East Asia: From Miracle, to Crisis, to Recovery

Prospects for the Coming Decade

Joseph E. Stiglitz

Asia Vision

Signs of Recovery:Miracle is at the source

• GDP growth rate - fastest in the world (6.5%)• Stable exchange rate• High reserves• Growing exports• Growing portfolios and private direct investments• Increasing consumption• New job creation• Low and unthreatening inflation (less then 3%)• Rising government revenues• Increasing productivity

GDP growth rates in 1999

6.5

0.12

1.88 2.1

3.69

5.6

2.09

0

1

2

3

4

5

6

7%

GDP Growth Rates in East Asia

-15

-10

-5

0

5

10

15

1996 1997 1998 1999 2000 2001

Indonesia

Korea

MalaysiaPhillipines

Thailand

China

%

Increase in Private Consumption

Increasing Productivity in East Asia

East Asia is Far from Full Recovery• Need to look beyond just exchange rates and financial

variables to “real economy”• Overall, real wages have not recovered, and unemployment

remains higher than before the crisis• Many people pushed into poverty

– Crisis caused increase in poverty by 13 million ($1 a day standard)• 10 million in crisis affected countries, and 3 million in China

– Using $2 a day standard, more than 30 million were pushed under the poverty line

– Increased poverty (under $1 day) by 18% in non-China East Asia

• Thailand, the most faithful follower of IMF programs, still has not recovered to 1997 levels, and almost 40% of loans are still non-performing

From Crisis to Recovery

• Two competing interpretations– IMF diagnosis was correct; countries undertook

necessary medicine, recovery followed, once again confirming the wisdom of the doctor

– IMF diagnosis was widely off the mark, the recovery was based on the long standing strengths of the region and addressing specific weaknesses, and the quick recovery was due more to countries departing from IMF prescriptions

Support for the Second Interpretation:IMF Misdiagnosed

• Although weaknesses needed to be addressed,

• IMF diagnosis was unconvincing:– The problem was not exclusively one of transparency

• Many countries with less transparency and weaker financial institutions did not have crises

• Last set of crises had occurred in Scandinavia (among most transparent of countries)

• Most of problems (e.g. excessive leverage of Korean firms) were well known

– Diagnosis of fundamental structural weaknesses was incorrect• weaknesses, if fundamental, could not have been corrected quickly;

recovery would not have been as rapid as it has been

IMF Misdiagnosed (continued)

• IMF allegation: lending by weak banks under corrupt crony capitalism

• Marginal lending by western banks, presumably without government intervention, was based on sophisticated risk management analyses

• Bad borrowing as much the fault of the lender as the borrower– Every loan has both a borrower and a lender– Basle risk adequacy standards contributed to short

term lending– inadequate regulation of Japanese banks played a role

Recovery is not Evidence that Prescription/Diagnosis was Correct

• All downturns come to an end• Question - Was duration and depth of crisis longer than

necessary?• Post Hoc, Ergo Propter Hoc• Recovery not attributable to IMF programs

– Malaysia, without IMF program, recovered as fast or more quickly than those with IMF programs

– Korea’s success can be attributed to its departure from IMF prescriptions in key ways

• Recovery is testimony to fundamental underlying strengths of Asian economies

Reasons for RecoveryThe Miracle was Real: Underlying strengths that

had led to the Miracle• Principle of shared growth• High investments in human capital

– Low inequality in education (which reinforced low economic inequality)

– Investment in technical training

• High Savings and Investments– Sound macro-economic policies

• Leading to less economic volatility—fewer recessions-- than elsewhere • Openness to foreign technology• Promotion of specific industries• Export push• Strong entrepreneurship and management

High Savings Rates

0

510

1520

25

3035

40East Asia

ECA

OECD

LAC

MENA

South Asia

Africa

%

Science and Engineering Students in 1994

(% of total tertiary students)

0

1020

3040

50

60%

Asia and the New Economy

• There is a new economy

• The attributes that contributed to Asia’s initial growth are enabling it to take take full advantage of the new economy

• Taking advantage of the new economy can allow East Asia to achieve full recovery

The New Economy• The new economy and old economic laws

– Despite major changes in the way economy operates,• some of the old economic laws still relevant (scarcity)

• but may need new laws since knowledge and information, which are at the heart of the new economy, are fundamentally different from conventional commodities

• The changing structure of the new economy– weightless economy

– manufacturing declining, services increasing (change as dramatic as change from agriculture to industry)

– In United States - As a percentage of GDP, manufacturing went from 27% to 17% in 1959 and 1996 respectively; service went from 9% to 20% in 1959 and 1996 respectively.

The New Economy (continued)• Improved performance of the economy

– increasing productivity due to using new technologies

• Increasing the pace of innovation itself– lower fixed cost of innovation

– institutionalized innovation

– “mechanized” innovation

– more rapid dissemination of new ideas due to new technologies

• End of the business cycle– Fluctuations reduced (not eliminated); shocks will happen

– Better control of inventories

– Decreased importance of sectors that relied on inventories

• Lower unemployment without inflation– increased competition as a result of better information

– increasing wages matching increasing productivity

What is Required to Succeed in the New Economy

• Innovativeness

• Ability to adapt quickly to new technologies

• Entrepreneurship

• Flexibility

• Competition

Key to successful economies in the new economy

• Entrepreneurship– A willingness to accept risk—and failure—on

all parts, including• Capital markets that supply funds (e.g. venture

capital) to new risky ventures—going beyond deal-making involving rearrangement of existing assets

• Workers that are willing to accept risk

– A respect for, and a willingness to accept, innovativeness

Keys to successful economies in the new economy (continued)

• Flexibility

– Flexible labor markets• No life-long jobs

• Life-long employability

– Requires life long learning

• Education system that teaches the ability to learn

• Safety nets for those displaced in the process of change

– Flexible capital markets

– Flexible product markets

– Flexible governments• Supporting innovation

• Instead of suppressing innovation with oppressive bureaucratic regulations that divert attention from innovation and inhibit the establishment of innovative firms

Keys to success in the new economy (continued)

• Competition

– A driving force for innovation– Monopolies try to suppress innovation,

threatens vested interests

Asia’s Potential to Succeed in the New Economy

• Demonstrated adaptability and flexibility• Highly competitive structures• Large numbers of highly educated individuals, especially

in technology and science • High levels of entrepreneurship • Strength is broad based, reflected in high levels of

literacy• Compared to many other countries, the lower levels of

inequality suggests less danger of a growing digital divide and more broad-based participation in the new economy

Asia’s Competitive Advantage in the New Economy

• Technology is becoming increasingly crucial to keeping business relevant - and competitive - in the new economy

• East Asia is the world’s largest producer of electronics hardware

• East Asia must leverage its competitive advantage in hardware production (as market for technology products will likely continue to increase)

• While increasingly applying the new technologies to boosting domestic economy efficiency

Electronics Production

High-technology exports (% of manufactured exports) in 1998

0

5

10

15

20

25

30%

In aggregate, East Asian economies recorded a trade surplus of $1000 billion in electronic goods in 1999, up $15 billion from 1998, while the rest of the world registered a deficit of more than $160 million

IT ands Telecommunications

East Asia needs to increase application of new technologies

Internet Hosts (per 10,000 people):

0 5 10 15

East Asia

ECA

LAC

MENA

South Asia

Africa

1998

1997

1996

1995

1994

China’s Short-Run Prospects Today

• 10% annualized growth rate between 1999 and first quarter of 2000

• Growth will likely ebb to a 6% pace over the remainder of the year, with an estimated growth rate of 8% for the year

Multiple Challenges Facing China Ahead

• Some easy, or at least, well understood

• Others, not as easy, just coming to the fore

The “Easy” Problems• There is the danger that the “old economy” will try to suppress the

new

• The relative importance of the old SOEs will continue to decline in the new economy

• There are weaknesses in the financial system, of which the government is well aware, and is taking actions to address

– Can they be effective unless the problems of the SOE’s are addressed?

• There is insufficient focus on developing the domestic economy, as well as the traditional “export orientation”

– In which a vibrant private housing sector can play a key role

• Restructuring the economy will require– creating a national labor market, enabling free mobility within the country

– a national safety net, e.g. national social security (pension system)

The Harder Problems• China is simultaneously going through transition and development. It can see the pitfalls on all sides:

The breakdown of social capital in the economies in transition

Evidenced by public corruption and mafia-like private activities

Environmental degradation

• Will China be able to avoid these pitfalls?• Will it be able to move from rural based development to

urban development?• In the process, creating “livable cities”? E.g. cities in

which public transport will play a more important role than in most other cities of comparable size

Questions Remaining:• Throughout the transition/development process, China

has been able to maintain broad national consensus on reform, precisely because there has been broad participation in the benefits. Will China be able to maintain the social consensus?– By ensuring that the fruits of reform are shared broadly

including among the poorest regions of the country and the poorest within each region

• Can the political system adapt to the demands of the new economy?– Maintaining an innovative society requires openness and

flexibility that “old line” bureaucrats feel uncomfortable with

Concluding Remarks• Asia Miracle was real and based on real strengths

• All market economies had fluctuations - what is remarkable is how stable East Asia has been

• All market economies have weaknesses - what is remarkable is the resolve with which so many are being addressed

• Asia is poised for a full recovery, partly based on taking full advantage of the new economy

• And looking beyond, China and East Asia are poised for a second generation of the Asia Miracle