Interview with Homi Kharas on East Asian Renaissance: Ideas for Growth

We argued in the report that a middle income country, not only does one have to have all of the same fundamentals that are necessary for success to move from low-income country status to middle income country status, but one also needs to manage three very important transitions, and those are the transitions from diversification and producing a broader array of goods to specialization and a focus on those goods in which a country has a global comparative advantage, the transition from investment which simply requires more savings and more buildings to in innovation which requires the ability to do things differently, and the transition from basic education to one where the educational system delivers a much broader array of skills that are required for the labor force.

These are three difficult transitions, but ones that any middle income country must tackle vigorously if it will be able to move to the next stage and become developed.

I think that a focus on poverty alleviation is extremely important, and I think that what we have demonstrated in this report is that many East Asian countries are champions of poverty reduction. They have managed to reduce poverty by about 250 million people over the last five years. That is to say, there are 250 million fewer people living under the poverty line today than there were five years ago, so I think the type of strategies that being implemented in these countries is one that is delivering on poverty reduction.

I would like to emphasize that our report is not just about absolute poverty. It's also about the way in which East Asian countries are catching up to more advanced countries, and it's about what needs to happen once a countries have managed to satisfy core basic needs but would still leave people in an extremely vulnerable state and one where their survival may be improved, but their quality of life still lags behind.

So, what needs to be done in order to bring these kinds of economies up to the more advanced standards of developed countries and what we have emphasized in this report is that that requires a change in strategies. It's not just the same strategies that were required to reduce the basic deprivations of poverty, but it's something different.

And in the report, we argue that those are the challenges of increasing trade and being able to have countries capitalized on economy of scale, of ensuring sound financial systems, and also having domestic systems which are capable of bringing into the economies the ideas from the rest of the world that are necessary to propel economies being forward, so more innovation.

I think that view is not correct, and it is not what we are arguing in this report. In this report, we are emphasizing that the economies in effect Asia are exploiting technologies in which economies of scale are prevalent, and the implication of that is that the location of production very much depends on initial conditions. We argue that small changes in policy can actually have big effects on outcomes because of economies of scale.

There are considerable advantages for countries which are able to embrace these new technologies and develop a platform domestically that is globally efficient. So, we would argue that actually the state does need to be strong and active, and we have laid out in the report three areas where we believe that the state is doing a decent job in East Asia, and three areas where the state, we would urge them to do more.

The three decent jobs being done are trade, finance, and innovation. On the trade side, governments across the region have invested heavily in infrastructure and logistics, and East Asian countries have the most efficient airports and seaports in the world. We would urge them to continue with this agenda and to do more in integrating logistic infrastructures, to reduce the costs of moving from firms and factory gates to these traded hubs.

On finance, we argue that the state has done a very commendable job of shoring up financial systems and making them less vulnerable to the kind of crisis which erupted in 1997. And on innovation, we argue that already there has been a move towards greater tertiary education and towards the training of more scientists and engineers and knowledge workers that is positioning East Asian countries well for the kind of economy they will need in the future. These are all critical state functions.

Where we urge the state to do more is on urban management, particularly in some small- and medium-sized cities. We have found that there is a considerable divergence of performance amongst cities in the region, and while some of the large cities function reasonably well, many of the smaller cities do not. Cities are faced with environmental issues, issues of dealing with the influx of migrants with waste water issues, and a number of issues on the management of land and regulations. Cities that do better on these scores will benefit; but for countries to benefit, all the cities in that country must improve their functioning. Second, we argue in the report that states must do more to ensure social cohesion. The benefits of growth in East Asia are today increasingly concentrated spatially within cities, and socially within a small group of urban workers. The benefits are not naturally reaching out to people in rural areas, and it is a responsibility of the state to ensure that benefits are more broadly shared so that there is a cohesive, stable social environment in which development can take place.

And last, we argue in the report that states must do more to address corruption. In East Asia, there is a transition from, in some countries, corrupt centralized governments and a transition is needed to move to clean, decentralized governments.

The move from centralized to decentralized is happening quite rapidly, and it's easier to accomplish because it simply requires a devolution of monies and authorities to local governments. But the move from corrupt public sectors to clean public sectors takes longer and needs to be institutionalized and is happening at a slower pace, although there are encouraging signs of progress.

So, these are the three areas in which the state needs to do more: cities management, social cohesion, and anticorruption.

What I would say is that across the region there is much much greater awareness today about the need to deal with corruption, and most governments in the region are putting in place strong programs to try to deal with this. There have recently been very public arrests in China of local officials on corruption charges. In Indonesia, the president has made dealing with corruption one of the pillars of his platform for development. And in many other countries as well, anticorruption campaigns are growing in strength.

The good news for East Asia is that there are several examples in Hong Kong, Singapore, the Republic of Korea and increasingly in Malaysia where anticorruption campaigns have proven to be successful, and the degree of corruption has been vastly reduced, if not eradicated. That shows that it can be done if tackled with committed leadership.

In terms of our report, we have emphasized both the importance of social cohesion and the importance of dealing with corruption in ensuring that economies in East Asia continue to make progress, and in both these areas the role of youth is critical. It is the younger generation that has command of many of the information and communications technology that is so important in developing a transparent society and demanding accountability from their public leaders, and so it often falls to youth to point out where the problems lie, and at the same time through their command of technology and knowledge, youth can be very important in building coalitions for social change and for ensuring social stability.

So, I believe that youth have a very important role to play in the future of these countries.

The harder question to answer is whether these technologies directly and significantly reduce poverty, and that is because very often it is not the poor people themselves who have command of these technologies, and they do not, therefore, directly reap the benefits of the economic growth. That goes more to urban workers and to skilled knowledge workers, many of whom reside in cities.

We believe, though, that these ICT technologies indirectly help the poor because, by generating growth, they provide the basis for governments to have more robust systems of raising revenues and redistributing them through provision of services to people in rural areas. In this way, the potential to command service delivery is greatly increased.

But we would also argue that simply trying to achieve this kind of redistribution through the public sector will not be enough. There are, indeed, many examples of where rural areas can also be connected to the global and regional economies as long as there is sufficient provision of infrastructure. In countries like Japan, there are important examples of the one village/one product type where rural villages specialize in producing a certain product and have been able to find their own comparative advantage in the world and raise their living standards accordingly. This is one reason why countries like Japan and, to a large extent, Taiwan (China), have been able to develop while minimizing the gap between urban and rural areas.

What is important is to make sure that there is no inadvertent taxation of agriculture and of rural production, and that there is sufficient attention devoted to the provision of infrastructure to connect rural areas with urban centers and thereby connect them to the global economy at large.

We have also found that the return to infrastructure spending is quite high, and so these investments do pay for themselves. That suggests that it is also possible to mobilize additional private financing to help meet the costs of certain types of infrastructure, especially in power, telecommunications, and ports, for example, which are revenue-raising activities.

If the private sector can provide the funding for those through public-private partnerships, then the public sector can devote more of its own resources to the provision of rural roads, water supply, and other types of infrastructure where cost recovery is less feasible. We think that it will be possible for countries in East Asia to generate the kinds of resources that would be required in order to provide this additional infrastructure into rural areas.

I think the answer is one should not try to stem this influx. In many ways, it is a positive feature of development. One should instead try to ensure that as the migrants come to cities, they do have access to all of the services that are rendered to other citizens. One should try to ensure that the migrants have the opportunity to develop their own housing, to purchase land, and to get jobs. But at the same time it is extremely important to ensure that migrants are moving to cities for economic opportunities and not just because of the better social services that they may be able to obtain in cities. That, in turn, requires that much more attention be paid to the delivery of social services in rural areas.

At the moment, rural service delivery is lagging considerably because of limited resources of local communities in rural areas and their limited capacities. Improving both the resources and the capacities to deliver social services in rural areas will be critical to ensure that when the decision to migrate is made, it is an efficient decision both for the individual and for the economy as a whole.

But this is far from a common market. There are still considerable obstacles to trade in services and, indeed, to the movement of people within the region. There needs to be considerable progress in all of those areas before one can think about a common market in Southeast Asia.

The sole exception to this is Burma. Burma is, unfortunately, not open to the rest of the world and not well integrated with the region or with the global economy. It is extremely difficult to know, because of the closed nature of the Burmese economy, whether this economy is growing or not, and whether any poverty reduction is happening in Burma on the scale that it is happening elsewhere in the region.

The other novelty is that with the decline in transportation costs, it is now feasible to source each stage in the location which yields the best combination of price and quality. What is new about regional production networks is that they are a demonstration that comparative advantage can be extended internationally rather than restricted globally. This means that firms are now able to source components wherever the cost-quality combination is best. That expansion of the supplier base is aiding the productivity of firms and improving their competitiveness and profitability.

At the same time, because of this phenomenon, many more countries are now able to participate in the expansion of the most dynamic industries which are demonstrating economies of scale such as the electronics industries, some machinery industries, and others. This means that the benefits of global expansion of demand for these goods is more broadly shared across countries than was the case before. One result of this is that East Asia is one of the only regions in the world where the gap between the richest and the poorest countries is actually narrowing, what economists call convergence, rather than widening as is happening elsewhere in the world where regional production networks are not yet well established.

Asian countries, in fact, are finding that good corporate governance is good for business. They are finding that companies with good corporate governance have lower financing costs in capital markets, have an easier time in participating in supplier relationships with large multinationals who continue to dominate the regional production networks and have an easier time in incorporating some of the new technologies from abroad that are important for their growth because they respect intellectual property rights.

So, good corporate governance, I believe, is a centerpiece of the new growth of Asian economies.

That was the experience of most of the East Asian economies when they were poor, and it remains the experience of those East Asian countries that continue to be poor, such as countries in the Mekong, like Laos, Cambodia, and Vietnam.

But for the middle-income countries of the region today, growth tends to be associated with increasing income inequality. That is generating greater difficulties with maintaining the kind of social cohesion that East Asian countries are famous for, and that poses the new challenge that must be resolved politically rather than economically because the economic forces are no longer coincident with social desires to have equitable societies.