Economic Principals

What to worry about in the world, economically speaking? At the top of most lists today would be Japan. The world's second-largest economy has been mired in depression for a decade and shows few signs of resuming robust growth.

Then comes sub-Saharan Africa, where many countries actually have been becoming steadily poorer for thirty years, ravaged by killing and disease. And of course there is Islam, much of which has resisted integration into the global economic system.

The rest -- China, Eastern Europe and Russia, South Asia and South America -- seem for the most part to taking care of themselves, with occasional exceptions.

There will be plenty of turbulence in the years ahead, as these nations work their way into the international division of labor.

But if the past is any guide, ahead are decades of rising incomes and longer lives for billions of persons. Goodness only knows about the environment, local and global.

When kids go to college these days to learn about what makes countries grow, they are taught the standard tools of neoclassical growth analysis: the capital-labor ratio, the capital-deepening process, the long-run steady state.

They learn the importance of technical change. They are told that the great advantage is that the developing countries can catch up. But they do not learn much about how.

"Poor countries do not need to find modern Newtons to discover the law of gravity," write Paul Samuelson and William Nordhaus in their introductory text. "They don't have to repeat the slow, meandering inventions of the Industrial Revolution; they can buy tractors, computers, and power looms undreamed of by the great merchants of the past."

Samuelson and Nordhaus cite the classic case of Japan. Towards the end of the 19th century, they say, its government sent students abroad to study Western technology, otherwise "took an active role in stimulating the pace of development" and built railroads and utilities. In due course, Japan moved into position as the world's second largest industrial economy.

It sounds like what my old editor used to call the Hydraulic Theory of Profits. Just "pump up the margins" to achieve the desired results.

So why do some countries succeed in growing faster than others? When students go on to graduate school, they study more intently the gap between rich and poor. The last fifteen years have seen a tremendous fad in technical economics for the use of small models in connection with data sets consisting of a relative handful of variables from many countries in hopes of identifying by statistical means the secrets of economic growth.

Some popular recipes for economic development (from a list prepared by Stanford Business School econometrician Romain Wacziarg in a recent issue of the Journal of Economic Literature): heavy capital investment, extensive schooling, relatively little income inequality, low fertility, temperate climate, good seaports, laissez-faire government, well-developed capital markets, political and/or economic freedom, strong property rights, ethnic homogeneity, British colonial origins, common-law legal systems, political stability, good governance, foreign direct investment, and suitably-conditioned foreign aid.

These various "all-encompassing hypotheses concerning the sources of economic growth periodically surface," writes Wacziarg. "With the support of adequately chosen cross-country correlations, [they] enjoy their fifteen minutes of fame." They may even be true, or some part of the truth. But they are not persuasive, he says.

The situation has become such that "simply pronouncing the words 'cross-country growth regression' in an academic seminar increasingly attracts scorn or disgust."

And yet, he concludes, "There are no good alternatives to comparative growth studies to explain differences in the wealth of nations." Quite a lot has been learned in fact from the binge of cross-country regressions, he says, by way of reviewing William Easterly's highly-readable review of the recent literature, The Elusive Quest for Growth: Economists' Adventures and Misadventures in the Tropics. It is just that much more remains to be discovered. The next generation of studies should be more econometrically sophisticated, with causal relationships clearly spelled out and larger samples of data.

Maybe so. In fact, some quite different approaches are being made to the question of why some countries succeed at development while others fail. Some of the most interesting are careful case studies. One such is Beyond Late Development: Taiwan's Upgrading Policies by Alice Amsden and Wan-wen Chu.

Amsden is a professor of political economy in the Department of Urban Studies and planning at Massachusetts Institute of Technology. Chu is deputy director of the Sun Yat-sen Institute of the Academia Sinica in Taiwan

Amsden and Chu are interested in "second-movers," copy-cat nations caught somewhere in between the cutting edge of technological development and the days when low wages for unskilled workers made basic industry attractive. There are many of these mid-tech economies around the world.

In The Rise of the Rest: Challenges to the West from Late Industrializing Economies, Amsden surveyed a dozen non-western nations whose economies had substantial manufacturing experience before World War II -- Argentina, Brazil, Chile and Mexico in Latin America, Turkey in the Middle East, and India, China, Korea, Taiwan, Malaysia, Indonesia and Thailand in Asia.

This group had divided neatly into two basic types -- "independents" and "integrationists," corresponding to the familiar corporate decision to Make or Buy.

Integrationist nations were those like Mexico and Argentina, or, to a lesser extent, Brazil or Turkey, who subordinated their knowledge-base to that of the cutting-edge nations, mostly through the mechanism of foreign direct investment in their firms. Local expenditures by foreign investors on science and R&D in these firms were negligible.

Independents, on the other hand -- China, India, Korea and Taiwan in particular -- had begun investing heavily in proprietary national skills, through the vehicle of large, competitive nationally-owned firms.

The choice was never black or white, wrote Amsden. All nations had to "buy" foreign technology from global leaders through licenses and the like. No nation could fail to invest in its local engineering skills. And many rapidly industrializing countries in Asia and Eastern Europe had yet to firmly choose a strategic path. But in general, the typology held up.

In "Beyond Late Development," Amsden and Chu argue that the key to exploiting second-mover advantage requires scale economies. That means big businesses and the developmental and regulatory arms of the state. She traces the rise of Taiwan's electronics industry, which as recently as 1975 consisted mainly of a few small firms, most of them with fewer than 100 workers.

By 2000, the situation had dramatically reversed. Nationally-owned firms with more than 500 employees had become dominant. Many foreign-owned firms had been driven out of Taiwan by rapidly rising wages. And Taiwanese market leaders had become adept at diversifying into the next wave of popular mature-market products -- from televisions to calculators, from semiconductors and computer notebooks to cell phones, or so they hoped, and soon enough, bio-tech.

How? Break-aways and spin-offs, for one thing. Taiwanese engineers and managers quit the foreign-owned firms for which they worked to start their own businesses. Chinese-American engineers returned from Silicon Valley to become "big men," or government-abetted entrepreneurs.

Heavy investment in education and research was another factor, Amsden and Chu say. Taiwanese firms partnered with universities, opened laboratories, created "listening posts" in research centers overseas, and succeeded in creating a "reverse brain drain."

But most of all, these increasingly big businesses became adept at moving in behind market leaders elsewhere, playing Dell Computer to IBM in business after business. The technology may have been invented elsewhere, but Taiwanese firms became second to none at quickly "ramping up" to large-scale manufacturing in industries where declining profits, once sky-high, were not yet paper thin.

All this was possible only because firms were big and few and tightly managed from the top down, and because the government stepped in with a wide array of policies designed to support national firms, including home-market protection.

It is not that the government never made mistakes, say Amsden and Chu. But so far even the worst of these -- over-investing in high-end education in the 1950s and 1960s -- turned out to have a very silver lining.

Those scientists and engineers had been forced to go to America and Europe when they couldn't find jobs. But when the "brain drain" of the 1970s reversed, they returned home with a wealth of practical experience.

So what institutions should other latecomers cultivate if they wish to emulate Taiwan's success?

Big nationally-owned firms, both private and public, not just in manufacturing but in service industries such as banking and telecommunications as well.

Sophisticated government regulators pursuing supportive policies -- not thumbing their noses at the World Trade Organization, with its interest in competition, but systematically favoring selective attempts to achieve global scale.

Above all, first-rate universities and other educational and research institutions, competitive among themselves and open to all comers.

And if that sounds like America in the early 20th century, or Japan after World War II, or India, with its pharmaceutical and software industries today, it cannot be altogether accidental.