(Reprinted from HKCER Letters, Vol. 30, January 1995)
Understanding Rapid Economic Growth:
A New Tale of the Four Asian Dragons
Y.C. Richard Wong
The unusually rapid and sustained growth of both output and exports in the Newly Industrialized Economies (NIEs) of East Asia (Hong Kong, Singapore, South Korea, and Taiwan) has led many economists to believe that productivity growth in these economies, especially in their manufacturing sectors, has been extraordinarily high. But a recent study, Alwyn Young of the Massachusetts Institute of Technology shows that once factor accumulation has been taken into account, productivity growth of the East Asian NIEs is not particularly impressive. Their economic growth is mainly due to the accumulation of factors of production and the sectoral reallocation of resources.
Factors Contributing to Economic Growth
There are many aspects of economic growth, but the crucial one is the increase in the real value of output produced by a unit of labor input. As an example, the value of output per hour worked in the US has roughly doubled in the period 1950 to 1991. Such increases in productivity can be attributed mainly to increases in the amount of capital used per hour worked as well as to technological progress.
The capital stock of an economy includes all the buildings, structures, and machinery used, in combination with labor time. It is obvious that each unit of labor can bring about more output as the capital stock per hour worked increases. But this is not the only and not necessarily the most important factor underlying economic growth. Studies by economists such as Robert Solow and Moses Abramovitz have shown that capital stock per hour worked accounted for approximately only 15% of US economic growth in the first half of this century. The remaining 85% could be attributed to technological progress. Edward Denison came up with similar results in his study of growth in the US and some European economies in the period 1950 to 62, although during this period the contribution of capital stock was slightly greater on average.
Technological progress causes a given increase in the capital stock per hour worked to generate output more effectively. Conversely, it makes possible the attainment of any given increase in national output with a smaller increase in capital stock per hour worked. This increase in output per hour worked due to technological progress is called an increase in total factor productivity (TFP).
It should be noted that capital stock per hour worked is not an entirely independent factor. In particular, it can rise as a result of increases in TFP. As advances in technology make labor and capital more productive, firms will exploit progress by investing in newer and better capital stock. In fact, the studies mentioned above have estimated that capital accumulation in the US and other industrialized economies has largely been in response to increases in TFP. If the effects on growth of such resulting changes in the capital stock are attributed to TFP, then the rising TFP has been the single most important factor behind economic growth in the European and American economies.
Determinants of TFP Growth
Three determinants of TFP growth have been identified: inventions, economies of scale, and learning by doing.
The invention of both new ways to produce existing products and of new products is the primary source of TFP growth in industrialized countries. An improved process of making an existing product directly enhances productivity by economizing on labor and capital or on intermediate inputs such as raw materials and energy. The invention of new products raises productivity indirectly by shifting labor and capital from old uses to new ones that are presumably of higher value, thus increasing the overall value of output.
Invention activities are in general related to R&D expenditures and the average education level of the working population. However, whether international differences in R&D expenditures can help explain international differences in per capita GDP growth remains an open issue. Some empirical studies support the relationship while others dispute it. The contribution of education to TFP growth is much better established.
A second important determinant of TFP growth is economies of scale, i.e., falling unit costs at higher levels of production. Economies of scale can exist when the size or capacity of production facilities increases, or because of specialization. Specialization can raise TFP because less time is lost due to workers switching from one task to another, or because some workers may be better at some tasks than other workers are. The efficiency gain from specialization of tasks within a firm extends to the specialization of production across firms as well: if production is organized so that a large number of firms produce very specialized products, the productivity of labor and capital will be higher.
The degree of specialization depends on the size of the market. The economic integration of geographically dispersed markets is perhaps the most significant channel through which economies of scale contribute to the growth of TFP. When regions that did not previously trade with each other begin to do so, market size for producers in both regions expands, making it possible for more and more firms to profitably adopt bigger plants and to profitably specialize.
The integration of markets can come about for various reasons. Better transportation as a result of improved and more extensive railroad and highway systems reduces the costs of moving goods around, thus expanding the geographic size of markets. Removal of trade barriers such as tariffs promotes trade between regions and is another channel through which the geographic size of markets may increase. The most obvious illustration of this point is the rapid economic integration of Southern China with Hong Kong in the decade following the opening of China.
The third source of TFP growth is learning on the job or learning by doing. As individuals working together in a factory gain experience in the production of a new product or process, they learn to waste less time and raw materials in producing a given volume of output. Consequently, TFP increases simply as a result of experience. However, while TFP growth from learning effects may be substantial, it ultimately stops. This does not mean that TFP growth as a result of learning by doing will after some time cease for the economy as a whole, though, since new products and new processes are added every year, providing fresh opportunities for learning effects to increase TFP.
Growth of the East Asian NIEs
Of the various factors contributing to economic growth discussed above, which is the most important in explaining the miraculous performance of the East Asian NIEs? Most economists would rule out invention activities, since these economies have not been technological leaders. On the other hand, the outward-oriented development strategy that they espouse could be the crucial factor underlying their economic growth, as they exploit the benefits of specialization and larger market sizes. In addition, the effect of learning by doing might also be an important factor, and in this regard these economies benefit as technological followers: they can use the results of costly R&D investments of others. Both specialization and learning by doing contribute to TFP growth, the single important factor behind economic growth of the US and Europe earlier this century. However, a recent study by Alwyn Young ("Lessons from the East Asian NIEs: A Contrarian View", NBER Working Paper No. 4482, October 1993) of 118 economies provides evidence that TFP growth of the East Asian NIEs has not been particularly impressive in comparison with other economies. Instead, their growth can be largely attributed to increases in capital stock per hour worked.
Annual Growth of
Output per Capita
(1960 to 1985)
Output per Worker
(1960 to 1985)
(1970 to 1985)
Note: Figures in brackets refer to rankings in the sample of 118 economies.
In order to understand the growth experience of the East Asian NIEs from an international perspective and to facilitate comparisons, Young turns to the popular Summers and Heston purchasing power parity data set. The table presents the relevant growth rates for the 4 economies together with their corresponding rankings among the 118 economies in the sample.
It can be seen from the first row of the table that the growth of output per capita in the NIEs during the 1960 to 1985 period was truly remarkable. These high rates of roughly 6% put them among the five fastest-growing economies in the world and more than quadrupled the standard of living of their citizens during this period. More significantly, their performance was substantially better than that of other economies in the sample. The standard deviation of growth rates in the sample is 2%. If we use this as a measure of dispersion, it is interesting to note that only 15 economies are within one standard deviation of the slowest-growing East Asian NIE (South Korea), i.e. with growth rates between 3.7% and 5.7%. The remaining 100 or so economies all grew at rates lower than 3.7% in the same period.
Standard of Living Versus Productivity
To understand the factors behind the growth of output in the NIEs it is necessary to turn our attention from output per capita, which reflect standards of living, to output per worker, which is more closely linked to productivity. In terms of labor productivity the growth performance of the East Asian NIEs is both less spectacular than and less different from the rest of the sample.
Figures in the second row of the table show that turning from output per capita to output per worker takes an average of about 1% per annum off the growth rates of the NIEs. The drop of 1.6% per annum is particularly drastic in the case of Singapore, and it should be kept in mind that this drop lasted for 25 years. In comparison with the performance of other economies, only Taiwan remains in the top five. And, again using the sample standard deviation (2%) as a benchmark, there are now a total of 42 economies within one standard deviation of the slowest-growing East Asian NIE (Singapore), i.e. with growth rates between 2.3% and 4.3%. In fact, it has unexpectedly come to light that other developing economies such as those of Egypt, Greece, Syria and Cameroon have performed well in comparison with the East Asian NIEs.
The difference between the performance of the East Asian NIEs in terms of output per capita and output per worker is due to rising labor participation rates in all four economies. As the post-war baby boomers aged and as female labor force participation increased, the aggregate participation rate in all four economies rose rapidly. For given values of output per capita, a higher participation rate has pulled down the output per worker since there are now more workers in the population. Nevertheless, even allowing for rising participation rates, with growth rates of output per worker still among the top 14 in a sample of 118, the performance of the four NIEs remains impressive.
Comparing Capital Input and TFP Growth
As discussed above, growth in output per unit labor input (or output per worker in Young's case) can arise either because of increases in capital per worker or because of TFP growth. Which of these accounts for a larger share of growth in the four NIEs? The data shows that with the exception of Hong Kong, during the 1960 to 1985 period each of the NIEs experienced an extraordinary rise in its investment to gross domestic product (GDP) ratio. Between 1960 and 1980 the ratio of investment to GDP doubled in Taiwan, tripled in Korea and quadrupled in Singapore (reaching roughly 38% in 1984). Such an increase is not typical elsewhere in the world. Outside Asia, the investment to GDP ratios for other continents were either more or less constant or they declined over the period. The high rates of capital accumulation in the four NIEs surpassed the growth of the labor force, leading to high growth in capital per worker and hence output per worker.
Using econometric techniques, Young decomposes the growth of output per worker into growth of capital per worker and TFP growth. The results are quite interesting and are given in the third row of the table. In terms of TFP growth, although Hong Kong remains one of the top performers in the world economy, Taiwan and South Korea are now ranked 21st and 24th respectively. While this remains a strong performance, these countries are no longer dramatically out-performing the rest of the world's economies. A total of 81 out of the 118 sample economies lie within one standard deviation (again, 2%) of Taiwan and South Korea. Surprisingly, economies such as those of Bangladesh, Uganda, Iceland and Norway are now seen to have out-performed those of South Korea and Taiwan. Singapore, where participation and investment rates have risen faster than in any of the other NIEs, experienced only 0.1% TFP growth for the period 1970 to 1985. It is now relegated to a rank of 63rd in the world economy, just ahead of Sri Lanka and just behind India.
Changing the assumptions used in the econometric estimation of TFP growth does not alter the results to any great extent. Overall, in terms of TFP growth, Hong Kong, South Korea, and Taiwan rank somewhere in the top 15% of the world's economies. With the exception of Hong Kong, their performance is not substantially better than the majority of the sample economies. On the other hand, Singapore lies at around the 50th percentile mark, with a performance not much different from the slow-growing economies of South Asia.
The miraculously high output per capita growth rates of the four East Asian NIEs can to a certain extent be attributed to the rise in their participation rates and, to a much greater extent, to the fast rate of capital accumulation. However, this by no means implies that pure factor accumulation as such will necessarily lead to high rates of economic growth, since the larger amounts of labor and capital inputs could be misallocated. Factor accumulation in the four NIEs has been contributing substantially to growth because these economies on the whole allow the increasing amounts of labor and capital to move from the less productive sectors to the more productive ones. They rely more on the market mechanism in the allocation of resources than on non-market means.
In terms of TFP growth, the NIEs as a whole, with the exception of Hong Kong, did not noticeably out-perform most of the other economies in the world, as their growth rates of output per capita would suggest. Leaving invention activities aside, the gains from economies of scale and learning by doing--the two other sources of TFP growth--to the four NIEs are only comparable to those of the rest of the world.
In terms of output per capita and output per worker, the growth of Hong Kong and Singapore are equally impressive. However, Hong Kong does much better in terms of TFP growth. In other words, Hong Kong does not require as rapid capital accumulation as Singapore does in order to remain at the same level. Since capital accumulation is financed either by domestic saving or foreign saving, people in Hong Kong can afford to save less or borrow less from foreign economies. Saving less now means more consumption now, while borrowing less now means more consumption in the future (after repayment). This difference between Hong Kong and Singapore was also discussed in another article by Alwyn Young (see HKCER Letters, no. 15, July 1992). It has been pointed out that because of industrial policy targeting on the part of the government, firms in Singapore did not fully capture the gains from learning by doing in the production of existing products before they were induced by policy incentives to switch to new ones. On the other hand, industries in Hong Kong were subject to much less policy distortion and have been able to benefit more from market incentives.