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An East Asian RenaissanceIdeas for Economic Growth

Indermit Gill and Homi KharaswithDeepak Bhattasali, Milan Brahmbhatt, Gaurav Datt, Mona Haddad, Edward Mountfield, Radu Tatucu, Ekaterina Vostroknutova, and others

Office of the Chief EconomistEast Asia & Pacific Region, The World Bank

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Why East Asia?

Regional trade links Information connectedness Intraregional finance

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4

5

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A Middle Income Story

Well-tested strategies for low income countries stable macro, open trade, education,

investment Most of East Asia is now middle income Middle income countries can be

squeezed between rich innovators and cheap labor

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Middle-income countries: the stars of this show

A second group of East Asian economies has caught up with Latin America (Per capita income growth in East Asia and Latin America, 1900-2000)

0

5,000

10,000

15,000

20,000

25,000

1900

1903

1906

1909

1912

1915

1918

1921

1924

1927

1930

1933

1936

1939

1942

1945

1948

1951

1954

1957

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

Upper Latin America 8 Low er Latin America 8 Upper East Asia 5 High Income

Low er East Asia 5 High Income Upper East Asia 5 Developing Low er East Asia 5 Developing

East Asia High Income 5

Latin America 8East Asia Developing 5

High Income

Low and Middle Income

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From middle income to rich: 3 transitions

Diversification to Specialization Accumulation to Innovation Basic to Advanced Skills

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Economies of Scale drive the transitions

International Integration permits Specialization

Specialization breeds Innovation Innovation requires higher education

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First diversification, then specialization

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Specialization

New trade structures Selected Industries, intermediates,

regional production networks Innovation systems Finance

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Trade and integration

Facts East Asia is the most open region for trade in goods Parts and components and intra-industry trade has grown

rapidly Sectors exhibiting increasing returns have seen the

biggest expansion in exports Implications

Liberalize trade in business services Make logistics more efficient Enhance market access through regional integration; keep

rules of origin simple

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East Asian exports grew in sectors with increasing returns

-4.0 -2.0 0.0 2.0 4.0 6.0

Textiles

Apparel

Leather

Footwear

Wood products

Pharmaceuticals

Iron and steel

Non-electronics machinery

Electrical machinery

Instruments

scale elasticity > 1

scale elasticity = 1

change in export share 1994-2004

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Intra-industry trade in East Asia has boomed

Share of parts and components in total exports and imports, 1990 and 2003

48.8

47.9

28.3

15.3

23.0

26.0

27.2

13.5

15.6

26.0

17.9

6.4

16.6

21.6

16.1

15.2

50 40 30 20 10 0

Philippines

Malaysia

Taiwan

Japan

Korea

Thailand

China

Indonesia

% of Imports 2003 % of Imports 1990

55.6

39.5

33.9

32.6

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22.1

15.1

9.1

17.8

19.5

16.9

22.9

15.8

11.3

4.1

0.8

0 10 20 30 40 50 60

Philippines

Malaysia

Taiwan

Japan

Korea

Thailand

China

Indonesia

% of Exports 2003 % of Exports 1990

Source: Okamoto (2005).

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Ideas and innovation Facts

Korea, Taiwan, Hong Kong are joining the technology leaders of the world

Internationally competitive firms (exporters) are driving industrial growth; R&D and skills are driving innovation

Regional knowledge flows are increasing: earlier such flows were through new equipment—now they also involve more direct use of patented knowledge

Implications Keep outward orientation and competitiveness Aggressively upgrade tertiary education

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East Asia’s innovation effort has been escalating

Patents per 100,000 Population and Per Capita Income

-5

0

5

10

15

20

25

30

35

40

8.9 9.4 9.9 10.4 10.9

Log(GDP per capita)

Paten

ts/10

0,000

popu

lation Regression

relation between patents and per capita income

Japan

Hong Kong

KoreaSingapore

United States

Patents per 100,000 Population and Per Capita Income

-0.02

0

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

0.18

0.2

6.4 6.9 7.4 7.9 8.4 8.9

Log(GDP per capita)

Paten

ts/10

0,000

popu

lation

China

Regression relation between patents and per capita income

Indonesia

Malaysia

Philippines

Korea

Thailand

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Firm dynamism comes from new products and technologies

Table 3.2. Most Important Source of Technological Innovation (% of Firms)

Cambodia

2003 Indonesia

2003 Malaysia

2002 Philippines

2003 Thailand

2004 Average

Embodied in new machinery or equipment 42.1 48.7 49.9 43.0 33.1 43.4

Developed in cooperation with client firms 11.9 15.1 8.6 9.7 17.2 12.5

By hiring key personnel 14.5 17.9 11.4 14.2 3.0 12.2 Developed/adapted within the establishment locally 16.1 4.7 7.2 8.3 19.4 11.1

Transferred from parent company 6.0 2.7 11.0 4.3 11.8 7.2

Developed with equipment or machinery supplier 1.6 7.0 5.2 5.0 7.2 5.2

Other 7.8 3.9 6.7 15.5 8.2 8.4 Source: World Bank. Investment Climate Surveys.

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Finance and risk

Facts Bank claims on the corporate sector have fallen since the

1997-98 financial crisis Foreign exchange reserves have soared since the financial

crisis Bank-dominated financial systems are better suited for

financing trade than for promoting innovation—financing for innovation requires better pricing of risks through markets

Implications Local credit risks need to be better identified and managed Regional cooperation may be a more efficient way to

address the fear of floating Develop better securities markets, especially corporate bond

markets

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East Asia is less exposed to bank credit since the crisis

Bank Claims on East Asia, 1995 and 2004

34 29

315

77

177

154

165

216

0

100

200

300

400

500

600

700

800

1995 2004

Bil

lio

ns o

f U

S $

US Japan EU Others

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But access to finance can be a problem for many firms Figure 4.3: Access to finance is a problem for exporters and non-exporters

0

10

20

30

40

50

EAP, ave CHN IDN KHM PHL THA VNM

Pe

rcenta

ge o

f R

esp

ond

ent F

irm

s

Exporters Non-Exporters

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Growing complexity of growth in MICs: scale

Table 2 The growing complexity of development: Economies of scale

Force Growing Complexity Strategic Imperatives From: Exploiting

comparative advantage

+ To: Also exploiting scale economies

New opportunities Policy priorities

Specialization Labor intensive exports +

Parts and components trade

Regional production networks

Logistics

Ideas and human capital

Basic and secondary +

Post-secondary education

Regional knowledge spillovers

Scientists and engineers

Managing economies

High savings and low deficits +

Risk management Regional financial stability

Corporate bond markets

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Scale economies can breed social stresses

Urbanization Inequality Corruption

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Cities and congestion

Facts Cities have three times the productivity of rural areas,

reflecting agglomeration economies East Asia is witnessing the largest rural-to-urban shift in

human history: 550 million over next 25 years Large cities are coming under stress; secondary cities are

growing faster Implications

Urban growth will drive regional differences Make large cities more livable Improve connectedness and economic management of

smaller cities

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East Asian cities are as livable as those in Latin America

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But urbanization is still to come for EAP

Urban Population Growth Rates, 2005-2030

2.25

2.98

-0.38

1.721.72

2.19

-0.23

1.34

1.1

1.68

-0.19

1.01

-1

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

North East Asia South East Asia East Europe Latin America & Caribbean

Pro

jecte

d A

nn

ual

Avera

ge G

row

th (

%)

2005-2010 2015-2020 2025-2030

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And slums are already a big problem in East Asia

Figure 5.5: A third of East Asia’s city-dwellers live in slums

Slum popula tion (% o f Urba n Po pula tio n), 2001

72

38

23

66

24

65

2

47

34 3228

72

58

3343

01020304050

6070

80

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Inequality and cohesion

Facts Poverty rates have been falling rapidly in cities Within-country inequality is high because of urban-rural

and coastal-interior gaps Within-country inequality is rising because of rising within-

urban and within-rural inequality Implications

Access to services, especially education, should not depend on location as much as it does

Segmentation in labor markets by space and social groups should be reduced

Rapid skill formation can offset high postsecondary wage premium

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Inequality in East Asia has been increasing

PHL

THA

CHN

IDN KORLAO

MYS

VNM

15

20

25

30

35

40

45

6 6.5 7 7.5 8 8.5 9 9.5 10

Log(per-capita GDP (constant 2000 PPP$))

Thei

l ind

ex o

f inc

ome

ineq

ualit

y

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Inequality increases in China decomposed

Figure 6.2: Changes in inequality in China: A decomposition of Theil indices, 1990-2002

8.1

12.6

4.1

8.48.9

14.8

0

5

10

15

20

25

30

35

40

1990 2002

Inter-sectoral

Urban

Rural

Source: Authors’ calculations based on household survey data for China for 1990 and 2002.

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Decentralization and corruption

Facts East Asia’s decentralization is progressing faster than

institutionalization of checks and balances Contestability of political power has grown in East Asia Tolerance for corruption is low in East Asia

Implications Corruption is seen as a significant threat to growth and

perceptions of corruption are worsening Corruption could become a more serious obstacle to

growth unless transparency and accountability at local levels develop

Speed up the transition from rule of man to rule of law

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Corruption can hamper business

Table 7.1: Corruption can be a severe constraint for enterprise in East Asia

Is corruption a constraint to business? (percent of responses)

Country No Minor Severe or major

Cambodia 4.7 39.4 55.9

Indonesia 29.3 29.2 41.5

Philippines 40.6 24.3 35.2

China 24.1 48.5 27.3

Thailand 49.7 32.1 18.3

Malaysia 53.8 31.7 14.5

Vietnam 52.3 17.8 14.2

Source: Investment Climate (Enterprise) Surveys of the World Bank and IFC, using un-weighted averages.

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Growing complexity of growth in MICs: distribution

Table 3 The growing complexity of development: Distribution of economic rents

Force Growing Complexity Strategic Imperatives From: Letting

markets work + To: Also addressing coordination failures

Pressing challenges

Policy priorities

Agglomeration Mega-cities +

Midsized and small cities

Congestion Connected small & mid-sized cities

Social and spatial effects

Unskilled wage growth +

Urban skilled wage growth

Inequality Access to social services

Managing societies

Small centralized governments +

Decentralized governments

Corruption Transparency & accountability

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Conclusion: East Asia needs a third integration

East Asia got market access with global integration, and has grown.

East Asia has become competitive with regional integration, and is being transformed.

But East Asian countries have to do better with domestic integration to become rich.

Middle-income East Asia needs a third integration, this one at home.