Success and failure in the world’s most dynamic region

How Asia Works” is a book written by Joe Studwell describing the economic history of Asia and highlighting the differences between the various economic policies that led to either development success or failure. Indeed, Northern and South Eastern Asia both experienced several decades of double-digit economic growth, triggering increased interests throughout the last 50 years and fueling talks of a coming ‘Asian Century‘. But the Asian Financial Crisis of 1997 brought a different reality: while North Asia held on and has now reached the status of ‘developed country’, South East Asia remains stuck between poor and middle income traps.

To explain the mechanisms behind this divergence, Joe Studwell bases his analysis on 3 ‘basic’ steps of sustainable economic development toward the status of developed country: successful agricultural reform, export oriented manufacturing, and financial control. He then proceeds to describe how Japan ‘discovered’ this sequential development path by studying the German and American economic development histories. But Japan didn’t follow a script: instead, it tinkered with various ideas, doing more of what works -and less of what doesn’t. It may sound easy, but so far only a handful of countries have succeeded into growing from developing to developed nation status.

Starting with the Meiji era, and then again after the Second World War, Japan paved the way for an entire continent’s growth model, one that was widely envied but not always followed. Indeed, South East Asia’s development path shows quite a different process -and result-, which can be summarized as follow: wrong headed economic orthodoxy and political capture by elites.

For countries to develop, the first step is to reform agricultural land, where the lion share of the people are employed. Economic history shows that only the egalitarian redistribution of land from large landowners to small peasants allows the increase in productivity gains necessary to increase food production, triggering both a decrease in food imports (which weight heavily in countries’ foreign exchange reserves) and an increase in demand for domestic manufacturing.

In East Asia, the threat of communism forced governments to enact land distribution among the population, and until the late 1950’s international institutions such as the World Bank and the IMF supported such policies, successfully seeding the success of East Asia. But rapid ideological changes occurred in these institutions, and when South East Asia’s turn came only a few years later, they turned their back on land reform while powerful local families fiercely blocked such developments to these days.

However, agricultural reforms help increase the overall wealth of the country, and once it reaches a critical stage (a sizable increase in food production, decrease in food imports and overall wealth increase), the second step is the creation of an export oriented manufacturing sector in which world markets are used to assess domestic manufacturers ability to compete internationally by providing invaluable information as to their actual competitive advantage while increasing foreign reserves and allowing countries to rapidly increase their technological know how. Once again, a clear divide can be drawn between protectionist, export-oriented, government supported industries in North Asia, and domestic oriented, monopolistic and foreign technology dependent South East Asian companies.

The third step is to keep financial institutions under tight government control to support the policies described above. Firstly, banks must be forced to lend to farmers and finance infrastructures that may not necessarily yield attractive returns but will strongly support the country’s development. Then during the push toward manufacturing, banks must provide funds to companies able to show export contracts, pushing them to compete internationally and weeding out less competitive structures.

Financial institutions should also be forced to take on severe losses if necessary. These losses are paid by the household sector through repressed interests rates that allow banks to earn a margin large enough to cover their debt over the long term. In addition, the rapid economic development allows all sectors of the economy to expand a pace above the growth debt, effectively covering potential losses. This implicit deal lasts only as long as the economy invests into productive assets, but usually countries first undergo massive malinvestments (with resulting debt crisis) before the financial sector is finally reformed.

But above all, financial resources must be allocated to support the country’s development. Indeed, in South East Asia, the lack of implementation of the 2 first step didn’t generate sustainable economic development, even in countries were the banking sector was kept on a short leash. On the other hand, countries that succumbed to the free market economic school liberalized financial institutions, who, instead of supporting national development, went on to more lucrative consumer credit and fueled real estate bubbles throughout the region, wrecking economies without producing long term value.

Finally, Mr. Studwell closes with the case of China, evaluating how the country performs in light of the above policies. While praising the incredible development of the last 30 years, Mr. Studwell goes on to explain that the only factor setting China apart in terms of economic development is… the sheer size of the country. Indeed, the Chinese development model shows no major breakthrough compared with previous cases such as South Korea or Japan, who both reinvented manufacturing processes and established new world standards.

China’s main difference is that is significantly blurred the lines between private and state ownership, making those companies focusing on governmental projects instead of private ones or consumer goods, thus significantly limiting its market prospects, profit margins, and increasing mistrust of foreign governments. Another drawback is that state-led upstream monopolies are squeezing downstream private companies, severely constraining their ability to grow into world leading companies. In fact, the 2 speeds approach devised by the Chinese government delivered rapid growth rates but it remains to be seen whether it will actually deliver the long term wealth targeted.

How Asia Works is thus a formidable work, allowing us to understand economic development not only in Asia, but also in the rest of the world. It is also a powerful, fact based blow to the dominant economic orthodoxy claiming that free markets and rapid deregulation are the basis for economic development. Instead, economic history proves that active government support is the key driver to canalizing entrepreneurs’ energy and thus fostering national development.

The IMF and the World Bank, even though they actually were at the root of East Asia’s success through agricultural reforms described above (and whose advices were subsequently politely ignored), quickly shifted toward market-oriented policies that have proven to be wrong all along (including in other parts of the developing world such as Latin America or Africa). South East Asian countries who applied the policies of international institutions are today in a quagmire from which there is little chances of exit because of both external (the West) and internal pressures (vested interests feeding on monopoly rents created by deregulation policies enacted to… get rid of governmental monopolies in the first place). East Asian countries, on the other hand, nodded affably when these institutions were blaming them and showing them the ‘right way’, but focused on government led development that showed successful results.

Joe Studwell thus brings powerful, empirical and accessible historic lessons to the policy debate for developing countries around the world, and allows us to draw an easy framework with which to analyze economic development that deviates sharply from theoretical, ideological and non-empiric economics.

How Asia Works Cover

Written by Carlito, with help from Ludo and Steve

About Carlito Riego

"Great perfection may appear imperfect, but its usefulness is inexhaustible. Great abundance may appear empty, but its usefulness cannot be exhausted. Great correctness may appear twisted, great skills appear crude, great eloquence appear awkward. Activity conquers cold; inactivity conquers heat. Clear serenity governs the world." - Lao Zi