Perspectives on East Asian Growth

Remarks on the 1997-1998 Pacific Economic Outlook
Willard Hotel, Washington, DC, June 3, 1997

Jeffrey Frankel, Member of the Council of Economic Advisers

It has been three years since Paul Krugman wrote his Foreign Affairs article on the Myth of Asia's Miracle. His article was very controversial at the time. Yet now it looks prophetic, given the economic slowdown that overtook much of East Asia last year, the downturn in the global market for semi-conductors [and other electronics], fears of over-extended property markets in many Asian cities, the financial problems afflicting some countries such as Thailand, and the deep malaise that seems to be afflicting others such as Korea.

East Asian growth outlook

The PECC and its associate institutions (The Asia Foundation...) do a real service in producing the Pacific Economic Outlook. I have read this year's with interest. East Asia's dynamic countries [excl. Japan, Russia, Vietnam...] are reported to have grown at about __ in 1996, and are forecasted to grow at about __ in 1997...and 1998. These numbers represent a decrease compared to 8.3 % over the period 1978-95. [Excluding China, the growth rates averaged 7.3% over 1974-95, and 9.5% over the period 1960-73]. This is a slowdown by East Asian standards.

Will history record 1996-97 as a minor downward blip on the strong growth paths of East Asian miracle countries? Or, is this the first sign that these countries have hit the growth wall that Krugman seemed to predict [i.e., that there is no reason for them to grow faster in the future than Western countries]? As the title of this meeting puts the question as "Has the Bubble Burst?"

I do not believe that high Asian growth rates are a thing of the past. Nevertheless, Japan has probably completed the process of converging to European/North American income levels. Even assuming that the present recovery in Japan is well-established, which is by no means clear, there is no reason to expect the country to return to growth rates in excess of the U.S., let alone the rates of earlier decades. Some of the other Asians are well along on the same trajectory as Japan, and are likely to slow down from their very rapid growth rates of recent decades.

I am going to suggest that the laws of economics work similarly in East Asia as elsewhere. U.S.-style economics may hold more good lessons for other countries than we ourselves thought a few short years ago. If they are to sustain rapid growth rates, the East Asians may have to learn a few of these lessons.

The East Asian Miracle

The appropriateness of the word "miracle" lies in the eyes of the beholder. What if Krugman had chosen to phrase his conclusion differently: "The miracle of East Asian growth is due to miraculous rates of investment in physical and human capital."? Most readers would have been less surprised by the article than they were. Yet this is really what the article said.

Krugman was reporting the work of Alwyn Young. Krugman and Young calculated that most of the growth in some East Asian countries, especially Singapore and Japan, could be explained by simple factor accumulation. Importantly, the accumulation of "human capital," as measured by schooling, is included as a factor of production. Accumulation of capital, both physical and human, explains most of East Asian success. These countries built up their economies by brute force, the authors say. There is no increase in total factor productivity [no "Solow residual"] left, to attribute to openness or stability or culture, or anything else. In this sense there never was a miracle.

Krugman claimed that there was little reason to expect rapid growth to continue in East Asia in the future. Even if residents of Singapore and Japan continued their remarkable propensities to save, their economies would run into diminishing marginal returns to capital.1

These fundamentals -- saving, education, openness, sound fundamentals, and so forth -- can be duplicated elsewhere in the world. Does this mean there is nothing peculiarly Asian about the origins of the Asian miracle?

Is there a superior East Asian model of capitalism?

Some have proposed an East Asian model of capitalism. Among the distinguishing characteristics are:

These aspects have not all been thoroughly studied by Western economists [who have trouble fitting them into their abstract models]. But others have emphasized them, in some cases arguing the case for an alternative model to fit Asian circumstances, but in some cases generalizing worldwide, and even implying that the United States should re-structure its policies in light of some lessons from East Asia, e.g., subsidizing exports or protecting production in some favored sectors.

There is no longer much doubt, if there ever was, regarding the superiority of capitalism over socialist/command economies. But that conclusion does not in itself justify asserting the superiority of American-style capitalism over other varieties of capitalism. (1) The U.S. does not correspond perfectly to the laissez-faire neoclassical economy of textbooks, (2) some deviations from pure laissez-faire are in fact called for, and (3) American deviations are not always and in all circumstances precisely the best ones.

An example: the structure of financial systems. The U.S. model (shared with the UK and so sometimes called the Anglo-Saxon model) relies heavily on securities markets, with an assist from venture capital markets. To be sure, banks play a role; but even bank loans tend to be made on arms-length terms. Certainly the government has little to say about where bank credit is allocated. The system that has developed in some Asian countries, on the other hand, has been closer to the Japanese model. Without denying the important differences among these countries, the Asian models feature high debt/equity ratios, place greater reliance on bank loans than on securities markets, have closer relationships between banks and the companies that borrow from them, allow extensive corporate cross-shareholding, and are accustomed to greater guidance from the government in their credit allocation decisions, including the imposition of compulsory financing on banks in combination with repression of the rest of the financial system through, e.g., taxes on securities transactions.

Five to ten years ago, economists were wondering if the Japanese system might not be superior to the Anglo-Saxon one. Research took both theoretical and empirical forms.3 The theoretical models assumed asymmetric information (between borrowers and lenders). The idea is that, from the viewpoint of a firm seeking to finance an investment project, the typical investors in the securities markets is a stranger, who has no way of knowing whether to expect your project to have as a high a return as you claim. Such investors will demand a premium to compensate them. The empirical tests confirmed that firms were better able to finance their investment projects internally, than when they had to go to the securities markets and convince strangers of the worthiness of their projects. Thus relationship banking was thought to be a possible way around the asymmetric information problems that impede capital markets. It was said that when a firm suffered a temporary setback, the short-sighted American financial system would cut it off from funds, while Japanese banks had longer horizons, and would give the borrower the resources to see it through.

The question ultimately was an empirical one. The Japanese system seemed to work very well. It produced high rates of investment and high rates of growth. It was said that to have provided Japanese investment with a low cost of capital, giving Japanese industry an advantage over American competitors.4 Versions in Korea and other countries seemed to be working well also.5

But now the much-vaunted Japanese financial system is looking tarnished. Precisely the attribute of the system that previously appeared to be a virtue, the willingness to go on lending to firms in distress, now turns out to have been the source of serious problems. [The same might be said for some other countries like the case of Korea's Hanbo bankruptcy in January.] Every country has its bumps in the road. One does not want to conclude too much from a single episode. But I believe it fair to say that several aspects of the East Asian model have been called into question recently: close relationships between banks and corporate borrowers, heavy government involvement in resource allocation, and special priority to industrial sectors that were once thought key to industrial development or strategic in export markets (e.g., steel, in the Hanbo case). Other areas where the U.S. model may have some useful lessons include the flexibility of American labor markets and the retail sector, as well as deregulation in such sectors as telecommunications and airlines.

The Clinton Administration's Policies Toward Asia and the Pacific

So far, I have been speaking more as a university professor than as a government official. But perhaps I should say something about the Second Clinton Administration's policies.

Let me begin by saying that the 2nd Clinton Administration, like the first, is an internationalist administration. During the first four years, the crowning achievements [in the area of international economic policy] were the ratification and implementation of the NAFTA and the Uruguay Round. We hope and expect to continue this momentum in the second four years [as the President made clear in his State of the Union message].

In the coming year, I think that probably our single most important objective in the area of international economics is obtaining from Congress the authority to negotiate trade agreements on a fast-track basis. There are two aspects about which I should re-assure this audience. The first is that we are indeed committed to getting fast-track. The second is that you should view fast track as an indication of our commitment to an open rule-based multilateral trading system, notwithstanding that the first and most obvious uses for it may be regional, particularly negotiating the accession of Chile to NAFTA.

On the first point, we are pushing ahead, despite the decision to postpone the date of the effort until the Fall. The President has sounded the fast-track theme at every opportunity: the State of the Union message, visit of Chilean President Frei, April speech before the Amer.Soc.News.Editors [4/11/97; 14 paragraphs], and a foreign policy retreat with Congress. The relevant Cabinet Secretaries are engaged, on the Hill and in public [Daley, Barshevsky, Rubin, Albright, Glickman]. Trade Representative Charlene Barshevsky has met personally with close to 100 Members of Congress, especially the new members. (Historically, some new members need help expanding their horizons to acquire a global perspective.) The White House is consulting closely with Congress to develop a bill that commands broad bipartisan support.

On the second point -- in particular, why those outside of the Western Hemisphere should want the USG to have fast-track authority:
(1) APEC remains a key manifestation of the Administration's commitment to remaining engaged in East Asia and the Pacific. We look forward to the next summit of Ministers and Leaders in Vancouver.
(2) We hope to be able to use fast-track authority, not just in regional negotiations, but in multilateral negotiations as well. If we get sufficiently broad authority, possible areas of multilateral negotiation include agriculture, government procurement, and high-tech (e.g., ITA). [I am also open to hearing other suggestions.]

Moreover, I believe that the current movement toward regional trading arrangements is -- in a political economy sense -- consistent with worldwide movement toward liberalization more generally. It need not necessarily be this way. One can think of examples from history and reasons in theory to support the idea that regionalism undermines multilateralism. If I can return to being a professor again for just a minute, the IIE is about to publish a book on Regional Trading Arrangements that I wrote when I was a Senior Fellow there, before I started my current job. This study looks econometrically at how FTAs and other regional agreements have affected the geographical pattern of trade flows. The book finds, as one would expect, that such RTAs as NAFTA, Mercosur, the Andean Community, the European Union, and ASEAN have tended to boost trade among their members. One might also expect that this increase in trade would be at the expense of trade between members and non-members, i.e., that there would be trade-diversion. But the study finds that for most of these groups [EU, Mercosur and ASEAN], to the contrary, there has also been an increase in trade with non-members (though not as large as the increase with fellow members). The implication is that regional agreements, under present circumstances, can help build political momentum for liberalization with respect to non-members. I can assure you that those in the American political process who oppose NAFTA or its expansion into South America would also like to raise obstacles to free trade in the Pacific.

An example of how regionalism can support multilateralism is President Clinton's so-called "Triple Play" of late 1993.6 As you recall, it was the President's idea to upgrade the Seattle meeting of APEC ministers that had been scheduled for November 1993, by adding a high-profile Leaders' Meeting. In this way, the United States signaled to the Europeans that if they continued to allow French farmers to hold up the Uruguay Round, other countries might proceed with other initiatives without them. This message carried credibility because of its fortunate timing, coming as it did on the heels of the hard-fought approval of NAFTA in the U.S. Congress. Thus, the NAFTA outcome demonstrated the political will necessary for meaningful agreements, while the APEC meeting demonstrated the possibility that agreements would cover a fraction of the world economy that was sufficiently large and dynamic to give the Europeans cause for worry at the prospect of being left out. In this episode at least, it appears that regional initiatives helped bring about multilateral agreement.


Bergsten, C. Fred, 1994a, "APEC and World Trade: A Force for Worldwide Liberalization," Foreign Affairs 73, no.3, May/June, 20-26.

Bergsten, C. Fred, 1994b, "Sunrise in Seattle," International Economic Insights 5, no.1, January/February.

Destler, I. M., 1995, American Trade Politics 3rd Edition, Institute for International Economics, Washington, D.C.

Kahler, Miles, 1995b, Regional Futures and Transatlantic Economic Relations, Council on Foreign Relations, New York.

Frankel, Jeffrey, "The Evolving Japanese Financial System, and the Cost of Capital," Chapter 9 in Restructuring Japan's Financial Markets, edited by Ingo Walter and Takato Hiraki, Irwin Press and New York University, NY, 1993, 235-285.

Frankel, Jeffrey, "Foreign Exchange Policy, Monetary Policy and Capital Market Liberalization in Korea," in Korean-U.S. Financial Issues, U.S.-Joint Korea-U.S. Academic Symposium Volume 3, edited by Chwee Huay Ow-Taylor, Korea Economic Institute of America, Washington, D.C., 1993, 91-107.

Frankel, Jeffrey, "Recent Changes in the Financial Systems of Asian and Pacific Countries," Sixth International Conference of the Institute for Monetary and Economic Studies, Bank of Japan; in Financial Stability in a Changing Environment, Kuniho Sawamoto, Zenta Nakajima, and Hiroo Taguchi, eds., MacMillan Press, 1995, 161-200.

(with David Romer and Teresa Cyrus) "Trade and Growth in East Asian Countries: Cause and Effect?" Pacific Basin Working Paper Series No. 95-03, Federal Reserve Bank of San Francisco, July 1995. Revised, NBER Working Paper No. 5732, August 1996.

Hoshi, Takeo, Anil Kashyap, and David Sharfstein, 1988, "Corporate Structure, Liquidity, and Investment: Evidence from Japanese Panel Data," Sloan WP #2071-88, September. Quarterly Journal of Economics, 1990.

Hoshi, Takeo, Anil Kashyap, and David Sharfstein, 1990, "Bank Monitoring and Investment: Evidence from the Changing Structure of Japanese Corporate Banking Relationship," in R.G.Hubbard, ed., Asymmetric Information, Corporate Finance, and Investment, University of Chicago Press, Chicago.

Hoshi, Takeo, Anil Kashyap, and David Sharfstein, 1990, "The Role of Banks in Reducing the Costs of Financial Distress in Japan," Journal of Financial Economics, Sept.

Krugman, Paul, 1994, "The Myth of Asia's Miracle," Foreign Affairs 73, no. 6, Nov./Dec., 62-78.

Young, Alwyn, 1994, "Lessons from the East Asian NICS: A Contrarian View," European Economic Review Papers and Proceedings, May.


1. Krugman (1994); and Young (1994).

2. One study finding an effect of openness, even when controlling for the endogeneity of trade, is Frankel, D. Romer and T. Cyrus, 1995. [Openness is found to be particularly important for Singapore, Hong Kong and Malaysia.]

3. Hoshi, Kashyap, and Sharfstein. Frankel (1993) is a survey.

4. Frankel (1993a).

5. In a 1993 paper I allowed that "One should hesitate before condemning Korean 'financial repression,' given how successful the development process has been over the last thirty years (p.96)". But I did add "Nevertheless, it may be time to move on conclude that it is indeed time for Korea to move on.

6. Bergsten (1994b, pp.18-20), Destler (1995, p.228), and Kahler (1995b).

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