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Review of “How Asia Works”

August 11, 2014

How Asia Works: Success and Failure in the World’s Most Dynamic Region, by Joe Studwell

How Asia Works is a great book for anyone interested in actual developmental successes. For all the focus on developmental failures, it’s nice to see a book take a serious look at the best thing to happen to humanity since the Green Revolution. Successes do happen, and by studying them, perhaps we can learn to replicate them.

The book is divided into 4 parts:
1. Farming
2. Industry
3. Banking
4. China

Feudalism doesn’t work. It doesn’t matter whether you call it imperialism, slavery, or communism, large collectivized farms where individual output and autonomy are disregarded in favor of scale are inefficient. Studwell documents how small scale farming has higher yields than the alternatives across a wide variety of countries and crop types. While large scale farming may have higher per-worker productivity, ultimately it doesn’t matter because land is more scarce in poor countries.

The larger the operation, the more intractable the principle-agent problem is. Without incentive to work hard and invest, farmers don’t. Compounding this problem is the tendency of poor countries to exploit peasants with monosonistic marketing boards to squeeze out rents. Farmers respond to the high effective tax rates with reduced production.

Studwell recommends that countries limit land ownership to 4 hectares per family. Studwell puts together a great case that it provides a solid foundation for peasants to improve their economic situation and provide food stability for the growing country. You want peasants to be rich enough to support themselves and be able to export a bit to provide hard currency for the regime. When agricultural productivity hits a certain level, the children of the current generation of farmers can migrate to the cities and join the industrial economy.

Perhaps the best metaphor for export promotion industrial policy is an internship. No one expects a college student to make enough money selling their term papers to pay for their college. It is unreasonable to expect poor countries to make competitive profits selling their manufactured goods. The costs of unprofitable firms in the short run are paid back when the workers of those firms learn enough to compete on a global scale.

The primary problem a developing country faces is technology acquisition. There is nothing fundamentally different about the richest and the poorest countries besides the technology they use to produce goods. All of the natural resources which the world has today were on this planet before humans existed. The essential question for development is not “How do we acquire resources?”, but “How can we teach ourselves to produce the way rich countries do?”. This means that policies which are inefficient from a profit perspective are quite useful for development. The benefits which Studwell argues are essential are learning, providing employment, and achieving minimum efficient scale.

Studwell advocates export promotion as the preferred way to develop the scale and skills needed to succeed in the global economy. It is easy to see Krugman’s influence. Studwell’s mental model is all about building scale, connecting workers in large networks of trade, and building comparative advantages in certain fields. One of the assumptions driving this model is that workers and knowledge does not flow freely across political borders.

Step 1: Create a large number of manufacturing firms.
Step 2: Organize the banking sector to lend to them on subsidized terms. Base the size of the subsidy on export success. This is important because it forces firms to produce products of far higher quality than they could get away with selling domestically. Foreign consumers aren’t going to buy garbage, but domestic consumers might not be able to afford any better and/or might be forced to buy from a domestic monopoly. International sales are constrained by international competition.
Step 3: Eliminate underperforming firms. The subsidies allowed firms under the minimum efficient scale to survive, which in turn allows a country to support more firms than it otherwise would be able to, which in turn allows politicians to mercilessly eliminate the underperforming firms. The state is acting in lieu of the competitive market. Because firms know they are competing with other domestic firms, they are less likely to rest on their laurels.

Lenin’s political model can be summarized by “political cronies are replaceable”. The East Asian economic model is “economic cronies” are replicable. Politicians don’t need to get attached to any particular firm. They can start with large number of cronies and eliminate the ones who don’t perform. As long as the subsidies keep flowing, the rats will dance to the tune.

I thought this was the weakest part of the book. I get the need to subsidize exports in their infant state. I’m not sure the banking sector needs to be structured around it. Studwell does make the highly under-recognized point that debt and inflation are totally overblown threats to development. The IMF (which I have long considered to be incompetent and self-serving), advocate policies which help creditors, not which help the country. They pretend like those interests are one in the same, but they are not. Inflation is bad. Defaulting is bad. Neither, however, is the end of the world and relative to remaining poor, they are totally insignificant. 15% inflation is fine. Seriously. I know all the critiques of inflation, from neo-Classical to Austrian, but the bottom line is that countries can grow with relatively high inflation so long as it doesn’t become hyperinflation.

Studwell sometimes conflates corrupt banking with deregulated banking. The worst example is Indonesia, where he references a banking sector that lent to political cronies so they could throw amazing parties. There are situations where a bank would lend for short run profits rather than long term growth, fine, but don’t conflate that with lending to the dictator’s brother who just spends it all on cocaine and prostitutes. That’s not “free market banking”. To be fair, real free market banking is astonishingly rare, even in the developed world, but that fact speaks volumes about how unimportant finance is to growth.

This chapter is an overview about how the rest of the book applies to China. If you’re interested, buy the book; I’m not going to summarize it. The most interesting aspect was Studwell’s discussion of the transition from export promotion learning policies to free market efficiency policies. When a country is poor, you want to protect and promote industry so your workers gain the skills they need to succeed, even if it costs you in terms of consumption and competitiveness. When a country is rich, you want to maximize efficiency because trade protection just slows you down. Your workers are already at the technological frontier, so export promotion doesn’t gain you anything. One difficulty policymakers face is transitioning from one to the other.

Any subsidy creates rents, and therefore interest groups, who can get quite powerful. Subsidies persist well past their usefulness. In the U.S., some examples include sugar, automobiles, and airlines. In Japan, Studwell gives the example of rice farmers who are among the most subsidized workers on the planet. Clearly, the Japanese don’t need any more help growing rice in 2014. They’ve been at the technological forefront for 30 years. However, efficiency promotion policies are not conducive to learning. Infant firms are cut down quickly by international competition before workers can learn the skills they need to succeed. Even when countries do foreign direct investment, which most economic studies show help growth, the host firm is often very jealous and protective of their production techniques. In any event, it’s better to be a corrupt middle income country than a poor country, so perhaps it better just to export promote and worry about efficiency when you come to that stage of development.

I think Studwell fails to take Public Choice and the New Institutional school seriously enough. He lives in a world where great leaders can accomplish great things. Where leaders fail, it is because they have the wrong ideological lens to look at the world, not that they are brutal kleptocratic dictators bent on retaining as much personal power as possible.

I’m pretty squarely in the “institutional forces” camp, although it is refreshing to hear from the other side. Ideas do have an impact on the world. I think the best lesson of China is that you can be a brutal dictator, have economic growth, and still retain power and an incredibly luxurious lifestyle. If you’re a dictator, development is nice, so long as you can remain in power. If the cost of development is regime change, it’s not worth it. Park Chung-hee may have helped Korean development, but at the end of the day, he was killed by his own cronies. Development is often the antithesis of stability.

No good free market counterexamples. It’s one thing to say free market doesn’t develop as quickly as export promotion. It’s quite another to find a free market country that didn’t develop quickly. Most examples of free market development are 150 years old, and are long since rich today, so it’s kind of hard to compare. Ahh well. If the technique develops a country in two decades, it’s really hard to argue with.

Avoiding rent seeking politics is difficult. It’s hard to eliminate underperforming firms. It’s hard to get rid of unnecessary subsidies. It’s hard to redirect payments to cronies toward industrial development. Just because you have the road map doesn’t mean driving somewhere is easy. I think Studwell understands all this, it’s just a bit underemphasized.

No mention of India. Perhaps it’s out of scope. Compared to East Asia, India went straight from import substitution toward free market policies (note I say toward, not to). They are developing very quickly. I think Studwell could justly say that India could use more heavy industry and infrastructure spending, so his model is still better.

Overall, this is a really good book, well deserving of the praise it has gotten.

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