Neoliberalism and the Developmental State in Asia

1. Neoliberalism and the Developmental State in Asia C.P. Chandrasekhar

2. The Asian Story • Different countries in Asia have served as example of development success with transition from low to middle and even developed country status. • Japan the first Asian success. • But three tiers of development after Japan • First tier: Korea and Taiwan. • Second tier: Malaysia, Indonesia, Thailand • Third tier: China (and India?)

3. The success of Asian late industrializers • Between 1970 and 1995, the share of the industrialised countries in global manufacturing value added fell from 85 to about 78 per cent, while developing countries registered an increase in their share from 10 to 20 per cent • Almost all of this shift in manufacturing production was to countries in East and Southeast Asia, the combined share of which more than doubled from 4 per cent to 11 per cent over this period

4. The paradox • Early Asian success was attributed by many to the Developmental State which “got prices wrong”: Japan, Korea and Taiwan. But this too privileged growth based on exports. • Subsequent tiers of industrialization were seen as founded on letting markets work or adopting neoliberal policies. • Support from the1997 crisis and subsequent trajectory of the early miracles? • With the transition in China and India, Asia became the showcase for neoliberalism when it had failed elsewhere.

5. Amsden and late industrialization • Countries that industrialize without the competitive edge of a monopolized original technology • Different from countries that experienced the first and second industrial revolutions. Former had the benefit of invention (search for new products and processes), the latter of innovation (mass commercialization of invention). • The mode of late industrialization has been one of borrowing technology from more technically advanced societies, or what may be called learning. • True of all successful industrializers in Asia, including Japan

6. Similarities • Important role for the State even if with differences. The state in Korea, Japan and Taiwan has been more effective than other late-industrializing countries because it has had the power to discipline big business, and thereby to dispense subsidies to big business according to a more effective set of allocative principles. • Intervention rather than market determines prices: interest rates, exchange rates, export subsidies, directed credit, etc. “If the metaphor of the First Industrial Revolution is ‘laissez faire’, and that of the Second ‘infant industry protection’, then that of late industrialization is a category comprehensive enough to overcome the penalties of lateness—call it ‘the subsidy’. “

7. The interpretation • Industrialization is constrained by demand, both internally and externally. • Any country, particularly a small one, can produce without regard to the size of its home market, so long as it can export. The problem is that most Third World countries cannot export because they are not competitive internationally, despite low wage rates – problem is that raising productivity and creating international competitiveness, not effective demand • Issue not one of inadequate effective demand, but of too much. What is needed is more foreign exchange, savings and public revenues; for these, and not effective demand, are the constraints on exoanding the pie.

8. The Korean case • High profits in Korea’s mass-production industries have been derived not merely from investments in machinery and modern work methods (what Marx calls ‘relative surplus-value extraction’ and what the school of regulation calls an ‘intensive’ regime) but also from the world’s longest working week (what Marx calls ‘absolute surplus-value extraction’ and what the regulationists call an ‘extensive’ regime). • In Korea these two forms of profit making operate side by side, and characterize the same group of workers simultaneously. Land reforms also plays a role.

9. Differentiating features • Central coordination linked to broad diversification may be a unique competitive advantage, or scope economy, of late industrializers, for it allows them to enter new industries quickly and efficiently. • Subsidies in Korea (as in Japan and Taiwan) have been allocated to big business according to the principle of reciprocity, in exchange for performance standards, whereas in other late-industrializing countries subsidies have tended to be dispensed as giveaways • The corporate office, inclusive of R&D functions, tends to be the strategic focus of companies that compete on the basis of innovation, because it is at the administrative level that new technology is developed and marketed. By contrast, the shop floor tends to be the strategic focus of firms that compete on the basis of making borrowed technology work.

10. Challenge to export pessimism • The fallacy of composition argument • The price effect of UDC competition • The state of the world economy argument • The concentration of LIC exports • The concentration of relocative FDI flows • The obstacles to migrating from labour to technology-intensive exports • Export dependence and the transient miracle

11. The Indian alternative • Export pessimism and import substitution • Implications of geography and demography for the size of the domestic market • The legacy of industrialization at Independence • Commitment of the State

12. Belied promise • The share of manufacturing in GDP did rise from around 9 per cent in 1950-51 to 13 per cent in 1966-67. But it did not cross the 14 per cent mark for a little more than a decade after that, and touched 16.4 per cent at its peak in 1996-97. • In 1960, industry contributed 37 per cent of GDP in Brazil, 45 per cent in China, 19 per cent in India, 19 per cent in Indonesia, around 25 per cent in South Korea, 19 per cent in Malaysia and 19 per cent in Thailand. By 1985, the figures were 45 per cent in Brazil, 43 per cent in China, 26 per cent in India, 36 per cent in Indonesia, 39 per cent in South Korea, 39 per cent in Malaysia, and 32 per cent in Thailand. By 2010, industry’s share fell in some (due to the rise of services) but increased further in others. The figures now were: 28 per cent in Brazil, 47 per cent in China, 27 per cent in India, 47 per cent in Indonesia, 39 per cent in South Korea, 44 per cent in Malaysia and 45 per cent in Thailand.

13. Limits to growth • Failure to implement land reform meant that mass market for manufactures remained constrained and the system was faced with an agricultural constraint. • Failure to finance public expenditure with taxation • Wage goods constraint: • Profit squeeze due to a rise in the product wage in the non-agricultural sector; • Inability to sustain public expenditure in the context of persisting agricultural inflation.

14. Is export-led constraint free? • Not really for a number of reasons. Consider Japan, Korea and the second-tier industrializers: • Lose of cost competitiveness • Infrastructural bottlenecks • Exchange rate appreciation • Shift to non-tradables and speculative investment • Need to open up market, especially financial markets • Implications for financial firms • Vulnerability to boom bust cycles • Impact on overleveraged firms

15. Lessons from the 1997 crisis • Limits to externally driven growth • Banks and financial institutions are not merely prone to over-exposure in individual markets, but to exposure reflective of unsound financial practices. • Corollary: supply-side factors were likely to result in boom-bust cycles in financial flows to developing countries • Sudden and whimsical turn-around in flows can set off currency speculation in the host country

16. Increased MNC presence • In current dollars, the value added of U.S. MNCs grew at an average annual rate of 3.1 percent, to $3,593.0 billion in 2009 from $2,644.7 billion in 1999. • The value added of parents grew at an average annual rate of 1.7 percent to $2,453.4 billion, and the value added of foreign affiliates in U.S. dollars grew at an average annual rate of 7.0 percent to $1,139.6 billion. • Faster growth abroad was concentrated in emerging markets, such as China, Brazil, India, and Eastern Europe.

17. Lessons from the 1997 crisis 2 • When the surge in capital flows is reversed, a massive liquidity crunch and a wave of bankruptcies result in severe deflation. Asset prices collapse and pave the wave for international acquisitions of domestic firms at low prices. • A crisis triggered by finance capital becomes the prelude for conquest by international capital in general, with substantial changes in the ownership structure of domestic assets.

20. US MNCs value added in 2009

21. Annual percentage change in value added 1999-2009

22. Some evidence on relocation • Developing countries not a major beneficiary and India not a major beneficiary among developing countries. • Relocation can be be associated with very low value addition in the exporting hub. • China’s example suggests that this is likely to be truer in large countries where MNC interest is in the domestic market. • Implications for policy?

23. The China experience • The large increases in the value added of affiliates in manufacturing in China were widespread by industry and mainly reflected expanded production to serve the large and growing local market. • Roughly two-thirds of the total output of these affiliates was sold to local customers in both 1999 and 2009. The share of these affiliates’ total output that was sold to U.S. customers actually declined to 10.2 percent in 2009 from 16.3 percent in 1999.

24. Implications for Miracle growth • Difficult to sustain • Shifting location of the current miracle • China and India recent favourites

25. The age of finance • Global finance after the 1970s • The pressure to exploit the opportunity • Understanding financial liberalisation • Impact on cross border flows • Implications for successful countries

26. Reduced trade dependence? • One striking feature of recent growth trends in the region is that in most of the important economies, net exports (or the excess of export over imports) is not an important contributor to GDP, and therefore a major stimulus to growth. • Amounted to less than 10 per cent of GDP in China and Thailand and less than 5 per cent in Korea during the 2000s. Malaysia is an outlier, with its ratio of net exports to GDP fluctuating between 16 and 23 per cent in this period. • The perception that the leading economies of the Asian region are benefiting from a stimulus from external markets is true, if at all, only of China and to a much lesser extent Thailand.

28. Investment as driver • The two countries that have been topping the growth league tables in recent years, China and India, have been recording increases in their gross capital formation to GDP ratios. The ratio for China is way above that in other countries, approaching half of GDP in recent years. The ratio in India rose sharply between 2001 and 2007, but is showing signs of slipping since. • While Indonesia, Korea and Thailand too have recorded relatively high investment ratios, their levels in the 25-30 per cent range are not such as to warrant the conclusion that autonomous investment has been the principal driver of domestic demand.

30. Some implications • However, in both China and India, questions have arisen about the mode of financing such investment, with excessive reliance on borrowing. This is acceptable so long as the returns from such investment are high enough to ensure a profit after meeting interest and amortisation costs. Initially, this may indeed be true. But as a larger number of projects are brought into the credit ambit, the share of projects offering lower returns would rise. • This threatens the viability of the projects and therefore the sustainability of the investment boom and viability of the financial system as well.

31. Domestic demand: Consumption • In most Asian economies final consumption expenditure contributes around 65 to 75 per cent of GDP, serving as an important source of demand. The exception is China. In China extremely high investment rates have meant a decline in the final consumption expenditure to GDP ratio from a low of around 60 per cent to less than 50 per cent in recent years. • It is in the other economies of the region that consumption seems to matter as a source of demand and inducement to investment.

33. Autonomous demand? • Increased consumption, since it is tethered to increases in income, is not normally seen as a stimulus to investment and growth, but an outcome of the latter. • However, there is one way in which consumption can be “autonomous” in the sense that it is not tethered to current income. That would be true if a significant share of incremental consumption is financed with credit. • Unfortunately, this kind of path is not sustainable.

34. Regime of accumulation • Less noted associated tendency: • Similarity in the regime of accumulation • Shift to dependence on growth led by household debt financed expenditure away from public expenditure • Substantial rise in household debt in more than one Southeast Asian country • Worst off is South Korea but problem exists or emerging elsewhere in Asia as well

35. The South Korean problem • In 2010 (2011 survey), six out of ten households in Korea were in debt, and more than a third of them were unable to meet their annual expenses with their incomes • Debt also weighed heavy on current incomes. One in every 10 households spent more than 40 per cent of annual income on servicing that debt. • Having to borrow more to stay afloat, a large proportion of households could be caught in a debt trap that would force default.

36. Magnitude of the problem • Growth in household debt a longer-term phenomenon. From KRW 210 trillion in 1997, the debt of households in Korea rose to more than KRW 450 trillion in 2002 and stood at KRW 922 trillion at the end of June in 2012. • The ratio of household debt to net household disposable income rose from less than 100 per cent before the turn of the century, to the 3-digit mark in 2001, more than 140 per cent in 2006 and an unsustainable 160 per cent in 2011. • The 2011 figure is higher than the level that prevailed in the United States before the subprime crisis broke. • The household savings rate in what used to be a high-saving nation fell: from more than 15 per cent before the 1997 crisis to around 10 per cent in 2000 and a low of 2-3 per cent recently.

37. Household loans in total loans(%)

38. Three phases in Korea • Directed credit from a predominantly public banking system to private corporates in the industrial sector. Finances investment otherwise induced. • Shift (post financial liberalisation) of lending away from productive investment to sectors like the stock market, real estate and housing. Partly financed with low-cost foreign finance. Self-reinforcing up to a point. • Increase in lending to the retail sector—housing, automobile purchases and personal credit—with securitisation and transfer of risk. Borrowing by the bottom quintile in terms of income was increasing the fastest. Based on expansion of the universe of borrowers.

39. Implications • Displacement of exports and public expenditure with debt financed household expenditure as stimulus. • Credit expansion driven not by prior induced investment (JR). Autonomous public expenditure financed with debt and expansion of the universe of private borrowers. • Requires liquidity expansion. Requires also financial liberalisation that triggers shift to fragmented credit assets, with no external collateral and securitisation.

40. Other instances • In Malaysia too, the ratio of household debt to GDP has risen from 33 per cent in 1997 to 78 per cent in 2011. Household debt to disposable income ratio at 140 per cent • Before the crisis households accounted for a third of loans provided by the banking sector, and credit to the corporate sector accounted for 67 per cent of loans outstanding. After the crisis that ratio moved up and now stands well above the 50 per cent mark. • Housing loans account for 55 per cent of household debt, automobile loans for another 23 per cent and credit card advances for a little more than 5 per cent.

41. The Indian case • Sharp increase in credit financed housing investment and consumption, facilitated by financial liberalization. • Credit served as a stimulus to industrial demand in three ways: • Financed a boom in investment in housing and real estate. • Financed purchases of automobiles • Expanded demand for consumer durables.

42. Commercial Bank Credit Expansion

47. China: Debt finance and growth • In the early 1990s China’s government decided to accelerate growth. With the mandate to raise investment and promise of rewards if they did, provincial leaders went on a spending spree. • The result was a borrowing and spending spree, to finance not just infrastructure but large “prestige projects”, which were not revenue earning. They were helped by the fact that provincial governments substantially influenced appointments to and the operations of regional bank branches. • The inflationary spiral that followed and the evidence that provincial governments were finding it difficult to service the debts they had accumulated to finance these projects, led the central government to ban borrowing by provincial governments in 1994. But investemtn kept going through LGFVs.

48. The post-crisis stimulus • Credit growth in China has accelerated since the beginning of 2009, facilitated by the government’s decision to relax informal quantitative limits on bank credit growth as a response to the growth slowdown resulting from the deceleration in export growth. The resulting credit boom raised the level of net new bank credit by 50 percent compared with its level 2008 as a whole. • Such credit has financed a surge in public investment which when mandated by government is not constrained by expectations of market demand and profitability. But it has also hiked private investment, particularly in real estate. A credit surge of this kind encourages speculation, leads to asset price inflation and runs the risk of fuelling a bubble based on loans of poor quality.

49. Property bubble • According to a 2013 survey (by Gan Li), about 65 per cent of China’s wealth is invested in real estate. A lot of this investment could be speculative with 42 per cent of housing demand in the first half of 2012 coming from those who already own at least one home. In many areas, these new properties remain unoccupied, indicating that some of the construction is in areas where demand is low. This has led to price declines that can be damaging since investment has been financed by credit that needs to be repaid.

50. Debt burden • According to an audit conducted in the middle of 2011 in the aftermath of stimulus spending, local government-associated debt had risen to $1.65 trillion or around 27 per cent of Chinese GDP. In comparison, central debt was estimated at around 20 per cent of GDP. The audit showed that that outstanding local government debt rose by 62 per cent in 2009 alone, when Rmb 9600 billion was pumped into the system as part of the stimulus. • Overall, credit in China is estimated to have risen from 130 to 210 per cent of GDP over the last five years.