Stiglitz 1996

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Some Lessons from the East Asian MiracleAuthor(s): Joseph E. StiglitzSource: The World Bank Research Observer, Vol. 11, No. 2 (Aug., 1996), pp. 151-177Published by: Oxford University PressStable URL: http://www.jstor.org/stable/3986429

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S O M E L E S S O N S R O M T H E S T

S L N M I R C L E

JosephE. Stiglitz

The rapideconomicgrowth of eightEastAsianeconomies,often calledtheEastAsianmiracle, raisestwo questions:Whatpoliciesand otherfactors

contributedto that growth? And can other developingcountriesreplicatethosepolicies to stimulateequallyrapidgrowth?

Thisarticle,basedon casestudies,econometricdata,andeconomictheory,offersa list of the ingredients hat contributedto that success.But it is thecombinationof these ingredients,manyof which involvegovernment nter-ventionsacting together,thataccountsfor EastAsia's success.

heremarkableuccessof theeconomiesof EastAsiaraises hequestion:to whatcanthatsuccessbe attributed?nmostof theeighteconomiesthat are part of the EastAsian miracle -Hong Kong, Indonesia,

Japan, he Republicof Korea,Malaysia,Singapore,Taiwan(China),andThai-land-government undertookmajorresponsibilityor the promotionof eco-nomicgrowth.Whichpoliciescontributedo the successof these economies,andwhy?Ascertainingwhatwouldhavehappened n theabsenceof the speci-fiedpolicyis oftendifficult.Thatthegovernmentubsidized sector hatgrew

rapidlydoesnot imply hatthegrowthshouldbeattributedo thegovernment'saction.Thesectormighthavegrownwithoutgovernmentntervention.Thisarticle s an interpretivessaybasedon casestudies,econometricdata,

andeconomic heory.Informulating coherentexplanationof EastAsia'sex-perience, do notpresenta formulaor a simplerecipe,butrathera listof ingre-dients.Because heseingredients re interactive, nd because heywereintro-duced n conjunctionwithotherpolicies, he government'spproachhasto beevaluated sa package. ndeed,EastAsia'ssuccesswas basedon a combinationof factors,particularlyhe highsavingsrateinteractingwithhighlevels of hu-

mancapitalaccumulation,n a stable,market-orientednvironment-butonewith activegovernmentntervention-that was conduciveto the transferoftechnology.1

Eachof theeconomies s unique; achdiffers n itshistoryandculture.Some,suchasSingapore ndHongKong,aresmallcity-states.Othersare arge.Many

The WorldBank ResearchObserver, vol. 11, no. 2 (August 1996), pp. 151-77C) 1996 The International Bankfor Reconstructionand Development/ THEWORLD ANK 151

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areraciallyandculturallyhomogeneous; ome,suchasMalaysia,areculturallydiverse.Butit seemsimplausibleo attribute he successof each of thesecoun-triesto specialfactors; hetask instead s to discover hecommon hreads.

Moreover, he unique actors ypicallyrefer o certainculturalaspects,suchas a Confucianheritage, hat aresuspect:not thatlong ago,the Confucianheri-

tage, with its emphasison traditionalvalues,was cited as an explanation orwhy these countrieshadnot grown.To be sure,cultural actorsmay play animportant ole: the stresson educationhascontributedmuchto the successofthese countries.

StatisticalExplanations

Havingexpressed eservations bout theusefulness f cultural xplanations,it is important o note as well the limitations o the standard tatistical ech-niques.Foralmostfourdecades Solow 1957), the standard pproachhasbeento ask to whatextentthisgrowthcanbe explainedbyincreasesninputs, hatis,humanand physicalcapital,andexpendituresortheacquisition f technology.In thisapproach, he miracle s the amountof thisgrowththat cannotbe soexplained(the residual).Several uch studies haveargued hat the East Asianexperience an largelybeexplainedby rapid ncreasesn inputs-high levelsofinvestmentandheavyexpendituresor education.Krugman1994)andYoung

(1993, 1995) arguethat essentiallyall of the growthin Singapore an be soexplained.Others,such as KimandLau (1993) and WorldBank(1993), findmore evidenceof a positiveresidual,but even then it is not unusuallyhigh.Therearea varietyof technical easonswhy the applicability f thismethodol-ogy to at least severalof the EastAsian countries houldbe suspect.Whatevertheirflaws, however,these studiesstill offeran important esson:policiesthatincrease he accumulation f physicaland humancapital are likely to leadtomorerapidgrowth.The realproblem s whatthese studies eaveunanswered.The uniqueandchangingcircumstances f each

countryand

the multitudeofprogramsnvolved,eachwith a number f potentially mportanteatures,mplythata statistical tudywould berelevantonly foraddressinghebroadestques-tions:weresavingsratesunusuallyhigh, or werefinancial estraints ssociatedwith fasterratesof economicgrowth?Such studiesdo not identify hose fea-tures thatfacilitatedwhat in retrospectwas a remarkableransformation f theeconomy.To understandhis transformation, nswers mustbe found to thefollowing:

First,why weresavingrates so high?Elsewhere, uch savingrates hadonly

been attainedunder hecompulsionof stronggovernmentorce,as intheCom-munistcountries.Althoughstudiessuggest that these savingrates may be ex-plainedin part by economicfactors-such as highgrowthrates that spurredhigh saving rates, as consumptionaggedincreases n incomes(Carroll,Weil,and Summers 993; Stiglitzand Uy 1996)-government actionsalso playedan

152 The World Bank Research Observer, vol. 11, no. 2 (August 1996)

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important role in mobilizing savings (although this virtuous cycle betweengrowth and savings was important as well).

Second, how was it possible to invest efficiently at such a rapidpace?To besure, if life consisted of nothing more than adding homogeneous capital to ahomogeneous productionprocess, East Asia's success would hardlybe remark-

able. But in that case other countries that attempted to invest rapidly wouldhave had far more successthan they have had.

Third, how was it possible to reduce the technology gap so quickly?Clearly,more was entailed than just buying technology. To encourage the transferoftechnology from foreign investors, the East Asian economies made enormousinvestmentsin humancapital, educatinglargenumbers of skilledengineersableto absorb and adapt the most advanced technology. And the East Asian econo-mies were willing to accept foreign investment and create an economic atmo-

sphere conducive to its entry.2Moreover, they combined these efforts with anemphasis on the most technologically advanced investment.

And finally how did EastAsia ensure that the benefits of rapidgrowth werespread widely among the population? Previous theories suggested that rapidgrowth was associatedwith rapidcapital accumulation,which in turnwas asso-ciated with high degreesof inequality;and that growth would in fact be accom-panied by an increase in the degree of inequality (Kuznets1955). Not only didthis assumption prove to be false, but there are reasons to believe that govern-ment policies that promotedgreaterequalitycontributed in no small measure to

the remarkablegrowth of these countries.

Metaphors of EconomicGrowth

Severalmetaphorsareusedto describethe processof economicgrowth. Thesemetaphors undoubtedlyinfluencehow we think about the subject.

An Engine Metaphor

Perhaps the most popular metaphor is that which refers to the engine ofgrowth-as if therewerea motordrivingtheperformanceof theeconomy.Capitalaccumulation is often givencreditfor beingthe engine of growth. And the coun-triesof EastAsiacertainlyhaveaccumulatedcapital at an impressiverate.Some-times the concept of capital accumulation is broadenedto includehuman capi-tal-the improvement in the skills of the labor force. And sometimes these twoare given credit not only for their directcontribution, but also for the technical

progress that might not have occurredin their absence.Once one identifiesthe engine of growth, one tries to makethe engine stron-

ger. Thus, if capital accumulation is the engine, the task is to increase capitalaccumulation. The role of government is to rev up the engine to encourage ahigher rate of capital accumulation.The engine metaphor has some important

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concerning future rates of return;given those expectations, they determinedtheir saving rate; meanwhile, profit-maximizing firms scoured the world look-ing for the best products and technologies to employ, given the costs of adjust-ment. In this metaphor, too, government played at most an ancillaryrole. Thismetaphor leaves unasked-and unanswered-such fundamental questions as,

What set the East Asian countries apart from other countries? Why is theirexperience so different?

ComplementingMarketsRatherThan ReplacingThem

Before the East Asia miraclethere were two dominant paradigmsfor devel-opment, one focused on markets, the other on government and planning. Thefirst had its

intellectualroots in Adam Smith's invisiblehand :markets lead toefficient outcomes. All that government needs to do to promote growth is getout of the way. The basic slogan is get the prices right. With the right prices,everyone will have an incentive to make the right resourceallocations. Under-miningthis particularreligionwas the disturbingobservation thatcountries thatseemed to get the pricesright-to follow all the advice of the visiting preachersof the freemarket-too often failedto grow. To be sure, likemedievalmedicine,there was always the allegation that the patient had not followed the doctor'sorders precisely, and it was this that accounted for the failure of the remedy.

At the opposite side were those who had little faith in the market and wholooked to government to ensure through the planning process that resourceswere deployed in a way that p'omoted economic growth. The lack of success ofthose countries that followed this paradigm has led to the virtualextinction ofthis school of thought.

Ironically, almost none of the successful industrialcountries followed eitherof these extreme strategies. They are mixed economies in which governmentplays an important role. The appropriate question to be asked is not whethergovernment should play a role, but what role and how can it be performedmosteffectively.

At the same time that the success of the East Asian economies and the col-lapse of the socialist economies called into question the standardparadigm,ad-vances in economic theory called into question the intellectual foundations ofthese two approaches. In the mid-19SOs Arrow and Debreu (1954) identifiedseveral conditions that must be satisfied if markets are to yield efficient out-comes. These include, first, the absence of externalities (externaleconomies ordiseconomies that affect the activity in question) and of public goods (com-

modities or services that, once provided, can be obtained without payment byothers); second, the presenceof perfect competition; and, third, a complete setof markets, includingmarketsextending infinitelyfar into the futureand cover-ing all risks. A market failure is said to occur where these conditions are notsatisfied. This approach identified specific interventionsby the government to

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correcteach market ailure, orinstance,pollution axesto correct orenviron-mentaldamage.Government ad a well-defined,highlycircumscribedole.

It was not until thirtyyears ater,however, hat the full limitsof the marketmechanismbecamewell understood.Hiddenin Arrowand Debreu's rame-work werestrongassumptions bout nformation ndtechnology.ntheirmodel

informationneed not be perfect,but it couldnot changeas a resultof actionstakenwithin the economy.Greenwald nd Stiglitz(1986) showed thatwhen-everinformationwasimperfect rmarketswereincomplete, overnmentoulddevise interventions hat filled in for these imperfections ndthat couldmakeeveryonebetteroff. Because nformationwas neverperfectandmarketsnevercomplete, these resultscompletelyunderminedhe standard heoreticalbasisfor relyingon the marketmechanism.Similarly he standardmodelsignoredchanges n technology; or a varietyof reasonsmarketsmayunderinvestn re-

searchanddevelopmentsee, orexample,Stiglitz1987, 1988,andArrow1962).Becausedeveloping conomieshaveunderdevelopedmissing)marketsand im-perfect nformation nd because hedevelopment rocess s associatedwith ac-quiringnewtechnology new nformation),hesereservationsbout headequacyof marketmechanismsmay be particularly elevantto developingcountries(Stiglitz 1989).

The modern theory of marketfailures recognizes, however, that government

interventions may not actually improve matters. Theories of regulatory capture

and rent-seeking imply that government interventionsmay contributeto ineffi-

cient resource allocation, and whatever their weaknesses, these theories havesufficient plausibilityto suggest that governmentsneed to exercise caution. How

the government intervenes may matter a great deal.

The fundamental mistake of the countries of the former Soviet Union and

those developing countriesthat triedto rely on planning was that they sought to

correct market failuresby replacing the market. The governmentsof East Asia,

by contrast, recognizedthe limitations of marketsbut confined thegovernment's

role to

* Policies that actively sought to ensure macroeconomic stability.* Making markets work moreeffectivelyby, for instance, regulatingfinancial

markets.

* Creatingmarketswhere they did not exist.* Helping to direct investment to ensure that resources were deployedin ways

that would enhance economic growth and stability.

* Creating an atmosphere conducive to private investment and ensured

political stability.

In short, rather than replacing markets, these governments promoted andused them. Such interventions had to be carefully balanced; if they were too

heavy-handed, they might have squelched the market.This agenda requiredgov-

ernment to design interventions in a way that reduced the likelihood of rent-

seeking behavior and that increased its ability to adapt to changing circum-


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stances.One suchmechanismwas a performance-basedeward tructurehatprovided tronggrowth-orientedncentivesandservedas a basisforawardinggovernment ubsidies.This structurewas relatively reefromcorruptionandhelpedto directresources o areas that producedhigheconomicreturns.An-other essential step was to design a civil service system based on merit, which

compensatedmployeeswellandbuilt n provisionshatreducedhedangers fcorruption.

Inthisdiscussion, heinterventions reorganized round ourmajor hemes:industrialolicies, ooperation ndcompetition,quality, ndexport-ledrowth.Some of the most importantactions to promote economic growth were directed

to thefinancialmarket,andtheseinterventionsre thesubjectof theaccompa-nyingarticle n thisjournalby StiglitzandUy.

IndustrialPolicies

Industrial oliciesaredirected tdeveloping ndencouragingertain ectors.Whatwere these industrialpolicies?Why were they adopted?And did theywork, eitherby directing esourceso desiredareasor, morebroadly, n pro-motingeconomicgrowth?

WhatPolicies WerePursued?Mostcountriessharedthreeobjectives:developing echnologicalcapabili-

ties;promotingexports;and buildingthe domesticcapacity o manufacturea rangeof intermediategoods (suchas plasticsand steel).Supportfor par-ticularindustriesand importsof the necessary oreigntechnologytook sev-eral forms. First, the support for education-particularly engineeringandscience education-provided an intellectualinfrastructurehat facilitatedtechnologicaltransfer.Second,the decisionto discourage through inancial

market regulations) the allocation of capital to areas such as real estate meantthat morecapitalwas availablefor areaswith highertechnologicalbenefits,suchas plants andequipment.Third,as discussed ater,thegovernmenten-couragedexports. Fourth, in some industries,particularlyhose with manyfirms,governmentpromotedtechnologyprograms, ncluding ciencecentersthat offeredservicesrangingfromidentifyingnew products o providingre-searchand development or firmsthathadno facilitiesof theirown. Taiwan(China)andMalaysiadeveloped ndustrialparksforhigh-technologyndus-tries, both to allow firms to capturesome of the diffuseexternalitiesassoci-

ated with these industriesas well as to lower the barriers o entry. (Diffuseexternalities arise when the actions of one firm benefit-or confer costsupon-many firms,ratherthan, say, just one upstream irm or one down-stream firm.) And finally, the government provided explicit and implicit sub-sidies (through cheap credit) to industries it wished to support.


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An importantelement in the expansion of certain industrieswas a receptivity

to direct foreign investment. The East Asian economies not only resistedxeno-

phobic aversions to foreign investments, but they also induced capital inflows

by providing sound macroeconomicmanagement,a stablepoliticalenvironment,

and well-managed labor marketswith educatedworkers. In manycases govern-

ments took explicit steps to ensure that a transferof technological and human

capital would accompany these inflows. Foreign investment increasedthe paceof expansion, reducingthe constraintsimposed by limitationson the availabilityof capital, domestic entrepreneurship,and technological know-how.

Why WereIndustrial Policies Adopted?

Market failures are likely to be particularly significant in developing coun-

tries for several reasons.3Understandingthese market failureshelps explain thepolicies that were adopted and the reasons they were so effective.

WEAK AND NONEXISTENTMARKETS. n the early stages of development, mar-

kets often do not exist or work well, so prices may not providegood signals for

resource allocation. In East Asia capital markets were particularlyweak, lead-

ing government to create institutions to promote savings (the postal savings

banks) and to extend long-termcredit (the development banks). Governmentsalso tried to develop the financial infrastructureby helping to establish bond

and equity markets (Stiglitz and Uy 1996).Having promoted savings, governments had to decide how to allocate these

funds. If there had been well-established market institutions for allocating long-term capital, governments could have made use of those institutions. But be-cause the governments had to decide how to allocate resources, it was naturaltodirect the funds to projects that would yield the highest level of social welfare.

TECHNOLOGICALSPILLOVERS. rivatemarkets have inadequate incentives for

investing in the production and acquisition of technology, largely because it isdifficult to appropriate the returns to knowledge. Developing countries typi-

cally operate at a level of technology far below that of industrial countries;

development is, to a largeextent, the process of acquiringand adaptingexisting

technologies. Patent protection ensuresthat the seller can command some pay-ment for new technology, but it does not provide much protection for a firmthat transfers and adapts an existing technology. Adopting and adapting new

technologies involves a risk. If successes are quickly imitated, then firms face aheads I lose, tails you win situation: when they succeed, there is little profit

because of the force of competition; when they fail, they lose money.

MARKETINGSPILLOVERS. till another kind of valuable information concerns

marketing. Knowing where there is a market for a product is not information

that can be kept secret. If a firm spends money to discover that Americans like


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madras shirts, then any manufacturer of madras shirts can take advantage of

that information. The converse is that the products of a country establish a

reputation. Thus, Japan'sreputation for high quality benefits all Japanese pro-

ducers.

Suchmarketingspillovers have led governmentsto adopt programsaimed at

promoting the country'sproducts. (In Hong Kong these programsare financed

by a special tax. In Singaporethey are directed by the powerful Economic De-

velopment Board.) Spillovershave also resulted in an arrayof programsto im-

prove the countries'reputation. Most notable in this respectis the recent effort

by Taiwan (China)to encourage its domestic firms to obtain brandrecognition.

RETURNSTO SCALE:a problematic explanation. Not all of the argumentsad-

vanced as rationales for industrial policies are persuasive, however. One that

seemed particularly nfluential in Japan held that government intervention wasrequired to rationalize industry. It was argued that without government sup-

port, firms would be too small, and the large number of such firms would re-

duce the profitability of all firms in a sector. (Thus, the Japanesegovernment

not only condoned the increasedconcentration in the steel industryin the late

1960s but, in one of its most famous mistakes, tried to discourageHonda-at

the time a successfulmanufacturerof motorcycles-from enteringthe automo-

bile market.) This argument is unpersuasive because if theretrulywere increas-

ing returns to scale, then a single firm would benefit by increasingits produc-

tion; in time its costs would be lowered, and it would then be able to undercutits

rivals. Natural economic forces lead to the rationalization of industrieswithout

government intervention.

A slight variantof the argument about returns to scale does have some valid-

ity. Increasingreturnscombinedwith a shortageof capitalmaystunt small firms.

They cannot expand to take advantage of increasingreturns either becausetheycannot get access to capital or because the only form of capital to which they

have access is credit, which imposes too high a risk. In this case, government

interventioncan lower the costs of capital and increase economic efficiency.Increasingreturns,especially when combined with capital market imperfec-

tions, provide the foundation for strategictrade policy. Historically, arguments

for government trade interventions focused on industrieswith learning by do-

ing. If today's production lowers future marginal costs, that creates a form of

increasing returns akin to the more familiar static increasingreturns. A firm

that expands production lowers its future production costs and undercuts its

rivals. The infant industryargumentholds that protection is important so that

the young firm can gain the experience required to lower its production costs

and allow it to becomeviable. Critics of this argumentclaimthat if the firmis tobe profitablein the long run, it should incurany necessarylosses today. Butthis

assumption is based on the premise that capital markets are perfect. With im-

perfect capital markets, a firm may not be able to sustain the losses that would

enable it to produce at a level at which it would eventually become profitable.


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Moreover, if the firmis unable to appropriateall the returns to its learning,then

social returnsto production will exceed private returns (Dasgupta and Stiglitz

1988). In addition, dominant firms in industrialcountries are likely to take ad-

vantage of the lack of competition that prevailswhen learning is important by

raising pricesand increasingtheir profits. Government policies may be directed

at tryingto appropriatesome of these rents (theexcess profits that resultfrom adominant competitive position).

COORDINATIONFAILURES.The widespread absence of markets in developing

countries means that prices cannot perform their coordination role. Govern-

ment may thus have to assume a more active role in performing this function.

The traditionalexamplesrelateto the developmentof downstreamand upstream

industries:developing a steel-manufacturing ndustrydoes not pay unless there

is a steel-using industry;and developing a steel-using industry does not pay ifthere is no steel-manufacturing ndustry.If both wait, nothing happens.Accord-

ing to this view, the government has an important function in coordinating the

two activities. Such coordination failures, it is argued, are likely to be most

important when the returns to scale are large. For instance, if manufacturing

steel is deemed to be desirable, it is necessaryto build a large steel plant and a

large steel-using industry. Other market failures, such as the absence of risk

markets, interactwith this failure: argerisks are likely to accompany such large-

scale investments, and the market provides no mechanism by which these risks

can be divested. Moreover, no single entrepreneurcould amass the capital re-quired, and the imperfections of the capital marketmean that it cannot supply

the funds required.Developing countriesare less likely than industrial countries

to have the organizations capable of undertakingthese large investments in a

single sector, let alone the capacity to undertakethe investments in both the

upstreamand downstream firms. Thus coordination problems may be larger in

developing countries, and the capacity to deal with them may be smaller.

The earlierargumentsfor coordination failures(Rosenstein-Rodan 1943 and

Murphy, Shleifer, and Vishny 1989) were rightly criticized as unpersuasive(Stiglitz 1994a). Such a problem could easily be addressed through trade-one

of the solutions devised by the East Asian countries(without benefit of the theo-

retical literature).It is possible to develop a steel-using industry simply by im-

porting steel and to develop steel producers without steel users simply by ex-

porting steel.

In the early stages of rapidgrowth, the subsectorsresponsible for the takeoff

in many, if not most, of the East Asian countries-textiles, footwear, sporting

goods, toys-were not those in which economies of scale or coordination prob-

lems seemed importiant.But there was a more subtle form of returns to scale inwhich government intervention did matter and which affected growth even in

these areas: the availability of a wide range of intermediate-often fairly com-

plex-goods, tailored for the producersof final goods. The sellersof these inter-

mediate goods do not capture all of the benefits that their greater availability


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provides.The improved two-way flow of information betweenthe producerand

the user, which permits bettercoordination in the developmentof the interme-

diate and final goods, is a benefitof proximity. That explainswhy importing the

intermediategood does not serveas a perfectsubstitutefor domestic production

and also provides a rationale for government intervention. In Malaysia it isclaimed that the local auto manufacturerhas provided important spillovers to

the intermediategoods firms that produce parts and that these firms, in turn,

have benefited producersof other final goods.

STRATEGICNEGOTIATIONS.n negotiations with other countriesor companies,

the governments of East Asia have often recognized-and taken advantageof-

the natureof the marketenvironment.The outcome of any bargaining depends

on the strength of competition on both sides. By reducingcompetition among

buyersof technology and tryingto increasecompetition among sellers, the gov-ernments succeeded in appropriatingmore of the surplus associated with the

transfer of technology than otherwise could have been captured. In Japan, for

instance, a single firm was sometimes given the right to negotiate a licensing

agreement;it might then be compelled to sharethe technology with other firms

in the industry.

Did These Policies Work?

Industrialpolicies have been widely criticized, on the (somewhat contradic-

tory) grounds that they were ineffective or distortionary.The firstcriticism sug-

gests that industrial policies are more form than substance. Critics cite statistics

such as the small percentage of loans made by the development banks. These

statistics are unconvincing, however: the consequences of, say, a loan by the

IndustrialBank of Japan may be fargreater than the actualdollars lent, because

of either its signaling or risk-sharingeffect (Stiglitz and Uy 1996). Government

policies that increase the equity of a firm can have immense effects through the

power of leveraging. Beyond that, there was a wide range of instruments foreffecting industrial policies; it is the cumulative effect of all of these that mat-

ters. The criticism is more properly directed at those who have suggested that

Japan'sMinistry of InternationalTrade and Industry totally controlled the allo-

cation of resources. This assumption is wrong on two counts. First, firms made

most of the decisions about resourceallocation-influenced, to be sure, by gov-

ernment policies, but not directly controlled by them. None of the East Asian

countries is a command-and-controleconomy. Second, the view that govern-

ment makes decisions on its own seems misguided. Consultation between busi-

ness and government was extensive (and many of the top leaders of businesswere former government employees).

The charge that industrial policy was distortionary,however, is of more con-

cern. Even if there is a rationale for government intervention,this view alleges

that government does not do a good job at picking winners. Instances of mis-


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takesby thegovernment retypicallycited.Insomecasesthegovernmentdis-courageda firm(Honda,forexample),when in retrospectt clearly houldnothave; and in othersthe government ncouraged omeindustry suchas petro-chemicals),whenin retrospectt probably houldnot have.

Therearefourresponseso thiscriticism.First,good decisionmakingythe

government ecessarilynvolvesmakingmistakes: policythatsupportedonlysurewinnerswouldhavetakenno risks.Therelativelyewmistakes peakwellfor the government'sbilityto pickwinners.Second, he governmentwas notheavy-handed. lthought mademistakesof judgment,t didnotforce tsopin-ions onotherswhentheywerewilling o risktheirowncapital.This soneof thestrengthsof decentralized ecisionmaking:t ensures hatmistakenviewswillnot dominate.

Third,to a largeextent,governmentpolicies were not directedat picking

winners n thenarrowsenseof the term.Severalgovernments ecided o sup-portexport-orientedndustries.na sense,thatwas choosinga winningdevel-opmentstrategy; t did not necessarily ntailmicromanaging. venwhen thegovernmentdentified n industry orsupport, hebanksseemto havehaddis-cretion to select which firms or projectswithin that industryto support.

Fourth,ndustrial olicieswerefocusednotsomuchonpickingwinnersas onidentifyingmarket ailures-instanceswhereinvestors ouldnot capture argepotential pillovers.Concern boutsuchspillovers elpsexplain hegovernment'sencouragementf high echnologyndustries. raining rovides nother xample.

Firmswouldbenefit roma trained aborforce,but,becauseworkerscanleavefor a better ob oncetheyaretrained, irmshaveinadequatencentiveso pro-ceed withtraining.Yeta skilledworkforce s essential oreconomicgrowth,sogovernment ndertooko improve hequalityof thelabor orcebyemphasizingeducation.

Moreover, he criticismof industrialpoliciesas misguidedattempts o pickwinnersignoresthe broaderrangeof governmentactions,suchas its role inspearheadingheexpansionof certainmanufacturingectors. Pickingwinners

seems to implycullingfroma fixedpool of applicants o findthose with thehighest ong-run ocialreturns.EastAsiangovernments ave nsteadperformedanentrepreneurialole.Entrepreneurshipequiresombiningechnological ndmarketingknowledge,a visionof thefuture,a willingnesso takerisks,andanability to raisecapital.In earlystagesof development, hese ingredientsaretypically n shortsupply.The governmentsn EastAsiastepped n to fill thegap-but in a waythatpromotedrather hanthwarted hedevelopment f pri-vate entrepreneurship.

Governmentwasalsoeffective nmonitoringherecipients f itssupportand

ensuring hattheydidnot siphonoff fundsfor privateuse. Othergovernmentpolicies,suchas thosethatledto moreequityfinancing, educedhemagnitudeof themonitoringproblem;hatis, theyresultednfirmshavingmoreappropri-ateincentives. tillotherpolicies,suchasthosethatenhancedhestabilityof thebanking ystem, edto moreeffectivemonitoringby financialnstitutions.


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similarculturalbackgrounds ave not displayed he samesortof cooperativebehavior eeninJapan.It seems farmorelikelythatgovernment ctionsweremoreimportanthanculture n shaping hesebehavioralpatterns.

Of the institutionsandmechanisms hat facilitated ooperation,an impor-tant role was playedby businesscouncilsset up to share reliableand timely

information.Whydid notsomebusinessesryto free ide, o obtain heinfor-mationprovidedby otherswhileprovidingnoreal nformationhemselves? heanswer is, in part, that they were in a longer-term elationship; firmthat

cheated would be ostracized romthe circle.The fact that the governmentwas included n these circleswas important:irmswantedto know what thegovernmentwas thinkingaboutspecificprojectsor what policychangeswereplanned.Evenif a firm'scooperative nstinctswent astray,self-interestwas astrong incentive. Moreover, by paying attention to these councils, the govern-

mentensured hatthegainsfromcooperationwereevengreater.Thegovernment's iscretionaryowersenabledt to reward ooperation ndhonesty,andtherewas at least a fearthat the lackof cooperationand the ap-pearance f dishonestywould bepunished.Governmentnterventionnmarketscreatedrentsthatthe government ould then allocateto participantswho be-havedcooperatively. orexample,byrestrictinghe formation f branchbanks,a largefranchise aluewasassociatedwith theright o havea branch.Similarly,restrictingreditmeantthataccessto credithadvalue. And the Bankof Japan(thecentralbank)could,on a discretionaryasis,providebankswithadditional

fundswhenneeded.The relative tabilityof the EastAsiangovernmentsncreasedhe incentives

for establishingong-termcooperativerelations.At the sametime, long-termrelations nhancedheeffectiveness f incentivesStiglitz ndWeiss1983).Firmsthat performedwell on one projectcouldexpect to be rewardedwith anotherproject.

TheEastAsiangovernments lsotriedto createanenvironmentonducive oclosecooperation mongbusinesses. nJapan, orinstance,hegovernmentried

to encouragemergers.To the extentthat theseprogramsweresuccessful andthere is considerable ontroversyabout that), they reduced he difficultiesofcooperation.Thesmaller hegroup, heeasiercooperations to attain.Herethegovernmentwas walkinga fine line;a smallgroupcould-and may-have ledto collusionbyrestrictingompetition. nsomecircumstances,hegovernmentapprovedthe formationof so-calledrecessioncartels.Thesecartelswere anexplicitattempt o dealcooperativelyandcollusively)withthe problems hatarise n a recessionwhenthere s excesscapacity n a capital-intensivendustry.Undercertainconditions,as demandshiftsdown, pricesdropand firmsare

unableto recover heircapitalcosts. Recessioncartelswere a way to restrictcompetitiono enable heindustrynquestion o avoid he lowprices hatwoulddamageallthefirms.Whetherhegainswereworththe costsof reduced ompe-tition,higherprices,andunderutilizedesources s not clear,however.Becauseof the strong ncentiveso cheaton sucharrangements,artelsareseldomsuc-


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cessful without legalsanctions from the government.In some cases theJapanese

government paid firmsto destroy equipment, and in others, to seal equipmentshut. Even these tactics were not always successful; some firms did not com-

pletely dismantle their equipment.

Labor markets were similarly designed to encourage cooperative behavior.

The Japanese patternof lifetime employment was important because it meant

that employees had long-term relationships with employers, which facilitated

cooperative behavior.The rapidincrease in wages that came with age and expe-

rience provided a strong incentivefor workers to stay with their organizations.

The averagepay of each age cohort increasedsharply,but differentiationwithin

the age cohort remainedsmaller than in, say, the United States.Japan's preva-lent compensation scheme, in which a large part of the salary was paid as an

annual bonus (based largely on profits of the previous year), also encouraged

cooperation because workers had, in effect, an equity stake in the firm. Thisform of risk-sharingmay be particularlyimportant in early stages of develop-ment when capitalmarketsareunderdeveloped. Becausewages are basedon thegroup's performance,the individual has an incentive to monitor his peers tomakesure thathisco-workersareworkinghard(ArnottandStiglitz1991; Stiglitz1990b). One might even go further. Basing salary on individual performance

encourages self-interested,noncooperative behavior. Conversely,paying wagesbased on group performancesignals the importanceof cooperative behavior.

Also importantin Japan'slabor marketwas the government-establishedPro-

ductivity Council, which dealt with the degree of inequality that could existwithin a firmand limitedsalariesof top managers to no more than ten times thewages of the lowest-paid workers.4This compressed wage structureenhancedthe sense that top managementwas not taking advantageof workersand led togreatereffort and lower labor turnover.

Cooperative behavior between firms and their employees is particularlyim-portant in facilitatingtechnological change. Workersare often in the best posi-tion to identifyimprovements n efficiency, although such improvementsdo not

always redound to the benefit of the workers. Becauselabor-savinginnovationsmay result in less demand for labor and higher unemployment, employees areoften reluctantto disclose such ideas. If, however, the firmprovidesa guaranteeof lifetime employment, existing employees will see no conflict between theirinterests and those of the firm. Moreover, when wages are based partially onfirm profitability, interests coincide: if the productivity-enhancinginnovationenhances profits in the long run, employees will share in the gain. Of course,when growth is rapid firms can more easily promise that labor-savinginnova-tions will not resultin reducedemployment, which makes it more credible that

all (existing) employeeswill benefit from such innovations.Cooperative behaviorbetween firms and their banks was also evident in the

operations of capital markets. In Japan each firm had a long-standingrelation-ship with a single bank, and that bank played a large role in the affairs of thefirm.Japanesebanks, unlikeAmericanbanks, are allowed to own shares in the


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firmsto whichtheylend,and when theirclientfirmsare introuble, heystepin.(The fact that the bank owns shares n the firm meansthat there is a greatercoincidenceof interest han therewould be if the bankweresimplya creditor;see Stiglitz1985.)Thispatternof active nvolvement etween endersandbor-rowersis seenin othercountriesof EastAsia andwas activelyencouragedbygovernments.

Another importantaspect of business-governmentooperationin Japanhas beenthe attemptto reducebankruptcies,which have beenmarkedly esscyclical than those in the United States and other countries. This patternreflectsnot only the country'sbettermacroeconomicperformanceand a le-gal structure hat encouragesactions shortof bankruptcybutalso an activegovernmentpolicy directedat avoidingthe economic disruptioncaused bybankruptcy.

Combining Competitionand Cooperation

The EastAsiancountries ucceeded not always,butwitha remarkablere-quency) n harnessingheadvantages f cooperationwhileretaininghe advan-tages of competition.Cooperation o increaseefficiencycan easilybe turnedinto collusion to raise prices and restrict output and entry. Worse still, discre-tionarypowersneeded orcooperation angiveriseto rent-seeking ndcorrup-tion. Competitionbothenhanced fficiencyandreducedhescopeforabusesof

discretionarypowers.In fosteringa competitive ndustrial tructure, overn-ments lookednot so much at the numberof firmsin an industry,but at theeffectivenessof the competition; ompetitionmay be moreeffectivewith twoevenlymatchedfirmsthan with one firm competingwithmanysmallrivals(NalebuffandStiglitz1983).

By the sametoken,the processof identifyingwhichworkers o promote nJapanese irmsmay be moreeffective n encouraging ompetition han is theprocess in theUnitedStates.InJapan,whereworkersarelessmobile,a cohort

of workershired ogetheradvances ogether.They allworkhard; hey all haveto signalthattheyarecommitted o the firm; hey all remain n thecontest.IntheUnitedStatesdecisions oncerningwho is on anupward areeradderoftentake place earlier. Underthat system, incentivesmay be strong in the earlystagesof individualcareers,but theymay be greatlyattenuatedoncethesedecisionsare made.Thosewho knowthattheyarenot going to be winners avelittlereason to workhard.

One methodintroduced o stimulatecompetitionwas the use of contests.Governmentsrewarded irmsthat performedwell relativeto others(suchas

in exports) by, for example,providingthemwith accessto capitaland for-eign exchange.In manyinstances, the value of the prizearosefrom the gov-ernment ntervention:f thegovernmenthadnot createdartificialscarcityofcapital or foreignexchange,an increasein availabilitywould have had noincentive effect.


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Well-functioningcontests arecharacterizedby rules that establisha clearcri-

terion for rewards,such as export performance;specifythe nature of the reward

(the allocation of credit or foreign exchange); and indicate who will evaluate

performance. This system reduced the scope for abuse of bureaucraticdiscre-

tion at the same time that it providedstrong incentives.

Ironically, licensing requirementsput in place to restrict competition maygive rise to more competitive behavior. At various times, the Japanesegovern-ment imposed restrictionson the expansion of capacity in certain industries. It

awardedlicenses to expandcapacity on the basis of firms'previousmarketshares.

Thus performance-particularly growth-in one year may increaseprofits not

only in that year, but also in subsequentyears.

Growthwith Equality

Although industrial policies attempt to direct resource allocations in waysthat maximizegrowth, incomedistributionpoliciesseek to promotegreaterequal-ity. Historically, the development process has been characterized by markedincreases in inequality (the Kuznets curve). It was alleged that the massive

amounts of capital accumulation requiredcould only be attained through sig-nificant inequality; the poor simply could not save enough. Moreover, growth

creates winners (the owners of those firms that do well), and losers (workers

displaced from lagging industries,in particularagriculture).The economies ofEast Asia were able to achieve rapid growth without an increasein inequality.Indeed,active policies promotingequalityprobablyenhancedgrowth (figure1).

In Korea, Japan, and Taiwan (China), land reforms-at least partially im-

posed from the outside-were important in the initial stages of development.These had three effects: they increased rural productivity and income and re-sulted in increasedsavings;higher incomes provided the domestic demand thatwas important in these economies before export markets expanded; and the

redistributionof income contributed to political stability, an importantfactor increating a good environmentfor domestic and foreign investment.In lateryearspolicies to ensuremore equitabledistributionof income contin-

ued to contribute to economic growth, with positive effects that more than off-set the possible negative effects of reduced capital accumulation upon whichearlierdiscussions had focused.These policies continued to contribute to politi-cal stability. High and increasingwages reduced inequality, made workers notonly more satisfied but also (by standardefficiencywage arguments)more pro-ductive, and promoted cooperative relations between workers and firms. Poli-

cies that attempted to restrict real estate speculation (by limiting lending forthat purpose) can be viewed both as part of industrial policy and as part ofincome distributionpolicy. While they directedfunds into industry,they limitedthe increases in the prices of housing relative to what would otherwise haveoccurred. Such price increaseswould have led to demands for furtherwage in-


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Figure 1. Income Inequality and Growthof Gross Domestic Product, 1970-93

GDPgrowth per capita (percent)

8

Indonesia o Singapore 0 Botswana6 - Indonesia O 0Hong Kong

Thailand O 0 Chile

4 - Sri Lanka 0

Pakistan o Italy Brazil SJapan 00 ni2 k

JalpBelgium 0 France Q Colombia

Australia0 Nepal DSwitzerlandBangladesh 0 0 Bolivia 0 Mexico

0 - Philippines 0 Mauritania

Argentina0 0Venezuela

-2 0 Ghana 0 Kenya

0 CMted'Ivoire0 Peru

-40 Zambia

I , .I I I I I I , , , ., l ,

0 5 10 15 20 25Income inequality'

a. Incomeinequalitys measuredby the ratioof the incomesharesof the richest20percentand the poorest20 percentof the population.

Source:WorldBank data.

creases and would have had particularlyadverse effects on the very poor, who

often seem unable to obtain adequatehousing under such conditions.Additionally, policies ensuringuniversal literacy both increasedproductivity

and promoted greater equality. The emphasis on female education led to re-duced fertility, thus mitigating-he adverse effects of population pressure felt inso many developing countries, and it directly increased the supply of educatedlabor. Most studies suggest that a worker's wage performanceis more directlyrelated to nonschool factors, such as home background, than to education inschool. Education of women can be thought of as a roundaboutbuthigh-returnway of enhancing labor force productivity.

In Thailand a programto provide credit to the rural sector, although largelymotivated by concerns about communist insurgency, seemed not only to havepromoted equality but also to have yielded reasonably high economic returns.And in Malaysia, policies that would be regarded as affirmativeaction else-where were able not only to draw upon a reservoirof humantalentthat had not

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beenwell usedbefore,but to weld togethera nation thathadalreadydemon-strateda potential orethnicstrife.

Therearepositive elations etween rowthandequality.Highratesofgrowthprovidedresourceshatcouldbe usedto promoteequality, ustas the highde-greeof equalityhelped ustain hehighratesof growth.Althoughhismayseemto be littlemore thancommonsense, until the experience f EastAsia, com-mon sense suggestedquitethecontrary: rowthproducednequality, ndin-equalitywas necessary orgrowth.

Export-OrientedGrowth

Why focus on exports?Shouldnot countriessimplyproduce he goods in

whichtheyhavea comparativedvantage,whether hathappenso beproductsthatareexportedorsubstitutesorgoodsthatarecurrentlymported?' uccessin exportingprovidedpolicymakerswithan objectivewayto awardcreditandforeignexchange.6Two questionsarise:why are exportsa bettermeasureofperformancehanprofits?Andsecond,do markets eward uccess n anappro-priatewaywithoutgovernmentntervention?

In measuringperformanceo determinewhich firmsto favor with creditand otherscarceresources,governments acedan informationproblem.Allgovernments ace a similarproblem,but in the context of development, he

informationproblem s particularly everefor two reasons.First,relativelyfew firmsmay be engaged in similar activities, so bases of comparisonarelimited.Second,a host of problems must be overcome-new supplier rela-tionships,new markets,and so on. In suchcircumstances, hort-runprofitsmaybeimperfectndicatorsof long-termperformance.Consider, orinstance,the two sourcesof profits:those derivedfrom exports, and those derivedfromdomesticsales.The lattermayreflecteitherthe firm'sefficiencyor itsmonopoly position in the economy. The profits that resultfrom imperfect

competitionin the domesticmarketaccrueat least partiallyat the expenseof consumersand shouldnot be thought of as a social gain. By contrast,afirm that succeeds in the export marketis more likely to be economicallyefficient. It can marketa productat a lowerprice thancanforeignrivals, orone better tailoredfor the world market.Exportmarketsaremorelikelytobe competitive.Andeven if theyarenot, it is of no concern: heprofits of thefirmarethen at the expense of foreignconsumers.Indeed,fromthe export-ing country'sperspective, indinga nichewithin whichsomemarketpowercan be exercised s to be rewarded,not condemned.

Otheradvantages realsoassociatedwithexports.Firmsearnagreatdealininternationalmarkets,benefitingromspillovers elated o bothmarketing ndproductionknow-how.Forinstance,success n producingntermediateoodsrequiresproducingo standardshataretypicallyhigher hanthosethatprevailwithindeveloping ountries.Thisgeneratesa demand or testing aboratories.


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The recognition hat standards re mportant nd the knowledgeaboutproduc-ing goods of higherqualityhas implications crossa broadrangeof products.Moreover, he contactsestablishedhrough xportingmaybeof valuewhenthefirm decides o enterrelatedmarkets. t will, for instance,knowwhereto turnto acquireadvanced echnology.

Froma social perspective, uccess n exportingmay be a better ndicatorofwhethera firmmeritsadditional unds han success n sellingdomestically, utbankshavetypicallypreferredending o firmsengaged n thedomesticmarket,andfora simplereason.Banksdo not care whethera firmmakessocialreturnsor private returns,as long as it can repaythe loan. Banks are less informedabout foreignmarketsand thus consider t riskier o lendfor exportprojectsthan for the domesticmarket.

It has been argued hat the preferencesEastAsiangovernments aveto ex-

portswereintendedsimply o offset the disadvantages f tariffsand other re-strictionson imports.Fromthis perspective, overnmentwas not promotingexportsbut simply getting he prices right. Uponcloser examination evenwithout a detailedscrutinyof the statistics), his argumentappears aultyontwo grounds.First, t refers o averagesof exports;butwhat is relevant s theeffective ubsidyon particular xports. fsome exportsareencouragednd oth-ers (perhapsunintentionally) iscouraged,t is apparent hatgovernmenthasintervened n the allocationof resources.Second,the government ctuallyen-gagedin a wide rangeof activitiesbeyonddirectsubsidies o promoteexports.

Export Promotion Activities

Fouractivitieswerevery importantn promotingexport growth: heprovi-sion of infrastructure; referential ccess to capitaland foreignexchange; hedevelopment f exportmarkets; ndlicensingandotherregulations esignedoenhance hereputation f the country's xports.Asnotedpreviously,heclose,long-term elationships etween xporters ndgovernmentsan be creditedwithmakingthesemechanismswork.

THE PROVISIONOF INFRASTRUCTURE.ecause poor infrastructure s an impor-

tant barrier o trade, East Asian governmentshave invested n infrastructure,includinggood port facilitiesand mproved ransportationystemso reduce hecosts of shippinggoods abroad.Transportations not the only aspectof infra-structurehat has receivedgovernment ttention.Singaporehas beeninvolvedin effortsto providean adequate upplyof electricityandan effective elecom-municationsystem,bothvitalto the country'sdevelopmentsa financialenter.

PREFERENTIALCCESS O CAPITALND FOREIGN XCHANGE.Most of the coun-tries of EastAsia engaged n some degreeof financialrestraint,hatis, capitalmarketswerecontrolled o give priority ndustriespreferentialccess o capitaland foreignexchange(Stiglitzand Uy 1996). Although n somecasesgovern-


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ments provided subsidies (including lower interest rates) to encourage the ex-

pansion of favored industries,most observers believe that the access to credit

was far more important.

Critics of this access raise the issue of fungibility:what if the governmentdid

provide credit and funds for investment in export-oriented industries?So long

as money is fungible, largeconglomerates could simplydivert to otheruses those

funds that would have been allocated to exports. Consequently, financing ex-

ports may have little incrementaleffect on exports. From this perspective, the

allocation of capital to the export sector has no marginaleffect. It has only an

inframarginal effect on firmsthat are successful in exporting. This view, how-

ever, does not take account of the process by which funds are allocated. If past

export performance is used as one of the criteria for judgingthe creditworthi-

ness of the borrower,firms have an incentive to increaseexports. And firmsthat

were successful exporters had demonstratedsome set of abilities. If those abili-ties were correlated with other abilities that enhanced the likelihood of high

marginal returnsto investment, then the use of export performancemay have

been an efficient selection mechanism.

DEVELOPING EWEXPORTMARKETS.nformationproblemsassociatedwiththe development of new export markets go beyond the problems of reputa-

tion. One noted earlier was the public good nature of information. As in

the case of other public goods, a strong case can be made for public provi-

sion. And many of the East Asian economies have done just that. For in-stance, Singapore's Economic Development Board has actively worked on

developing foreign markets and takes an active interest in what goods might

be produced for export. Business executives are invited to join official trips

abroad to persuade them that it is in their interests to enter into meaningful

business relationships overseas.

ENHANCINGHEREPUTATIONFTHECOUNTRY'SXPORTS.n the 1950s and

early 1960s, Japanese products had a reputation for being shoddy. Americanand Europeanbuyers had little information about individual Japaneseproduc-

ers and were likely to make unfavorable inferences concerning any particular

product. Because establishing a reputation is expensive for any firm seeking to

export (particularly when consumers have strong negative prior beliefs), indi-

vidual firms had little incentive to improve the quality of their products. The

government conducted a concerted effort both to improve the quality of the

products and to establish brand reputations for Japanese firms, so that they

would have private incentives to maintain their reputation. Here is an example

of an interactionbetweencooperative behavior and individual ncentives. A simi-lar process is occurring in Taiwan (China), where the government is effectively

providing subsidies for firms to establish brand recognition. In doing so, firmswill have a private incentive to maintain high quality, with positive effects onthe reputation of Taiwanese products in general.


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Conclusion

One of the reasons for attemptingto delineate what East Asian governments

did that resulted in such high growth rates is that other countries would like to

replicate their success. If they did the same thing as the governmentsof East

Asia, would they too grow at such rapid rates?To be sure, many countries didsimilar things, but often with adverse ratherthan positive effects. They created

development banks, only to find that the development banks diverted scarce

savings into projects with low returnsand made investments that did more toline the pockets of politicians than to raise the welfare of the country. The East

Asian miracle had many dimensions:rents were created, but they were used to

encourage growth, not dissipated in rent-seeking. Government and businessescooperated closely, but they collaborated without collusion. Many aspects of

this transformation can be explained, and to the extent that they can be ex-plained, it is possible that what they did can be replicated.A high rateof savingleads to high growth; allocating resources on the basis of contests and other

performance-basedmeasurescan both provide high-powered incentivesand re-duce the scope for corruption;egalitarian policies, including active educationpolicies, can contribute to a more stable political and economic environmentand lead to fastergrowth througha more productive labor force. Governmentsthat use markets and help create markets are likely to be more successful inpromoting growth than governmentsthat try to replace markets.

What generalizations can be drawn from the findings of this article? To besure, not all of these generalizations are held with the same degree of confi-dence. In some cases, there are alternativeinterpretationsof the events and evi-dence. But a combination of theory and evidence supports these conclusions.Included in the discussion below are several interventions in the financial mar-

ket, which, although mentionedonly briefly, are amplifiedin the accompanyingarticle by Stiglitz and Uy in this issue. Because governments in differentcoun-tries pursuedsomewhat differentpolicies, not all the statementshold with equalvalidity in all countries; some may not even hold within all sectors of

a givencountry. These conclusions are organized around six themes.

* Makingsociety function better.Economic growth requiredthe maintenanceof macroeconomic and political stability. Policies that sustained a moreequitable distribution of income-and that supported basic education forwomen as well as men-contributed to economic progressby encouraging

political stability and cooperative behavior within the private sector. Theresultwas a betterbusinessclimate for investmentand moreeffectiveuse of

human resources.* Adaptability of government policies. Government policies adapted to

changing economic circumstances,rather than remainingfixed. As the EastAsian economies grew more complex, government had less need to assumean active role and found it more difficult to act effectively on a broadscale.


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* Governmentand markets. Governmentsplayed an active role in creating

market institutions, such as long-term development banks and capital

markets to trade bonds and equities, and in establishing an institutional

infrastructure that enabled markets to work more effectively. These

institutions and marketshelped ensurethat the high volume of savingswas

invested efficiently. Governments also used their control of financial

marketsto help directresourcesin ways that stimulatedeconomic growth.

This control was probably more important than direct subsidies or low

interest rates. Credit was directed not only toward priority areas, but away

from speculative real estate and consumer durables.

Policies to improve government-business cooperation enabled govern-

mentsto design programs that servedthe needs of the businesscommunity,

createda favorable businessclimate, and encouraged business to direct its

energiesinways that contributed to highsocial returns.Sharing nformationenhanced the quality of decisionmaking.

By using, directing, and supplementing markets rather than replacing

them, the private sector remained the centerof economic activityin most of

the East Asian countries; when the private sector disagreed with the

government, it was permittedto go ahead and risk its own capital.

* Promoting accumulation of physical and human capital. The introduction

of postal savings institutions and provident funds resulted in higher

domestic savings. At the same time, measures that establishedprudential

regulations (and in some cases, entry restrictions) enhanced the safety andsoundness of financial institutions and promoted financial deepening. A

variety of programs increased the returns to private investment and

facilitated the development and transfer of technology; these included

policiesthat promoted education andtraining, provided infrastructure,and,

in most countries, established a receptivity to foreign investment.

* Altering the allocation of resources. Governments in East Asia used

industrialpolicies to affect the allocation of resources in ways that would

stimulateeconomic growth. They took an entrepreneurial ole in identifyingindustries in which research and development would have high payoffs.

Support for industry, such as the establishment of research and science

centers and quality control standards, was important both in attracting

foreign investment and in encouraging domestic investors. Emphasizing

industrieswith strong backward and forward links and large externalities

may have helped long-term growth. In the short term, the lack of

profitability does not provide a good measure of the potential long-run

contribution to growth, precisely because it is the discrepancy between

private and social returns that motivates government intervention.Governmentsactively encouraged firms to export. Exports provided a

performance-based riterion or allocatingcredit, encouraged he adoption of

international tandards,and accelerated he diffusion of technology. Contests

among exporters were used widely as incentive devices. The essential


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ingredients f contests are rewards(herethe allocationof credit),rules(measures f performance),nd refereeswho evaluateperformance).n aworld hortofperfect ompetition,ontests anprovide trongncentives ithlimited isks,and, f therulesarewellspecified,educebureaucraticbuses.Government oliciessupportingnvestment.Mild financial epression adapositiveeffectoneconomicgrowth.Theeffectson national avingsandonthe efficiencywithwhichscarcecapitalwas allocatedwerelikelypositive;positive incentiveeffectsmay have beenassociatedwith the contestforscarce redit,and theincreasedquityof firmsandbanks(because f lowerinterestrates)enhanced heirability o bearrisks.Equally mportantwereothergovernmentprogramshat led to more effectiverisk-sharingwithinthe economy. Risk-sharingreducedthe effective cost of capital, thusstimulatinginvestment.Government ntervention n internationaleco-

nomic relations(for instance,in bargaining or foreigntechnology,inimpeding ertaincapitalmovements, nd in insistingon certainransfers ftechnologyas partof foreign nvestment)mayhave enhanced henationalinterest,promotedeconomic tability,andenhanced avings.

No singlepolicyensured uccess,nor did theabsenceof any single ngredientensure ailure.Therewas a nexusof policies,varying romcountry o country,sharing he commonthemes hatwe have emphasized:overnmentsntervenedactively n the market,butused,complemented, egulated,andindeedcreated

markets, ather hansupplantedhem.Governmentsreatedanenvironmentnwhich marketscould thrive.Governments romotedexports,education,andtechnology; ncouraged ooperationbetweengovernment ndindustry ndbe-tweenfirmsandtheirworkers;and at the sametimeencouraged ompetition.

Thereal miracleof EastAsiamay be politicalmore than economic:why didgovernments ndertake hesepolicies?Why did politiciansor bureaucrats otsubvert hemfor theirown self-interest? venhere,the East Asianexperiencehas many lessons,particularlyhe use of incentivesand organizational esign

withinthe publicsector to enhanceefficiencyand to reducethe likelihoodofcorruption.Therecognition f institutional nd ndividualallibility averisetoa flexibilityandresponsivenesshat,in the end,must ie at the rootof sustainedsuccess.

Notes

Joseph E. Stiglitz is chairman of PresidentClinton's Council of EconomicAdvisers, on

leave from StanfordUniversity, where he is professor of economics. This is a shortenedversion of a paper written as part of the World Bankproject on The East Asian Miracleand Public Policy. Financial and technical support of the World Bank is gratefully ac-knowledged. The author is particularly ndebted to Marilou Uy. He has also benefitedfrom discussionswith Nancy Birdsall,John Page, Richard Sabot, Howard Pack, EdwardCampos, Masahiro Okuno, Masahiko Aoki, Daniel Okimoto, Lawrence Lau, ProfessorGato, ProfessorBaba, and dozensof other governmentofficials, academics,bankers, and

174 The WorldBank ResearchObserver,vol. 11, no. 2 (August 1996)

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industrialistswho gave generously of their time during this researchproject. Researchassistance from ThomasHellman is also gratefullyacknowledged.

1. In the literatureon this subject,particularreferenceshould be madeto the work ofAlam (1989), Aoki (1988), Wade (1990), Amsden(1989), Okimoto (1989), Lau (1990),Agrawal and others (1992), Johnson (1982), Pack and Westphal(1986), Itoh and others(1984), Komiya,Okuna, and Suzumura 1988), and Vogel (1991), as well as to the coun-

try studies of the WorldBank.The informationtheoreticfoundationof the analyses pre-sented here is set forth in greaterdetail in Greenwaldand Stiglitz (1986, 1988, 1992),Arnott,Greenwald,and Stiglitz(1993), and Stiglitz(1994b). The implications or govern-ment policy are discussed n greater engthin Stiglitz(1990a, 1991a, 1991b).

2. The contrast between India and Singapore could not bring this point home moreclearly:India,with a population300 times that of Singaporeand a grossdomesticproductten times as large,has a cumulativeforeigninvestmentone-fifteenththat of Singapore's.

3. The discussion of this section focuses on standardmarket failuresassociated withexternalities,missingmarkets,and competition.The Greenwald-Stiglitzheorems,whichgo beyond these standardmarketfailures, establishthat whenever information s incom-plete, a discrepancymay exist betweensocial and private returns.An importantapplica-

tion of this principlearisesin the context of capitalmarkets: he ratio of the privatereturnto the supplierof capital to the social returnmay differmarkedly(evenin the absence ofthe traditionalmarketfailures).For instance, private endersmay be able to appropriatealargerfraction of the total returns o real estate lendingthan to otherlending.For a fullerdiscussion of the implications,see Stiglitz and Uy (1996).

4. This should be contrastedwith the UnitedStates,where, for instance,in recentyearstop executives often received100 times the pay of recent hires. Within rapidlygrowingareas of China,the degreeof inequality s even lower,with managersgetting paid approxi-matelythree times the amountreceivedby workers.

5. Note that severalof the countrieswent throughan importsubstitutionphase,duringwhichtheywere verysuccessful.It is questionedwhetherthis phasewas necessary,whether

it helped (or hindered) he growth process, or whetherit was primarilya consequenceofthe particulareconomicdoctrinesthat were fashionable at the time.

6. The argumentshere are not those provided by government officials at the time (oreven subsequently).These focusedon more immediateconcerns: for instance,in the post-war era, with an overvalued oreignexchangerate,Japan was short of foreignexchange.To some extent, it saw export activities as offsettingthe disadvantages xportersfaced asa resultof the overvaluedexchangerate.

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