35. 3. 25. 2. 15.. 5.. 26

Figure 4: Exports and Imports as a of Chinese GDP, -present 36 34 32 3 28 26 24 22 2 18 16 14 12 8 6 4 2 Exports and Imports as a of Chinese GDP, -present Exports as a percent of GDP Imports as a percent of GDP Figure 41: Exports and Imports as a of Malaysian GDP, -present 1 Exports and Imports as a of Malaysian GDP, -present Exports as a percent of GDP Imports as a percent of GDP 9 8 7 6 5 4 3 27

Figure 42: Exports and Imports as a of Thailand GDP, 195-present 7. 65. 6. Exports and Imports as a of Thailand GDP, 195-present Exports as a percent of GDP Imports as a percent of GDP 55. 5. 45. 4. 35. 3. 25. 2. 15.. 195 1951 Figure 43: Exports and Imports as a of Indonesian GDP, -present 46. 44. 42. 4. 38. 36. 34. 32. 3. 28. 26. 24. 22. 2. 18. 16. 14. 12.. 8. Exports and Imports as a of Indonesian GDP, -present Exports as a percent of GDP Imports as a percent of GDP 28

2.3.3 Exchange Rate Rationalization Rationalization of the exchange rate means setting it at a level that reflects the relative productivity of the export sector when compared with competitors and potential competitors in the rest of the world. This often requires a devaluation of the domestic currency at the initial stage of the economic development drive. Such devaluations are common to almost all East Asian economies. It also involves the unification of pre-existing multiple exchange rates, if any, and the adoption of current account convertibility. The devaluations made possible the export promotion policy that also turned out to be attractive to foreign direct investors and lenders. In the following charts, examples of the devaluations undertaken by selected East Asian economies in the early phases of their respective economic development processes are presented. The exchange rate adjustments triggered significant increases in the shares of exports in GDP in the respective economies. Figure 44: Nominal Exchange Rate of the Japanese Yen, Yen/US$, 1949-present 37 Nominal Exchange Rate of the Japanese Yen, Yen/US$, 1949-present 35 33 3 29 27 25 23 2 19 17 15 13 1 9 7 1949 195 1951 29

Figure 45: Nominal Exchange Rate of the Hong Kong Dollar, HK$/US$, 1949-present 8 Nominal Exchange Rate of the Hong Kong Dollar, HK$/US$, 1949-present 7.5 7 6.5 6 5.5 5 4.5 1949 195 1951 Figure 46: Nominal Exchange Rate of the New Taiwan Dollar, NT$/US$, 1951-present 45 Nominal Exchange Rate of the New Taiwan Dollar, NT$/US$, New TW$/US$, 1951-present 1951-present 4 35 3 25 2 15 1951 3

Figure 47: Nominal Exchange Rate of the Singapore Dollar, S$/US$, 1948-present 3.5 Nominal Exchange Rate of the Singapore Singaore Dollar, S$/US$, 1948-present 3 2.5 2 1.5 1 1948 1949 195 1951 Figure 48: Nominal Exchange Rate of the Korean Won, Won/US$, 1948-present 18 Nominal Exchange Rate of the Korean Won, Won/US$, 1948-present 16 14 12 8 6 4 2 1948 1949 195 1951 31

Figure 49: Nominal Exchange Rate of the Renminbi, Yuan/US$, -present 8.5 Nominal Exchange Rate of the Renminbi, Yuan/US$, -present 8 7.5 7 6.5 6 5.5 5 4.5 4 3.5 3 2.5 2 1.5 1 Figure 5: Nominal Exchange Rate of the Renminbi, Yuan/US$, -present Nominal Exchange Rate of the Renminbi, Yuan/US$, -present 9 8 7 6 5 4 3 2 1 Jan-78 Jul-78 Jan-79 Jul-79 Jan-8 Jul-8 Jan-81 Jul-81 Jan-82 Jul-82 Jan-83 Jul-83 Jan-84 Jul-84 Jan-85 Jul-85 Jan-86 Jul-86 Jan-87 Jul-87 Jan-88 Jul-88 Jan-89 Jul-89 Jan-9 Jul-9 Jan-91 Jul-91 Jan-92 Jul-92 Jan-93 Jul-93 Jan-94 Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan- Jul- Jan-1 Jul-1 Jan-2 Jul-2 Jan-3 Jul-3 Jan-4 Jul-4 Jan-5 Jul-5 Jan-6 Jul-6 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan- Jul- Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 32

Figure 51: Nominal Exchange Rate of the Malaysian Ringgit, Ringgit/US$, 1948-present 4 Nominal Exchange Rate of the Malaysian Ringgit, Ringgit/US$, 1948-present 3.8 3.6 3.4 3.2 3 2.8 2.6 2.4 2.2 2 1948 1949 195 1951 Figure 52: Nominal Exchange Rate of the Thai Baht, Baht/US$, 1948-present 5 Nominal Exchange Rate of the Thai Baht, Baht/US$, 1948-present 45 4 35 3 25 2 15 1948 1949 195 1951 33

Figure 53: Nominal Exchange Rate of the Indonesian Rupiah, Rupiah/US$, -present 1 Nominal Exchange Rate of the Indonesian Rupiah, Rupiah/US$, -present 1948-present 9 8 7 6 5 4 3 2.4 Investment in Basic Education In almost all of the East Asian economies, compulsory basic education (kindergarten through sixth grade) became the norm quite early in the process of economic development. Over time, compulsory education expanded first to nine years and then to twelve years. Tertiary education has become almost universal in the more developed East Asian economies such as South Korea and Taiwan. 3. The Evolving Sources of East Asian Economic Growth Professors Jong-Il Kim and Lawrence J. Lau found that the high rates of economic growth of the East Asian newly industrialized economies (Hong Kong, South Korea, Singapore and Taiwan) in the post-world War II period up to were mostly the results of the growth of tangible inputs (tangible capital and labor) and not technical progress or equivalently the increase in total factor productivity. By contrast, the economic growth of the developed Group of Five (G-5) countries (France, West Germany, Japan, the United 34

Kingdom and the United States) during the same period was mostly attributable to technical progress. These empirical results, as well as those of Alwyn Young s, form the basis of Professor Paul Krugman s () provocative article on the The Myth of Asia s Miracle. Professor Krugman s interpretation of these results is very pessimistic: According to him, because of the absence of technical progress, economic growth in these East Asian newly industrialized economies (NIEs) is bound to slow down and come to a halt eventually as a result of the diminishing returns to additional tangible capital accumulation. And among the tangible inputs, the growth of tangible or physical capital was the most important source. This has been enabled by the high domestic saving rates of the East Asian economies. Foreign aid, FDI and foreign loans were also helpful in augmenting the domestic savings at the beginning stage of the economic development of the East Asian economies. The initially low domestic saving rates of the East Asian economies rose quickly as real GDP per capita increased, providing the resources for continued investment in their respective own economies. The absence of measured technical progress in the East Asian developing economies is the result of the lack of investment in intangible capital (including human capital and R&D capital). Investment in intangible capital has risen sharply in some of the East Asian economies. This is reflected in rising enrollment rates at all levels of education as well as the ratios of expenditures on R&D to GDP. Beginning in the mid-s, evidence of positive measured technical progress can be found in the East Asian NIEs, and that the measured technical progress can be largely attributed to the growth of the stocks of human capital and R&D capital in these economies. 35

Table 1: Growth Accounts: Contributions of the Sources of Growth (Two-Input Model) Tangible Capital Labor Technical Progress (1) Full Sample : 4 NIEs and G-5 Hong Kong 74.46 25.54. South Korea 78.2 21.8. Singapore 64.8 35.2. Taiwan 84.4 15.96. Japan 49.9 4.84 45.26 Non-Asian G-5 Countries 38.71 2.77 58.52 (2) Full Sample: 4 NIEs, 4 ASEAN, China and G-5 Hong Kong 74.61 25.39. South Korea 82.95 17.5. Singapore 63.41 36.59. Taiwan 86.6 13.4. Indonesia 88.79 11.21. Malaysia 66.68 33.32. Philippines 66. 33.9. Thailand 83.73 16.27. China 94.84 5.16. Japan 55.1 3.7 41.29 Non-Asian G-5 Countries 41.51 1.97 56.53 3.1 Change from Tangible to Intangible Capital-Driven Growth In the late s and early s, the growth of intangible capital (human capital and R&D capital) has begun to be an important source of economic growth of South Korea, Singapore and Taiwan, supplanting the growth of tangible capital. After taking into account the effects of human capital and R&D capital, no additional technical progress or increase in total factor productivity can be found in South Korea, Singapore and Taiwan, in contrast to the G-5 economies, including Japan. Table 2: Growth Accounts: Contributions of the Sources of Growth () (Four-Input Model with Human Capital and R&D Capital) 36

4. The Rising Importance of Intangible Capital The principal sources of East Asian economic growth have therefore gradually evolved from the growth of tangible inputs such as tangible capital, enabled by the high saving rates of the East Asian economies and labor, to the growth of intangible inputs such as human capital, R&D capital and reputational capital (branding and goodwill), especially in the more developed East Asian economies. Sustained investment in human capital and R&D are essential for the occurrence of technical progress or growth in total factor productivity in an economy. The East Asian economies have been stepping up their respective investments in R&D as a percent of their GDPs. Figure 54: R&D Expenditures as a Ratio of GDP: G-7 Countries, Four East Asian NIES and China R&D Expenditures as a age of GDP: G-7 Countries, 4 East Asian NIEs and China U.S. Japan W. Germany U.K. France Canada Italy South Korea Singapore Taiwan China Hong Kong One indicator of the potential for technical progress (national innovative capacity) is the number of patents created each year. In the following chart, the number of patents granted in the United States each year to the nationals of different countries, including the U.S. itself, over time is presented. The U.S. is the undisputed champion over the past forty years, with 121,26 patents granted in, followed by Japan, with 5,677 patents. Since these are patents granted in the U.S., the U.S. may have a home advantage; however, for all 37

the other countries and regions, the comparison across them should be fair. The number of patents granted to mainland Chinese applicants each year has increased from 1 in to 4,637 in. The economies of South Korea and Taiwan were granted 13,233 and,646 U.S. patents respectively in ; they have been averaging approximately, patents a year each. Figure 55: Patents Granted in the United States: G-7 Countries, Four East Asian NIEs and China 1,, Patents Granted Annually in the United States: G7 Countries, 4 East Asian NIEs and China,, Number of Patents 1, US Japan W. Germany U.K. France Canada Italy Hong Kong South Korea Singapore Taiwan China 1 The stock of R&D capital, defined as the cumulative past real investment in R&D less depreciation of % per year, can be shown to have a direct causal relationship to the number of patents granted (see the following chart, in which the annual number of patents granted is plotted against the R&D capital stock of that year for each country or region). The chart shows that the higher the stock of R&D capital of an economy, the higher is the number of patents granted to it by the U.S. 38

Figure 56: Patents Granted in the United States and R&D Capital Stocks: Selected Economies 1,, The Number of U.S. Patents Granted Annually vs. R&D Capital Stocks,, Number of Patents 1, US Japan West Germany UK France Canada Italy South Korea Singapore China Hong Kong Taiwan 1 1 1,, Billions of Constant U.S. Dollars 5. The Partial De-Coupling Hypothesis Throughout the - global financial crisis, as well as the subsequent European sovereign debt crisis, the East Asian economies and the economies of the BRICS countries (Brazil, Russia, India, China and South Africa) continued to do reasonably well. China, in particular, has been able to maintain its real rate of growth above 7.5% since, lending credence to the Partial De-Coupling Hypothesis, that is, the Chinese and East Asian economies can continue to grow, albeit at slower rates, even as the U.S. and European economies go into economic recession. This partial de-coupling can occur because of the gradual shift of the economic centre of gravity of the world from the United States and Western Europe to Asia (including both East Asia and South Asia) over the past three decades. A particularly interesting development is the rise in intra-east Asian international trade. The share of East Asian trade destined for East Asia has risen to over 5% in the past decade. This is a sea change compared to 3 years ago when most of the East Asian exports 39

were destined for either the United States or Western Europe. Similarly, the share of East Asian imports originated from East Asia has remained above 45%. Figure 57: The Share of East Asian Exports Destined for East Asia 53 The Share of East Asian Exports Destined for East Asia 51 49 47 % 45 43 41 39 37 35 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan- Apr- Jul- Oct- Jan-1 Apr-1 Jul-1 Oct-1 Jan-2 Apr-2 Jul-2 Oct-2 Jan-3 Apr-3 Jul-3 Oct-3 Jan-4 Apr-4 Jul-4 Oct-4 Jan-5 Apr-5 Jul-5 Oct-5 Jan-6 Apr-6 Jul-6 Oct-6 Jan-7 Apr-7 Jul-7 Oct-7 Jan-8 Apr-8 Jul-8 Oct-8 Jan-9 Apr-9 Jul-9 Oct-9 Jan- Apr- Jul- Oct- Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Figure 58: The Share of East Asian Imports Originated from East Asia 59 The Share of East Asian Imports Originated from East Asia 57 55 53 51 49 47 45 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan- Apr- Jul- Oct- Jan-1 Apr-1 Jul-1 Oct-1 Jan-2 Apr-2 Jul-2 Oct-2 Jan-3 Apr-3 Jul-3 Oct-3 Jan-4 Apr-4 Jul-4 Oct-4 Jan-5 Apr-5 Jul-5 Oct-5 Jan-6 Apr-6 Jul-6 Oct-6 Jan-7 Apr-7 Jul-7 Oct-7 Jan-8 Apr-8 Jul-8 Oct-8 Jan-9 Apr-9 Jul-9 Oct-9 Jan- Apr- Jul- Oct- Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 % 4

Any doubt that the Chinese economy can be partially de-coupled from the world economy should be resolved by an examination of the following three charts. Even though Chinese exports and imports fluctuate like those of all other East Asian economies, the rate of growth of real GDP of the Chinese economy has been relatively stable compared to those of the other East Asian economies. Figure 59: Quarterly Growth Rates of Exports of Goods: Selected East Asian Economies 7 Year-over-Year Quarterly Rates of Growth of Exports of Goods in US$ () Annualized per annum 6 5 4 3 2 - -2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 213-3 -4-5 -6 China,P.R.:Hong Kong Indonesia Malaysia Singapore China,P.R.: Mainland Taiwan Prov.of China India Korea Philippines Thailand Japan 41

Figure 6: Quarterly Growth Rates of Imports of Goods: Selected East Asian Economies 9 Year-over-Year Quarterly Rates of Growth of Imports of Goods in US$ () 8 7 6 5 Annualized per annum 4 3 2 - -2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 213-3 -4-5 -6 China,P.R.:Hong Kong Indonesia Malaysia Singapore China,P.R.: Mainland Taiwan Prov.of China India Korea Philippines Thailand Japan Figure 61: Quarterly Rates of Growth of Real GDP: Selected East Asian Economies 2 Quarterly Rates of Growth of Real GDP, Year-over-Year, Selected East Asian Economies 15 Annualized Rates in 5-5 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 213 - -15-2 China,P.R.:Hong Kong Indonesia Malaysia Singapore China,P.R.: Mainland Taiwan Prov.of China India Korea Philippines Thailand Japan 42

6. Concluding Remarks The economic centre of gravity of the world has been gradually shifting to East and South Asia, and that of East Asia has been gradually shifting to China. The Chinese and East Asian economies have been partially de-coupled from the United States and Europe. The growth of tangible capital, supported by high domestic saving rates, was the principal source of early East Asian economic growth. Intangible capital (human capital and R&D capital) has been gradually supplanting tangible inputs (physical capital and labor) as the most important source of growth in the more developed East Asian economies such as Japan, South Korea, Singapore and Taiwan. The expansion of the non-agricultural sectors through the utilization of surplus labor and active participation in the world economy are common features of the development experience of successful East Asian economies. 43