Neoliberalism and the Developmental State in Asia

1
Neoliberalism and the Developmental State in Asia

• C.P. Chandrasekhar

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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?)

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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

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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.

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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

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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 latenesscall it the subsidy.
  

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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.

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The Korean case

• High profits in Koreas 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
  worlds 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.

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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 RD 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.

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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

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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

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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,
  industrys 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.

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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.

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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

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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

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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.

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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.

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US MNCs value added in 2009
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Annual percentage change in value added 1999-2009
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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.
• Chinas example suggests that this is likely to
  be truer in large countries where MNC interest is
  in the domestic market.
• Implications for policy?

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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.

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Implications for Miracle growth

• Difficult to sustain
• Shifting location of the current miracle
• China and India recent favourites

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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

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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.

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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.

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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.

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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.

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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.

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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

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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.

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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.

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Household loans in total loans()
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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 sectorhousing,
  automobile purchases and personal creditwith
  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.

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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.

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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.

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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.

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Commercial Bank Credit Expansion
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China Debt finance and growth

• In the early 1990s Chinas 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.

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The post-crisis stimulus

• Credit growth in China has accelerated since the
  beginning of 2009, facilitated by the
  governments 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.

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Property bubble

• According to a 2013 survey (by Gan Li), about 65
  per cent of Chinas 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.

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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.

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Signs of trouble

• But the wisdom of concealing a proactive fiscal
  policy, by making state-owned banks lend to
  state-sponsored financing vehicles, which in turn
  lend to state-backed projects is now in question.
  Defaults are on the rise.
• The five biggest banks which account for ore than
  half of all bank loans, wrote off Rmb569 (9.5bn)
  million in debts according to their 2013 results.
  That was 127 per cent more than in 2012.
• According to figures released recently by the
  PBC, loans provided by trust companies that
  populate the shadow banking sector rose by an
  annual 23 per cent to touch RMB17.3 trillion
  (2.9 trillion) or 30 per cent of credit advanced
  in 2013. Around 650 billion of trust loans are
  expected to fall due in 2014, raising the
  possibility of further defaults in different
  parts of the economy.

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Conclusion

• The regime of accumulation under neoliberalism
• It is indeed true that neoliberal policy has come
  to play an important role in Asia. It has,
  however, not succeeded everywhere. But only the
  success stories receive attention despite the
  1997 crisis.
• Even among successes what is missed is that the
  factors explaining the expansion of domestic
  demand, which supports this growth, are not
  necessarily sustainable.