Lessons from the East Asian Economic Miracle

July 29, 2019

Editor’s note: An analysis of how Asian economies grew stunningly through intentional policy and not laissez-faire free trade.

I’ve always had highly libertarian instincts, for both pragmatic and ideological reasons. You say civilians should be able to own rocket launchers, I demand that these rocket launchers not face a sales tax. But for me and people like me, the East Asian economic miracle poses a serious challenge: the greatest anti-poverty program in history involved not just a lot of capitalism, but a ton of state intervention as well. The history of East Asian economic growth in the last half of the twentieth century is a history of academics and the World Bank insisting that their policies couldn’t possibly work, followed by decades and decades of torrid growth.

[Byrne Hobart | March 11, 2019 | Medium]

So I decided to look into it. I read a few books (skip to the end for sources and recommendations), and learned a ton. As it turns out, though the Miracle is largely a triumph of capitalism, it also illuminates that economic growth depends on judiciously insulating certain parts of the economy from market forces.

In a way, you can look at success stories like Japan and South Korea as a different instantiation of two very American institutions: venture capital and private equity. The difference is that it was VC and PE as practiced by the state, rather than by individual companies; the timelines were longer, the plans were bolder, and the results were stunning.

No American company or investor has improved as many lives by as wide a margin as MITI, Park Chung-Hee, and Deng Xiaoping. But the methods are, at heart, startlingly similar: identify a critical inflection point, make a bold bet on an unproven market, “blitzscale” as quickly as possible, deftly react to crises, and carefully expose budding monopolists to hormetic doses of competition until they’re strong enough to monopolize on their own merits.

This is not just a theoretical exercise. An active trade policy has landed suddenly back on the policy menu in the US and other places. In the past, we’ve done it sort of shame-facedly, giving nice subsidies to Iowa in exchange for their tactically priceless supply of early caucus dates, periodically bailing out American companies when international exporters teach them the meaning of the word “competition,” and occasionally gesturing towards energy independence without putting any meaningful goals to paper.

But now we’re talking about trade in a more adversarial way, which is appropriate inasmuch as, in international trade, America has many adversaries — not places that hate us, just places that, as a side effect of their own policy goals, end up harming American economic interests. Of the many possible trade policies, most are bad and free trade is — on net, and in the aggregate — the best. However,the simple Ricardian model of trade makes a few untenable assumptions, and other countries have learned to exploit them. In the spirit of free inquiry and open debate, I am happy to explain why anyone who advocates either contemporary protectionism or contemporary free trade is wrong.

But we’ll have to start at the beginning: how did East Asian countries get so rich, so fast?

Origins: How Did the Boom Start?

I’d like to begin by rehabilitating another long-since discredited economist: you can’t really understand the Miracle until you learn to think like a Malthusian. Malthus’s original thesis was that since population grows exponentially and food production grows linearly (with some deviations), we’ll always tend to grow the population to the point that maximum food output can just barely support it, meaning that a single bad harvest leads to famine.

Granting the premises, this is true, and looking back at history, his premises arguably made sense. Populations had gone through boom/bust cycles before, albeit more driven by war and disease than by famine per se — but war and disease are both symptoms of overcrowding, so the model was predictive even though it mislabeled the terms.

Of course, the two mistakes he made were the two premises: as it turns out, food production can grow exponentially, while population growth slows as countries get richer and better-educated.[1] One important thing to keep in mind when you’re thinking like a Malthusian is to note that if your country is close to the Malthusian limit, it means the incremental farmer is not producing enough food to feed themselves — if the average person produces enough food for one person, and some people have good land, the more marginal land is necessarily producing less than that average. That’s important because the non-farming population is able to accumulate capital, which can eventually raise farms’ efficiency, at least on a per-farmer basis. While farmers invent a ton of stuff, they can’t manufacture at scale.

So the story of Western Europe, starting at around when Malthus published, went like this: Farmers produced enough resources to support some basic manufacturing; this manufacturing produced capital that made farms more efficient; fewer farmers required meant more manufacturing, setting off a virtuous cycle.

Arguably, the event that set off the Renaissance, and thus the Industrial Revolution, was the Black Death. By killing a third of Europe, it pushed us to well below the Malthusian limit, raised workers’ wages, and limited governments’ ability to tax city-dwellers. Things really started to take off in Northern Italy, which is also where the plague first arrived. Of course, it could have happened anyway, and could have happened elsewhere — the reason it hit in the first place was that trade had globalized enough that rats and fleas from China found their way to Venice, which wasn’t happening as much beforehand. But certainly the Bubonic Plague accelerated things by eliminating a lot of people and raising the marginal productivity of the survivors.

For countries that didn’t have Europe’s good fortune in getting a catastrophic plague right when their technology had advanced to the point that they could rapidly scale up non-agricultural productivity, there was some more waiting involved.

As Joe Studwell points out in How Asia Works, every one of the economic miracles started with land reform — in Korea and Japan, this was part of a series of postwar changes; in China, it happened a little later with the gradual rescission of agricultural collectivization.

Land reform’s effects were paradoxical: in the short term, the net effect was more agricultural labor. Individual farmers intensively working small plots can achieve much higher productivity per acre than big plantations can, at the cost of not being very scalable. But for a country on the edge of the Malthusian trap, that’s exactly what they need.

What happened next, in every successful case, was that governments decided as a matter of policy that they’d favor export industries, and in particular that they’d favor industries that could achieve long-term productivity growth. In some ways, these countries lucked out due to the Green Revolution: if agricultural productivity in general hadn’t started to rise, they would have been stuck at a slightly higher Malthusian limit.

In each case, the first inflection that set off the boom was land reform. After that, two things happened: First, each country had a trade surplus, and the smart ones invested it in capital equipment for stage two. Second, birthrates rose. Since they had previously been bumping up against the Malthusian limit, an increase in food supply led directly to an increase in babies.[2]

For policymakers, the name of the game is this: you have some hard currency, and some babies. In seventy years, these babies will retire, and the next generation may well be smaller. What do you do in 1950 to ensure that the retirement accounts of 2020’s 70-year-olds are as full as possible, so they can soften the impact of a high dependency ratio?

The process:

  1. Invest the trade surplus from food into light industry, i.e. textiles — this is a business where the main input is unskilled labor, so any poor country with a port and a smidgen of capital is, presto, the global low-cost leader.
  2. Invest the trade surplus from that into heavy industry (at first: steel and basic chemicals; eventually heavy machinery, cars, specialty chemicals, electronics).
  3. Relentlessly push your heavy industry to export; sell products that can compete globally, even if you’re taxing your population to subsidize your exporters.
  4. On that note: use aggressive financial repression; force people to save a high proportion of their marginal product (i.e. standards of living can rise, but should rise a lot less than GDP); direct that money into industries with economies of scale.
  5. Once you are the scale leader in a scale-driven industry, you can relax. But only a little! Now you have to worry about somebody else copying you. Japan’s world-beating steel industry got copied by South Korea, and their car industry faced competition there, too; Japan also lost their lead in electronics to China.

Case Study: Japan

Postwar Japan was an economic basketcase. The country had lost over two million lives, and American bombings had wrecked their industrial capacity. Even before that, Japan’s militarist government had warped the country’s economic development through a focus on arming for conquest.

As a consequence of all this, Japan’s GDP per capita in 1950 was under a fifth of the US level. Today, Japan’s GDP per capita is about two thirds of the US level.

When you try to evaluate the Japanese system, it’s important to note that it does not at all work the way it looks on paper.[3] In theory, Japan is a representative democracy, in which voters elect legislators who pass laws, etc. etc. etc. In practice, their system during the last half of the twentieth century was a sort of technocratic dictatorship, in which the foundational rules were not a written constitution but a set of bureaucratic social norms.

The protagonist of Japan’s industrialization is the Ministry of International Trade and Industry, which determined Japanese industrial policy. In the US, we’re used to thinking of government bureaucracies as slow and unambitious, but in Japan that wasn’t the case at all: MITI got the country’s best workers (the pass rate for their most challenging exam was 2%), and had an aggressive up-or-out approach. Talented people quickly got more responsibility, and they wielded immense power.

When MITI decided that Japan should be a steel exporter, they gave steel companies enormous loans to increase capacity. When the industry got overbuilt, MITI forced participants to merge. Since steel had economies of scale and was a useful input for other kinds of manufacturing, MITI decided that so if Japan were to have a future, it would start with steel.

And MITI was right. Japan became the world’s largest producer of steel by the early 80s, and their dominance in steel gave them a huge boost in shipbuilding and machinery.

Here are three striking illustrations of how powerful MITI was (one political, one sociological, one cultural):

  1. Japanese legislators could introduce their own bills, but these tended to get voted down. MITI could also suggest bills, which tended to get passed with near-unanimity. That Japanese Diet in the postwar period looked less like the US Congress than it did the Supreme Soviet of the Soviet Union. Once the legislators saw the bill, it was as good as law. In MITI and the Japanese Miracle, Chalmers Johnson argues that this was an efficient system because the legislators “reigned” (they were the public face of government, and enjoyed the electoral consequences of policy decisions) while bureaucrats ruled (i.e. they made the actual decisions).
  2. A study of the family trees of prominent Japanese people showed that high-level MITI employees tended to have more socially-prominent fathers-in-law than fathers. MITI, in other words, was where ambitious and upwardly-mobile young men wanted to work. Why bother getting rich when you can get powerful instead?
  3. There are no fewer than three novels about Shigeru Sahashi, a powerful MITI vice-minister. One of them got turned into a TV show. Imagine The West Wing, but the hero works at the Department of Commerce.

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