How to View the East Asian Economy?

1. How to View the East Asian Economy? J.D. Han King’s University College

2. In the Classical Economics by Adam Smith, there is no place for Institutions. -> Historically, at the time, Institution was “Ancien Régime” and feudalistic. -> Institution was by and large a hindrance and obstacle to human creativity.

3. Legacy to Neoclassical Economics • No place for Institution in any production or utility, or consumption function: Y = f (K, L; Technology) U = g(Qx, Qy; Tastes and Preferences) Institution is not even a conditioning variable or shift parameter.

4. Getting relevant to Neo-classical Economics • An increase in physical capital leads eventually to Diminishing Marginal Returns or a Decreasing MP of Capital -> Growth rates will gradually come down. -> “Convergence”

5. In the Solow Model of Neo-Classical Growth Model, the only way of maintaining a high growth rate or “sustained rapid economic growth” is to have Technical Innovation. -> In the Solow Model, the only production factors are K, L, and T.

6. Paul Krugman suggests that the Asian economic growth is mostly the “Intensive Growth”; an intense use of labor and capital inputs can explain the growth • Eventually there will be a limit to an increase in K, and L, and a declining growth rate will set in.

7. East Asian economic growth cannot be all attributed to Growth of Production Factor: Korean economy keeps going; Chinese economy has been doing so well for so long a time; It may take time but the Japanese economy will rebound

8. There might be another factor that affect economic growth and performance -> Human Capital - Revised Neo-classical Economists’ new tool -> Institutions/Structural Changes Social Capital; Government; Socio-economic–political System

9. These ‘New’ or ‘Endogenous’ variables have the same effect of Technical Innovation on the Production Function in the Solow Model; • It shifts up the Production Function (curve) upwards

10. Illustration with the Solow Model with an Increase in Human Capital, and Positive Institutional Changes

11. Two questions remain: • Can it explain the sustained high rates of economic growth? - There has to be a continuous change in these variables just like technical innovation - ‘Continuous Reforms’

12. Examples of ‘Continuous Reforms’ Japanese Meiji Reforms 明治维新 ……..” 周谁旧邦其命维新” …………Zhou is an old country but its fate is always new……. Korean Yousin Regim and New Village Movement Republican China New Life Movement Singapore New Country Movement

13. 2) Why did some of Structural Changes not work, such as the Great Leap Forward of the 1950s in China, or “Ju-Che of the 1980s in North Korea? Institutional changes may be not a substitution for technology, but only a conditioning variable which enhances efficiency. -> “Vitamins” themselves do not produce calories, but help calories to better use.

14. Institutional Economics • Old School T Veblen explained the seemingly stupid behaviors of super-wealthy people with the concept of “Conspicuous consumption”: U = f (Qx, Qy; Institutions/societal atmospheres conditioning individual preference) • New School Douglas North –Nobel Price 1993

15. ‘Narrow minded’ Contemporary Institutional Economics • There are bad, good, better and best institutions, depending on their contribution to Technical Innovation. • Bad ones will eventually evolve towards good ones as part of the Natural Law.

16. ‘problems’(limitations) of this line of thought • Limited idea of the Neo-Classical Economics: Institution is linked only to Technology, Physical Capital, or Human Capital, and is to work only through these production factors. • It is Dichotomy: ‘Good’ versus ‘Bad’ Bad institutions hinder K,L, and T by increasing ‘Transactions Costs’. • like ‘Evolution Theory’: move from the Primitive to the Sophisticated

17. The Respresentative Scholar: Douglas North • North and Fogel were awarded the Nobel prize "for having renewed research in economic history by applying economic theory and quantitative methods in order to explain economic and institutional change."

18. His Ideas • Poverty in the Midst of Plenty October 2, 2000 by Douglass C. North

19. “We must create incentives for people to invest in more efficient technology, increase their skills, and organize efficient markets. Such incentives are (to be) embodied in institutions” -> What ‘ideal type’ does he have in his mind?

20. Transaction costs as one of his key concepts • Steven N. S. Cheung defines them as any costs that are not conceivable in a "Robinson Crusoe economy or the costs that arise due to the existence of institutions or "institutional costs". -> The worse an institution, the higher the transactions cost.

21. Examples: Beyond the manufacturing cost , in the imperfect world we are bound to have: -Information Cost/Monitoring Cost/Communication Cost -Marketing Cost -Bargaining Cost -Compliance Cost -Political Cost -Lobbying Cost -Litigation Cost -Insurance Cost All other non-essential costs

22. Example 1. • Bargaining Costs between Employers and Employees -Through formal collective bargaining: this does not require any human elements and could be completely mechanical. -Through informal harmonization: this works when there is a shared common norm, and both parties are reasonable.

23. ‘Open-minded’ Way to Look at the East Asian Institutions Institutional/Cultural Relativism is needed: The East Asian economic institutions are the result of ‘Optimization’ for the given Socio-Economic-Political environment/constraint, and thus the Rapid Economic Growth proves the point. -> This ‘optimality’ applied to the pre-take off periods of the East Asian countries although exogenous and political factors constrained economic growth.

24. They are called ‘Revisionist’, but are in fact ‘Open-minded Institutionalist’ and ‘Believer in Cultural Relativism’ in economic institutions. • They are still different from Sociologists or other social scientists in that they believe that the Apparent Institution is the result of a common Economic Optimization , not the result of Cultural Determinism of each specific race or culture. • The Apparent differences between different ‘optimal’ institutions come from the given different constraints to each case.

25. Generalization of this Open-minded Institutionalist’s View • Depending on the given different circumstances, the same optimization process lead to Apparently Different Institutions. • No hasty ranking or judging Institutions by the Conventional (Western) standards • In other words, seemingly very different institutions may work for the same goals of optimization.

26. Application 1 • Samsung has no Labor Union whatsoever within the entire conglomerate. • Hyundai looks plagued with bitter labor strife by its labor unions all the time.

27. Samsung says that “It does not need Labor Union as it fully takes care of employees’ welfares.” The absence of union could save bargaining costs. In return for fine tuning and controls, Samsung’s salaries are much higher than other companies’ – “Efficiency Wage” It argues that it can have a distinct institution that leads to minimization of transactions-cost-saving institution.

28. Some argue that Samsung has been oppressing the spontaneous labor union movement.

29. Hyundai has different approaches to workers built on conflicts and checks. • Hyundai offers relatively low salaries and bargains very hard with workers. • Apparently bitter labor strife has no impacts on the share price of Hyundai

30. “Wrong Approach/Analysis” says • Samsung is gentleman. The management is benign and gentle. • Hyundai is ‘Nogada’ (manual workers). The management is coarse and short-tempered. -Trying to attribute outward difference to innate differences. “They are doing so differently as they are different”

31. It will be also wrong for ‘Narrow-minded’ Neo-Classical Economics’ based ‘Narrow-minded Institutional’ economist to think: • Eventually Hyundai will evolve towards something like Hyundai.

32. “Open-minded Institutionalists” say • Both companies are doing well, meaning that they are minimizing the costs and maximizing profits in the different ways that suit their circumstances best. -Two companies are given different structures of core industries. “They looks as if doing differently, but in fact underneath they are doing the same optimization. “

33. However, “stress test” shows difference: There are many whistle blowers in Hyundai. There are hardly any whistle blower in Samsung. • The long-run sustainability may be different: it remains to be seen.

34. Example 2: Amakudari • Definition: • Western Criticism: • The Advocate:

35. Long-run repeated reputational games, it would work to reduce transactions costs which could incur involving coordination and communication between policy makers and industries.

36. Expanding it to the East Asian Countries: • The Confucian leadership model is shown to be effective in maximizing economic growth rates and in minimizing transactions costs.

37. Can the East Asian way be more efficient and more cost-minimizing than the Western Free Market way? • The answer was ‘no’ up to the last year. • Now the answer could be ‘Yes’.

38. The East Asian economy will not automatically gravitate to the Free Market System anymore because it is the result of its own optimization and rationality. • So far the reforms were design to allure more of investment from the west. • China will reorganize its economy in the fashion of the Confucian leadership model.

39. Problems will rise when the West do not understand the fact that China is doing its own optimization for the given situation and make too harsh criticisms. ex) 1997 Asian Financial Crisis: Pulling investment out; Forced Devaluation; Forced Begging for Liquidity • China will not be pushed, but become assertive. • China will collide with the U.S. which represents the Free Market System. • China will try to build its own economic block. • The word countries in between will opportunistically watch which part is performing better.

40. Example 2 • Amakudari (read Ah-mah-Ku-Da-rih) 天孙制: Retiring government officials(regulator) become executives of private companies(regulatee) -in the Western View, this is the ultimate Conflict of Interests, and the root of corruption -in reality, it is not: in the repeated game with reputational values, there is an incentive against corruption by the incumbent of government officials. -This system reduces information/coordination cost between government and industry in the Japanese setting of industrial policies. This is important in a society where information processing cost is relatively high (refer to the parallel case in the Western society expounded in “Jews and Domincans Need not Apply” in J. Carr’s book Cents and Nonsense )

41. Example 3 • “Not so shameful monetary history of China” - J.D. Han’s On-going Research on the traditional Chinese Private Banks up to the 1949

42. They were different: from the late 1800s to the 1940s in China Western style Banks -large scale -Based on Collateral • Suitable for ‘arms-length-deals’ • Government liked them Old Chinese Banks -small/medium scale -Based on ‘Credit’ -Works well with the Institutions with good flows of information -Government did not like them -Prolific during ‘Chaos’

43. Conventional Wisdom • Chinese Old Banks are ‘backward and small’; ustable(no/insufficient collateral); ‘destabilizing’(speculative); and mostly illegal(underground and not controlled by government).

44. Revisionists’ View • The optimal size is endogenous; • It was based on Superior Information Processing; • Resilient and Quickly Restructuring • Superior Market Adaptability (high profits) • Private and free from government controls

45. J.D. Han’s View • Chinese old banks operated on Credit basis with superior information processing organization and capability in a society where 1)a large amount of credit was seasonally required for commerce (too large for collateral backing), 2)information as to the borrower was flowing rather freely, and3)‘Honor’(credit) was most important element in commerce. • The last two were due to uniquely Chinese socio-economic-political system at the time. Thus Chinese old banks were the best suited for commerce at the time.

46. I have been arguing that 1) it would be a mistake even for the contemporary China to model its banking system after the U.S. system, and 2) attention should be paid to the operation of the traditional Chinese bank.