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The Myth Of Asian Success

With the 2008 financial crisis, the East has shown increasing confidence that their system is superior than the West - Societies that accepted strong, even authoritarian governments and were willing to limit individual liberties for the sake of achieving overall net social gain would eventually perform economically better than the increasingly chaotic societies of the West.

Before turning to Asian growth, it may be useful to introduce the concept of growth accounting and review some important pieces of economic history. Economic expansion can be derived from two sources of growth: (1) increase in inputs - increase either the number of labors and/or the stock of physical capitals, (2) increase in productivity - can be achieved from optimizing the workforce via some sort of internal and/or external motivational system and/or from a more fine-tuned economic policy in the near term, however, in the long run, the increase in productivity will be primarily driven by technological advancement.

Now, let's turn to the example of rapid Soviet economic growth about six decades ago. It was one of the wonders of the world. Official soviet growth numbers were consistently being criticized and questioned. Nonetheless, Soviet claimed that the astonishing achievement was fully justified. Its economy was achieving a growth rate of twice as high as that attained by any important capitalist country over any considerable number of years and three times as high as the average annual GDP growth rate in the US by the early 1970s. When economists began to study the growth of the Soviet economy by using growth accounting, they actually found that Soviet growth was based on rapid input growth, rather than productivity growth. By some estimates, the productivity growth was almost nonexistent. The Soviet moved millions of workers from farms to cities, pushed millions of women into the labor force and millions of labors into longer hours, pursued massive educational programs, and plowed the ever-growing industrial output back into the construction of new factories. Soviet rapid expansion did eventually come to an end.

It is hard to see anything in common between the Asian success story of the recent years and the Soviet story six decades ago. Indeed, it is safe to say that a typical business traveler flying into Singapore's remarkable harbor with thousands of cargo vessels in endless lines off the coast or a typical business traveler walking into an unbelievably crowded mall in Shanghai, never even thinks of any parallel to its roach-infested counterpart in Moscow six decades ago. How is this Soviet example relevant to the modern world? Yet there are surprising similarities. The high growth countries in Asia, like Soviet Union of the 1950, have achieved rapid growth in large part through an astonishing mobilization of resources, rather than by gains in productivity.

Asia has been growing through mobilization of resources, in particular in countries like China and Singapore. Some statistics show that productivity growth in Singapore has been flat in the past few decades. Of course, Singapore today is far more prosperous than the Soviet when it was at its peak, because Singapore is closer to, though still below, the productivity of Western developed counterparts. The point, however, is that Singapore's economy has always been relatively productive by Asian standard, it was just starved of capital and educated workforce to further uplift its economic growth.

Singapore's case is admittedly the most extreme. Other rapidly growing Asian economies have not increased their labor force participation as much, made such dramatic improvements in education systems, or raised investment rates quite as far. Nonetheless, the basic conclusion is the same - there is little evidence suggesting improvements in productivity.

What about Japan and China? Japan, unlike the East Asian tigers, seems to have grown both through high rates of input growth and through high rates of productivity growth. Today's fast growing economies are nowhere near converging on the US productivity levels, but Japan is staging an unmistakable technological catch-up. However, for China, it is still a relatively poor country by GDP per capita standard. Its population is so huge that it will become the next economic power if it achieves even a fraction of Western productivity levels. And China, unlike Japan, has in recent years posted truly impressive rates of economic growth. Back to growth accounting, it is unclear what year to use as a baseline for the growth assessment in China. If one measures Chinese growth from the point at which it made a decisive turn towards the market, say 1978 Mao Zedong's later years, there is little question that there has been dramatic improvement in productivity as well as rapid growth in input. If one measures growth from before the Cultural Revolution, say 1964, the picture looks more like the East Asian "tigers" - only modest growth in productivity, with most of its growth driven by input growth.

If growth in Asia is indeed running into diminishing returns, it is likely that growth in Asia will still continue to outpace the growth in the West for the next decade and beyond even without much productivity growth, however, it will unlikely to grow at the pace of recent years. Going forward, the next priority on the list for Asian countries is to focus more on the long term sustainability of their economies, rather than the short term gains. To achieve this, investments in education, infrastructure, renewable energy, social security, and higher-value industries will have to be increased. The good news is, the technology that is required to drive these areas could be transferred easily across borders, and that newly industrializing nations are increasingly able to match the productivity of more established economies in a much shorter period of time. However, the future productivity for the later group remains questionable.

If there is a secret to Asian success story, it is simply the willingness to defer its gratification to secure better future. This has so far worked very well within the input growth oriented economies. However, by replicating the similar growth strategy with limited productivity growth will prove to be challenging in the long run in Asia.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.