A search for robust East Asian development models after the financial crisis: mutual learning from East Asian experiences

A search for robust East Asian development modelsafter the financial crisis: mutual learning from

East Asian experiences�

Choong Yong Ahn*

Chung-Ang University, Seoul 156-756, Korea

Received October 2000; received in revised form April 2001; accepted May 2001

Abstract

The purpose of this paper is to search for new robust East Asian economic development modelsfollowing the financial crisis. Specifically, this paper addresses both robustness and sustainability ofKorea’s Chaebol-led model, Taiwan’s SMEs-led model, and Malaysia’s FDI-led model, respectively.East Asia’s new development paradigm can be reformulated not only by adopting and learningadvanced financial innovations of global standards in the framework of Gershenkron’s “advantages ofbackwardness,” but also in the concept of “mutual learning” from both strengths and weaknesses ofdevelopment models of the three countries. East Asia has neglected too long some inherent wisdomsthat are contained in its “miracle models,” yet it shows that their different paths to development maylead to a positive policy convergence. © 2001 Elsevier Science Inc. All rights reserved.

JEL classification: O53; O16; O19; F34

Keywords: Industrial development; Asian financial crisis; Chaebol; FDI; SMEs; Mutual learning; Advantages ofbackwardness; Asian values

� An earlier version of this paper was presented at the 23rd ACAES International Conference in Seoul on “ThePost-Financial Crisis: Challenges for Progressive Industrialization of Asian Economies,” Hoam House, SeoulNational University, December 15, 1999. The author wishes to acknowledge the suggestions of anonymousreferees and Peter Nelson. Responsibility for any errors remains with the author.

* E-mail address: [email protected]

Journal of Asian Economics 12 (2001) 419–443

1049-0078/01/$ – see front matter © 2001 Elsevier Science Inc. All rights reserved.PII: PI I0885-2006(01)00095-1

1. Introduction

After decades of seemingly endless growth, some high performing economies in East Asiacame to an abrupt standstill and faced a serious economic crisis. What began as a subregionalfinancial problem sparked by the massive devaluation of the Thai baht on July 2, 1997,quickly spread throughout East Asia to encompass Indonesia, Malaysia, Hong Kong, Phil-ippines, and South Korea. During the following two years, these economies experiencedsome record downfalls. However, Taiwan, and to a lesser extent Singapore, were littleaffected by the financial turmoil during the crisis period.

Given its sound macrofundamentals, South Korea (hereafter Korea) at first was thought tobe free from the regional contagion effect. Yet less than 1 year after its acceptance withinOECD, it experienced its most severe economic crisis since the Korean War.1 With itsreadily available foreign exchange reserves nearly exhausted by early December 1997,Korea, after Thailand and Indonesia, received a record emergency assistance package fromthe International Monetary Fund (IMF) to avoid a moratorium on its foreign debt. It alsoagreed upon a dutiful implementation of stringent IMF conditionality.2

According to the East Asian Miracle report by the World Bank (1993), the group of eightEast Asian countries that include Japan, Korea, Taiwan, Singapore, Hong Kong, Malaysia,Thailand, and Indonesia, exhibited the highest growth rates in the world over the period 1965to 1990. These so-called high-performing Asian economies (HPAEs) grew twice as fast asother Asian countries, three times as fast as Central and South American countries, and fivetimes as fast as sub-Saharan countries in Africa. Their ability to combine long-term highgrowth with relatively balanced income distribution gave rise to the term economic “mira-cle.”

During the past three decades or so, the most successful industrializers of the East Asianeconomies have arguably been Korea, Taiwan, and Malaysia, each of them possessing“standard country” characteristics.3 Unlike most developing nations, the three representa-tives of Asia’s newly industrialized countries (hereafter RANICs), even with substantialdifferences in factor endowments and initial socio-economic conditions, have pushed export-oriented development strategies but have adopted highly differentiated microstrategies.

It is noteworthy that the outbreak of the Asian financial crisis in July 1997 affected thethree countries in substantially differential ways. Korea had no choice but to seek from theIMF the largest financial bailout package ever given to a member country. Malaysia alsoexperienced both a drastic fall in the value of the ringgit and its stock price index, but didnot seek IMF financial assistance. Instead, it adopted a capital control policy to preventinternational currency speculators’ activities. In contrast to Korea and Malaysia, Taiwanmaintained its usual growth path, although there was a marginal impact upon its stock andcurrency.

Can the financially troubled East Asian nations overcome the ongoing crisis and get backon the fast growth track after successfully restructuring their economies? Or, have Korea andother crisis-hit Asian countries finally reached their growth limits? To address these ques-tions, this paper will examine a robust East Asian development model following the financialcrisis. Specifically, there are three objectives: a) to review why the financial crisis hashappened in East Asia; b) to suggest that the troubled East Asian economies adopt not only

420 C.Y. Ahn / Journal of Asian Economics 12 (2001) 419–443

advanced financial innovations, but also “mutual learning” from both robustness and sus-tainability of the development systems adopted by the RANICs; and c) to suggest a newdevelopment paradigm to ensure sustained development in the 21st century. This will be donewithin the framework of Gershenkron’s “advantages of backwardness,” and by applying theconcept of the “mutual learning effect” concerning relative strengths and weaknesses ofdevelopment models of the three successful industrializers.

The organization of this paper is as follows: Section 2 considers some hidden butaccumulated weaknesses of East Asian economies, and some immediate causes for theirabrupt downfalls. Section 3 describes major distinguishing development features of the threerepresentative economies in East Asia. Section 4 addresses what East Asia’s troubledeconomies should learn from the global standard practices of advanced financial systems.Section 5 suggests what the East Asian economies can mutually learn from their respectivedevelopment models in the wake of financial crisis. Section 6 concludes with regionalimplications of newly emerging development models of the RANICs, and highlights thenecessity for organized regional cooperation in East Asia.

2. Accumulated weaknesses and shallow finance underlying theEast Asian “miracle”

Challenging the World Bank’s “East Asian Miracle” report, Krugman (1994) argued thatEast Asian economic growth was input-driven, that is, fueled mostly by the mobilization oflarge amounts of labor and capital, rather than by gains in efficiency. Because there is anatural limit to the accumulation of inputs due to diminishing returns, an economy relyingon the mobilization of inputs, without gains in their efficiency, would necessarily reach alimit to its growth. In this case, the label “miracle” is misplaced, since there is nothingmiraculous about economic growth based on factor accumulation.

Krugman’s argument is based on neoclassical growth theory, which postulates thateconomic growth is determined by inputs of capital and labor as well as gains in total factorproductivity. It is the last element that allows economic growth to continue, even afterdiminishing returns take effect, and thus provides a measure of efficiency. In sum, Krugmanargues that East Asia’s economic development is nothing extraordinary in the absence ofefficiency.

In the early stage of economic development, rapid economic growth can be achieved byutilizing well-established technologies from advanced countries, taking the “advantages ofrelative backwardness” as theorized by Gershenkron (1966). Investments in education alsomake high returns to capital possible in the initial stages of economic development. As aneconomy accumulates capital and achieves some economies of scale, returns from factors ofproduction begin to diminish.

This trend is clearly visible among East Asia’s high performing economies over the pastthree decades. As shown in Table 1, GDP growth of the RANICs has fallen respectively eachdecade while investment ratios of GDP have risen rapidly, with the notable exception ofTaiwan. As a result, the respective incremental capital output ratios (ICORs) of Korea andMalaysia have increased substantially over this period, although Taiwan’s ICOR has almost

421C.Y. Ahn / Journal of Asian Economics 12 (2001) 419–443

stabilized at a low level relative to those in the other two countries. The steeply rising ICORsof the RANICs indicate that the use of capital has become increasingly less efficient. In thiscontext, both Korea and Malaysia incurred increasing investments in capital-intensiveprojects with long gestation periods, leakages and initially underutilized capacity. Hence thelaw of diminishing returns emphasized by the neoclassical growth model seems to work inEast Asia in varying degrees.

Despite declining capital and labor productivity, the RANICs had achieved high growthrates using relatively sound macroeconomic fundamentals. However, in contrast to Taiwan,why did Korea, and Malaysia suddenly run into such an unprecedented economic crisis? Ananswer to this question can be found when reviewing the different growth models of thesecountries.

Korea’s “compressed growth model,”4 which was a seemingly effective and winningstrategy until the early 1980s, proved to contain some serious flaws. Fragilities and lax rulesin Korea’s financial sector meant that large amounts of financial resources, including foreigndebt, were misallocated to the government-initiated heavy and chemical sectors in order toobtain “compressed growth.” Corporate financial structures were also very weak, which ledbanks to accumulate a large amount of bad loans. Thus the rate of nonperforming loans offinancial institutions reached as high as 20%. Finally, the increased difficulty in rolling overexternal debt, mainly of the short-term variety, sparked the financial crisis in Korea.

The Malaysian economy also appeared robust at first, with high growth, low inflation,virtual full employment, and low foreign debt. However, the Malaysian banking system hadsimilar weaknesses as Korea’s financial system. Athukorala (1999) reports that a massiveaccumulation of outstanding domestic credit, and heavy exposure of Malaysian banks to realestate, construction and share trading, had taken place. During the early and mid-1990s,Malaysia built up the highest credit among the countries in East Asia, but with inadequatelysupervised and managed credit worthiness-based lending. Much of the expanded banklending to the property sector had taken the form of “connected lending,” rooted in thelong-standing intimate link between the government and business as part of the strategy ofrestructuring business ownership under its New Economic Policy.5

Given East Asia’s relatively strong macroeconomic trends until early 1997, the suddenfinancial crisis was a surprise to analysts. Long-standing strengths such as sustained growth,moderate inflation, high savings, acceptable external deficits and large government financial

Table 1Economic growth rate, investment ratio and ICOR of Korea, Taiwan, and Malaysia

Period Annual GDP Growth Rate(%) Investment Ratio (%) ICOR (number)

Korea Taiwan Malaysia Korea Taiwan Malaysia Korea Taiwan Malaysia

1970s 9.3 10.2 8.4 27.7 29.6 24.8 2.98 2.90 3.101980s 8.0 8.1 5.7 30.1 23.9 30.5 3.76 2.95 5.351990s 5.8 6.2 6.9 35.9 23.3 38.0 6.19 3.76 5.51

The ICOR was derived by dividing the average share of gross domestic investment in GDP by the growth rateof GDP.

Source: Government of Japan, Economic Planning Board, Asian Economy, 1999, p. 310 and 320 and AsianEconomy 2000, pp. 292 and 302.


surpluses, had lulled foreign investors and regulators into complacency. Moreover, theireconomies had maintained growth of about six percentage on average through most of 1997,despite large trade deficits. Yet the economies of Korea and some ASEAN membersunderwent sudden and dramatic downfall, as shown in Table 2.

In the case of Korea, some positive macroeconomic factors obscured the dichotomybetween a strong real economy on the one hand, an excessively-indebted corporate sector andweak profitability, and a poorly-supervised, shaky financial system on the other.

The second generation of NIEs (Malaysia, Indonesia, Thailand) has also suffered fromboth structural problems and a cyclical downturn. Particularly since the early 1990s, theselatecomers have been adversely affected by the new competitive forces stemming fromabundant low wage labor in China,6 the large competitive devaluation of the Chinese yuanand the severely weakened Japanese yen, leading to a serious deterioration in their balanceof payments.

Prior to the economic crisis in 1997, a substantial portion of foreign capital inflow into theregion took the form of low interest yen-based funds.7 In addition, the financial authoritieseven encouraged the inflow of “hot” money to take advantage of its low interest rates relativeto long-term capital, and a substantial portion of these funds ended up financing unprofitableinvestment projects. This large inflow, as high as 40–50% of GDP between 1995 and 1996,helped create a real estate and stock market bubble in Thailand, Indonesia and Malaysia, inwhich prices rose 50% to 100% over a 3- to 4-year period. Since August 1997, however, realestate prices have fallen by 20% to 40%.

The large investments designed to maintain high growth raised additional demand forimported facilities, parts and components, which further expanded current account deficits.At the same time, most of these countries were managing their currencies under a fixedexchange rate regime or within a managed floating system (Kawai, 1998). The large inflowsof capital under a rigid exchange rate system then led to a monetary expansion in theireconomies. After 1995, the Japanese yen began falling from a high of 79 to nearly 140 yento the dollar in June through August 1998. Because they moved mostly with the dollar, the

Table 2GDP related indicators, foreign exchange reserve, and stock market capitalization

Country GDP perCapita in1996 (US$)

GDP Growth Range per annum Stock MarketCapitalization(US$ Billion)

ForeignExchangeReserve (US$billion)

1970–96(%) 97(%) 98(%) End of 1996 End of 1996

Korea 12,410 8.4 5.6 �5.8 138.8 34.04Taiwan 17,720 8.3 6.3 4.8 273.7 88.04Malaysia 9,703 7.4 7.4 �6.3 307.2 27.00Indonesia 4,280 6.8 5.4 �13.7 99.8 18.25Thailand 8,370 7.5 �0.7 �7.0 80.6 37.73Philippines 3,060 3.6 4.8 0.6 80.6 10.03Singapore 25,650 8.2 7.6 1.5 150.2 76.85China 3,120 9.1 8.9 7.8 113.7 107.48

Source: Annual Reports of IBRD, OECD, and EIU.


East Asian currencies began to appreciate against the yen. In addition, the rapid rise indomestic wages did not help matters.

A serious liquidity problem in East Asia’s crisis economies was also caused by the widemismatch between repayment schedules of short-term borrowings and foreign exchangereserves (Table 3).8 Much of the short-term capital was used to finance long-term projects,with part of it even being used for speculative purposes. As of November 1997, about 67%of Korea’s external debt was short-term, and Korea’s mismatch between internationalliquidity and currency was the most serious among East Asian economies (Table 3).

In short, Korea and some East Asian countries failed to implement appropriate macro-economic policies, especially those regarding exchange rates, and did not effectively managethe flow and use of large amounts of foreign capital. By combining the losing competitive-ness of crisis-hit East Asian economies with inefficient and outdated financial systems andpoor supervision of banks despite increasing financial globalization, crisis seemed almostinevitable.

Summing up East Asian structural weaknesses and rigidities, Krugman (1998) succinctlynotes:9

By now the outline of how Asia fell apart is pretty familiar. At least in part, the region’sdownfall was a punishment for its sins. We all know what we should have known evenduring the boom years: that there was a dark underside to “Asian Values,” that the successof too many Asian Businessmen depended less on what they knew than on whom they knew.Crony capitalism meant, in particular, that dubious investments-unneeded office blocksoutside Bangkok, ego-driven diversification by Korean Chaebols-were cheerfully funded bylocal banks, as long as the borrower had the right government connections.

3. Some characteristics of the RANIC development models

Among the high-performing East Asian countries, perhaps none have provided moreeconomic lessons than Korea, Taiwan, and Malaysia. In contrast to urban state economieslike Singapore and Hong Kong, the RANICs’ experiences have more relevance to economicdevelopment policies of less developed Asian economies.

Table 3Liquidity and currency mismatches as of June 1997 (%)

Country Short-term debt/intern’alreserves

Short-term debt/total debt

Broad money/intern’al reserves

Korea 300 67 620Thailand 110 46 490Indonesia 160 24 620Malaysia 60 39 400Taiwan 1 n.a. n.a.

Taiwan has a short-term debt amounting to only US$ 100 million, which equals total debt.Source: IMF, International Financial Statistics.


3.1. Export-oriented but government-led industrial development

In Table 4, both the rapid growth and export expansion of the three RANICs are shownin comparison with U.S. and Japan. It is easily seen that the high growth rates of East Asianhigh performers are closely related to their phenomenal export expansion.

The rapid industrial development experiences of the RANICs under their export-orientedregimes suggest four sets of policy implications. First, they point to the importance of anexport-oriented industrialization strategy, which in turn requires price stability, high savings,and a realistic exchange rate in macroeconomic management. Second, industrial policy formanufactured exports should be not only flexible to meet the changing environment, but alsoaccompanied by development in finance, human resources, and infrastructure. Third, bothtechnology acquisition and indigenous R&D promotion should be consistently emphasizedto ensure rapid industrial growth. Last, latecomers’ industrial policies in the form of sectorspecific incentives, if applied to the allowable degree in today’s increasingly global envi-ronment, should be disciplined using strict performance criteria.

An overview of the three RANICs’ industrial policy regimes and resulting competitive-ness in an increasingly globalizing world economic order is presented below. Despite theircommon emphasis on export-based industrialization, the three countries have been differ-entiated according to industrial strategies. These primarily include a big business (Chaebol)approach for Korea, FDI-triggered industrial development for Malaysia, and SME-dominantindustrialization for Taiwan. However, except for Taiwan, financial sector development hasnot been parallel with industrial development. Why the RANICs have responded so differ-ently is also considered.

3.2. Korea’s chaebol-led export-based industrialization

Korea has been a representative member of the newly industrialized countries for severaldecades. It is widely agreed that Korea’s modern industrial development has occurred withina unique paradigm of a Chaebol10 dominant but export-based industrialization strategy. Inmany respects, Korea’s development strategies were patterned after the Japanese catch-upmodel with the West since the Meiji era. Indeed, Korea dramatically shortened the usual

Table 4Average annual growth rate of real GDP and export volume

Country Growth rate of GDP p.a. (%) Exports (billion US$)

1984–89 1989–94 1980 1985 1990 1994

Korea 9.8 7.2 17.5 30.3 65.0 96.0Taiwan 8.7 6.2 19.8 30.7 67.1 92.9Malaysia 4.6 8.6 13.0 15.4 29.4 58.8Japan 4.5 2.2 130.4 177.2 287.6 397.0U.S.A. 3.1 2.0 225.6 218.8 396.0 512.5

Source: World Economic Outlook 20-Year Extension, WEFA Group, March 1995, International FinancialStatistics, 1995, 1996, IMF.


phases of industrial transformation that most developed nations took over a century toachieve, and the government was heavily involved in the process of industrial development.Korea’s government-led industrial growth has been accelerated in conjunction with exportexpansion policies, which have blurred the line between industrial and trade policy. The aimof both policies has centered ultimately on enhancing the international competitiveness ofKorean exports.

Unlike in most developing countries, access to basic incentives in the 1960s in Korea wasautomatic and sector neutral for all production and commercial transactions related toexports.11 In the 1970s, the most extensive government intervention occurred by enactingseven special industry promotion Acts.12 These created Chaebols to promote heavy andchemical industries (hereafter referred to as HCIs) in order to upgrade industrial structuresthrough scale economies. The HCI promotion also was significantly motivated by thenecessity to build up national defense capability against potential North Korean aggression,in preparation for the reduction of U.S. ground forces stationed in Korea.

To exploit scale economies, private research and development potential, the Koreangovernment intentionally aided capital formation of the Chaebols as well as subsequentdiversification of their business lines. Government control over policy loans of their financialintermediaries served as the most powerful leverage to tame the Chaebols, in order toconform with national economic goals. As a major shareholder of commercial banks, and asa full owner of special purpose banks, the government provided viable HCIs with almost“unlimited” bank credit, with preferential interest rates, foreign loans, tax credits, accelerateddepreciation allowances and tax holidays. The Korean government then sanctioned Chaebolsto accommodate technologically challenging industrial projects (Kim, 1997) and overlyambitious export goals, and to accomplish them within a planned time frame, inducing aseries of challenging projects for the private sector. As a result, economic concentration ofthe Chaebols increased quickly, as shown in Table 5.

This concentration also affected market structure and brand image. Following intentionalpromotion of Chaebols, their expansion and increase in number created monopolies andoligopolies in major industries. Thus the combination of favorable industrial policy, andentrepreneurship of some dynamic businessmen, enabled Korea to succeed in establishingglobal brand image such as Samsung, Hyundai, Daewoo, SK, and LG, in areas likeautomobile assembly, semiconductors, shipbuilding, iron and steel (Amsden, 1989).

The period between 1986 and 1988 witnessed a sizable current account surplus due tofavorable external conditions, especially low energy prices, low interest rates, and a lowdollar vis-a-vis the yen. Korean policymakers recognized that import liberalization was a

Table 5Chaebols’ value-added share of Korea’s GDP (%)

Rank-ordered groups 1973 1977 1981 1985 1989

Top 10 5.1 10.6 20.4 24.1 22.7Top 20 7.1 13.3 26.3 29.5 26.7Top 30 9.8 16.3 30.8 33.1 29.6

Source: Sakong IL 1993, Korea in the World Economy, p247 and Korea Development Institute Estimates.


good way to bring in competition to protected but stagnant sectors of the economy, and toadjust to the ongoing Uruguay Round negotiations. As a result, the import liberalization ratioof manufactured goods rose from 37% in 1965, to 95.4% by 1988.13 Despite the free traderegime for exports, imports of consumer goods and related expenditures were controlledtightly.

At the onset of industrialization, Korea emphasized the promotion of absorptive capacityas well as indigenization of foreign technology through reverse engineering, while restrictingboth FDI and foreign licensing. As a result, Korean firms were able to assimilate importedembodied technology so rapidly that they managed to undertake subsequent expansion, andto upgrade industrial structure (Ahn, 1988). Formal R&D was not important when imitativereverse engineering was operational.

Owing to the low level of domestic savings during the early stages of industrialization, theKorean government maintained distinctive foreign investment policies, giving preference toloans over direct investment. From 1962 to 1986, the cumulative total of long-term foreigncapital amounted to U.S. $49 billion. Of this amount, commercial loans and borrowings fromdevelopment agencies represented 64.5% and 31.6%, respectively, but foreign direct invest-ment occupied only 3.9%. Korea’s heavy reliance on foreign borrowing to finance itsinvestment requirements is in sharp contrast to Malaysia’s reliance on FDI. Thus, FDI inKorea until very recently played a marginal role.14

Since the mid-1980s, the Korean economy has exhibited the symptoms of “high cost andlow efficiency” in an alarming way. An upward pressure on the general wage level wasintensified by an active labor movement spurred by political democratization beginning in1987, and through an unusual business boom induced by “the three lows” noted earlier. Sincethe end of the 1980s, real wages have outstripped labor productivity to significantly erodeinternational export competitiveness. In addition, infrastructure development has receivedlow priority, while large-scale housing development has been carried out with higherpriority.

In Table 6, the financial position of highly indebted, top 30 Chaebols is compared to thosein the U.S., Japan, and Taiwan. It should be noted that financial leverage of Korean firms wasfour times as high as for Taiwanese manufacturing firms. Faced by a chronic excess demandfor money under a high growth regime, highly leveraged Chaebols incurred financial costsmore than double those of their major trading partners. In order to overcome their financialdifficulties, they expanded and diversified their business lines instead of downsizing.

Korea’s chaebol-dominant industrialization strategy was at one time a winning strategy atthe expense of financial sector development, but it created a repressive financial regime.

Table 6Capital structure of manufacturing (unit: percent)

Korea U.S. Japan Taiwan1996 1996 1996 1995

Equity/total asset 24.0 39.4 34.1 53.9Debt/equity 317.1 153.5 193.2 85.7

Source: Japan, Ministry of Finance, Monthly Report of Budget and Finance, August, 1997. U.S. DepartmentCommerce, Quarterly Financial Report, Fourth Quarter, 1996.


During the “compressed growth” regime, banks in Korea were in effect the “quasi-fiscal”agents of government, providing an oblique mechanism for channeling financial resources toailing industries. A “too big to fail” mentality for both Chaebols and the financial sectorcreated a serious moral hazard, while investment decisions seemed to address the objectiveof increasing only market share and total output more than assuring adequate profitability.Consequently, the growth-oriented Korean model was less suited to face the more global-izing world economy and more integrated capital markets in the 1990s.

3.3. Malaysia’s FDI, export-led industrialization

Malaysia is a resource rich country. When the nation declared independence in 1951, themanufacturing sector accounted for less than 8% of GDP. The economy was heavilydominated by the processing of plantation-type agricultural products, occupying nearly 30%of GDP until the mid-1970s.15 However, as a result of rapid growth in export-orientedmanufacturing, its share of GDP made a quantum jump from 10.4% in 1965 to 33.1% in1995, as shown in Table 7.

In comparison with Korea and Taiwan, Malaysia’s industrial transformation truly standsout. In 1965, although Malaysia’s per capita GDP was more than double that of Korea andhigher than that of Taiwan by 20%, its manufacturing share of GDP was only one half ofKorea’s share, and less than one half of Taiwan’s share. However, the share reached 27% in1990, which was close to Korea’s share of 29%, and finally surpassed both those of Koreaand Taiwan by 1994. These rapid, major structural changes are shown in Table 8. Evenworldwide, Malaysia’s industrialization performance showed the highest points above theinternational average regression line derived by Syrquin and Chenery’s most recent cross-country pattern equation,16 the most rapid industrial transformation in the World Bank’scountry list shown in its World Development Report, 1995.

The manufacturing sector’s share of GDP surpassed that of agriculture in 1987, andmarked a turning point in the nation’s transition towards an industrializing economy.Furthermore, the share of manufactured exports in the nation’s total merchandise exportsjumped from 32.7% in 1985, to 60.4% in 1990. With this rapid expansion, the manufacturingsector contributed nearly half of the increase in the nation’s GDP during the Fifth Malaysian

Table 7Annual growth rates of GDP and industrial structure in Malaysia

1966–70 71–75 76–80 81–85 86–88 89–92 93–95

Growth Rate of GDP(%) 5.4 8.0 8.6 5.2 4.6 8.8 9.0

Share of GDP(%) 1965 1975 1985 1988 1990 1993 1995

Primary 31.5 27.7 20.8 21.1 21.1 16.1 12.8Mining & Quarry 9.0 4.6 10.5 10.6 9.7 8.0 7.4Manufacturing 10.4 16.4 19.7 24.1 26.8 30.1 33.1Construction 4.5 3.8 4.8 3.2 3.6 4.0 4.4Services 44.6 47.5 44.2 41.0 41.3 41.8 42.3

Source: Bank Negara Malaysia, Money and Banking in Malaysia, 1989 and Annual Report 1995.


Plan period of 1986 to 1990 (Ahn, Hong, & Kim, 1992). At the subsector level, resource-based (RB) industries, including wood and rubber products, led the industrialization drive inthe 1970s together with export-oriented, labor-intensive processing and assembly-type in-dustries such as textiles and electronics.

Malaysia’s industrial policy can be categorized into two main strategies: import-substi-tution (IS) first and then export-orientation (EO) regimes. Historically, the Pioneer IndustryOrdinance (PIO) of 1958 triggered state intervention in manufacturing. The state raisedtariffs on pioneer industries while concurrently attracting foreign firms. Industrial policyduring the IS phase did not discriminate against foreign capital in all manufacturingindustries, which later encouraged the most progressive FDI stance in the developing world.

Malaysia recognized from early on that it severely lacked the technology, manpower andcapital to undergo industrialization. Accordingly, the government created highly lucrativeincentive schemes for FDI by giving foreign investors a “pioneer status” with nationaltreatments. It also provided “one stop FDI administration services” to foreign investors at theMalaysian Industrial Development Authority. Following these incentives, FDI rapidlyflowed into the economy, especially in the 1980s, and has continued to be a distinctivefeature of Malaysia’s industrial profile (Table 9).

The MNCs, however, created problems and localized distortions with the domesticeconomy. Government FDI policy inadvertently helped create duality in manufacturing,between MNCs and the local firms. This duality became even more obvious followingenactment of the Free Trade Zone (FTZ) Act in 1971, and Licensed Manufacturing Ware-

Table 8Comparison of Malaysia’s per capita GNP and manufacturing share with Korea and Taiwan in selected years

Per capita GDP (US$) Manufacturing share of GDP (%)

1965 1973 1980 1990 1994 1965 1973 1980 1990 1994

Malaysia 258 550 1,690 2,320 3,520 9.1 15.0 20.6 27.0 32.0Korea 123 390 1,620 5,450 8,220 18.0 25.1 29.7 29.2 29.0Taiwan 217 695 2,344 7,954 10,215 22.3 36.8 36.0 34.4 29.0

Source: For Malaysia, Korea except 1965 data, World Bank, Trends in Developing Economies, 1992. For 1965data, see Chenery and Syrquin, Patterns of Development 1950–1970. Oxford University Press (1975) ForTaiwan, see Council for Economic Planning & Development, Taiwan Statistical Data Book, and National Incomein Taiwan, various years.

Table 9Foreign share of manufacturing in Malaysia (%)

1968 70 72 74 79 85 87 92

Establishment 6.0 n.a. 14.9 11.3 9.2 7.6 9.3 16.3Fixed assets 52.7 51.0 n.a. 46.6 33.9 18.6 22.3 40.0Output 48.2 n.a. 52.0 49.8 42.1 34.6 40.0 47.1Employment n.a. n.a. 33.0 33.5 32.7 28.8 33.8 44.2

Foreign share comprises fully owned and majority foreign equity in joint-ventures of limited companies.Source: Rasiah Rajah (1995).


houses (LMWs), with lucrative financial incentives through the Promotion of Investment Act(PIA) and the Investment Tax Allowance (ITA).17 The acts and their inducements alsoencouraged invited MNCs to operate primarily within designated industrial zones. TheMNCs, however, developed few linkages with local firms, operating within their “exportenclaves” due to lack of absorptive capacity of new technology on the part of Malaysia, andthe MNCs’ own interest in utilizing cheap local workers. In order to strengthen theselinkages, the government in 1990 imposed a domestic value added requirement of 50% forthose firms applying for the pioneer status incentives (Ahn et al., 1992).

Beginning in 1981, the Mahathir administration undertook the “Look East” policy toinitiate rapid industrialization by promoting the heavy and chemical industries, emulating theindustrial deepening efforts of Japan, Korea, and Taiwan. The Look East policy wasessentially a government-driven “Malaysia incorporated policy.” This industrial push wasvery similar to Korea’s heavy chemical industrial drive in the early 1970s. The Malaysiangovernment created the Heavy Industries Corporation of Malaysia (HICOM) to lead the wayfor a heavy industrialization push. HICOM targeted a number of large-scale, capital-intensive projects including iron and steel, nonferrous metals, machinery and equipment,paper and paper products, petrochemicals, and the national car (Proton saga).

Unlike Korea’s HCI drive, the Malaysian government intended to push capital intensiveprojects as public investment, but it also promoted joint ventures with foreign investors. By1988, HICOM had set up nine companies employing a total of 4350 workers involved insteel, cement, motor vehicle, and motor cycle engine manufacturing. These aggressiveinvestments culminated in the PROTON car, the largest of Malaysia’s HCI investments. Itwas a joint venture with the Mitsubishi company designed to produce 100,000 units per year(The World Bank “East Asian Miracle” study, 1993, p. 310). Like Korea’s premature HCIdrive in the early 1970s, which resulted in severe excessive capacity, the HICOM programalso ran into macroeconomic difficulties including declining terms of trade and fiscal deficits.Furthermore, the government was forced to bail out loss-making enterprises that were due topoor management.

In terms of FDI inflows, Malaysia truly stands out in comparison with other developingcountries. Out of total FDI inflows in East Asia, Malaysia alone accounted for 25%. Asshown in Table 10, the cumulative FDI that went to Malaysia for the period 1984 to 1994was 4.5 and 3.5 times as high as FDI flowing into Korea and Taiwan, respectively.

Looking at the electronic sector specifically, foreign domination is most visible as shown

Table 10FDI inflows of Malaysia, Taiwan, and Korea

Annual FDI inflows ($ million) FDI as % of GDI*

1984–89 1990–92 1993 1994 1995 Total 1984–89 1990–94

Malaysia 798 11,514 5,006 4,348 5,800 27,466 8.8 22.4Taiwan 691 3,480 917 1,375 1,470 7,933 3.3 3.0Korea 592 2,695 588 809 1,500 6,184 1.4 0.7

* GDI stands for gross domestic investment. The figures are simple annual averages.Source: UNCTAD, World Investment Report, 1996.


in Table 11. Malaysia’s electronics sector, which has played the most important role inMalaysia’s exports, has been comprised mainly of foreign electronics companies operatingin free-trade zones but without significant linkages to local firms.

As a result of their differences regarding FDI policies, the RANICs have experienceddifferent modes of technology transfers from FDI firms. For example, in contrast to Malay-sian experience, Korea has consistently relied on foreign borrowings and foreign technologylicensing rather than FDI for its industrial transformation. Taiwan’s experience lies some-where between that of Malaysia and Korea. Korea and Taiwan emphasized technologythrough reverse engineering and licensing transfers, while Malaysia strongly targeted aninternalized mode of technology transfer by inviting MNCs into the country.

Although the FDI-triggered industrial deepening proceeded with sound economic funda-mentals, for more than two decades, the Malaysian economy also encountered some seriousproblems as occurred in most emerging market economies in East Asia in the 1990s. Mostnotably, export-led growth since the late 1980s was followed by a construction and propertyboom, fuelled by financial sectors favoring short-term loans with collateral over moreproductive, but often more risky, lending in manufacturing (Jomo, 1998). The excessiveexpansion in such a nontradable sector worsened the current deficit and caused the asset pricebubble.

3.4. Taiwan’s SME-led, export-based industrialization

Like Korea, Taiwan is poor in natural resources. On the eve of economic takeoff, havingachieved successful land reforms, both countries had similar initial conditions. Taiwan’sGNP grew at 9.2% per annum over the period 1965 to 1988, growing in terms of per capitaGNP at 7.2% per year over the same period. Its annual growth rate of GDP slowed down butstill averaged 6.2% over the period 1989 to 1995.

Because of its high rates of growth and capital formation, Taiwan has constantly been usedas an example for developing countries regarding how to achieve both growth and equity.Along with rising income, Taiwan’s industrial structure has been rapidly transformed. Table12 shows that manufacturing in Taiwan was the main impetus for growth as well as forindustrial transformation.

After a brief import substitution period from 1953 to 1957, Taiwan took its first big steptoward export promotion in 1958, with a policy package that included a 25% currency

Table 11Share of total value added in Malaysia’s electronics sector

Year Local firms(%) Foreign firms(%) Joint venture(%) Total value-added(M$ million)

1983 14.42 85.44 0.14 1,413,9111985 8.01 91.87 0.12 2,881,4241986 10.42 89.38 0.21 1,690,0061987 11.74 88.11 0.15 1,958,5451988 13.34 86.64 0.03 2,409,501

Source: Malaysia, Department of Statistics.


devaluation, a unified exchange rate, export incentives, and widespread removal of quantityrestrictions (World Bank, 1993, p. 125). Like Korea, Taiwan offered preshipment loansbased on letters of credit, documents against acceptance of payment, and shipment docu-ments after completion of export orders. Based on comparative advantage in low-wage laborand existing technical capabilities, the industries promoted in the 1960s included such lightindustries as textiles, apparel, wood and feather products, bicycles, plastics, synthetic fibers,electronic components, consumer electronics, home appliances, watches and clocks. Duringthe export promotion period, FDI played an important role by replacing U.S. aid as the mainsource of foreign capital, while facilitating technology and skill transfers.

As the 1970s progressed, the government chose a more self-reliant economic developmentpackage of industrial consolidation and renewed export growth. This enabled Taiwan to facethe 1973 and 1974 oil crisis as well as new competition from lower-wage producers. Thegovernment’s new industrial plan focused on capital-intensive, heavy, and chemical indus-tries to increase production of raw materials and intermediate goods for export industries.

According to Riedel’s (1992) analysis Taiwan’s share of exports in GDP was exception-ally high, even after taking into consideration country size and resource endowments. Thecross-country regression by Riedel shows that Taiwan’s predicted share of exports in GDPshould have been 40% in 1986, but the actual share was 60%.

In contrast to Korea, Taiwan utilized predominantly small- and medium-sized enterprises(SMEs) and efficient “learning by doing” techniques to make export driven industrializationpossible.18 In Taiwan, there are no conglomerates like Samsung or Hyundai as in Korea.19

For example, as of mid-1983, Samsung Corporation in Korea had annual sales of US$5.9billion with assets of US$4.6 billion, and employed 137,000 people. Myers (1990, p. 54)reports that Formosa Plastic, Taiwan’s largest privately owned corporation, lagged far behindwith annual sales of US$1.6 billion, assets of US$1.7 billion, and a workforce of 31,211.

In Taiwan, numerous enterprises emerge and fail every day (Lau, 1990). As a result,markets have been relatively more open and competitive than in Korea. In 1971, within theSMEs, 68% were small-scale firms employing fewer than 20 workers, with another 23%comprising medium size firms employing up to 50 workers.20 Small firms, in particular,dominated the manufacturing of textiles, apparel, leather goods, wood and bamboo products,basic metals, metal products, machinery equipment, and miscellaneous industrial products.

Another important feature is that many SMEs took root near villages and small towns. Asa result, rural employment grew more rapidly than urban employment and generated a

Table 12Changes in industrial structure and sectoral growth rate of Taiwan

Sector Share in GDP (%) Annual growth rate (%)

1965 1980 1997 1965–80 1980–90 1990–97

Agriculture 24 8 3 2.3 8.0 0.3Industry 30 46 35 13.7 8.0 4.6(Manufacturing) (22) (36) (28) (14.6) (8.5) (4.4)Services 46 46 62 9.5 8.8 8.0GDP 100 100 100 9.9 8.0 6.4

Source: Republic of China, Council for Economic Planning, Taiwan Statistical Data Book, 1992.


tremendous upsurge of nonfarm income for rural households, sharing 79 and 89% of ruralhousehold income, respectively, in 1966 and 1976.21

Since the early 1980s, the absolute growth in the number of SMEs has been extraordinary,especially in fast growing sectors such as plastics and electronics. Pack (1992) offeredseveral reasons why SMEs in Taiwan could contribute to the extraordinary growth ofmanufacturing productivity. First, they exhibited great flexibility in movement along productlines. Second, Taiwanese SMEs managed employees more intensively to obtain high andgrowing productivity from a given set of factors. Third, they allowed for benefits fromextensive subcontracting and from the realization of economies of scope. Fourth, they havebenefited greatly from the ability to avoid complex organizational decisions, in particular onways to vertically organize large numbers of workers and departments.

In Taiwan, in contrast to Korea, scale economies were unlikely to have been a majorsource of growth in total factor productivity. In recent years, SMEs in Taiwan have adjustedso effectively that goods markets are as diverse as athletic shoes, computer keyboards, andpersonal computers. Each item of the SME producers made in Taiwan is so small in quantitythat exporters have easily found niche markets and have not been very selectively visible inbilateral trading with major importing countries.

Like Japan and Korea, selective intervention by the government was a critical componentof the Taiwanese policy mix, ranging from ownership of public enterprises to sophisticateduse of import-limiting measures, special credit facilities and so on (Wade, 1990). Often,industrial policy in Taiwan has been industry specific and nonuniform across industries,whether as tariffs or quantitative restrictions, or as research subsidies for specific products.

Unlike Korea, Taiwan’s industrial development was characterized by the more substantialpresence of MNCs. Taiwan has succeeded in providing MNCs with political and economicstability and firm commitments for growth. Ranis and Schieve (1985) have shown that MNCactivities accounted for less than 10% of value added manufacturing and employment in thelate 1970s. Both percentage indicators, however, were substantially higher than those ofKorea in the same period.

Taiwan’s labor market is better characterized as integrated and well functioning ratherthan segmented and inefficient, thereby assuring intersectoral shifts of employment. Inaddition, price stability, income equity and the absence of militant labor relations helpedTaiwan attract direct foreign investment as well as long-term foreign capital. These condi-tions and FDI helped Taiwan weather the contagion effect of the recent Asian financial crisis.

In contrast to persistent current account deficits in most East Asian economies, Taiwan hasmaintained sizable surpluses in both its trade account and overall balance of payments. Afterexpulsion from the UN, IMF and World Bank, Taiwan’s policy makers have consistently puthighest priority on maintaining sufficient foreign exchange reserves in order to free Taiwanfrom a foreign exchange crisis (Shea 1988). In 1996, Taiwan registered a surplus of US$11billion, or 4.7% of GDP in its current account, whereas Korea suffered from a record deficitof US$25.6 billion in its current account. By the end of 1997, Taiwan’s foreign exchangereserves stood at US$83.5 billion, while public debt amounted to a mere US$108 million.Taiwan’s foreign exchange reserves have always been one of the highest in the world in thepast several decades (Shea, 1998). Private external debt was only about US$7.5 billion,


because Taiwan has traditionally depended mainly on domestic savings to finance domesticinvestment, which is freed from short-term borrowing from international lenders.

Perhaps most amazing in Taiwan’s economic development process is an early recognitionof the potential impacts of ongoing financial globalization processes since the mid-1980s. Ithas fully embraced the importance of strong macrofundamentals and a sound financialsystem. While promoting financial liberalization and broadening its financial market, it hasalways emphasized credit discipline and prudential supervision of its financial institutions. Inaddition, Taiwan’s community financial institutions have been encouraged to merge withbanks or to convert themselves into commercial banks, thereby preventing such institutionsfrom becoming a source of financial instability.

Some important financial disciplinary measures include bringing the work of financialregulation and supervision within one single financial regulatory body, and actively imple-menting measures to write off bad loans. Most importantly, Taiwan ensured that the BIScapital adequacy ratio is maintained well above the internationally recommended level of8%, which was introduced as early as 1989.22 In contrast, Korea and Japan neglected theimplications of financial globalization but were pressured to adopt the BIS capital adequacyratio in early 1998, after the Asian financial crisis.

4. Learning from financially advanced countries

Asian financial crisis has provided Korea, Malaysia, and Taiwan with a testing ground toexamine relative robustness and sustainability of their respective development models. Towhat extent has each country weathered the contagion effect due to the Asian financial crisis?The answer to this question may well serve as an indicator to measure the effectiveness oftheir development models. A search for a new development paradigm can be done not onlywithin the framework of Gershenkron’s “advantages of backwardness,” but also in theconcept of “mutual learning,” which involves both learning and benchmarking from thestrengths and weaknesses of RANIC development models.

The relative robustness of major East Asian economies can be examined by both exchangerate market and stock market behavior in 1997 and 1998, as shown in Table 13. In contrastto severe volatility in most East Asian economies, Taiwan had only devalued its currency bya mere 13.8% in the same period, while experiencing the lowest drop in its stock market.

Litan and Rauch (1997) have elaborated succinctly the limits of the twentieth-centuryfinance model which contains two fundamental conflicts: the contradiction between prevent-ing failure while preserving market discipline, and the contradiction between market man-agement and competition.23 They assert that by extending the federal safety net so broadly,policy makers weakened incentives for depositors and even creditors to discipline banksagainst unwise risk taking. Hence too much protection or poorly designed protection canmake the financial system more dangerous, inviting moral hazard into the overall economy.

In this regard, the U.S. has stressed renewed focus on responsibility and discipline infinance, putting it well ahead of much of the rest of the world. In recent years, the U.S. hasstrengthened initial risk-based capital standards promulgated by the Basle Committee, byadding specific instruments relating to the concentration of credit risks, interest risks, and


market risks from trading activities. Regarding the second contradiction, the U.S. hasencouraged free and open competition in the finance industry, making it a cornerstone ofinnovation and consumer protection.

Information technology has also led the American financial system to adopt digitization offinance and automatic teller machines, and to allow finance without borders. These financialinnovations have also brought in phenomena such as securitization, which converts individ-ual assets into marketable securities through mutual funds and rapid proliferation of deriv-atives. In sum, the U.S. in recent years has established an efficient and robust finance industrywell ahead of the rest of the world, making it the most profitable industry in the economy.

As Pagano (1993) suggests in his formulation between financial markets and growth, onecan draw important policy implications for the East Asian economies in their search for apostcrisis model.24 The key to overcoming East Asia’s economic crisis and further promot-ing growth involves the development of effective financial intermediaries, creative duplica-tion of advanced practices and existing technologies, and promotion of indigenous techno-logical innovations. In order to do so, most of East Asian economies must eliminate thevicious cycle of bad debt created by government administered credit allocations and bymismanagement of business, especially large conglomerates, and let market principles taketheir course in the financial sector.

As Gershenkron (1966) pointed out, the greater the backlog of technical innovations thatthe backward country can adopt from the more advanced country, the greater is possibilityof successful industrialization. Accordingly, given their industrial base and disciplinedworkforce, the RANICs are increasingly well positioned to adopt into their developmentmodels the growing backlog of innovations from more financially advanced countries. ThusTaiwan, as an early adopter of such advanced financial practices as the BIS capital adequacyratio and outside dominant board, clearly provides a concrete example of success.

During their respective high growth periods, in both Korea and Malaysia a crony part-nership developed between business and the political elite. This granted nearly unlimitedexpansion for big businesses through “administrated credit” from the financial sector in thecase of Korea, and through “connected lending” in the case of Malaysia. As part ofrestructuring efforts in the postfinancial period, both nations have undertaken comprehensive

Table 13Change in exchange rate and stock market, 30 June 1997 to 8 May 1998

Cumulative percentage changein exchange rate June 30,1997 to May 8, 1998

Cumulative percentage changein stock markets June 30,1997 to May 8, 1998

Thailand �36.0 �26.7Malaysia �33.0 �46.2Indonesia �73.8 �40.0Philippines �33.0 �21.3Hong Kong 0.0 �33.8Korea, South �36.2 �50.0Taiwan �13.8 �9.1Singapore �11.6 �28.5

Sources: Bloomberg; Financial Times (various issues).


reform in the financial sector, introducing global practices such as BIS capital adequacyratios, new governance systems by inviting outside board members, new disclosure standardsand risk management practices, and so forth. And, most importantly, traditional connectedlending behavior has now shifted to rule-based and profit-oriented practices.

Within its extensive reform agenda, Korea has carried on financial sector reform toachieve four objectives: 1) restructuring of the troubled financial industry; 2) re-engineeringof financial institutions toward commercial orientation; 3) empowerment of human capital tolearn advanced banking practices and management; and 4) strengthening of prudentialregulation and supervision. In line with these objectives, 94 financial institutions includingfive commercial banks have either been closed or suspended. Furthermore, six large banksare currently proceeding with voluntary mergers in order to improve scale economies andefficiency. Many banks are being reborn as clean banks with BIS ratios of 10% to 13% (Ahn,1999).

In the case of Malaysia, an emergency National Economic Recovery Plan (Malaysia,1998) was implemented in 1998 to revive its usual dynamism. Since this policy action,Malaysian authorities have been more than willing to adopt a “virtual IMF program” withoutgetting IMF credit.25 While stabilizing the ringgit via a capital control policy, the Malaysiangovernment has also taken important reform measures to increase transparency of thefinancial sector, to strengthen the regulatory framework of the capital market, and to adoptliberal and market-based policies. In order to make the Malaysian banking system sound andresilient, nonperforming loans of banks have been removed and subsequently recapitalized.

In order to keep pace with increasing financial globalization, Taiwan has continuedamending outmoded financial regulations, eliminating restrictive financial controls, andcreating new channels for saving and investment. It continues to maintain its flexible system,which allows new companies to get an easy start and unprofitable companies to go bankrupteasily.

5. Mutual learning among representative Asian NICs

The relative robustness of the development models adopted by the RANICs is summarizedin Table 14. Differences in microindustrialization strategies are also clear, even within the

Table 14Major features of development models and present status of Korea, Malaysia and Taiwan

Country Model type Debt/equity inmanufacturing (%)

FDI/GDI (%) Government-directedcredit

Present status duringAsian crisis

1984–89 1990–94

Korea Chaebol-led 400–500 1.4 0.7 Strong IMF bailout neededTaiwan SMEs-led 87 3.3 3.0 Mild Little affectedMalaysia FDI-led 115 8.8 22.4 Mild Avoided IMF bailout

GDI (Gross Domestic Investment).Source: FDI/GDI ratios are from Bank of Korea, Yearbook on Managerial Analysis of Business Management,

various years.


outward-looking development paradigm. Under the export-oriented trade regime, Koreafostered the Chaebol approach, with little reliance on direct foreign investment (FDI). Incontrast, Taiwan adopted a small industry approach to take advantage of the global nichemarket and the wisdom of “small is beautiful,” with a more receptive attitude to FDI thanKorea. Malaysia, however, has pursued rapid industrialization with massive inducement ofFDI by developing both resource-based and nonresource based industries. This provides thethree countries with benchmarking grounds for assessing each other’s strengths and avoidingeach other’s weaknesses.

Among its many special features, the Taiwanese model deserves special recognition as a“flexible tiger,” a model based on small and medium size firms (Business Week, May 25,1998) with an average debt/capital ratio of about 80% (compared to Korea’s 400%, as shownin Table 14). By using overseas Chinese networks, Taiwanese firms have been able toconduct international transactions effectively, meeting little friction with their trading part-ners. In addition, Taiwan is now proposing a “green silicon island,” extending the ShinchiuScience Park venture businesses to the entire country.

In the case of Malaysia, the government has been working for more than a decade on agrand national vision for the 21st century. It seems that the government is determined toachieve a fully developed country status via the “Vision 2020” program. With a rebornfinancial system under its “Virtual-IMF” program, Malaysia is likely to achieve its nationalgrand objective. Well ahead of its neighbors in East Asia, it has also brought in such conceptsas cyber government and the information super corridor to adapt to the ongoing informationage.

Relative strengths and weaknesses of the three high performers can serve as benchmarksfor mutual emulations as depicted in Fig. 1. Korea, for example, can learn from the system

Fig. 1. Mutual learning schemes among the representative East Asian NICs.


flexibility of Taiwan’s SME-based model and from Malaysia’s FDI friendly environmentof development strategies. Malaysia can learn from Korea’s buildup of endogenousabsorptive capacity of foreign technology, and from Taiwan’s SME development strat-egy. Taiwan can consider Korea’s tendency to create global brand names rather thansimple OEM producers, why the Korean model has been ineffective in recent years, andwhy Malaysia’s regional contagion from her neighbors’ economic turmoil has been soserious.

From the perspective of endogenous growth theory, increasing the efficiency of thefinancial sector should be the most critical task for the East Asian economies. The financialsystem must find a new paradigm, as it can no longer be the tool for industrial targeting. Thegreat failure story of Hanbo Steel and Daewoo in Korea revealed the nonmarket elementsprevalent in Korea’s financial system. That a company like Hanbo, with little collateral andtechnology, could borrow up to twenty times the amount of its own capital, is symbolic ofthe gross inadequacies of Korea’s financial system.

During the post-crisis period, the new Korean government made an unyielding commit-ment to fully implement the reform mandates agreed upon with the IMF. The Chaebolsystem has since been substantially restructured by eliminating cross-loan guarantees, en-hancing the disclosure standard, and introducing a new governance system (Ahn, 2000). Amore efficient and transparent industrial organization is about to emerge through well-functioning bankruptcy procedures, mergers and acquisitions. The Korean governmenthas emphasized a “knowledge-based economy” as a new source of growth, in whichSMEs and venture businesses are key players. In this regard, Korea has been payingattention to the Silicon Valley model of venture businesses, and at Taiwan’s mushroom-ing venture business parks in order to look for new growth impetus in the postcrisiseconomic model.

Regarding Korea’s FDI regime, a drastic change has occurred to liberalize policies inorder to create “the most friendly environment for foreign capital in the world.” As aresult, one of the largest commercial banks was sold to a foreign company, and FDIinflow has rapidly increased. In this regard, Malaysia’s liberalization efforts have oftenbeen cited to change Korean’s long-standing nationalistic mentality concerning FDI(Ahn, 1999).

In order to produce human capital more suitable to economic development, the RANICshave long endeavored to cultivate a “learning” culture. In this effort, when analyzing totalfactor productivity, externalities and agglomeration effects must be considered along withthe traditional concept of economies of scale. Due to the positive externalities of education,it is clear that quantitative and qualitative improvements have and will continue to receivepriority attention as East Asian economies search for a robust, knowledge-based develop-ment model in the years to come.

In sum, the three representative performers in East Asia each have viable but uniquedevelopment models. Although they differ greatly in micro development strategies, they can,through mutual learning, search for, adopt and adapt a postcrisis robust development modelwith a substantial policy convergence that will ultimately generate similar macroeconomicperformance.26


6. Implications for regional development

The mutual learning prospects of the RANICs have important economic implications forother ASEAN nations, China and Japan. Above all, the RANIC members need to learn fromadvanced financial systems and technologies in the West, especially those in Anglo-Saxoncountries. There are several member countries within ASEAN that can still be classified asLDCs, and which have been eager to pursue rapid economic development using marketsystems. Despite their differences in cultural heritage and factor endowments, an appropriatepolicy mix derived from the RANIC models could well serve as benchmark guides for EastAsian LDCs in their own pursuit of rapid and sustainable development. As shown in Fig. 2,the potential learning transfers among these countries, and consequent benefits within theregion, are substantial.

The emergence of China as a global economic power will provide a further impetus forregional growth, after China’s full integration into the global economic system as a memberof the WTO early next year. Investments in social overhead alone within China andneighboring countries are likely to create a vast market in the region. China will also benefitfrom the competitive nature of the RANICs’ market-based economies while making itstransition from a socialist economy to a capitalist one.

Although it has until recently set the tone as the catch-up model for East Asian countries,

Fig. 2: External links of the RANICs mutual learning scheme.


Japan can learn from the flexibility and adjustments that have typified recent RANICbehavior in light of the current economic crisis, their adaptations to globalization, andfulfillment of IMF requirements. It must convert its traditional producer-oriented society intoa consumer-oriented one to improve not only Japanese consumer welfare but also regionaleconomic growth. It must restructure its ailing financial system in an expeditious manner, tospeed Japanese economic recovery from its long recession, and to provide a truly viableimpetus for East Asian dynamism. Japan can also play a greater leadership role by adjustingits chronic trade surplus vis-a-vis neighboring countries.

In order to ensure viable East Asian economies in the years to come, the countries mustincrease organized economic cooperation. A good example of how financial globalization isdeepening economic interdependence is seen in the increasingly sensitive relationship in-volving the Japanese yen, the Chinese yuan, and the Korean won. Given the industrial basethat has been created in the post-crisis period, there is no doubt that East Asia can more thanadequately perform as an efficient production center once restructuring takes place in aspeedy and efficient manner.

As a self-help and support mechanism on regional financial coordination, the ChianmgMai Initiative was agreed upon in May 2000 in Thailand by finance ministers of ASEAN�3(Japan, China, Korea). It allows currency swaps among ASEAN�3 economies, and signifiesthe first important regional coordination effort. Bergsten (2000) foresees that because of therecent financial crisis and nondiscriminatory nature of financial cooperation, East Asia’sorganized economic cooperation or potential integration movement might come first in thefinancial arena, rather than in trade and investment as found elsewhere. There is a criticalneed for East Asian countries to establish an institution that allows mutual consultationregarding exchange rates, interest rates, and foreign exchange reserves. They also must createan early warning system concerning unusual symptoms in financial indicators, and then takeprompt and corrective actions.

The RANIC economies share a Confucian tradition that emphasizes education and theadoption of new ideas among many traits comprising Asian values. Despite the economiccrisis, their cultural systems are sufficiently flexible to regard current problems as a “blessingin disguise,” and to take corrective action. If East Asia’s traditional sprit of scholarship andlearning can be combined with Western concepts of transparency, trust, and fairness, theireconomies will have little trouble reviving growth dynamism. Moreover, the experiences theRANIC economies have had, and the lessons they will learn, can be applied to the entireregion.

Notes

1. Since modern economic growth in the early 1960s, Korea registered negative eco-nomic growth just once in 1980 when President Park Chung-Hee was assassinated inthe wake of the second oil shock. Korean growth rate fell from 7.8% in 1979 to�2.2% in 1980.

2. Under the IMF financial assistance package, Thailand was allowed to borrow up toUS$ 17.2 billion, Indonesia US$ 43.0 billion, and South Korea US$ 58.4 billion.


3. According to Syrquin and Chenery (1989), a country should have a certain level ofpopulation and territory in order to provide the developing world with some relevantdevelopment implications. Being either an urban state or port city, both Singapore andHong Kong have some limited development implications to larger countries.

4. For the nature and consequences of the Korea’s rapid growth model, see Ahn (2000),and Ahn & Kim (1996).

5. For details, see Athukorala (1999), pp. 28–34.6. The average hourly wage of a Chinese worker in the mid-1990s is $0.90, far below

that of an Indonesian ($1.80), Filipino ($1.30), a Thai ($3.00) and a Korean ($8.00).China devalued the yuan by 35% in 1994.

7. Japan’s interest rate was only around 5% at a time when East Asian banks werecharging 16% for loans.

8. For details, see Goldsterin (1998), pp. 9–12.9. Krugman cites both the financial practice and corporate investment under crony

capitalism in East Asia as diagnosed by the IMF, but disagrees with the IMFsprescription to heal the deeply troubled Asian economies. For details, see Krugman(1998).

10. A Chaebol is a business group which consists of varied corporate enterprises engagedin diversified business areas, and typically owned and managed by one or a fewinterrelated families.

11. For details on incentive schemes such as the automatic access to bank loans forworking capital needed for export activity, and unrestricted, tariff-free access toimported intermediate inputs and raw materials needed in export production, see Ahnand Kim (1996).

12. The strategic HCI sectors identified by the government under the special acts includediron and steel, nonferrous metals, petrochemicals, fertilizer, machinery, electronicsand shipbuilding.

13. The import liberalization ratio of manufactured goods is measured by the ratio of theautomatic approval for import items to total tradable items.

14. According to a United Nations report, FDI in all developing countries in the early andmid-1970s accounted for between 10% and 20% of their total capital inflow. For acomparative analysis on the roles of MNCs and related FIDI between South Koreaand some key Latin American countries, see Ahn (1988).

15. For details, see Hoffmann and Ee (1980).16. Syrquin and Chenery (1987) covered 107 countries for various subperiods of 1950 to

1983 for their recent cross-country study. In order to analyze the cross-countrytransformation pattern, they used the average time-series equation to estimate sectorshares of various industries.

17. For a detailed review of industrial policy and foreign firms’ role in Malaysia’smanufacturing growth, see Rasiah (1995) pp. 74–98.

18. The small scale enterprises are characteristic of Chinese culture as evident not onlyin Taiwan but also Singapore and Hong Kong.

19. For details on the roles of direct foreign investment in Taiwan, see Ranis and Schive(1985).


20. For details, see Myers (1990).21. Taiwan’s off-farm employment in rural residential areas, and resulting nonfarm

income generation with 80% to 90% of total farm-household income, has been uniqueamong developing economies. In contrast, South Korea’s nonfarm income sharerecorded less than 20% in the corresponding period. However, South Korea’s non-farm income has been mainly cash income earned and sent to heads of rural house-holds by rural family members who were employed in the urban sector.

22. In a recent private meeting, the Chairman of the Bank of Taiwan confirmed thatTaiwan adopted the BIS capital adequacy ratio in 1989, just one year after the policyannouncement by BIS member countries in 1988.

23. For details, see Litan and Rauch (1997), Chapter 1, pp.14–36.24. For theoretical aspects as well as empirical implications, see Romer (1990).25. See Malaysia (1998), National Economic Recovery Plan: Agenda for Action, National

Economic Action Council.26. For the discussion on the policy convergence and best practices in the increasingly

globalizing world, see Sercovich et al. (2000).

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A search for robust East Asian development models after the financial crisis: mutual learning from East Asian experiences