The Asian Model

1. The Asian Model

2. I. Introduction The Asian model (AM) applies to those countries located in South and East Asia. Japan is notable pioneer on the Asian model, followed in the second half of the 20 century by the four tigers (Hong Kong, Singapore, S. Korea and Taiwan). Another country with Asian development features is China, a country that has experienced rapid growth in the last 3 decades. China began its development as a planned economy and now it appears to be developing as a mkt socialist economy. The AM applies to countries that began their development from a low initial level per capita income in a largely rural economy The main task was not the more efficient utilization of resources but the creation of capital and the drawing of labor out of agriculture, where workers were underemployed or redundant into industry. Capital formation in industry was necessary and this requires savings from the rural sector or foreign capital. Strong state is needed to raise the formation of capital, to allocate that capital and to draw labor from agriculture to industry The unifying feature of the AM is the high rates of savings and investment and the distinctive organization of capital markets and corporate governance.

3. II. Origins While the ASM and the EM has econ and philosophical foundations, the AM was developed in Japan and China in isolation from western influence; it is based on history and religion. Brief History: Tokugawa era (1603-1868)—military dictatorship brought peace, law, order, and isolation. Till 1854 Japan was a stable, isolated, agricultural (rice-based), reasonably prosperous, and feudal society. Modern Japanese History began with 2 important events: The forced opening of Japan by Admiral Mathew Perry on his second voyage to Japan with 8 military ships in February of 1854. The forced opening taught Japan that it must modernize to protect itself Japanese were sent to the west to learn from universities, Meiji Restoration in 1868 which replaced the military regime w/ a new government of progressive officials determined to embark in modernization. The Meiji Restoration refers to the period when Japanese economy was opened up to Western technology. Japan opened the door to foreign trade, equality of classes, eliminated feudal guilds, divided agricultural estates among the peasants, instituted monetary taxes and established businesses and supported private industry through loans and subsidies. Growth continued until 1938 and WW II. Land was redistributed to the farmers. Japanese students went abroad in large numbers to learn about western technology, The Japanese government invested also heavily in industry, infrastructure, and the military, and many industries were nationalized until a fiscal crisis in 1883 encouraged their privatization. A postal savings system was developed to encourage savings by average Japanese citizens, and the resulting savings eventually allowed for more investment.  Japan's modernization, high savings rate, export orientation, capital formation, and rapid industrialization led Japan during the Meiji Restoration to become the world's fastest growing economy at the time. Japan became an exporter to the west in many labor-intensive manufactures, such as textiles, and Japan's military also became more powerful. World War II—destroyed 1/4 of buildings and 1/3 of industrial machinery. Japan was not surrounded by other countries with expanding markets; Recovery initially was slow. Influence of Confucianism the religion of the educated classes in ancient Japan and China. Confucianism teaches a positive role for virtuous government, emphasized the qualities of loyalty, nationalism, collectivism, faith and bravery. encourages highest levels of social cooperationand equality of income (promoting educational opportunity, emphasizing group over individual, virtuous government). Japan’s economy was organized on the principle of a strong state to which the individual was subordinated.

4. 5. Asian econ development is based on theRelative Backwardness model of Gerschenkron -a country’s gross underutilization of its potentials Asian econ development is described by the relative backwardness model of econ historian Alexander Gerschenkron, to explain how a poor country such as Japan at the end of the19 century could rather quickly overcome underdevelopment (its relative backwardness) If the country becomes aware of the dangers of backwardness, can take steps to accelerate its econ growth. In Japan’s case, the necessary shock was Admiral Perry’s forced Japan to confront the gap b/w it’s actual and its potential econ achievements and to find innovative ways to overcoming its backwardness. Adopt western methods The state substituted industrial policy for mkt decision making Gerschenkron’s empirical prediction was that relatively backward countries would grow more rapidly than the industrialized countries once they decide upon a policy of industrialization A major reason for attention to the Japanese economy over the years has been an interest in the high rate of economic growth achieved in Japan.

5. 6. Characteristic of Japan’s growth from 1953 to 1971 “econ miracle”: High and persistent econ growth. higher rates of average growth-14% and capital grew at 9%. Since that the growth rates have declined reaching less then 2% for the years 1990-2000. In 2003, econ growth is 2.7 % Sources of growth: Growth of capital stock the largest contribution to growth, supported by saving rate. Technology contribution of knowledge and technology to factor productivity. Facilitated by the adoption of foreign technology. Labor growth in the quantity, working hours, and educational quality of labor. Low unemployment was promoted by the “permanent employment” system and flexible bonus income. Growth with increasing equality in distribution gov’t adopted policies to ensure that all groups benefit from growth-universal edu, public health, public housing programs. Increasing equality in distribution state-directed growth the gov’t was directly involved in industrial projects thru low interest loans form the Japanese Development bank; state industrial policy directed investment to specific targets. high levels of investment thru significant domestic savings high domestic savings rates Excess savings was exported, as national savings exceeded gross domestic investments. Japanese savings flooded into Southeast Asia, spurring econ development export driven growth from textiles exports shifted toward the high technology products that Japan could produce The result -Japan’s dramatic rise in relative living standards was achieved. The econ expansion for Japan’s rapid econ growth were a technology gap, a high rate of capital formation and the availability of labor. After being a closed economy for centuries, Japan had a technology gap and could absorb western technology thru imports of capital, a high propensity to save and the state promotion of capital formation.

6. 7. The Four Tigers-Hong Kong, Singapore, South Korea, Taiwan. a) The ”Four Tigers” are frequently associated with one another because of (characteristics): High and persistent econ growth Growth with increasing equality Used foreign trade to promote industrialization. have promoted exports of manufactured goods State policy supported export promotion over import substitution Export promotion -consists of state policies to promote export Import substitution -consists of policies that protect domestic industries from foreign competition via tariffs or other barriers. Although the ”Four Tigers” have used similar strategies for promoting economic growth and industrialization, these countries differ significantly in: population; per capita income; size as measured by land area. The GDP per capita is relatively equal to the U.S in Singapore, Hong Kong, Japan

10. b) Factors for rapid growth of the four tigers Growth supported by "market friendly" government policies, avoiding regulation of prices, interest rates, rents, and other payments, and by maintaining small budget deficits, stable monetary policies, low levels of foreign debt, and low barriers to internal and external trade. Openness to international trade (the most important factor) Export-led growth high levels of human capital investment (universal edu, investments in human capital, such as public health) high levels of private investment Secure property rights; the gov’t provide the physical infrastructure and human capital to make investments possible and attractive—transportation, communication facilities, skilled labor. high levels of savings Gov’t role in creating and maintaining stable and accessible financial institutions, giving savers confidence that their money will be safe Rapid income growth stable state policies providing stability, reasonably secure property rights Some gov’ts promoted foreign direct investment to supplement domestic savings and attract new technologies Hong Kong and Singapore promoted foreign investment; Japan and Korea were hostile to foreign direct investment rapid demographic transition

11. III. The Lewis Two-Sector Model Published in 1954; A. Lewis was awarded the Nobel prize in econ in 1979 for his contributions to understanding development. Used to explain the rapid growth of Asia Assumes a traditional agricultural sector in which labor is redundant, the marginal worker produces no additional output, and agri output is located among the farm population by tradition (divide the output evenly among themselves) rather than by commercial decision making. There exists a relatively small modern industrial sector in which decisions are made commercially (on the basis of the standard marginal analysis). The task of development is to transfer labor from agriculture (where labor is redundant) to industry (where MP is positive). The main question in Lewis’s two-sector model is what will cause the agricultural surplus to be transferred to industry

12. The main task is to transfer labor from agri to industry—which will occur only if the demand for industrial labor is increased. In order to increase industrial demand for labor, there has to be an increase in industrial investment. Additional investment raises the marginal product of labor, hence increase the demand for labor. The supply of labor is horizontal, because there will be a ready supply for labor to industry as long as the traditional agri wage is not bid up. The bidding up will not occur until the agri surplus labor is transferred out of agri. Na→ Na’, Qa is produced, same wage “surplus”= Qa – wages (in terms of agri goods) surplus→ industrial investment → raises MPL (demand for industrial labor) Therefore: ↑ employment; ↑ industrial output; Net result: the economy has not lost any agricultural output but has increased its production of industr output

13. 4. Mechanisms that will cause agri surplus to be transferred from agri to industry: • use the market to transfer the surplus • the farm population could be offered the opportunity to deposit savings in banks which would then lend the money to the industry • the state to impose taxes on agri population to force them to save, state revenue will be invested in industry • the state could “nationalize” agriculture to force transfer of savings from agri to industry (collectivization in Russia in 1930’s and China in 1950’s) • According to Arthur Lewis’s two-sector model, economic development in Japan and the Four Tigers is due to transfers of labor from agriculture to industry.

15. IV. Characteristics of the Asian Model 1. Corporate Governance: a) Industrial Organization: Big Businesses: Zaibatsu family-owned holding company controlled shares in a diversified group of industrial corporations, trading companies, and banks. After the war, American-written anti-trust legislation dissolved holding companies. Pre-war Zaibatsu were groups of companies owned and controlled by a family holding company, the family industrial group (composed of 20 to 30 firms). This system led to the substantial concentration of econ power in a relatively small number of diversified groups. Mitsui the largest from the pre war zaibatsu employed about 1.8 million workers, Mitsubishi more then a million. After WWII the US occupation authorities radically restructured the Japanese economy. All the major Zaibatsu were dissolved to smaller ones called keiretsu, but gradually some splinter companies re-established their former associations. They exchanged shares with other firms which bore the common Zaibatsu name and did business with each other.

16. Keiretsu—created after WWII, are conglomerates of horizontally or vertically integrated companies, owned by a single owner or a small group of owners, working close with government and banks. These groups usually involve cross holdings of stock. Conglomerate Keiretsu Groups (those w/ activities in a broad range of industries) are frequently grouped around a core company, which plays a leadership role in group management. Such a company may be trading company or bank. Trading companies that specialize in sales and marketing, especially overseas, are institutions unique to Japan. The keiretsu with origins in the prewar zaibatsu are quite old tracing their history hundreds of years ago Mitsui Group example, w/ long history and tradition, origins from 1568. Zaibatsu origins Mitsui, Mitsubishi, and Sumitomo Bank-Centered Groups Sanwa, DKB, Fuji, Tokai. Besides being the main financier of the member companies, the group bank also holds large chunks of shares of these companies and monitors their performances. Vertical Groups formed around a prime manufacturing company or production of a single product. Around the major company and its important affiliates, there are dozens and even hundreds of smaller suppliers and sales companies. Nippon steel, Nissan, Toyota, Hitachi. Toyota group focused on automobiles and parts, w/ involvement in distribution and finance.

20. Small Businesses 99% of Japanese companies employing 75% of work force employ fewer than 100 workers. Subcontractors 2/3 of small firms in manufacturing. Large firms shift the cost of holding inventories to subcontractors, and maintain their "permanent commitment" employment by adjusting the use of subcontracting. Retail stores Average store has only 4 employees. b) corporations are closely held by wealthy families or small groups of individuals. c) The principle way in which these groups are held together is by the cross-holding of capital (cross shareholding by one company of other company). instead of management and ownership being separated the owners tend to be powerful families who also serve as the management team; these families or groups of related individuals own not one company but group of companies in a complex pattern of cross-ownership in Europe-cross-ownership by banks, suppliers & customers is common, in Asia instead of institutions, one family owns a number of companies. extensive reciprocal (cross) shareholding by one company of other company.

21. Table 12.2 shows the extent of cross-holdings of shares in major keiretsu. These data show that 38.2 % of the capital of all the members of the Mitsubishi group is held by firms that are themselves a part of the group. Greater than 55% probability that anyone firm within a major keiretsu will hold shares of any other firm within the group.

22. d) Both Anglo-Saxon and European models rely on the “rule of the law” when they enter into contracts. In Asian countries which w/ the exception of Hong Kong and India use civil law, the “rule of the law” is less important. There are 2 types of contracting: Relational based on personal relationship and trust Market-based impersonal based on formal contracts backed by a rule of law The keiretsu system implies a closer relationship b/w purchaser and supplier. The relationships are long term and largely non mkt; Relational contracting is the primary form of contractingused in Asia; contracting based on trust rather than on impersonal transactions(by relational rather than mkt-based contracting). And is used in countries with relatively weak rule of law—Russia. The company fails to use price signals in the decision-making by relying on relational contracting. e) Except in Japan publicly traded companies are owned primarily by family or individual owners. Unlike the Anglo-Saxon model, where institutional investors own substantial shares of stock, institutional investors are not prominent in Asia, and they are rarely participating in management. Hence, relatively small role of widely held publicly traded corporations.

23. f) With family based ownership system, Asian companies appear to have resolved the key principle-agent problem b/w owners and managers the owners are the managers g) The rights of minority shareholders tend to be abused cannot influence management decisions h) Cross-shareholding the family owner can divert assets from one company to another and hostile takeovers are practically impossible i) Publicly traded Asian companies are not required to be transparent as companies that operate in the Anglo-Saxon model; no requirement to reveal transactions w/ related parties; losses due to declining asset values are not disclosed to shareholders

24. 2. The Capital Market Given the widespread use of relational contracting, the lack of protection of minority shareholders and the limited amount of accounting disclosure there are: limited purchases of stock by minority buyers Asian companies finance themselves by borrowing not by selling new shares of stock. This means that Asian companies are highly leveraged that is they have heavy debt burdens, which must be served by regular interest and principle payments Asian corporations tend to obtain their financing from banks that are closely related to the enterprises themselves. The Asian households have high rates of savings. Given the reluctance of households to invest in stocks as minority shareholders, their savings flow primarily into banks, if not abroad In European model the banks act as the primary financial intermediaries; the Asian flow of savings into the banks is similar to European model. To a greater degree than in Europe Asian banks base their lending on political and industrial-planning criteria. Most Asian banks are not subject to strong supervision. Banks & other financial institutes are poorly regulated & large financial institutions count on being bailed out by the gov’t if they are threatened by insolvency (bad and risky lending). Asian corporations tend to obtain their financing from banks that are closely related to the enterprises themselves. The Japanese companies are less dependent on the stock mkt than American companies. Has lower levels of return on equity than the U.S.

25. 4. Labor Markets Anglo-Saxon-“hire and fire” labor mkt that is flexible and moves labor resources from one activity to another quickly. Europeanmodel-rejects Anglo-Saxon model as consistent w/ fairness to workers and replaces w/ highly regulated model that makes firing difficult. The Asian model combines the limited regulation of the Anglo-Saxon model with industrial paternalism practices that protect employment during downturns Asian model has features from both AS and EM Lifetime employment policies, which protect workers from being laid off, they work for the same company until retirement (family, children): Coverage about 25-30% of industrial labor force. During the 1990s, the proportion of long-tenure (10-year plus) workers was 43% in Japan, compared to 26% in the U.S. Advantages Security and loyalty of workers who are covered. May contribute to adoption of technology because workers have little fear of technological unemployment and employers know their company will benefit from training. Disadvantages Companies cannot fire workers during bad times; redundant, incompetent, unmotivated workers retained. For older employees and workers not included in system—greater job uncertainty. Lifetime employment system is in decline Limits to the concepts of paternalism and lifetime employment: only 30% of industrial labor is covered by some form of guaranteed employment

26. Japanese firms have ways to create flexibility in employment temporary labor force and bonus system subcontracting for industrial parts small firms have flexible employment and wages Seniority wages wages are dependent on length of service, like guaranteed employment the seniority wages system applies to those privileged workers who have a lifetime commitment w/ the firm. Workers tend to be promoted & paid accordingly to time of service. System is in decline. Bonuses account for 20% of pay in manufacturing. Benefits—employee motivation; savings—if the bonuses are regarded as transitory income, permanent income hypothesis suggests that a large portion of the bonus income will be saved. Labor unions are relatively week w/ exception of South Korea in Japan they tend to be enterprise union such as Sony union and do not represent economy-wide branches or crafts. The degree of unionization in large companies is high but in small firms there is a low level of unionization.

27. 4. Income Distribution The Asian model has combined high growth with a relatively even distribution of income. Factors to combine growth with equity Governments adopted policies to ensure that all groups benefited from econ growth. Growth and equality both supported by programs of public health and education, trade liberalization, and support for small business. Less inequality usually means greater political stability and measure more equitable distribution of education & health. The most likely cause of low income inequality is the more even distribution of human capital (edu & health) in Asia. Japan rapid econ growth caused property income to rise rapidly, causing income inequality. Taxation has a relatively small role in income redistribution. Personal tax rates are highly progressive, an unusually large proportion of tax receipts come from business profit taxes, and a small proportion comes from the regressive consumption tax. The overall tax burden is relatively light. Transfers government has paid little attention to income redistribution because families and businesses take care of their own. Social security costs will increase as a growing percentage of the population reach retirement age.

28. 5. Industrial Policy (IP) is a gov’t strategy to help important business sectors become more competitive and to adjust to the changing structure of the economy. It is the active intervention of gov’t to promote or change the course of industrial development. Designates industries for priority development based on growth potential and contribution to growth of other sectors. Japan was the pioneer of the Asian brand of industrial policy. It can be said that in the Asian model: the gov’t has played an important role the Ministry of finance and the bank of Japan are responsible for the traditional functions of monetary control. Ministry of Economy, Trade and Industry (MITI) is responsible for international trade, domestic production, and domestic industrial policy Ministry of finance, the bank of Japan, Ministry of International Trade and Industry (MITI) State industrial policy directed investment to specific targets and develop industries that would be the core of the econ growth, industries that are competitive in the world markets-electronics, automobiles. Components of IP Strategic—the goal of helping industries to be more competitive and therefore, facilitate the national econ growth. IP is future oriented, attempting to anticipate future international trends and mkt developments. Inherently discriminatory—IP is a micro econ policy b/c government must decide which industries/sectors are important for econ growth To facilitate adjustments to the constantly changing nature of production and markets, IP tries to be mkt conforming—anticipating where the mkts will be. IP helps to change the structure of the economy that foster domestic and international competitiveness of its industries and firms. During the 1970s Japan had a sustain growth.

29. Dramatic decline in econ performance in the 1990’s. Problems in econ:: reliance on large companies retarded the growth of smaller and more innovative businesses the relation b/w banks and large companies have caused banks to make large unprofitable loans the close relation b/w government and business has created a vast system of corruption the lifetime employment has prevented large concerns from downsizing to become more efficient Inefficiency The sun also rises, Oct 6th 2005, The Economist Crashing stock- and property markets, mountains of dud debt, scores of corruption scandals, vast government deficits and stagnant economic growth in the 1990’s. There has been a gradual process of reform in financial regulation, corporate law, in capital and labor markets. Labor market: most big companies chose to maintain their commitment, asking workers to take pay cuts and waive bonuses rather than lose their jobs, but ceased to hire new graduates.

30. changes to employment law, firms found flexibility by hiring part-timers and others on temporary contracts, both at far lower cost than for regular workers. Canon, for example, a successful electronics firm that still firmly maintains a lifetime commitment for its “core” workers, employs fully 70% of its Japanese factory staff on such “non-regular” terms, Since April 2005, the employment data have shown something new and more promising: full-time employment is growing faster than the part-time sort for the first time in a decade, and although some of that growth is still in full-time contract work, regular employment is rising too. Wages are also rising. 1993-2002, annual GDP growth 1.2% (compared to 2.9% average for industrial countries). Since 2002 recovery in Japan began that still continues today. 2003—econ growth 2.7%; 2005—2.8% (but unlike the previous expansions when growth rates were 5-10%). promotion of exports many Asian economies have used heavy-handed industrial policy combined w/ consistent promotion of exports , e.g. South Korea. Korean industrial policy aimed to promote exports, was executed thru a virtually free-trade regime for export activities. Asian firms that tied their fate to the export mkt and to competition according to world mkt prices had to learn how to compete and how to introduce technology that would allow them to do so.

31. 6. Provision of Income Security One of the prime features of the EM was the generous provision of income security for everyone. the Asian model has largely rejected the European model of state provision of income and healthy security lesser role of the welfare state can be contributed to cultural factors, tradition, the religion emphasize the role of the family & the obligation of younger generation to take care of elderly in their retirement years The Asian countries (exc. Japan) have younger population; therefore they have a smaller welfare state. Japan’s public pension system& public health insurance was created in 1961 Health care Japan has the longest life expectancy--76 years for men and 82 for women--and among the lowest infant mortality rates in the world. A prime factor in Japan's success has been the nation's health care system, which offers universal coverage and stresses preventive care. 80% of Japan's hospitals and 94% of its physician-run clinics are privately owned. Patients are free to select care providers, and competition ensures an adequate number of facilities, except in rural areas. While recently on the rise, health care costs remain relatively low in Japan. Prices are regulated through a "fee schedule" determined by the Ministry of Health and Welfare in consultation with insurers, health care providers and consumers. All doctors receive the same salary regardless of experience.

32. Most Japanese employees and their dependents obtain health insurance through their employers, financed largely through mandatory payroll contributions from both employers and employees. The self-employed, people working for small businesses, and others not covered can apply to the government for low-cost National Health Insurance, which provides coverage similar to workplace-based insurance. The Japanese focus on preventive care has played an important role in containing costs. Problems: Some in Japan have asserted that private practitioners, limited in the fees they can charge, have a tendency to over-prescribe drugs from their attached pharmacies public spending on health is relatively low Japan -8% of GDP on health, the private households spend 2%; EU-10% of GDP on health, where the state pays 7-8%; USA-15.2% of GDP on health, half of that is paid by private hhlds. Education Compulsory, free nine-year education followed by public and private upper-secondary schools and supplemented by preschool and after-school education. Elementary school grades 1 through 6; lower-secondary school grades 7 through 9; and upper-secondary school grades 10 through 12. About 94% of lower-secondary school graduates attend upper-secondary schools

33. Total Health Expenditures as a Share of GDP, U.S. and Selected Countries, 2003 http://www.kff.org/insurance/snapshot/chcm010307oth.cfm