Human Capital, Not "Industrial Policy," Explains East Asian Success
"Communism failed, yet people still don’t want to accept that markets are superior to central planning, so some scaled back their claims and began arguing that what nations needed was something called “industrial policy.” The government doesn’t have to control resources directly, but rather it must take an active role in deciding what it is worth investing in and the kinds of products it wants to manufacture. The state must control capital, as setting up a well-functioning legal system, solving narrow coordination problems, and otherwise leaving things to the market is insufficient...
The success of East Asia is basically the number one story in global economics since 1945. After the end of World War II and most of the colonized world achieved independence, there was hope that new nations would catch up to the West. That generally did not happen, except for Israel, a few oil-rich Gulf countries, and a handful of states in East Asia, namely Singapore, Japan, Taiwan, and South Korea, with China appearing to be on a similar path. For the most part, the countries that started out rich stayed rich, and the countries that started out poor have stayed poor. This has had economists and intellectuals more generally looking around for answers as to why this is..
The Gulf Arab countries have oil, but what did East Asia have? Why was this the only region of the world that started out at the very bottom rung of development and then took off, without natural resources being the explanation?
Joe Studwell’s How Asia Works (2013) is probably the most famous book arguing that industrial policy is the answer...
The problem here is that, as Scott Sumner has pointed out, basically everyone does some form of industrial policy. This is not necessarily because industrial policy is a good idea, but because politics leans towards letting concentrated interests get their way. Businessmen lobby the government for special privileges, leaders like having power, so whatever kind of cronyism evolves in a nation gets called “industrial policy.” When countries get rich, we say it’s thanks to industrial policy. When they fail, we say that they didn’t do it correctly or maybe the leaders were greedy.
Studwell, of course, doesn’t say that any old industrial policy will do. He tells a story in which there are three steps you must take to get wealthy:
Redistribute land to maximize output from agriculture
Direct investments and entrepreneurs towards manufacturing
Interfere in the financial sector to make sure to support small-scale agriculture and manufacturing development
The market won’t take step three on its own, because businessmen and consumers have time horizons that are too short. Some countries pursue “import substitution industrialization,” which involves protecting manufacturers in order to have them sell to the domestic market. East Asia, in contrast, sought export-oriented growth, where firms were encouraged and incentivized to sell to the rest of the world, which made them subject to market forces. Nations of the region pursued his preferred policies and then grew, and other countries can learn a lesson from this.
There is nothing in Studwell’s book, other than short time horizons, that explains why governments (and only East Asian governments!) are better able than markets to direct the efficient use of capital. Investors buy long-term bonds all the time, and entrepreneurs make bets that won’t pay off for decades. What makes it so much more difficult for the market to direct resources toward the most efficient long-term uses of capital in developing countries, and why can we expect better from government? Studwell believes in economic incentives, but seemingly only for farmers and individual factories, not for private investors. He tells us that the issue is that investors and consumers have too short time horizons, but then provides examples of land reform increasing productivity almost immediately.
This is strange, as he spends a lot of time arguing that small-scale farming is more efficient than large-scale farming, hence land reform makes sense as a way to increase productivity. But if that’s true, why can’t the market see that? Large landlords would have an incentive to split their land up in a way that would maximize efficiency. If elites in countries like Japan and Korea are as a class too set in their ways to do this, then under free market competition investors might buy the farms from them and make them more productive, or the small minority of owners who figure out how to better run their businesses will outproduce the rest. There’s no theoretical reason why markets should not get to the more economically efficient outcome in the absence of government restrictions on trade or commerce. The idea that you need the state to figure these things out is asserted but never explained.
Studwell’s arguments lack strong theoretical foundations, and mostly rely on empirics instead. The question therefore becomes whether we actually need to invoke government policies to explain East Asian success. Surely, policy matters somewhat, which is why China did not achieve rapid growth under Mao and why North Korea continues to live in abject poverty. But among countries that have adopted somewhat normal policies, one may wonder whether choices that governments made were all that important for cross-national comparisons.
There are two ways to look at East Asian economies. From the perspective of poor countries in the mid-twentieth century, they’ve massively overperformed. But from a human capital perspective, they are mostly underperformers...
I use PISA rather than IQ scores for the primary analysis mainly because the latter makes people uncomfortable, and PISA is a gold-standard educational assessment carried out across the world on representative samples...
Chinese and South Korean industrial policy are often held up as major success stories. But both nations are underperformers given the cognitive abilities of their populations. Taiwan and Hong Kong are about where you would expect them to be. The urban centers of Singapore and Macau blow other East Asians out of the water...
Here’s a paper looking at cross-national cognitive ability by three mainstream scholars. The results are the same no matter how you gather the data. East Asians are the best performers, then Europeans, then most of the rest of the world, then sub-Saharan Africa. You can come up with whatever reason you want for this, but the pattern is undeniable and reveals itself no matter what measures you use or how you gather the data. There’s an attempt to cancel Richard Lynn now for being sloppy in estimating IQ scores in many developing countries, but regardless, his work has in a broad sense replicated about as well as anything we have in the social sciences.
One might try to argue that industrial policy somehow makes countries smarter. It is true that the arrow of causation runs in both directions. Smarter countries get wealthier, but we’ve seen many instances where nations getting wealthier has improved cognitive performance. That’s why North Korea and South Korea are perhaps 10-20 IQ points apart. But even North Korea isn’t that low by global standards, and China isn’t that wealthy despite its high cognitive performance. It’s about on par in its living standards with Serbia and Mexico – nations not particularly known for their accomplishments in science and tech. East Asians are always much smarter than their level of development would indicate...
North Korea has about as many Math Olympiad winners as India, despite having a 50 times smaller population and much lower living standards. If Parra and Kirkegaard are in the ballpark of being correct by giving North Korea an IQ score of 88, this is valuable information, because it gives us a theoretical minimum of how low East Asian IQ can go if you reduce them all to the lowest form of degradation faced by any modern people. Cognitive ability is much lower there than it otherwise would be under any other form of government, but still higher than much of the world. Even if the North Korean IQ were 80 – and this would be hard to imagine given their accomplishments in the Math Olympiads and developing military technology – the country would still be a massive overperformer in intelligence given how poor it is.
You might be asking yourself why East Asians are so smart. My experience is that if you hint that there might be something genetic going on here, even otherwise measured and intelligent people crawl into the fetal position, and start screeching and ripping out their hair. Since I don’t want to bring psychic trauma to anyone, we will call the reason for East Asian success “culture,” even though no one can explain how this East Asian culture magically survives the most extreme social upheavals imaginable, including Mao’s Cultural Revolution and three-quarters of a century under perhaps the most radical long-lasting personality cult the world has ever seen in North Korea. Do the cultures of present day North Korea and Japan seem similar to you? If you say yes, then I don’t really know what culture means.
Set aside also the fact that somehow the Confucian stress on forming families and leaving behind descendants appears not to in any way affect modern behavior. But Confucius from beyond the grave somehow still makes East Asians good at math. Whatever. We don’t need to bother ourselves with such paradoxes, and can even accept a theory of Global Kendism. It is enough to say that high East Asian cognitive ability is real and it precedes that region of the world becoming wealthy.
The human capital theory is simple and direct. East Asians have high cognitive ability and make better inventors, workers, and entrepreneurs. As long as they aren’t subject to something as extreme as the rule of Mao or the Kim family, they will eventually achieve first-world standards of living. Policy matters in the same way it does for other countries, where free market reforms are good and central planning is bad.
The industrial policy story, in contrast, depends on a large number of unlikely assumptions...
Japan’s successful land reform occurred in the late nineteenth century. Those of South Korea, China, and Taiwan occurred in the second half of the twentieth and early twenty-first centuries. East Asian success has been consistent across massively different systems and various historical eras.
Imagine that you had God-like power over history and were trying to design an experiment to see whether it is policy or human capital that matters more. You would take East Asians, and maybe assign them to different treatment conditions:
An ex-British colony that became independent in 1965 (Singapore)
An ex-British colony that was given to China in 1997 (Hong Kong)
A former Portuguese colony, now a special administrative region of China (Macau)
Over four hundred years of unified and independent government (Japan)
A former colony of the last country, aligned with the US (South Korea)
Give the last country a neighbor and make it the most closed society and extreme personality cult in the world (North Korea)
The winning side in the Chinese Civil War with a communist government (China)
The losing side in the Chinese Civil War with a capitalist government (Taiwan)
History was almost perfectly designed to test the theory that “East Asians will succeed in pretty much any circumstances short of being ruled by Mao or the Kim family.” Imagine looking at this history, all the diverse paths these nations took, and coming to the conclusion that they all just happened to adopt the right policies. How do you always get the same policies in East Asia regardless of what else is happening in the world? Their historical circumstances are massively different, and they all eventually led to fast development. I really don’t know what more a person would need to discount the idea that specific policies are what made this region of the world special.
Studwell doesn’t make any attempt to show that countries outside of East Asia didn’t try many of the same policies. For example, between 1980 and 1997, Zimbabwe redistributed 3.5 million hectares of farmland by finding willing buyers and sellers. The pace picked up in 2000, with another 10.8 million hectares then being redistributed through more coercive measures. Throughout the 1980s, Zimbabwe also pursued aggressive support for manufacturing and had strong capital controls. The country is nonetheless world famous as a basket case.
Ethiopia beginning around 2000 consciously attempted to follow the East Asian path. The results have generally been disappointing...
Ethiopian policy included heavy state planning, public investment in infrastructure, targeted support for manufacturing, and close state-business coordination. The government controlled the financial sector to channel cheap credit toward priority industries, protected “infant” sectors, and aggressively courted foreign manufacturers — especially in textiles, apparel, and leather — through industrial parks modeled on Chinese special economic zones. Like the East Asian cases, Ethiopia pursued export growth rather than import substitution, sought to build a disciplined bureaucracy, and emphasized agricultural productivity as a foundation for industrialization.
Ethiopia has not experienced the takeoff success of East Asian countries. If you asked Studwell what happened, he would probably say that Korea and Japan did industrial policy the right way while African nations did it the wrong way. You can always make up a new story and tack on additional complexity to your theory. But given that the human capital argument is simpler and has no contradictory evidence that I can see, we should probably go with that one...
Studwell’s comparisons between Northeast and Southeast Asia similarly leave much to be desired. After praising the land reform programs of Japan, South Korea, and Taiwan, he explains why seemingly similar policies in the Philippines didn’t work...
Studwell similarly writes “One of the most interesting country comparisons is between Korea and Malaysia, because under Mahathir Mohamad the latter made a unique political commitment within south-east Asia to industrialisation based on north-east Asian experience. Yet the outcome was far from what was hoped for.”
A lot of countries try land reform and industrial policy. When things don’t work out well, you can always go back and find the reason that they didn’t do it exactly right or it somehow doesn’t count. Maybe it is true that East Asian governments always understood how to choose the right policies and implement them in the correct way, while nobody else in the developing world can figure this out. If that is the case, however, why assume government programs are what is making the difference? Why not just posit that East Asians are more competent, and leave it at that? Why is “Northeast Asians always happen to choose the best policies under extremely different political systems” a theory that is preferable to “Northeast Asians are more productive under a market economy”? The latter is much more parsimonious.
Studwell’s refusal to consider any kind of human capital or culturally based explanations leads him into some entertaining directions. I got a particular kick out of this part.
In this respect, land policy is the acid test of the government of a poor country. It measures the extent to which leaders are in touch with the bulk of their population – farmers – and the extent to which they are willing to shake up society to produce positive developmental outcomes. In short, land policy tells you how much the leaders know and care about their populations. On both counts, north-east Asian leaders scored far better than south-east Asian ones, and this goes a long way to explaining why their countries are richer.
So Northeast Asian leaders just cared more about their people? What kind of explanation is that? Maybe it’s a cultural thing? But the whole book is about cultural explanations not having any power, and the need for us to focus exclusively on policy. So I guess Studwell’s theory is leaders who care → the right industrial policy → economic development. But I think once you’re adopting theories based on the idea that some governments are just staffed by better people, you’re conceding a lot to cultural theories, which is odd when your entire thesis is that they need to be rejected.
Studwell’s inclination towards hand-wavey explanations about why only Northeast Asians adopt the right policies reaches new heights of absurdity in the following passage.
Unfortunately, there were to be fundamental policy differences in Malaysia when compared with Japan, Korea and Taiwan. Compounded by an already lacklustre performance in unreformed agriculture, these differences were more than enough to derail Mahathir’s industrial ambitions. The new leader failed to grasp the need for export discipline, and on trips to north-east Asia his Korean and Japanese hosts did not explain the dirty secrets of protectionism to him. [emphasis added] This was hardly surprising when the self-interest of these states was now in selling turnkey industrial plants and construction services to countries like Malaysia.
If only they had told Mahathir the secret, which, unlike Northeast Asians, Malaysians somehow can’t figure out on their own!
At some points, Studwell’s deep admiration for Korean authoritarianism gets downright bizarre...
Why didn’t anyone else ever think of that before? Bring businessmen together, tell them they’ll take orders from the state. This is not the kind of thing that has a good historical record. Sure, it worked out relatively well in South Korea, but we have every reason to believe that basically anything other than communism would’ve worked in that country, because of the human capital endowment of the population. Even where Koreans did communism, they formed the most extreme, long-lasting, and competent – if your measure is establishing and maintaining control – form of communism the world has seen. And the fact that South Korea is much poorer than all of its neighbors with similar test scores except North Korea and China indicates that its system has been pathological, not something anyone else should emulate.
A final indication that human capital is the main advantage East Asia enjoys is, as Scott mentioned, the success of the Chinese diaspora in Malaysia, Thailand, and Indonesia. Studwell is clearly aware of this, as he lists affirmative action policies as one reason that Malaysia hasn’t done that well. Yet the fact that different ethnic groups in the same country can have widely disparate outcomes is itself strong evidence for human capital and cultural explanations of economic results.
There’s another perspective we can take that makes East Asian economic performance look even worse.
In the US, 97% of people who finish high school, get a full-time job, and get married before they have children avoid poverty. Imagine you could wave a magic wand and not only make the entire American population academically perform at the level of upper middle class white students, but also almost completely do away with illegitimacy, extreme drug abuse, and crime.
What do you think would happen to the American economy? Imagine how rich we would be if we cut all forms of anti-social behavior to fractions of what they are now. Urban crime in particular is a massive drain on growth, rendering many kinds of public transportation unusable, causing long commutes and basically making the housing stocks of major cities rot away.
Imagine that you’re much smarter than me, and I also party all the time and abuse drugs while you live a completely sober lifestyle. If I end up more economically successful than you are, you need to look inward and ask what you’re doing wrong. That is the situation of East Asia relative to the US and Europe.
Sometimes, people who want to defend East Asia will say things like “life is more than just GDP! Go walk around Tokyo and walk around Alabama and tell me Alabama is richer.” You’re missing the point here. It’s great that East Asians are not fat, stay quiet on the subway, and don’t commit crimes. But life in those countries would be even better if they could be as wealthy as Americans too. Higher GDP is not what causes American dysfunction. Rather, US economic success over Europe and East Asia is a mystery to be explained given the characteristics of the American population.
I wouldn’t completely blame policy for the fact that East Asia has largely failed economically when accounting for human capital and its lack of antisocial behavior. If I did, I would be no different from Studwell. It seems likely that there are East Asian personality traits that inhibit growth and are not likely to be malleable by government policy...
Yes, yes, GDP is not everything. But it’s not nothing either. There is no reason to believe that the things people find preferable about Korea or Japan over the West are the result of those nations being poorer. Westerners have a lot of social pathologies. But making consumer goods in Chicago more expensive will not make the South Side of the city as walkable or charming as Tokyo. We should all focus on increasing GDP as the goal of economic policy. Things like crime and illegitimacy also matter, but call for different sets of analyses and policy tools to deal with.
If you want to blame capitalism for Americans being fatter and more criminally inclined than South Koreans, I might as well blame industrial policy for Korea’s rock-bottom birth rates and weird relations between the sexes... Attributing American pathologies to greater wealth, lower taxes, or whatever is pure cope, and the next thing that skeptics of free markets fall back on once you continue to show that all their economic arguments are wrong...
Major East Asian nations reaching a standard of living that is in most cases lower than the typical European country, and much below that of America, is an argument that industrial policy has failed, not that it has succeeded."
