Getting Interventions Right: How South Korea and Taiwan Grew Rich

Author(s): Dani Rodrik, Gene Grossman and Victor Norman

Source: Economic Policy , Apr., 1995, Vol. 10, No. 20 (Apr., 1995), pp. 53-107
Published by: Oxford University Press on behalf of the Centre for Economic Policy
Research, Center for Economic Studies, CESifo Group, and the Maison des Sciences de
l’Homme

Stable URL: https://www.jstor.org/stable/1344538

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GROWTH POLICY
GROWIH POLICY 5555

Get
how South Korea and Taiwan
grew rich

Dani Rodrik
Columbia University

1. INTRODUCTION

To any economist interested in growth, the East Asian experience since the earl
1960s poses enduring challenges. In 1960, South Korea was poorer than man
sub-Saharan African countries, and Taiwan not all that much richer (Table 1).
Since then, these two countries have experienced average increases in per-capit
income of 6.8% and 6.2% respectively, with the result that they have left far
behind not only these African countries, but also others like Mexico and Argenti
which had been much richer. How these two countries managed to transform
themselves from economic basket cases into economic powerhouses remain
something of an enigma.
The standard story to which most orthodox economists subscribe is one
export-led growth (see, for example, Tsiang, 1984; Kreuger, 1985; World Bank
1993; Little, 1994). During the 1950s, the story goes, both of these countri
engaged in traditional import substitution policies, with multiple exchange rate
high levels of trade protection, and repressed financial markets. By the late 1950
each country had exhausted the 'easy stage' of import substitution. This, togeth
with the impending reduction in US aid - which had been the main source

I am grateful toJagdish Bhagwati, Paul de Grauwe, Ann Harrison, Arvind Panagariya, Andr6s Rodriguez-Clar
Robert Wade, Adrian Wood, Alwyn Young, Panel members and especially Gene Grossman and Charles Wyplos
for helpful comments, Eytsung Kim for excellent research assistance, and the CEPR MIRAGE project f
financial assistance.

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1.: OI ,G* SUMMARY

Most explanations of Korea's and Taiw

since the early 1960s place heavy

orientation. However, it is diffic
orientation could have played a signifi

countries' growth. The measured i

profitability of exports durring the 1960

account for the phenomenal expo

Moreover, exports were initially too sm

effect on aggregate economic perform

story focuses on the investment boom

countries. In the early 1960s both econ

well-educated labour force relative t

stock, rendering the latent return to

subsidizing and coordinating investmen

policy managed to engineer a significan

return to capital. An exceptional degr

and wealth helped by rendering gov

effective and keeping it free of rent

orientation of the economy was the r

demand for imported capital goods.

Dani Rodrik
Economic Policy April 1995 Printed in Great Brita
? CEPR, CES, MSH, 1995.

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56 56 DAM DANI RODRIK
RODRIK

Table 1. Co

Country Per-capita GDP, Per-capita GDP, Per-capita GDP,

1960 1989 growth,
(1985 dollars) (1985 dollars) 1960-89 (%)

South Korea 883 6206 6.82

Taiwan 1359 8207 6.17

Ghana 873 815 -0.54

Senegal 1017 1082 0.16
Mozambique 1128 756 -2.29
Brazil 1745 4138 3.58
Mexico 2798 5163 2.36
Argentina 3294 3608 0.63

Source: Penn World Table 5.5.

foreign exchange for both economies - led policy-makers in the two countries to
alter their economic strategy and adopt export-oriented policies. These policies
included the unification of exchange rates accompanied by devaluations, various
other measures to stimulate exports (including most significantly duty-free access
for exporters to imported inputs), higher interest rates, and some liberalization of
the import regime. As a consequence of these measures, as well as a broadly
supportive policy environment (encompassing macroeconomic stability and public
investment in infrastructure and in human capital), exports took off in the mid-
1960s. Export orientation led both economies to specialize according to
comparative advantage, resulting in rising incomes, investment, savings and
productivity.
This orthodox account has been criticized for downplaying the active role of
governments in Taiwan and South Korea in shaping the allocation of resources.
Observers like Amsden (1989) and Wade (1990) have argued that the reforms of
the 1960s went considerably beyond giving markets and comparative advantage
free rein. According to these authors, governments in both countries had clear
industrial priorities and they did not hesitate to intervene (through subsidies, trade
restrictions, administrative guidance, public enterprises or credit allocation) to
reshape comparative advantage in the desired direction. Interestingly, however,
the orthodox and revisionist accounts converge on the importance of the export-
oriented strategy in having disciplined firms and enhanced productivity growth.
The World Bank's detailed recent study, The East Asian Miracle (1993), has
attempted to incorporate some of the revisionist objections (particularly on the role
of directed credit) into the standard account.
I will argue in this paper that the standard story, as sketched above, is
incomplete and quite misleading on the importance it attaches to the role of export
orientation in the growth performance. It also has backward the causal

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GROWTH POLICY
GROWL'H POLICY
57
57

relat
othe
mid-
initi
increase in this ratio.

A much more plausible explanation for the economic take-off is the sharp
increase in investment demand that took place in the early 1960s. The reason for
this investment boom is the key issue addressed in this paper. I will argue that in
the early 1960s and thereafter the Korean and Taiwanese governments managed
to engineer a significant increase in the private return to capital. They did so not
only by removing a number of impediments to investment and establishing a
sound investment climate, but more importantly by alleviating a coordination
failure which had blocked economic take-off. The latter required a range of
strategic interventions - including investment subsidies, administrative guidance
and the use of public enterprise - which went considerably beyond those discussed
in the standard account. That government intervention could play such a
productive role was conditioned in turn by a set of advantageous initial conditions:
namely, a favourable human capital endowment and relatively equal distribution
of income and wealth.

I will elaborate on these arguments below. It is useful to set the stage first by
reviewing some of the key elements of the Taiwanese and Korean miracles (section
2). Next, I discuss the shortcomings of the export-based explanations of these
miracles (section 3). I then turn to some of the distinctive initial conditions -
relative abundance of human capital and equitable income and wealth distribution
- which appear to have played a role in both countries' economic performance
(section 4). Section 5 lays out the paper's central arguments on coordination failure
and the governments' role in removing it. Section 6 discusses the investment-
stimulating policies followed by the two governments in light of the preceding
analytical framework. Section 7 asks how it became possible for detailed
interventions to be carried out efficiently and with little rent seeking. In section
8, I discuss a number of objections to the arguments. Section 9 closes the paper by
offering some concluding remarks. The formal model providing the foundation for
the central argument is presented in the appendix.

2. THE CONTOURS OF A MIRACLE

We begin by reviewing some of the key facts about the two countries' econ
performance over the last three decades. Figure 1 shows their spectacular g
performance since the early 1960s. We note that economic growth has fluc
widely around a high mean. Both economies were particularly hard hit by t
oil shocks of the 1970s, but in each case output recovered remarkably quick

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58 58 DAM DANI RODRIK
RODRIK

[ Kore

-2 1 I I I I I i I I i I i I i I I I I I I I
1954 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90

Figure 1. Per-capita growth rates (three-year moving a

Source: Penn World Table 5.5.

Figure 2 is the chief exhibit for the export-led growth hypothesis. The
export-GDP ratio rose from virtually zero in Korea to more than 30% by the
early 1980s, and from around 10% in Taiwan to over 40%. In both countries, the
increase in export orientation was particularly rapid in the decade from the mid-
1960s to the mid-1970s, and has abated somewhat since then.

I Korea ...... Taiwan I

%30

0 i -T rI - I ,-- l t I l i I I I I I I I I I i t I i t I I I I I
1952 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90

Figure 2. Export/GDP ratios, 1952-90

Sources: Council for Economic Planning and Development, Taiwan Statistical Data Book, 1982 and
1992; Economic Planning Board, Major Statistics of the Korean Economy, various issues; IMF, International
Financial Statistics.

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GROWTH POLICY
GROWTH POLICY 5959

I- Ko
40

35

30

25

20

15

10

0 I I I I t I I I I I t t I I I I I I
1951 53 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89

Figure 3. Investment/GDP ratios, 1951-90

Source: Penn World Table 5.5.

Less discussed but certainly more important is the spectacular increase in the
investment effort, shown in Figure 3. Investment rose from around 10% of GDP in
the late 1950s in both countries to 30% in 1980. Since 1980, investment has
continued its upward trend in Korea, but has declined somewhat in Taiwan. This
investment effort has been matched by a roughly equivalent increase in savings.

Table 2. Comparative productivity growth statistics

Country Period Total factor productivity growth (% per year)

Economy Manufacturing
South Korea 1966-90 1.2* 2.7
Taiwan 1966-90 1.8 1.4

Argentina 1940-80 1.0 n.a.

Brazil 1950-80 2.0 n.a.
1960-80 n.a. 1.0
Chile 1940-80 1.2 n.a.
Colombia 1940-80 0.9 n.a.
Mexico 1940-80 1.7 n.a.
1940-70 n.a. 1.3
Venezuela 1950-70 n.a. 2.6

* Non-agricultural economy.
Source: Young (1994). Latin American

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60 60 DAM DANI RODRIK
RODRIK

Consequ
(Taiwan)
Finally,
Taiwanes
countrie
careful c
Taiwan, a
TFP figu
countries
a 'meta-p
finding:
essentiall
that onc
taken int
inescapab
is capital

3. WHAT IS WRONG WITH THE EXPORT-LED GROWTH HYPOTHESIS?

As pointed out in the introduction, the standard account gives priority to the r
of export orientation in explaining the economic performance summarized in
previous section. A particularly clear statement comes from Ian Little (1994):

the outstanding success of Korea and Taiwan from the early 1960s to the m
1970s was based on a phenomenal growth of labour-intensive manufacture
This branch of manufacturing took off because exports were highly profita
once the bias against manufacturing for export was removed. The hi
profitability also depended on a relatively well-educated hard working doc
labour force which was, apart from the natural rate of increase, fed by a lar
movement out of agriculture ... High profits and increased earnings f
recruits to the industrial labour force led to a very rapid rise in savings. The
was thus a virtuous circle.

Upon a closer look, however, this account is not quite convincing for a number of
reasons discussed below.

1 The World Bank (1993) study mentioned above reports high TFP growth in these countries, but its analysis has
been seriously challenged by Young (personal communication) and Little (1994).
2 This statement does not contradict the fact that both countries have managed to increase greatly the
sophistication of the manufactured goods they produce, from toys and apparel to consumer electronics and
semiconductors. What it suggests is that this transformation has been fully paid for by investments in physical and
human capital.

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GROWTH POLICY
GROWI7H POLICY 61
61

3.1. The sw
significan
Countries
almost alw
profitabili
Taiwan is h
export tak
already be
boom got u
exports di
rise, often
following

3.1.1. Kor
preoccupie
particular
1980). Th
programm
retain a s
consumpti
free-mark
incentives w
materials
exporters
of the curr
rate.

Later, after President Park took over in a military coup on 16 May 1961, the
scope of export subsidization was greatly enlarged. The subsidy on export credits
was increased and exporters were exempted from the commodity tax and the
business activity tax. The income tax on export earnings was reduced. There were
also direct cash grants on exports, but these were phased out by 1965 (Frank et al.,
1975). However, the incentive effects of the devaluations and the cash grants were
eroded by expansionary macroeconomic policies that led to rising inflation in
1962-3 and a renewed gap between official and parallel exchange rates in 1963. A
large devaluation in May 1964 served once again to unify the currency. After
1965, export subsidy programmes were expanded further. In that year, the
existing practice of giving priority to exporters in acquiring import licences was
formalized and expanded. Exporters were allowed automatic access to duty-free
imports of raw materials and intermediate inputs up to a limit. This limit was
determined administratively, on the basis of firms' and industries' input-output
coefficients plus a margin of 'wastage allowance' (Frank et al., 1975). Since the
imports acquired under the wastage allowance could be sold in the domestic

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62 62 DAM DANI RODRIK
RODRIK

market, th
credit to ex
that the w
average, a
virtually un
varied from

There is n
exporting c
However, i
around 195
is largely d
link system
official and
export inc
widening sc
1960 only p
This can b
Korean exp
monetary
import link
like), and w
relative to
index is th
captured to
prices of ex
We note th
1964-5 was
actually be
from 1964
until the
export-GDP
relative pr
policies we
guise (see,
policies in

3 At first sight
would act as an
dollar earnings t
the system.
4 The subsidy equivalent of the export incentives are taken from Kim (1988). This, and the earlier Frank et al.
(1975) study on which these estimates are based, are the most authoritative and widely cited sources on the
quantitative aspects of Korea's trade regime.

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GROWTH POLICY
GROWTH POLICY 6363

30 120

Relativ
25- - 100

20 80 .

n a ct, 0
15- -60 8
Q.

w
10 - - -40
Exports/GDP - -4

5 - -20

0 n n , , , , , , , , , n, , ,I o
55 57 59 61 63 65 67 69 71 73 75

Figure 4. Relative price of exports: K

Source: Frank et al. (1975), Kim (1988) and

commonly have been in other develo

from taking the ratio of the effect
exchange rate for imports (both ca
that the resulting number is arou
However, it turns out that the compar
is much larger, suggesting (if the n
export bias in the earlier period (see
8-10C).
Hence the export spurt was not associated with a significant increase in the
relative profitability of exports. This has been noted by others. In their
authoritative study of Korean development, Mason et al. explicitly state that 'the
industrial policy changes that took place in the first half of the 1960s did not clearly
result in a significant increase in the measurable incentive to export'. Frank et al.
(1975) attempt to estimate the sensitivity of Korean exports to exchange rates and
export subsidies, and note that 'the main difficulty [in doing so is] that from 1955
to 1970 the effective exchange rate for exports remained remarkably steady'. The
same point is noted byJones and Sakong (1980) as well.
In resolving the apparent paradox, these authors resort to arguments that are
not entirely satisfactory. Mason et al. suggest that it was the stability of incentives
that was responsible for the export boom (see also Frank et al., 1975). But since the
incentive in question is the profitability of exports relative to other activities, there
is no clear reason why enhanced stability should have favoured exports over other

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64 DANI RODRIK

activities.5 Jones and Sakong (1980) resort to a range of explanations, including

greater stability, reduction in rent-seeking opportunities, simpler input acquisition,
clear political leadership, a more favourable 'business climate', and non-pecuniary
incentives such as presidential awards for successful exporters. Once again, the
more compelling among these factors are not specific to exporting activities, and
therefore cannot account for why exports increased faster than other activities.6
With regard to the import regime, there was no significant import liberalization
until 1967, when the switch from a positive list to the negative list was
implemented. Under the new regime, the regulations began to specify only those
items that were prohibited, rather than those that could be imported subject to
restrictions (as in the past). In the period 1961-3, the number of items positively
listed as importables subject to government licensing, quotas, foreign currency
allocation and other regulations ranged between 1000 and 1600. Under pressure
from the balance of payments, the government actually reduced the number of
importable items to fewer than 500 in late 1964. The 1961-3 level was restored in
1965, and further increased later, until 1967 when the switch occurred (Hong,
1993).

3.1.2. Taiwan. In Taiwan most of the export incentives were put in place in the mid-
to late-1950s, even earlier than in Korea, and the currency was unified during
1958-61. By 1954-5, the system of import duty and commodity tax rebates for
exportable production had already been implemented. In 1956, manufacturers
were allowed to retain up to 80% of the foreign exchange they earned from
exports and use it for their own import needs. (This ratio was raised to 100% of
export earnings for most items after the exchange rate reform of 1958.) In 1957, a
relatively generous export credit programme was started. Finally, the multiple
exchange rate system was unified during 1958-61 in several stages: (1) in April
1958, the multiple buying rates were consolidated into two buying rates, in parallel
with two selling rates; (2) in November 1958, exports and imports under the lower
rate were brought up to the higher rate; and (3) further minor devaluations and
simplifications were undertaken during the following two years (Hong, 1993; Lin,

5 It is true that, in the presence of sunk costs associated with exporting, uncertainty in the pre-1964 period may
have prevented entrepreneurs from switching existing production from the home market to world markets.
However, the export boom that took place was not a matter of switching production: it entailed the establishment
of new capacity specifically oriented towards foreign markets. With greater stability in relative incentives, the first-
order effect should have been to enhance the profitability of investing in new capacity for both foreign and home
markets.
6 In discussing the same issue, Frank et al. (1975) draw what is in my judgement the correct conclusion: 'it is
plausible to hypothesize that South Korean exports were constrained more by the capacity to produce goods than
by the relative profitability of producing for export instead of domestic markets'. To extend this to its logical
conclusion, we must therefore search for explanations for why it became profitable to invest and expand
productive capacity.

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GROWTH POLICY
GROWTH POLICY 65 65

50 130

45^ -120

\\ 40J- -110
L 35 - Real exchange rate -0
40 -100 1
. 30- 0
-90 o
g 25- c
x -80
W 20 - Exports/GDP _
15 - - 70 t0
a:

10 --60
5- -50
0 I I I I1 1 I I 40
1960 62 64 66 68 70 72 74 76 78 80

Figure 5. Real oxchsnge rates and export

Sources: Kuo (1983, Table 14.4) and Council fo
Statistical Data Book, 1982 and 1991.

1973). By July 1960, the difference bet

market price of foreign currency had be
Unlike in Korea, we do not have a synt
rate for exporters. So we have to conte
rate index (not inclusive of export su
However, as discussed above, we know th
already been deployed by the late 1950s.
accurate idea of the trend in the relativ
diagram shows that the initial export sp
a decrease in export incentives, indicate
(the product of a fixed exchange rate).
exports increased steadily until 1973
export-GDP ratio resumed its climb. By
of exports stood roughly at its level of
than four times as large. It is a safe
presented with a real exchange rate char
predicted a fourfold increase in the exp
question is the domestic price of tradabl
to the price of non-tradables. This ratio
country with no market power in intern
With regard to import liberalization, t
Korea's. There is a trend towards liberali
the consequence of the increase in expor

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66 66 DAM RODRIK DANI RODRIK

payme
could n
Could
incenti
evidenc
The ex
compa
Turkey
have b
than an
latter i
more t
Of cou
export
and Tai
place in
import
export

3.2. Ex
It is no
an inve
either
boom.
of expo

180 25

160 - - 23
140 -e

~ 120 - Real exchange rate Exports/GDP - 19

-17
c 100 - E
80- -1

60 - -1

40 - rPrivate investment/GDP -9
20 - J -7
0 ; I I I I I I I I 5
1979 81 83 85 87 89

Figure 6. Turkey, 1979-90

Source: OECD, Economic Surveys: T

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GROWTH POLICY
GROWTH POLICY 67 67

180 18

160- \ Real exchange rate - 16

140 - - 4 l

120 - Export volume -2

C

100- 0
(D1

0 I i I I I I Ii 0O
1980 82 84 86 88 90

Figure 7. Chile, 1980-91

Source: Bosworth et al. (1994).

considerable lag. This is obviously important, in so far as exports (unlike

investment) do not directly lead to economic growth.
Consider two important examples, Turkey and Chile. In Turkey, there was a
massive increase in the profitability of exports in the early 1980s (of more than
50%), with considerable import liberalization as well. These reforms were
accompanied by an impressive increase in the export-GDP ratio (Figure 6). Yet, as
Figure 6 shows, private investment actually fell in this period, and did not recover
until the second half of the 1980s. In Chile, a fall in the relative profitability of
exports in the late 1970s was accompanied by an investment boom. Investment
collapsed in 1982-3 as a result of a major financial crisis. Export incentives
increased significantly after 1982, but private investment responded sluggishly
until 1989 (Figure 7).
We should not be surprised to find that export incentives and investment can co-
vary in different ways. Int exa le, there is no reason to supse that export
orientation should be associated with an increase in investment demand. Export
orientation makes some sectors more profitable and others (import-competing
activities and non-tradables) less so. The same is true of import liberalization.
The net effect on investment demand is indeterminate. If anything, the logic of
relative factor endowments and the Stolper-Samuelson theorem suggests an
opposing presumption: in capital-poor countries like Taiwan and South Korea
during the 1950s and 1960s, an increase in the relative price of exports should
have been associated with a declcod in the return to capital, and hence reduced
investment!
investmnent!

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68 68 DAM DANI RODRIK
RODRIK

3.3. The

Since th
of expor
least. Ex
10% in T
for only
small b
decompo
domesti
coefficie
have acc
reports
domesti
was mor
Such dem
unsatisf
relates e
with ma
an incre
caused b
increase
any sign
Korea an
the mod
increase
A usefu
(CGE) m
treat the
that the
agricult
the econ
export-o
Korean g
outward
(1992). T
small p
measure

3.4. Prod
It is not
cumulat

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GROWTH POLICY
GROWTH POLICY 69
69

argumen
came no
technolo
perform
East Asi
outward
CGE mo
Asian d
The tro
were as
provide
themsel
Rodrik,
of produ
correla
industr
nothing
such fin
product
this sco
been sp
growth
develop
periods
[includ
suspicio
technolo
Moreov
made in
1993; Pa
from w
countri
around
income.
strong

3.5. The

As men
hypothe
experie
causal r

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70 70 DAM RODRIK DANI RODRIK

Box 1

The in
by po
deman
capita
U1, w
respec
terms
expan
econo
panel.
move
impor
trade
The f
impor
relativ
in do
increa
increa
relativ
for th
reduc
mark
rate d

7 The g
intertem
non-trad
price of
profitab

by th
Box 1.

Consider an (exogenous) increase in the profitability of investment, followed by

an increase in the share of investment in GDP. Suppose that the country in
question (like Korea and Taiwan during the 1960s) has a comparative
disadvantage in producing capital goods. The investment boom will require a

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u) U)
G)

c: c..
t

0 0
0.
E E

Exportables Exportab

(a) Short run (b) Long

Figure 8. Consequences of an in

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72 72 DAM RODRIK DANI RODRIK

40

35

Imports
30

25

a. / /\^y< Investment
O 20

0 15 15 /

0 I I I I I I t I I I I I I I I I t I l I I
1960 62 64 66 68 70 72 74 76 78 80 82 84 86 88

Figure 9. Imports and investment: Korea, 1960-88

Sources: Penn World Table 5.5 and Economic Planning Board
various issues.

commensurate increase in imports (also as a share of GDP). And if international

borrowing is not unlimited, exports must rise (as a share of GDP) to pay for the
imports. Hence, we will observe an increasing trade orientation alongside the
boom in investment. This story reverses the causality between growth and exports.
Export orientation enables growth (by allowing imports to increase), but it is not its

45

40

Imports /
35

30

(I 25
'5 Investment
20
, 20 _ //

15 0 _'

0 I i I I I I I I I I I I f I I I I I I I I I I I I I I I I
1952 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90

Figure 10. Imports and investment: Taiwan, 1952-90

Sources: Penn World Table 5.5 and National Income in Taiwan Area of the Republic of China (1993).

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GROWTH POLICY
GROWTH POLICY 73 73

14

12
I'\M
10 /
? / . /
8 /F\ !
/ \ *."' /1 \
6 /
? / // ^, \

2 ' ^I " Ch .......

Manuf. goods by materia Foo
0 I i It t I I
t I i I I i i I I t i t t ! i
1960 62 64 66 68 70 72 74 76 78 80 82 84 86 88

Figure 11. Imports as a share of GDP: Korea, 1

Source: Economic Planning Board, Major Statistics of the K

ultimate determinant. Ultimately, the reasons

reasons why it became profitable to invest.
This story is quite consistent with the Korea
a casual look at the data shows that in both c
closely related. As Figures 9 and 10 make clea
quite closely the behaviour of investment. In K
rise (as a share of GDP) until around 1980,
Taiwan, investment and imports rise in tandem
decline somewhat. Figures 11 and 12, showing

16

14
\ Machinery and transp. equip. \
12 \ \

/
'...,
,
."--' \'
8 * Agric. products \

6 Chemicals .

4
2; '\Basic
.--' ,metals
--\ ,,,

00^~~~~~~ ' , Textiles

0 I I I i I I I iI I I I t I I i
1952 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90

Figure 12. Imports as a share of GDP: Taiwan, 1952-90

Source: Council for Economic Planning and Development, Taiwan Statistical Data Book, 1982, 1991.

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74 74 DAM RODRIK DANI RODRIK

clear t
and tr
mainly
ratio.
with i
and fr

3.6. T
In bot
to pro
consti
develo
export
having
demo
1993).
Government policy was helpful as well. Real interest rates were raised for
depositors to levels that were either positive or only mildly negative (Taiwan in the
1950s and Korea in the 1960s). In addition, an increase in public savings made an
important contribution to total savings in both countries. In Taiwan, the increase
in the savings rate in the early 1960s coincided with a sharp increase in
government saving after 1961 (Kuo, 1983). This was enabled in turn by a
reduction in government consumption. And in Korea, 'it was the rapidly
increasing contribution of government savings and the steady inflow of foreign
savings which enabled Korea to achieve the very high rate of investment during
the 1962-73 period' (Hong, 1976).

3.7. Recapitulation
The proposition that Korea's and Taiwan's economic performance can be
ascribed to export orientation faces serious difficulties. The switch towards export-
oriented policies cannot account for the sustained export boom since the mid-
1960s, and even less for the equally impressive and sustained investment boom.
Export growth itself can explain only a limited part of the early growth in output.
The increasing share of exports in GDP is quite consistent with a story of

8 According to Box 1, the openness of the economy must necessarily decline once the investment ratio stabilizes.
However, there are a number of confounding features in the Korean and Taiwanese experiences. Foremost
among these is the large-scale import liberalization that has taken place in both countries during the 1980s.
9 As Robert Wade has reminded me, the argument about investment-led exports is not new. However, I have had
difficulty locating sources in the published literature which place priority on investment demand and at the same
time explain the rising export-GDP ratio. Bradford (1990), for example, seems to suggest a causal role for
investment, but it is unclear as to why the investment was allocated disproportionately in export-oriented sectors.

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GROWTH POLICY
GROWTH POLICY 75
75

investm
search f
private
argues
conside
rather s

4. IMPORTANCE OF INITIAL CONDITIONS

While South Korea and Taiwan were both quite poor around 1960, their s
indicators placed them among the ranks of countries at several times their inc
levels. Table 3 shows Adelman and Morris's (1967) index of socioeconom
development for a range of countries, as measured around the late 1950s and e
1960s. This index is derived from factor analysis and is based on a large numb
indicators meant to capture characteristics of social structure and soc
organization. (The indicators include the extent of dualism, urbanizati
importance of an indigenous middle class, social mobility, literacy, m
communications, cultural and ethnic homogeneity, fertility, national integrat
and sense of national unity, and modernization of outlook.) Adelman and Mo
place Taiwan and Korea in their most advanced group, even though their per
capita incomes are considerably below average.
If we focus specifically on indicators of educational attainment, we see the s
discrepancy with the level of per-capita income. Table 4 displays data on thr
educational indicators which are commonly employed as explanatory variable
cross-country growth regressions. The table shows the actual school enrolment
literacy rates in Korea and Taiwan in 1960, as well as the corresponding rates
would have been expected on the basis of these countries' per-capita income le
alone. The latter are derived from cross-section regressions of educatio
indicators on per-capita income and its square. We find that both countries

Table 3. Socioeconomic development and income

Index of socioeconomic Per-capita GNP, 1961 ($)

development, c. 1960

South Korea 0.85 73

Taiwan 1.05 145

Brazil 0.79 186

Cambodia -0.55 101
Ivory Coast -0.98 184
Morocco -0.57 150
Cyprus 1.08 416
Jamaica 1.06 436

Source: Adelman and Morris (1

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76 76 DAM RODRIK DANI RODRIK

Table 4. FadJicational indicators

Primary enrolment ratio Secondary enrolment ratio Literacy rate

Predicted Actual Predicted Actual Predicted Actual

Korea 0.57 0.94 0.10 0.27 0.31 0.71

Taiwan 0.62 0.96 0.12 0.28 0.36 0.54

Source: See text.

virtually universal primary school e

income levels stood at around 60%
rate compared to the norm, and T
high. It is clear that both countrie
educated than would be predicted
The other respect in which Ko
exceptionally equal distribution o
long-standing historical reasons, and
in both countries during the 1950
and land distribution for 41 countries for which both measures are available for a

year around 1960. Korea and Taiwan are the two countries closest to the origin:
that is, with the lowest overall inequality.
These initial conditions can account, in a statistical sense, for a large part of the
two countries' economic performance since 1960. Table 5 shows the results of
regressing growth and investment rates on initial primary enrolment and

0.70

0.65
*

0.60
0 .
E Az MMg

8 ,t ,
0.50
0.50 Finlnd *
0.45 .
* 9
*_
C 0.40
.5
0.35
0 Korea Taiwan ?
0.30 *^^~~~ **

0.25

0.20
C ).3 0.4 0.5 0.6 0.7 0.8 0.9 1.0

Gini coefficient for land

Figure 13. Measures of income and la

Source: Alesina and Rodrik (1994).

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GROWTH POLICY
GROWTH POLICY 7777

Table 5. G

Independent Dependent variables

variables
Per-capita GDP growth, 1960-85 Investment/GDP, 1960-85
(1) (2) (3) (4)

Intercept 6.22* 3.71* 16.06* 18.06*

(4.69) (3.86) (2.64) (4.32)
Per-capita GDP, - 0.38* -0.38* 0.94 0.49
1960 (-3.25) (-3.61) (1.76) (1.08)
Primary 2.66** 3.85* 11.01** 14.11*
enrolment, 1960 (2.66) (4.88) (2.40) (4.11)
Gini coeff. for - 5.22* - 5.50* - 21.04* - 16.59*
land (-4.38) (-5.24) (-3.85) (-3.64)
Gini coeff. for -3.47 14.44
income (-1.82) (1.66)
R2 0.53 0.53 0.43 0.50
Sample size 41 49 41 49

Notes: Numbers in parentheses are t

* Significant at the 1 % confidence
** Significant at the 5% confidence

inequality indicators (as well

for which inequality data are
and statistically significant c
negative association betwee
subsequent growth. Despite
exclusion of investment as a
these regressions do rather
national variation in growth
Table 6 shows that almost 9
1960 can be 'explained' by th

Table 6. Proportion of growth

Actual growth Predic

(1960-85) (%)

South Korea 5.95 5.24 88

Taiwan 5.68 4.96 87

Argentina 0.48 1.58 329

Brazil 3.52 1.96 56
India 1.37 3.46 253
Kenya 0.96 1.46 152

Notes: Predicted growth rates

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78 78 DAM RODRIK DANI RODRIK

excl
the
Kor
noth
Arg
grow
they
cond

5. THE COORDINATION FAILURE INTERPRETATION

5.1. The argument

What we need is an explanation that can account for the main outlines of Kore
and Taiwanese economic performance, and which also has a role for the speci
set of initial conditions discussed in the previous section. Such an explanation c
be constructed along the following lines.
First, by 1960 Taiwan and South Korea shared a set of advantageous init
conditions relating to social infrastructure. In particular, both economies had
skilled labour force, relative to their physical capital stock and income levels. Th
initial conditions made both countries ready for economic take-off, in the sen
that the latent return to capital accumulation was high.
Second, for a number of reasons, the economic take-off could not take pla
under decentralized market conditions. Chief among these reasons are
imperfect tradability of key inputs (and technologies) associated with moder
sector production, and some increasing returns to scale in these activities. Th
conditions created a situation of coordination failure. In other words, while t
rate of return to coordinated investments was extremely high, the rate of return t
individual investments remained low.

Third, governments in both countries undertook a set of measures starting in the

late 1950s that not only removed some policy-induced distortions, but also served
to coordinate and subsidize private investment. These measures included: credit
subsidies, tax incentives, administrative guidance and public investment.
Fourth, this active government role helped remove the coordination failure that
had blocked industrial growth. As private entrepreneurs responded to these
measures, the resulting investments turned out to be profitable not only in financial
terms, but in social terms as well.

10 Another possibly important initial condition, emphasized by Adrian Wood in personal correspondence, is the
lack of a good natural resource base in Korea and Taiwan. This is in part related to the high educational
attainment ratios relative to income: as Wood points out, countries with the same level of education per worker
but more land would have had a higher GNP per capita and lie closer to the regression line. But in addition, the
meagre natural resources gave these countries a clear comparative advantage in manufactures, allowing them to
enjoy both rapid industrialization and rapid trade expansion.

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GROWTH POLICY
GROVTH POLICY 79
79

Fifth
(with
had
insul
thes
critic

Sixth
neit
appr
adeq
Seve
payi
incre
than

5.2.
Ther
econ
a coo
the m
pres
reaso
exist
pres
are.
Imag
trad
secto
relie
inpu
well-
they
mod
(in p
Such
mod
were
labou
to sp
scale
prof
in th

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80 80 DAM RODRIK DANI RODRIK

moder
the pr
dema
produ
Coord
with b
sector
econom
capita
the fi
Taiwan
capita
Marke
econom
activit
about
resour
about)
pecun
policie
(1984
Matsu
Rodri
One p
presen
frame
prereq
of non
sector
endow
and T
activit
Upon
tradab
count
throu
moder
are fo
workm
these
tradab
(as wh

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GROWTH POLICY
GROWTH POLICY 81 81

comple
are ne
techn
techn
bluepr

The ta
distan
all - o
world)
advert
Only
channe
in tran
such
impro
aspect
interac
produc

Some e
to life.

5.3. Case studies: Hyundai and Lucky-Goldstar

The importance of specialized labour skills and the complementarities they
generate across manufacturing activities is illustrated by the experience of
Hyundai, one of Korea's huge conglomerates (chaebol). Hyundai first entered
manufacturing in 1964 by building a cement plant. According to Amsden (1989):

Hyundai used its cement plant as a laboratory to train its managers with
background in construction, before assigning them to other manufacturing
affiliates. Trainees gained experience in inventory management, quality and
process control, capacity planning, and so on, thus spreading basic production
skills throughout the Hyundai organization. After Hyundai Cement, the next
manufacturing affiliate in the group was founded in 1967 and named Hyundai
Motors. Twenty years later it became the first independent automaker from a
late-industrializing country to export globally. The first president of Hyundai
Motors was a former president of Hyundai Cement.

Korean government policies were highly partial to conglomerates like Hyundai.

By giving them access to subsidized capital, the government allowed them to
internalize many of the labour market spillovers in the fashion described in the
quote.

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82 82 DAM RODRIK DANI RODRIK

Hyu
imp
com
foun
ship
only
that
cons
capa
but
Mor
wou
Only
(int
depe
The
an i
and
ship
by
capt
The
in th

My
no c
jars,
run
box
pro
into
com
the
insu
rela
in A

The
well
thus
so b
In b
man

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GROWTH POLICY
GROWJ7H POLICY 83 83

and Sako
to capita
1962-6,
manufac
1957-62,
became m
rates rose
the not
industrie
post-196
sector m
enterpri
how Lin

The dom
produce
increase
chemical
glutama
well as f

In other
linkages
We note
the econ
failure. A
governm
bringing
enterpri
(1986):

In Taiwan, the basic philosophy underlying [the government strategy] is that an

economy will undergo certain stages of development, and at each stage there
are certain key industries (such as integrated steel mill, large shipyard, and
petrochemical plants) which through various linkages will bring about
development of the entire economy. This strategy also assumes that government
officials know what those key industries are and what policy measures should be
adopted to develop these industries. (Hou, 1988, cited in Hong, 1993)

" Little (1994) calculates that the annualized return to investment in Korea was 31.1% during the period
1963-73. However, his calculations also show a reduction in the rate of return subsequently, to 18.3% during
1974-9. He attributes the decline to the HCI drive.

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84 84 DAM DANI RODRIK
RODRIK

Indeed, T

For furt
chemical
steel pro
developm
income e
should b
specializa
economy

Hence, w
with the ideas discussed here.

6. GOVERNMENT POLICIES TO SUBSIDIZE AND COORDINATE PRIVATE

INVESTMENT

Under the conditions discussed in the previous section, there exists a large role fo
government intervention. Such intervention can take many different forms. Mos
directly, policy-makers can coordinate private-sector production and investment
decisions through their control over credit allocation, the tax regime and trade
policy, as well as through 'administrative guidance'. Government policies t
subsidize investment in the modern sectors of the economy have a large payof
because they get the private sector to internalize the coordination externalities
The same outcome can also be obtained through investments by public enterprise
themselves. The Korean and Taiwanese governments used a combination of thes
interventions, thereby raising the private return to capital in the modern sectors to
the level of the social return.

6.1. Improving the investment climate

As indicated above, both governments actively subsidized and coordinated private
investment. However, one of the most important changes that took place in the
late 1950s in Taiwan and the early 1960s in Korea was a substantial improvement
in the investment climate overall, brought about by a reorientation of government
priorities. We can view this as an important prerequisite to the effectiveness of the
interventions themselves.

During much of the 1950s, economic goals did not rank particularly high with
the Taiwanese leadership. The government was preoccupied instead with the
reconquest of the mainland. By the end of the decade, it became clear that the
communist regime was firmly entrenched: '[Taiwan's] party elders came to see
that economic development could be a better guarantee of the party's survival'
(Wade, 1990). Thereafter, the government turned its energies to eliminating many
investment-deterring distortions (such as multiple exchange rates and macro-

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GROWTH POLICY
GROWTH POLICY 85
85

economic
Program
investmen
juncture
towards
nineteen-
climate be
the libera
an officia
new plant
The story
military c
his prede
attention
economic
to econom
These pr
matters, a
and Sakon
who unde
while othe
of the na
Wealth A
regime. T
commitm
businessm
episode se
productiv

6.2. Investment subsidies

In Korea, the chief form of investment subsidy was the extension of credit to lar
business groups at negative real interest rates. Korean banks were nationali
after the military coup of 1961, providing the government with exclusive co
over the allocation of investible funds in the economy. 'Allocation of under-p
credit [became] by far the most important single instrument of governme
microeconomic control' Jones and Sakong, 1980). Korean firms were hi
dependent on external credit, as borrowing made up two-thirds of their cash
during 1963-74. According toJones and Sakong, 'the general bank [lending]
has typically been half of the curb-market rate; and second, the real bank ra
often been negative and generally below even the most conservative estimate
the opportunity cost of capital'.

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86 86 DAM DANI RODRIK
RODRIK

With ban
was need
role in th
on the bas
activities
technolog
be award
favoured
in Taiwan
growth o
1971, the
to 72% (T
chaebol as
industria
Another
through t
most nota
would b
circumsta
governme
neurs, an
groups, i
governm
industry
of Presid
eventually
the firm'
and suppl
discussed
could activ

Table 7. Size distribution of maninfscturing firms: Korea

Number of 1966 1971

employees
Number of Percentage Percentage Number of Percentage Percentage
firms of workers of value firms of workers of value
added added

5-49 21013 39.4 24.9 21045 27.9 12.8

50-199 1326 20.8 17.6 1605 18.3 15.2
200 and
above 379 39.8 57.5 762 53.8 72.0

Source: Hasan (1976).

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GROWTH POLICY
GROWTH POLICY 8787

Table 8. Tax credits and reimbursements as a share of

the relevant tax base: Taiwan

Year Percentage

1955 0.4
1956 0.7
1957 0.8
1958 1.5
1959 3.4
1960 5.6
1961 9.8
1962 8.5
1963 12.4
1964 12.4
1965 13.1
1966 14.9
1967 18.0
1968 17.2

Source: Lin (1973, Table 6-5

regulation forcing Ko
implicit investment
consequence of the fin
undertaken in the sec
chemical industries).
In Taiwan, investmen
generally positive and
enterprises did get c
socialize investment ri
the form of tax incent
in 1960 in conjunction
represented a 'sweepin
for investment. The
reduced to 18% of ann
holiday for new invest
was given to undistrib
earnings, and to proce
exempt from stamp ta
import duties on pla
instalments after star
1965, at which time t
listed in the investmen
electrical machinery
chemical fertilizers, p

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88 88 DAM RODRIK DANI RODRIK

exempt
is take
The qu
observ
relevan
associat
tally, t
around the same time.

6.3. Direct co-ordination of investment decisions

In addition to providing subsidies, the Korean and Taiwanese governments play

a much more direct, hands-on role by organizing private entrepreneurs i
investments that they may not otherwise have made. In Taiwan, it was
government that took the initial steps in establishing such industries as plastic
textiles, fibres, steel and electronics. In Korea, in the words of Amsden (1989
'[t]he initiative to enter new manufacturing branches has come primarily from the
public sphere. Ignoring the 1950s ... every major shift in industrial diversificat
in the decades of the 1960s and 1970s was instigated by the state.'
Wade (1990) describes how Taiwan's first plastics plant for PVC was built und
government supervision, and handed over to a private entrepreneur up
completion in 1957. In 1966, three more private firms began producing PVC. A
four relied on an imported intermediate. Meanwhile, the state-owned Chines
Petroleum Corporation (CPC) produced ethylene, from which an intermediate
suitable for processing into PVC could be derived at a cheaper price than
imported intermediate. 'So the government forced the four private producers
PVC to merge in a joint venture with the Chinese Petroleum Corporation and
another state-owned chemical company, in order to adopt a more efficie
ethylene-using production method' (Wade, 1990). (While Wade is not explicit
this, there must have been some scale economies or complementarities t
prevented CPC from unilaterally moving into the production of the ethylen
based intermediate, without waiting for a commitment from the downstream
producers.) The story illustrates nicely the coordinating role of the governmen
A similar account is given regarding fibres:

The government ... decided to oversee the creation of a rayon-making plant

part of a plan to diversify the textile industry away from cotton fibre. Wi
much help from US advisors it brought together an American synthetic fib
company with several local textilers from both public and private firms, an
oversaw negotiations on the terms of the joint venture . . . The resulti
corporation ... was the largest 'private' firm on the island at the time [195
... In 1962, this same state-sponsored rayon company, together with a state

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GROWTH POLICY
GROWTH POLICY 8989

financing a
production

Private firms
Finally, the
electronics in
Organization
it to local fir
and entered a
later moved to
commerciali
It is interest
industries to
concepts', su
extensions -
Wade mention
1980s was to
electronics a
highlights ga
linkages may
resonate with
In Korea, as
internalize so
had to nurtu
was not hesit
coordination

The state m
fertilizers, o
profitability
alive some un
that eventua
shipbuilding i
light to heav
iron and ste
heavy machi

The case of s
the governm
products wer
with the res
shipbuilding
Daewoo] foun

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90 90 DANI RODRIK DANI RODRIK

arm t
Koje i
says M
out of
is now

6.4. U
Public
privat
They
produ
establ
select
cemen
many
indust
countr
as dir
Not o
outpu
the cr
data o
accoun
countries as India and Tanzania.

Table 9. The importance of public eutepli;se in GDP and investment (%)

Public enterprise share of

Year
GDP Capital formation
South Korea 1963-4 6.7 31.2
1971-2 9.1 21.7
Taiwan 1954-7 11.7 34.3
1958-61 13.5 38.1
1962-5 14.1 27.7
1966-9 13.6 28.0
1970-3 13.3 30.5
1974-7 13.6 35.0

India 1966-9 6.5 29.6

Tanzania 1970-3 12.7 48.2
Argentina 1978-80 4.6 19.6

Sources: Wade (1990, Table 6.2), from origi

in GDP for Korea, which is from Jones

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GROWTH POLICY
GROWIH POLICY 91
91

Jones an
enterpris
set of pr
summariz
[were] ch
output-m
substitut
with a hi
The case
not entir
down by
World Ba
steel. Th
governm
subsidies
generati
supporte
POSCO ev
most eff
mills wi
stimulate
to spare
from 44 to 75%.

7. HOW COULD INTERVENTION BE IMPLEMENTED EFFECTIVELY?

To any economist with experience in the developing world, what is striking about
the policies discussed in the previous section is their similarity to those commonly
employed in many other, considerably less successful economies. Why have these
interventions, along with many others not specifically discussed (such as
quantitative trade barriers or local content requirements), been successful in
Taiwan and Korea and not elsewhere? One part of the answer to this question has
already been given: the imbalance between a well-educated labour force and a low
endowment of physical capital meant that the return to coordinated investments -
and therefore government policy aimed at coaxing these investments - was quite
high.
This is an important part of the story, but not the entire story. While the initial
human capital advantage may have been a necessary condition for intervention to
work, it was not sufficient. On top, what was required was a competent, honest and
efficient bureaucracy to administer the interventions, and a clear-sighted political
leadership that consistently placed high priority on economic performance. In
Korea and Taiwan, unlike in so many other developing countries, these additional

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92 92 DAM RODRIK DANI RODRIK

requir
of rel
additi
the ot
How e
thing
landed
occup
refor
insula
growt
centra
and ag
institu
pressu
could
organ
Secon
imme
the p
inequa
(Alesi
pursui
which
leader
Third
focus
This i
having
gener
is inc
burea
sticki
restri
politi
burea
Park,
his ec
mome
Hence
played
is pro

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GROWTH POLICY
GROWTH POLICY 9393

intervention c
seeking.

8. SOME FREQUENTLY ASKED QUESTIONS

The arguments I have made in this paper are naturally controversial.

challenged one of the most widely held beliefs in development economics: na
the view that South Korea and Taiwan owe their growth to export-ori
policies. I have also argued that both economies on balance greatly benefited
extensive government intervention in markets, a proposition which neocla
economists are trained to regard with suspicion. The professionally co
response to these arguments is, and perhaps should be, a high degree of scept
All the more so since some of my arguments, regarding the existenc
coordination failure in particular, lack direct empirical confirmation, even if
are suggestive and broadly consistent with the evidence. Without more de
micro- and industry-oriented studies, we will not know with any degr
confidence whether the hypothesis I have put forward has great relevance to
two cases. My hope is that this paper will stimulate such research, as w
providing some clues and a set of organizing principles to guide it.
This section addresses some of the more common reasons for scepticism.

8.1. Can we really distinguish between export and investment strategies?

One objection is that the distinction between a trade-oriented strateg
investment policies is too sharp, that these governments were preoccupied
both exports and investment. It is argued that the potential distortion
investment incentives and other interventions were kept in check b
requirement that enterprises eventually become competitive in world mar
Indeed, some of the investment subsidies were in practice contingent on e
performance. Besides, since so much of investment went into exportables, ex
must indeed have been profitable.
Nothing I have said in this paper should be taken to imply that exports di
play a facilitating role in Korea's and Taiwan's growth miracles. In fac
implication of my argument is that without the increase in exports the inves
boom would probably not have taken place. It is possible, as the above indi
that exports also made a contribution by acting as a disciplining device on sub
receiving firms.12 However, none of this is very helpful in understanding
made these countries take off. An adequate analysis has to confront the que

12 However, the analytical basis for this argument has, to my knowledge, never been properly laid out. If ful
an export target is the price to be paid for hefty subsidies, many firms will willingly pay the price. There is
inherently efficient or desirable about the resulting exports.

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94 94 DAM RODRIK DANI RODRIK

why did
which o
that th
policy b
range o

8.2. Doe
enough
Investm
other S
from e
system
allocatio
where
govern
with th
Overloo
and gro
empiric
14. Con
accumu
experien

0.40 -

0.35 -

0.30- * .

.0.25 ** * * * **
? 0 *," *K*?* eKorea
E Taiwan

?/* . *. * * ?
0.15 -

0.10 t

* ^ * * * *
0.05 -

I0 i 0 I o 1
-0.04 -0.02 0 0.02 0.04 0.06 0.08
Growth

Figure 14. Relationship b

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GROWTH POLICY
GROWL'H POLICY 9595

overall corre
(like South K

8.3. Isn't the evidence on coordination failures too weak in view of failed
government interventions elsewhere?
As already noted, the case for coordination failures is based on circumstan
rather than direct, evidence. This is not the kind of evidence that will move any
with strongly held priors on the inefficiency of government interven
Traditional arguments against it abound. The 'big push' ideas of the 1950s
led nowhere. How is it possible for governments to 'pick the winners'? And
about the example of free-market, yet successful, Hong Kong?
Without disagreeing on the need for more evidence, I would point o
number of things. First, I have tried to be explicit about the conditions u
which a coordination failure is most likely to exist, and have not treated
generic issue, as in much of the early (and current) literature. There is no
implausible about the presence of these conditions in the South Korea and T
of the 1960s. Second, I have tried to bring a considerable amount of case s
evidence to bear on these issues. In fact, so voluminous is the case study lite
on government interventions (and their apparent success) in these countrie
one may as well regard the main problem as being one of finding an adeq
theory on which to hang this evidence, rather than locating the evide
support a particular theory. The framework I have proposed here helps us
sense of the findings of this case study literature, something that is hard to do
the conventional approach.13
This approach also clarifies why 'picking winners' was not so difficult in
early years of the Korean and Taiwanese experience. Policy-makers in
countries only had to look at Japan and more advanced countries to see th
future. Of course, once the catch-up is nearly complete, it becomes more dif
to play the same game.
Finally, Hong Kong's experience is not as telling as it may seem at first gl
and not only because Hong Kong is a small city state, with significant geogr
and historical advantages in foreign trade. Hong Kong was already a h
investment country by 1960: its investment ratio stood above 20% (of GD
1960, almost double the figure for Korea and Taiwan at the time. Consequ
Hong Kong never faced the challenge of raising investment. And the abse
government policy in this regard reveals itself in an investment ratio tha
remained virtually flat since 1960. Therefore, one might as well read the

13 A clear example is the need to square the Korean and Taiwanese governments' emphasis on inter-
linkages with the complete neglect of such linkages in standard welfare economics.

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96 96 DAM DANI RODRIK
RODRIK

Kong evid
governme

8.4. Doesn
an even si

Recent th
physical
growth is
capital ho
market fa
not need
countries.

Table 10
translate
roughly
indicator
Paraguay
Korea and
has much

Table 10. C

Per- Prim
capita ratio
growth,
1960-89 Predicted Actual Predicted Actual Predicted Actual
Dominican
Republic 2.48 0.64 0.98 0.13 0.07 0.39 0.65
Philippines 1.58 0.62 0.95 0.12 0.26 0.36 0.72
Paraguay 2.72 0.65 0.98 0.14 0.11 0.40 0.75
Sri Lanka 1.83* 0.65 0.95 0.14 0.27 0.39 0.75

*1960-85.
Source: Same as Table 4.

9. CONCLUDING REMARKS

The role of government policy in Korea and Taiwan is open to dive

interpretations. In principle, one could argue in favour of any of the follow
propositions:14 (1) government policy was a hindrance, but these countr

14 With thanks to Gene Grossman, for laying out these different positions. I am borrowing his wording he

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GROWTH POLICY
GROWTH POLICY 9797

overcame it n
it either; (3)
which woul
experience o
because the
throughout th
countries to m
economists t
foreseeable f
policies made
I have argued
best be under
they were d
investments w
had a high pa
where the lat
educated wo
distribution
and allowed i
policies (and c
they enable
orientation a
This approach
miserably w
resemblance
Taiwan share
attainment r
these other c
government

Discussion

Gene Grossman
Woodrow Wilson School, Princeton University

It is always a pleasure to read one of Dani Rodrik's papers. They are clear, well
organized and well argued. And they are always provocative.
This paper is no exception. Dani challenges the view that trade policy 'explains'
the success of South Korea and Taiwan. In fact, he takes the orthodoxy head on,
and tries to demolish it entirely. Export orientation could not deserve pride of
place in these stories, he argues, because: the timing of the export booms was not

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98 98 DAM RODRIK DANI RODRIK

right t
large
orient
surely
growt
activit
empiri
Having
to rep
conditi
relativ
a coor
modern
more f
arise,
conditi
policy
discuss
the ey
shows
success
I find
could
change
movem
improv
large b
Barro
a relat
specif
regres
second
of regr
of per
and fe
ratio; t
spendi
of (on
numbe
possibl
growt
marke

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GROWTH POLICY
GROWTH POLICY 99 99

Table 11.

Korea Taiwan

1965-75 1975-85 1965-75 1975-85

Net convergence effect 0.028 0.023 0.026 0.017

Investment/GDP ratio 0.002 0.008 0.003 0.008
Government consumption 0.007 0.014 -0.008 -0.003
Black market premium 0.001 0.005 0.003 0.006
Number of revolutions -0.003 -0.003 0.002 0.002

Fitted value 0.081 0.061 0.060 0.040

Actual per-capita growth 0.078 0.063 0.061 0.057

Note: Contributions to per-capita GDP growth measured as deviati

Source: Barro and Lee (1993) and additional calculations by Robert

Using the estimated coefficients from the growth r

decompose a country's growth experience into its pr
shows the results of this decomposition for Korea an
the contribution of each variable to the fitted growth
expressed relative to the sample mean for all coun
effect' is the combined impact from the initial v
female educational attainment, and log (life expectanc
what Dani terms 'the initial conditions'.

The table shows that, with the possible exception of Taiwan in the period from
1975 to 1985, the short list of regressors 'explains' most of these two countries'
growth experience; perhaps there is no 'miracle' here. Moreover, the biggest
contribution to growth comes from the 'net convergence effect', i.e. the fact that
these countries had low initial per-capita GDP levels, but high initial levels of
human capital per worker (and thus, by implication, low initial physical capital to
worker ratios). The relatively modest levels of government consumption also
seemed to play a role. Apparently, the elimination of price distortions, to the
extent that this is captured in the change in the black market premium, is not a big
part of the story.
The argument that there existed coordination failures that inhibited investment
in the moder manufacturing sectors in Korea and Taiwan until the government
intervened to overcome them is intriguing, but requires further elaboration and
empirical investigation. I am not sure how one would definitively establish the
existence of a coordination failure, let alone the potential for one in a
counterfactual world where government policy was different. I am naturally

15 The Barro and Lee paper does not report the decomposition for individual countries. The table here is based
on calculations performed by Robert Barro, to whom I am grateful.

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100 100 DAM RODRIK DANI RODRIK

inclin
trade
such
mark
have
extern

Dani
could
Sala-i
where
phys
equili
growt
huma
fact t
Dani
predi
the P
somew
that,
by th
count
the 'im
I wou
(1994)
econo
high
capit
differ
more
super
be sm

In th
gover
My ow
I susp
that s
this v
start
that w
in pla
chang

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GROWTH POLICY
GROWFH POLICY 101 101

targeted
coordina
were nec
know th
surely be

Victor Norman
Norwegian School of Economics and Business Administration

There are two main arguments in this paper. One is that the success of South
Korea and Taiwan had little to do with export orientation. The other is that
government intervention, to overcome a coordination failure, had a lot to do with
their success. The arguments are linked, but it is useful to consider the two
separately.

Export orientation and growth

To a traditional trade theorist, the idea of export-led growth might be comforting

and politically appealing, but intellectually puzzling. If growth stems from a
growing resource base or better technology, there is no obvious link between trade
and growth, except in so far as a static gain from trade, by producing higher
income, could give higher savings. And even that link is weak, since the gain from
trade is a permanent one, with a correspondingly low marginal propensity to save.
In that perspective, it is not Rodrik's argument which is surprising. The
surprising assertion is the conventional one that Korea and Taiwan (and a number
of other countries) have taken off industrially through large-scale exports.
A puzzle remains, however. Why is the belief in exports as a source of growth so
persistent? And why is a strong correlation between export orientaton and growth
apparently observed in so many countries?
The answer is, I think, that there are good reasons to expect - at least for small
countries - a strong correlation between exports and growth, even in the absence
of a simple causality between the two. The correlation derives from perhaps the
oldest observations in economic theory: namely, Adam Smith's assertion that the
division of labour is limited by the extent of the market. If there are economies of
scale - internal or external to firms - efficient production is only possible if there is
access to markets of sufficient size. In countries such as South Korea and Taiwan,
that simply was not the case. To take one of Rodrik's own examples: the Korean
shipbuilding industry has a world market share of 25%, and much of its efficiency
derives from its scale. Three firms (Hyundai, Daewoo and Samsung) account for
93% of production; and Hyundai alone builds 10% of all new tonnage in the
world (Nagatsuka, 1994). Clearly, production units of this size could not have been
developed on the basis of the internal Korean market for transport equipment.

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102 DANI RODRIK

In the Adam Smith view then, market size is a prerequisite for growth. It is not
the cause of growth, however. Access to large markets is of no help unless the
internal conditions, such as the quality of the labour force, market infrastructure,
savings, etc., are right. The point is simply that internal conditions are not
sufficient, unless the market is large enough. That may explain why exports and
growth are strongly correlated for small countries, while countries such as
Germany and the USA could combine industrialization with protection.
Rodrik suggests an entirely different explanation for the correlation between
exports and growth - that growth generated import demand, which in turn
generated exports. That cannot be correct. As shown in Rodrik's Figures 4 and 11
(for Korea) and 5 and 12 (for Taiwan), the export boom preceded the import
boom. For Korea, for example, the ratio of exports to GDP trebled from the early
to the mid-1960s - from a level of around 2% to 6% in 1965, and roughly 7% in
1966-7. Imports of capital goods, on the other hand, did not take off until the
second half of the decade. They amounted to between 2 and 4% of GDP from
1960 to 1966, then rose to around 7% in 1967 and more than 9% in 1968. It takes
exceptional belief in the foresight of policy-makers if this is to be seen as consistent
with the view that 'thanks to appropriate macroeconomic and exchange rate
policies, export supply was adequate to meet the increase in import demand, and
rose alongside imports'.

Investment and coordination

If my interpretation of the role of exports is correct, it is easier to accept the rest of

Rodrik's story. There could well have been a coordination failure which prevente
industrial take-off and rapid export growth in the 1950s, and it might be that
government intervention to overcome the failure was important. One should ask
however, why he argues for a complex intervention story (direct intervention t
overcome a coordination failure) when a simple one - a high saving and
investment rate - suffices. As he demonstrates, in the 1960s the rate of investment
rose sharply in both South Korea and Taiwan. He also shows that saving by
publicly owned firms was a major source of higher investment. In Korea, for
example, public enterprises in 1963-4 accounted for 31.2% of capital formation
while only contributing 6.7% of GDP. Furthermore, the governments in the two
countries stimulated private savings and investment through credit subsidies an
tax incentives. One can argue that these measures were sufficient to initiate a self
reinforcing process of industrialization. In fact, in Rodrik's own model they woul
be sufficient. Why then add a less convincing story about government coordination
of investment projects?
The complex story is particularly puzzling when contrasted with the examples
cited. Rodrik citesJones and Sakong, who argue that the Korean government had
a 'coherent set of preferences' for public enterprises, favouring industries wit

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GROWTH POLICY
GROWTH POLICY 103
103

'high f
concent
exports
instruct
also cur
governm
intensiv
The oth
cosmet
insuran
me. The
inputs f
equally
for exam
A centra
was pos
from pr
a lot of
business
the con
depend
regulat
military
public s
The asse
remains

General discussion
Several Panel members wondered under exactly which conditions the results
claimed by Rodrik would obtain. Thus there were discussions about whether it was
a story about two sectors (one backward, one moder) or about capital
accumulation. The role of human capital was often explicitly mentioned.
In establishing a favourable climate for investment, George Alogoskoufis
pointed out, the political regime is important. It is essential to have a regime that
guarantees that there will not be expropriation. David Begg made a similar point
regarding the role of the exchange regime, including restrictions to capital
movements, and the risk of partial expropriation through devaluation and inflation
as well as limits to where to hold incomes from profit. Mathias Dewatripont
stressed the importance of the initial distribution of wealth, which is one of the
preconditions listed by Rodrik. Unequal distribution of wealth may create pressure

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104 104 DAM RODRIK DANI RODRIK

for re
the m
growt
exceptions.
Hans-Werner Sinn thought that the paper dismissed too quickly the
Hecksher-Ohlin theory. He observed that this theory is compatible with the
stylized facts used by Rodrik. If the economy starts from a situation where only the
labour-intensive commodity is produced, then allowing capital movements
immediately triggers capital inflows. These inflows have nothing to do with
government intervention; they simply reflect natural scarcities.
Assaf Razin raised another issue. He questioned the treatment of relative prices
of exports as exogenous. On the contrary, he expected that a push for exports
would lead to an exchange rate appreciation. Dani Rodrik responded that it is
possible to treat that relative price as exogenous as long as it is acceptable to treat
Korea as a small country with no market power. Inderjit Singh wondered about
the role of the size of military spending. He noted that a country with less military
expenses should perform better. He also thought that the paper should have
looked at the importance of the homogeneity of society. Much as with equality, a
homogeneous society is often characterized by less social conflict. Alessandra
Casella questioned measures used to evaluate equality. She further asked whether
the policy which had been carried out had increased inequality.
Xavier Vives drew a parallel with Japan. In this case, he felt that the
coordination of investment had indeed been important, as stressed by Rodrik. Yet,
in his view, the role of public subsidies has been mostly symbolic as their size has
been quite modest. He was seconded by Michel Keen, who asked Rodrik to
provide more information on the size of investment subsidies.

APPENDIX

The model discussed here is taken from Rodrik (1993), to which the reader is referr
further details (see also Rodriguez-Clare, 1993). We focus on a small, open econom
can produce two tradable final goods. Both of these goods are produced under con
returns to scale. The first of these is a labour-intensive good, requiring labour and c
which we associate with the 'traditional' sector. Its unit cost function is given by O
with w and r standing for the wage and rental rates prevailing in the economy. The
good, produced in the 'modem' sector, uses capital and a range of intermediate go
(producer services and specialized inputs) that are imperfect substitutes for each oth
use the Dixit-Stiglitz-Ethier specification for the way that these intermediates ent
production function of the modern good. In a symmetric equilibrium in wh
intermediate goods are available at price p, the unit cost function of the modern g
given by q(r,pn-1/(1-l), where a > 1 is the elasticity of substitution between any
the intermediate goods. Note that the productivity of the modern sector is linked
number of input varieties available: as n increases, unit costs in the moder sector d

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GROWTH POLICY
GROWTH POLICY 105 105

As discusse
They are pr
production
the workfor
function of
the skill le
representat
economies
monopolisti
p = wA(h)c
- MC]/p =
intermedia
be written
marginal re

(z) = (Al)
This fixes the ou
alone. Hence, an
change in n. Le
and K and L fo
prices of the m
equations of th

O(w, r)> 1, r > 0, r[0(w, r)- 1] = 0 (A2)

o(r, pn-l/("-l)) > 7, X > O, X[4(r, pn-1/(-l)) - 7] = 0 (A3)

wz(h)c(z) > p, z > 0, z[w)(h)c(z) -p] = 0 (A4)

Ow(w, r)r+?(h)c(z)nz = L (A5)

)r(W, r)r + Or(r, pn-1/('-l))X = K (A6)

p (r, pn- 1/(-))X = nz (A7)

The first three equations are the appropr
relate domestic costs to prices. The next tw
where we have used the fact that the part
respect to factor prices yield unit factor d
condition for the intermediate-goods sect
system (w, r,p, n, z, X, Y) to be determin
A key feature of the model is that the co
both the skill level of the workforce

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106 106 DANI DANI RODRIK
RODRIK

intermediate
be competi
intermedia
intermediat
modern sect
produced.
But when h
economy s
uncompetiti
active. The
economy is i
enter the m
though a lar
profitable. T
sufficiently
intermediat
When there
at least as h
generally the
the equilibri
just explaine
returns; and
resources in
return to ca

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