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3.3  Impact of structural policies

It is clear from Figures 3 and 4 that while there is some evidence of income convergence, there is still considerable scope to enhance standards of living in the region by both lifting growth in laggard economies and by lifting growth in general. Furthermore, even for the currently high-growth economies there is evidently no assurance that the economic structures and processes that propelled their initial growth are necessarily the solution to ongoing convergence.

Recent thinking suggests that what it takes to achieve growth at lower income levels may be different from what it takes to sustain growth at higher levels of income, and over the long term (World Bank, 2007; Rodrik, 2003; Gill and Kharas, 2007). This implies that structural reform is an ongoing challenge, and raises the question of not only how to lift performance in the slower-growing economies but also whether the recent impressive growth performances of some economies in the region can be sustained in the future. The World Bank (2007) identifies a number of transitions that economies may need to make to move from middle-income toward higher-income status, including: transition from being able to absorb knowledge to becoming a source of innovation; developing deeper financial systems; and managing greater urbanisation. There are many cases of economies succeeding in reaching middle-income status but not meeting the challenges of transitioning to high-income levels (eg, many economies in the Middle East and Latin America). However, there are examples of economies in the region that have made this transition successfully (eg, Japan; Hong Kong, China; Singapore; The Republic of Korea; and Chinese Taipei).

Evidence also suggests that convergence mechanisms may not be operating as well as expected in some economies due to barriers behind the border. Addressing these sorts of issues is the challenge of structural policy. The following section considers the implications of structural policies for the convergence mechanisms outlined in Section 2.2: capital flows, technological spillovers, migration, and intraregional trade and specialisation.

3.3.1  Capital flows

For most of the 1980s, emerging Asia was a net importer of financial capital, in line with the predictions of economic theory. However, since the 1997-98 Asian financial crisis emerging Asia has become a net capital exporter. Recent analysis suggests the explanation for this lies in investment performance rather than an excess of saving. Kramer (2006) notes that, excluding China, savings have been relatively stable over the past 10 to 15 years and, according to some studies, broadly consistent with economic fundamentals. By contrast, private investment declined sharply after the Asian financial crisis and some recent studies suggest that investment in emerging Asian economies is low relative to fundamental determinants. To some extent, this could be seen as “making up” for the previous over-investment (see for example Chinn and Ito, 2005; Eichengreen, 2006; and IMF, 2005).

Kramer considers three possible reasons for the investment decline in emerging Asia: financial and corporate sector restructuring following the 1997-98 financial crisis, competition from China, and changes in perceptions of risk. He concludes that financial and corporate sector stresses and restructuring following the financial crisis impacted on investment, but these effects were not enduring. China’s success in attracting FDI has raised questions as to whether China may be attracting capital inflows at the expense of other economies. However, Kramer notes that recent studies have not found any evidence of China diverting FDI from other Asian economies.

Concern has also been expressed that FDI into China is diverting FDI flows away from Latin America. Garcia-Herrero and Santabárbera (2007) empirically investigate how Chinese inward FDI affects FDI flows into Latin America. They find no diversion of FDI away from the six largest Latin American economies studied to China during the period 1984 to 2001.[11] However, during the more recent period (1995 to 2001), FDI in China appears to have impeded FDI in Mexico and Colombia, but not the four other Latin American economies studied (including Chile). They conclude that Latin American economies will benefit from China’s increasing demand for raw materials in terms of both increased exports and inward FDI from China into sectors related to raw materials. Latin American economies will need to further open these sectors to foreign investors to reap the full benefit of opportunities presented.

Perceived risks in emerging Asia are higher than in the pre-crisis period and could explain the sluggish recovery of investment in the region. The perceived increase in risk, despite moves to reduce vulnerabilities after the crisis (eg, by making exchange rates more flexible, strengthening banking and corporate sectors, and the accumulation of large foreign exchange reserves) could reflect more realistic perceptions by investors in the post-crisis period. For example, a World Bank study finds that the ranking of the perceived governance environment is weaker now than in the pre-crisis period across the six dimensions of voice and accountability, political stability, governance effectiveness, regulatory quality, the rule of law, and control of corruption (Kaufmann, Kraay and Mastruzzi, 2005).

Kramer concludes that while it is impossible to identify the “right level” of investment with any precision, investment may be enhanced by moves to increase certainty, such as implementing prudent monetary and fiscal policies, structural improvements in the investment environment at the microeconomic level, notably in governance frameworks, and by broadening and deepening financial systems.

The World Bank (2007) notes that cyclical explanations for the slower growth in investment among East Asian economies (excluding China) in the post-crisis period have become less convincing as time has elapsed since the crisis. Analysts have identified increased uncertainty and the quality of the investment environment as likely to have played an important role in the slow investment recovery. This in turn suggests that investment climate and governance reforms to reduce the scope for uncertainty about policies and laws are likely to have payoffs for investment and growth in the region.

In contrast to other Asian economies, the level of investment in China is high, and consumption levels low, relative to international comparisons and economic fundamentals. Aziz (2006) uses a standard neoclassical growth model to investigate these compositional issues and finds that the low cost of capital is an important explanatory factor for low consumption levels, and could be caused by nonperforming loans, borrowing constraints, and uncertainty over changes in government guidance in bank lending. Aziz concludes that if China wants to “rebalance” toward greater levels of consumption, then banking sector reforms and financial market development are likely to be important. The 11th Five Year Plan approved in March 2006 placed the broad long-term challenge of rebalancing of the pattern of growth on the Chinese government’s agenda (World Bank, 2007).

One of the consequences of low investment and high saving in the Asian region is for large current account surpluses and deficits across the Asia-Pacific region. Kennedy and Slok (2005) examine whether structural reforms are the answer to global current account imbalances. They find that growth-enhancing structural reform may have impacts on current accounts. However, the empirical evidence suggests that links may be tenuous and specific to individual types of reform. They conclude that such structural reforms should be undertaken because they allow economies to grow faster and improve general welfare. The potential for structural reform to help to reduce external imbalances should be thought of as a welcome by-product, rather than a specific or central policy objective.

3.3.2  Technological spillovers and migration

Trade and FDI can lead to technological spillovers which increase productivity in three key ways (Keller, 2004). “Learning-by-doing” benefits suggest that trade liberalisation can result in firms accessing larger markets allowing greater production experience, which in turn increases productivity. “Learning-by-importing” arises when productivity is increased by drawing on the foreign stock of knowledge embodied in imported goods. Lastly, “learning-by-exporting” stems from experience interacting with foreign buyers and consumers and competing with foreign firms, which overtime increases productivity. Studies have found that exporting firms have higher levels of productivity. However, it is difficult to find evidence of causation between exporting and productivity as firms could be exporting because they are more efficient. Indeed, most studies of the relationship attribute higher productivity of exporting firms to a self-selection effect rather than due to exporting causing higher productivity (Greenaway, Gullstrand and Kneller, 2005).

Case studies on East Asian economies since the early 1960s have strongly emphasised technological spillovers from learning-by-exporting (see for example Rhee, Ross-Larson, and Pursell, 1984). However, these results do not seem to be supported by international evidence from econometric panel studies which find little evidence of learning-by-exporting effects (Keller, 2004; Greenway and Kneller, 2007; Wagner, 2007).

FDI is generally considered the main way in which technology is spread internationally, because it creates a large amount of interactions between foreign and domestic firms (Saggi, 2002). Nevertheless, there is mixed evidence as to whether there are technological spillovers from FDI and international trade. Studies have found evidence that technology travels with imports (ie, “learning-by-importing”), but the magnitude of the spillovers has not yet been firmly established (Keller, 2004).

Taylor (1995) examines the relationship between trade, openness and migration in the Asia-Pacific region since the 1970s and finds that migration played little part as a determinant of growth or income convergence. This result is perhaps unsurprising given restrictions on migration during this period.

The World Bank (2007) identifies the facilitation of migration within economies (particularly from rural to urban areas) as having the potential to contribute to a more flexible business environment and to encourage greater equity within economies. There are a number of factors that inhibit internal migration including de facto restrictions on the movement of people across regions, and the poor access to services (eg, education, housing and health services) for migrants in destination areas. For example, while China has removed controls on population movements, the right of people to settle is still restricted. The household registration (“hukou”) system will not permit rural residents to claim State benefits in urban areas. Similarly Viet Nam has a registration system where by if an individual is not a resident of the district in which they reside they do not have full entitlements to government services (Deshingkar, 2006).

3.3.3  Intraregional trade and specialisation

Traditional trade models were developed at a time when production processes were not fragmented. Such models therefore focused on the trade in final goods, where goods produced in one economy, were sold as finished products to consumers either domestically or internationally. This form of production reflected the costs and logistical difficulties associated with locating separate parts of the production process in different locations.

With the advent of lower transportation costs and improved communication networks it is now often more cost effective to locate separate parts of the production process in different locations in order to take advantage of lower production costs. Production is becoming increasingly fragmented into a number of discrete tasks, and international trade is becoming progressively more based on a “trade in tasks”, rather than a trade in goods.

Grossman and Rossi-Hansberg (2006) have developed a variant of traditional trade models that allows for the trade in tasks (the “GRH model”). The GRH model treats offshoring of production in the same was as technological progress. In the model, as the cost of offshoring declines, firms that use tasks that are offshored intensively, are more profitable and are able to expand more than firms that rely more heavily on tasks that cannot be easily offshored. This process is similar to technological progress where an improvement in production techniques allows greater output for the same level of inputs.

The literature suggests that increased intraregional trade and vertical specialisation of production processes have increased the importance of economies having markets that are flexible enough to adjust in line with their evolving comparative advantage.

The share of emerging Asian economies in world exports has increased substantially over the past 25 years (from 8% to 19% between 1978 and 2002).[12] This is in large part due to increased intraregional trade of intermediate goods, which in turn seems to be driven by greater geographical dispersion of production processes and vertical specialisation (Zebregs, 2004). This intra-industry trade has been closely associated with flows of FDI and the establishment of regional production networks (World Bank, 2007).

The integration of China into the world economy has had a major impact on trade flows, and has played a large part in the rise of intraregional trade. Between 1995 and 2005 almost all of the increase in emerging East Asia’s share of world exports (15.5% to 17.9%) came from China (including Hong Kong China), which increased from 4.5% to 7.7% of world trade.[13] World trade shares among other East Asian economies either fell or only increased slightly over the period (World Bank, 2007). This raises both challenges and opportunities for economies in the region. The challenge for those economies with competing trade structures is that they will need to have the flexibility to reorganise away from sectors in which China has a comparative advantage. The ongoing relocation of production processes across borders highlights the importance of economies in the region making further progress with structural reforms, including in corporate and finance sectors, product markets, strengthening public sector governance, and taking other steps to create a good business and investment environment.

Lall and Weiss (2007) show that the trade structure of most Latin American economies generally complements that of China. China’s increased demand for raw materials has resulted in an export boom in Latin America. However, they conclude that China may pose a serious threat to Latin America’s long-term economic development. A heavy reliance on primary and resource-based products is not conducive to technological upgrading and diversification, and any such upgrading may face a strong competition threat from China, because China may have already “taken” (ie, China may have already moved into producing) the kind of products that Latin American economies may feasibly move to. Latin American economies are a high-wage location relative to China and will therefore need to invest in higher levels of skills and/or technology to offset this.

This section examined growth and convergence mechanisms identified by traditional and modern economic growth models and discussed possible domestic structural policy impediments to these mechanisms in the Asia-Pacific region. The next section uses economic indicators to identify specific micro-level impediments to growth and convergence, such as regulation, taxation and property rights.

Notes

  • [11]The six Latin American economies included in the study are Argentina, Brazil, Colombia, Mexico, Venezuela and Chile.
  • [12]Zebregs (2004) defines “emerging Asia” as China; Hong Kong, China; India; Indonesia; Korea; the Philippines; Singapore; Chinese Taipei; and Thailand.
  • [13]The World Bank study defines “emerging Asia” as China; Hong Kong, China; Malaysia; the Philippines; Singapore; Korea; Chinese Taipei; and Thailand.
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