02 Apr 2013

New research on 16 Asian economies finds role of total factor productivity in their stellar economic performance

Twodecades after their track record of spectacular growth first drew widespread scrutiny, even comparisons with Soviet-style mobilisation of resources, Asian nations continue to outpace other regions in economic growth.

Now new studies by an economist in Singapore have found that, contrary to earlier assertions, the growth streak, particularly in more recent years, has been driven by inspiration as well, not just perspiration.

In the mid-1990s, studies of the remarkable economic catch-up by the four Asian tiger economies (Hong Kong, Singapore, South Korea and Taiwan) between 1965-1990 concluded that their rapid output growth had been almost entirely input-driven, fuelled by intensive build-up of capital in particular.

Interestingly, TFP gains became the most important source of growth for South Korea and Taiwan between 1990 and 2010, according to Prof Vu.

Efficiency gains or improvements in total factor productivity (TFP) apparently contributed little, if at all, to their growth. This led to a blunt dismissal of the East Asian growth model in a famous 1994 paper by Paul Krugman, The Myth of Asia's Miracle. The miracle of Asia's extraordinary growth surge was but a flash in the pan, based on perspiration rather than inspiration, said Prof Krugman. He noted that Singapore, in particular, had grown through a mobilisation of resources that would have done Stalin proud.

Pattern of growth

Miracle or not, new research on economic growth in Asia by an academic at the Lee Kuan Yew School of Public Policy in Singapore, Vu Minh Khuong, has unearthed the secret in the region's stellar economic performance. This secret lies not in achieving superior TFP growth but in sustaining reasonable TFP growth rate in spite of rapid capital accumulation over extended periods, he told BT.

The assistant professor's studies cover 16 economies over the two decades from 1990 to 2010. The economies are the two giants China and India; the four tiger economies; six Asean countries (Cambodia, Indonesia, Malaysia, Philippines, Thailand and Vietnam), and four South Asian nations (Bangladesh, Nepal, Pakistan and Sri Lanka).

What Prof Vu found is that the four tiger economies' early pattern of capital-driven growth is now seen prominently in Asia's emerging economies, especially China and India.

From just 4 per cent in 1990, China's share in the world's capital investment surged to 29 per cent in 2010. Over the same period, its share in global GDP (gross domestic product) grew from 4 per cent to 14 per cent.

India has seen a similar, if less striking, pattern: Its share in the world's capital investment rose from 3 per cent in 1990 to 7.5 per cent in 2010, while its GDP share doubled from 3 per cent to 6 per cent over the two decades.

High capital accumulation would typically spell diminishing returns on efficiency. But what Prof Vu found was that, despite the high capital inputs, TFP's contribution to growth in most of the 16 Asian economies was notable during 1990-2010, and indeed improved in the second decade.

In fact, interestingly, TFP gains became the most important source of growth for South Korea and Taiwan between 1990 and 2010, accounting for 49 and 43 per cent, respectively, of their GDP growth, Prof Vu noted.

This implies that growth of these two economies has been driven more by efficiency improvements and technological progress in the past two decades, he said.

Singapore, however, is a notable exception to the trend: Its TFP share of GDP growth remained a paltry 1.7 per cent during 1990-2000, though it did improve to 15.2 per cent in the following decade.

Prof Vu, who is from Vietnam, also found that the 1997 Asian financial crisis seemed to have resulted in transformational effects on the most affected economies Indonesia, Thailand, Malaysia, Philippines and the tiger economies.

I found robust TFP growth in the most affected economies in 2000-2010 compared to their performance in 1990-2000, he told BT. For example, the share of TFP in GDP growth increased from minus 9.7 per cent in 1990-2000 to 22 per cent for Indonesia, from 13.1 per cent to 36.6 per cent for Malaysia, and from 3 per cent to 30.6 per cent for Thailand.

In contrast, the Asean countries that were not hit by the crisis, such as Vietnam and Cambodia, in fact saw a marked worsening in TFP growth.

Vietnam's share of TFP in GDP growth plunged from about 34 per cent in 1990-2000 to 2.3 per cent in the following decade; for Cambodia, its TFP share fell from 14.6 per cent to 3.2 per cent.

The better TFP showing in the crisis-hit countries implies that these economies have significantly enhanced their growth efficiency in the post-crisis period, said Prof Vu. He attributed the improved growth efficiency to reforms and mindset changes with transformational effects.

The investor and the government have become more diligent in making investment, he said, pointing to notably lower rates of fixed investment as a percentage of GDP for the most affected economies in 2000-2010 compared to the preceding decade.

The governments in these countries have carried out serious reforms to liberalise the economy, improve business environment and build macroeconomic resilience, Prof Vu said.

The crisis, he added, has induced both government and private sector to engage more proactively in speeding up structural change, which shifts resources from lower productivity sectors and users to higher ones. Prof Vu who had had industry experience as a CEO and as an economic adviser to a mayor in Vietnam before his academic career cited the Thai automotive industry as a vivid example of this dynamics. Post-Asian crisis, the Thai government lifted a restriction on foreign-majority ownership in automotive firms and encouraged foreign direct investments, steering the industry from domestic sales to export-driven growth.

Prof Vu's research findings are being published in a book titled The Dynamics of Economic Growth: Policy Insights from Comparative Analyses in Asia, expected out on the shelves in a few months. The book delves into the surprise, speed and scale of Asian growth and identifies common elements in the economies' successful growth strategies.

The recipe for achieving sustained high economic growth is simple and not new, said Prof Vu. It consists of policy initiatives and priorities along three strategic directions: exploiting the country's backwardness; upgrading the absorptive capability; and creating favourable conditions for investment, structural change and efficiency improvements.

Emotion and enlightenment

In embracing openness, efforts should be focused not only on promoting exports and attracting foreign investments but also on importing new ideas and technologies, he said.

Upgrading the country's absorptive capability calls for a comprehensive effort in building human capital that should include promoting innovation, he said.

Not least, the vision, strategic intent and commitment of the country's leaders in charting its future is key.

As a nation embarks on an economic catch-up endeavour, it should first check up its two drivers of a great development process: emotion and enlightenment, said Prof Vu. Emotion implies its aspiration, anxiety and a sense of responsibility for the country's future, while enlightenment is associated with its freedom of ideology, mindset openness, eagerness to learn. These two drivers can be considered as the two wings of a bird. If they are not strong enough, a nation cannot fly high in its economic catch-up endeavour.

And given his findings about the Asian economies' sustained TFP gains, in this spirit, for a developing country, especially when its income is still low, 7-10 per cent GDP growth with 1-1.5 percentage points contributed by TFP is preferable to 4-5 per cent GDP growth with 1.5-2 percentage points from TFP, he said.

That's because of the very low capital stock per capita in most developing countries. For example, relative to the United States, capital stock per capita in 2010 was 3 per cent for Cambodia, 8.4 per cent for India, 9.7 per cent for Vietnam, 18.3 per cent for Indonesia, and 29.6 per cent for China, he noted. Therefore, fostering rapid capital formation is an effective way for these countries to speed up their economic catch-up.

But a country should review its growth strategies if its TFP growth is experiencing a marked decline, such as in the cases of Vietnam and Cambodia during 2000-2010, he added.

While these lessons are most relevant to lower-income countries, there are pointers for the richer economies as well.

One key takeaway is that the government needs to pay special, strategic attention to sustaining high capital rates of return for the entire economy while making every effort to promote investment, said Prof Vu. And this would call for an effective development strategy to open up the economy, upgrade and foster structural change.

This piece was published in Business Times on 23 July2013.