Fault Lines: How Hidden Fractures Still Threaten the World Economy (11 page)

Government intervention has sometimes gone much further. K. Y. Yin, an electrical engineer who was also a voracious reader of economic texts (including Adam Smith), was Taiwan’s chief economic planner in the 1950s and is often referred to as the father of Taiwan’s industrial development.
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He commissioned a study in 1953 that identified plastics as an important area for Taiwan to enter. According to a possibly apocryphal story, Yin used his access to information on bank deposits to identify an individual, Y. C. Wang, as someone who had both enough savings and the entrepreneurial zest to undertake a plastics project, and instructed Wang to do it.
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The first Taiwanese plant for polyvinyl chloride (PVC) was built under government supervision and transferred to Wang in running order in 1957. He went on to build the Formosa Plastics Group, Taiwan’s largest business.

There are, however, a number of problems with government intervention that favors a few. Nothing prevents a corrupt government from distributing favors to incompetent friends or relatives, a problem that has plagued countries like the Philippines. Even if a government starts out with the best intentions and carefully screens incumbents, government protection means that those who become lazy and inefficient are not forced to shut down. A key conundrum for governments therefore has been how to retain the disciplinary incentives provided by the market while still allowing firms the room to make profits and build organizational capabilities.

Some governments tried to instill a sense of efficiency and quality directly. For instance, the Taiwanese planner, Yin, ordered the destruction of twenty thousand substandard light bulbs at a public demonstration in Taipei and confiscated tons of substandard monosodium glutamate, the food additive.
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In those cases, the message to producers got through. But governments need a source of discipline more systematic than the whims of bureaucrats, one that would be applied without sparing the favored few.

A second problem with favoring producers in developing countries is that households get a raw deal, and so consumption tends to be low. For starters, wages tend to be low because the many workers in low-productivity agriculture constitute a reserve army, waiting to take up factory jobs at low wages, and keep industrial wages from rising rapidly. But over time governments can also interfere in the wage-setting process, favoring manufacturers over workers so as to keep firms competitive and profitable. Also, the favored firms may pay low prices for government-controlled natural resources such as energy and minerals. Governments make up the shortfall in their revenue by taxing households more, even while the firms charge high prices for the goods they sell to those same households in the cartelized domestic markets.
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To add insult to injury, banks offer low government-set deposit rates for household savings, thus cutting further into household income, even while making subsidized loans to businesses.

In sum, the need to create strong firms may lead the state to favor the producer and the financier at the expense of the citizens. As a result, consumption is unnaturally constrained in such economies. The India of my youth was not dissimilar to the Korea that my Korean friends still remember, where wages were low, work hours long, and consumption frowned on. Indeed, many of them recollect how dim Seoul was at night, because bright neon lights advertising consumer goods were prohibited. Midnight curfews both ensured security and prevented young workers from wasting their energy on an unproductive night life. So a second problem of managed capitalism is that because consumption is repressed, firms are deprived of large domestic markets.

One way to both discipline inefficient firms and expand the market for goods is to encourage the country’s large firms to export. Not only are firms forced to make attractive cost-competitive products that can win market share internationally, but the larger international markets offer them the possibility of scale economies. Moreover, because they are no longer constrained by the size of the domestic market, they can pick the products for which they have the greatest comparative advantage.

Often, the starter sector in developing countries is easy-to-make but laborintensive consumer goods like garments and textiles. Having consolidated the protected textile sector as described earlier, the Taiwanese government started putting in place incentives to export. By 1961, Taiwanese textile exports had become a big enough threat that the United States imposed quotas on them—a sure sign that Taiwan’s textile industry had come of age.

Once industry learned the basics of production in textiles, it started moving up the technological ladder to produce more complicated goods. As late as 1970, textiles were still Korea’s leading export, followed by plywood and, curiously, wigs, whereas its major exports today include cars, chips (silicon, not potato), and cell phones.
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Today, it is China, Vietnam, and Cambodia that compete to export textiles.

Developing-country governments tried to enhance incentives even further by offering greater benefits to firms that managed to increase exports. For instance, because foreign exchange was scarce in the early days of growth, imports were severely restricted. Successful exporters were, however, given licenses to import, and the prospect of making money by selling these licenses gave them strong incentives to expand their foreign market share. In situations where foreign countries imposed import quotas, or where raw materials were scarce, the government also allocated a greater share of these to the more successful exporters. So both indirectly and directly, the efficient were encouraged.

The export-led growth strategy does not mean that government reduces its support to industry. Indeed, exports may initially require more support if domestic firms are to be competitive globally. Some countries have provided a general subsidy by maintaining an undervalued exchange rate or holding down wages by suppressing or co-opting unions; such strategies are more easily followed by authoritarian governments. Others have provided a specific targeted subsidy by underpricing key raw material or energy inputs to exporters or by directly providing cash rebates for exports or for importing manufacturing equipment intended to produce exports.

What is clear is that a necessary concomitant to the strategy of government intervention to create strong domestic firms is to push them to prove their mettle by exporting. Managed capitalism has proved enormously successful in its immediate objective of getting countries out of poverty. It is not, however, an easy strategy to implement.

Managed capitalism initially requires a producer bias that is not easy to sustain in populist democracies. Then the government, despite coddling firms in their early years, has to turn and push them toward exports. For small nations like Taiwan, limited domestic markets made the second step virtually a necessity. But for countries with large domestic markets like Brazil, that second transformation was long delayed.

One country that flubbed this move was India. Under its first prime minister, Jawaharlal Nehru, India did strive to build organizational capacity. Although Nehru reserved industries like steel and heavy machinery for the state sector, he never actively suppressed the private sector. Instead, a system of licensing—the infamous “license-permit raj”—was put in place, ostensibly to use the country’s savings carefully. This meant guiding investment away from industries that bureaucrats thought were making unnecessary consumer goods (even durable ones such as cars), and instead into areas that could lay the basis for future growth, such as heavy machinery. The result, however, was that incumbents, typically firms owned by established families that were well enough connected to procure license early, were protected from competition. Barriers were also erected against foreign competition in order to provide a nurturing environment to India’s infant industries until they matured and became competitive.

The protection India offered these industries, however, became an excuse for the companies to become “Peter Pans”—companies that never grew up. Car manufacturing is a case in point. Over nearly four decades, only five different models of the Ambassador car were produced, and the sole differences between them seemed to be the headlights and the shape of the grill. After growing rapidly just after independence, the Indian economy got stuck at a per capita real growth rate of about 1 percent—dubbed the “Hindu” rate of growth.

Like Korea or Taiwan, India should have made the switch toward exports and a more open economy in the early 1960s. But because the protected Indian domestic market was large, at least relative to that of the typical late developer, firms were perfectly happy exploiting their home base despite government attempts to encourage exports. This is not to say that government efforts to change were particularly strenuous, especially given that protected firms were an important source of revenue to the ruling party for fighting elections. Democracy at this stage may well have seemed a source of weakness: leaders like Park Chung Hee in Korea and Lee Kuan Yew in Singapore did not have to worry about such niceties. As a result, India stayed closed, poor, and uncompetitive long after the economies of countries like Korea, which were at similar levels of per capita income in the early 1960s, had taken off.

Not every country has been able to succeed with an export-led growth strategy. Moreover, this strategy also has weaknesses that may become clear only gradually, as countries grow rich. To understand these weaknesses, we should take a closer look at Germany and Japan. Neither was really poor after World War II—their people were educated, these countries had the blueprints to create the necessary organizations, and some of their institutional infrastructure survived—but both had devastated, bombed-out economies, with their capital stock substantially destroyed, large firms and combines broken up or suppressed by the occupation authorities, and households too downtrodden to be an important source of consumption. Exports were the obvious answer to their problems.

With a large number of workers still in agriculture, and with labor organizations docile, postwar wages initially did not keep pace with the extraordinary rate of productivity growth (a measure of the growth in efficiency with which inputs are used and thus a measure of the profit margins that can be distributed to workers through higher wages). As a result, corporations were able to generate substantial profits for a while.

In both countries, the mature banking sector took on part of the role that was played by the government in the countries discussed earlier. Close cooperation between firms and universal banks in Germany, cemented by share holdings by firms and banks in one another, led to domestic cartels and diminished domestic competition, allowing corporations to focus their energies on competing in foreign markets. Similarly, in Japan, the ties between firms and banks in the bank-centered networks called
keiretsus,
which were overseen by the powerful Ministry of Finance and the Ministry of International Trade and Industry (MITI), resulted in a canonical version of managed capitalism.

Once the excess labor in agriculture was fully drawn in to the manufacturing sector, however, wages inexorably increased to keep pace with productivity growth in the efficient export sector. By 1975, hourly wage rates in manufacturing in Germany had caught up with those in the United States, and Japan caught up in the early 1990s. Low wages therefore no longer offered a competitive advantage for the exporters. More problematic, once the initial phase of catch-up was over and Germany and Japan approached the levels of capital per worker that existed in advanced economies such as the United States, the growth rate of investment slowed considerably, and so did imports of capital goods. With the postwar households conditioned to limit consumption, and successive governments intent on disciplined macroeconomic policies, both Germany and Japan started running large trade surpluses. These initially helped them repay foreign borrowing but eventually resulted in increasing pressure on the currency to appreciate.
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To stay competitive, both countries had to move up the value chain of production and to the frontiers of innovation, making more and more high-tech, skill-intensive products. More important, they also had to improve productivity steadily. They certainly managed to do this in the sectors that exported or competed with imports, the so-called tradable sector. But problems eventually emerged in the domestic nontradable sector, in areas like construction, retail, and hotels, where foreign competition was often naturally absent and sometimes deliberately kept out. Although the extent of government intervention to support exporters was naturally disciplined by international competition—after all, regardless of how much the government helps, if you produce a shoddy product at too high a cost, you will lose export market share—there were no such constraints in the nontradable sector. Productivity growth eventually lagged because the market forces that would force the inefficient to shrink or close were suppressed.

Japan has fared worse than Germany in this respect. As a part of the European Union (EU), Germany is subject to the EU’s rules on fostering domestic competition—though because it has substantial power in the union, it plays a big role in watering them down. Japan has not found any equivalent external discipline in Asia. As a result, the close relationship between government and incumbents has been particularly detrimental to efficiency in the domestic-oriented production sector.

Many a visitor to Japan is surprised at the sight of elevator ladies in hotels—women whose job it is to usher guests into the next available elevator, even though bright lights and buzzers clearly indicate, to anyone who can hear or see, which elevator is next. Perhaps these women had a function when elevators were a new invention, when spotting the next elevator was a challenge, and elderly guests had to be coaxed to get in. That the job has not been done away with over the years, or transformed to retain its essential functions (greeting visitors) while allowing the women to do some useful work, suggests an uncompetitive service sector.