Information about Asia and the Pacific Asia y el Pacífico
Chapter

9 Successful Strategies for Structural Adjustment

Author(s):
Ungku Abdul Aziz
Published Date:
March 1990
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Information about Asia and the Pacific Asia y el Pacífico
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Author(s)
GOSAH ARYA*

After decades of development efforts, countries once called backward or undeveloped find themselves not too better off than before. Setting out with strong determination to eradicate poverty and bring about income equality, and after drying up foreign financial assistance, they have only been able to marginally narrow the gap between themselves and the economically advanced countries. Today, they are still classified euphemistically as developing countries. Only a few have been promoted to the rank of “upper middle-income” group by the World Bank. Included in this group are the Asian newly industrializing economies comprising Korea, Taiwan Province of China, Hong Kong, Singapore, and Malaysia—to name only those in east Asia.

In attempts to advance their development prospects, countries have pursued various policy reforms. While the timing may be different, most adopted the inward-looking strategy of import substitution in their early phase of development, taking advantage of the existing domestic demand for consumer products in the drive toward industrialization. After finding out that import substitutability had been exhausted and that their trade and payments positions had not improved, they gradually turned to a more outward-looking approach.

With a more open economy resulting from the outward-looking strategy, development prospects would depend very much on world developments. In particular, the last fifteen years have generally been a difficult period for developing countries with an open position, as the world economy has been both erratic in its growth and quite volatile in its financial market.

Looking at statistics reported in Table 1, the world output growth, which averaged almost 5 percent a year in the 1960s, slowed to an annual average of 3.7 percent in the 1970s, and declined to about 2.5 percent a year for the period 1980–87. Within the decade of the 1970s, annual growth was not at all smooth. It was the first time in recent history that industrial countries experienced a negative growth rate, sending the world economy into a deep recession. The 1980s also started off with a prolonged recession, lasting over a couple of years. World trade, which reached a peak in terms of growth in 1974, stagnated during most of the early 1980s; while the two oil shocks in 1973–74 and 1979–80 added percentage points to the world inflation, the dwindling oil market of the mid-1980s led also to difficulties for oil exporting nations. Recorded high rates of interest in the early 1980s not only prolonged the world recession that followed the second oil shock but also added to the debt-servicing burden of debtor countries. Meanwhile, industrial countries, also affected by world developments, not only became more protective of their industries—which had an effect of reducing world trade—but also reduced their official financial outflows upon which developing countries depend for financial assistance.

Table 1.World Economy: Selected Indicators(In percent)
Growth of Real GDPInflation RateGrowth of ExportInterest Rate
YearWorldIndustrial

countries
WorldIndustrial

countries
WorldIndustrial

countries
Eurodollar

rate
1961–694.974.864.303.498.709.565.35
1970–793.733.2610.198.1420.5419.018.02
1980–831.821.6112.777.182.532.3613.41
1984–873.233.4111.204.019.0710.958.25
Source : International Monetary Fund, International Financial Statistics.
Source : International Monetary Fund, International Financial Statistics.

This unfavorable international environment has made economic adjustment a strenuous task. To raise the level of income and to spread the fruit of development to the majority already require a great deal of struggling and the right combination of policies, but to have to cope and contend also with the adverse world economic condition, an extra effort is inevitable and policies need to be constantly mended. Appropriate policies for development become ever more crucial than before if countries are to overcome problems without much disruption to their long-run growth path.

In this paper, the patterns of development and domestic adjustment of selected developing countries in east Asia in the midst of changing world economic conditions are discussed. The purpose is to examine the conditions underlying the success of these countries in implementing their adjustment strategies. The economies chosen for the study include the four newly industrializing economies of Hong Kong, Taiwan Province of China, Korea, and Singapore, and the ASEAN-4, namely, Indonesia, Malaysia, the Philippines, and Thailand.

PERFORMANCE

Despite international economic turmoil in the 1970s, Hong Kong, Taiwan Province of China, Korea, and Singapore, which had much earlier endorsed an export-led growth strategy, had maintained a fairly high rate of growth, registering about 8 to 10 percent a year on average. Only with the prolonged world recession in the early 1980s did their growth rate slow down to 6 to 8 percent between 1980 and 1987. Even with this low rate, their economic performance surpassed that of all nations combined by a wide margin. Although the ASEAN-4 were slow in adopting the outward orientation, they were able to maintain a relative high rate of growth throughout the 1970s compared with the rest of the world. The good performance was extended into the early 1980s, despite the world economic downturn, with a growth rate ranging from over 3 percent a year for the Philippines to almost 7 percent a year for Malaysia. In the face of the slackening oil market of the mid-1980s, oil exporting ASEAN countries could not keep up with the good performance and grew at a rate below the world average. The Philippines, passing through political turmoil, had a negative rate of growth for the period 1984-87 (Table 2). Only Thailand survived the international economic disturbances of the 1980s and enjoyed high growth.

Table 2.Growth of Production: Average Annual Growth Rate
GDPAgricultureManufacturingOther Industries
1971–791980–831984–871971–791980–871984–871971–791960–831984–871971–791980–831984–87
Hong Kong9.357.458.53nanananananananana
Taiwan Province
of China10.015.988.891.900.121.5313.196.2411.099.946.708.04
Korea9.815.259.203.823.061.1617.855.7013.118.804.778.341
Singapore7.3628.594.312.982−0.74−6.638.8324.656.416.90210.323.75
Indonesia8.115.993.0714.283.673.62313.208.6910.9238.954.310.983
Malaysia7.976.662.7115.192.993.11312.036.865.3335.368.493.021
Philippines6.263.23−0.924.912.392.447.363.12−1.656.523.73−2.23
Thailand7.015.615.884.263.652.5010.965.037.336.956.546.47
Source: Asian Development Bank. Key Indicators.Note: na = not applicable.

Average for 1984–85.

Average for 1975–79.

Average for 1984–86.

Source: Asian Development Bank. Key Indicators.Note: na = not applicable.

Average for 1984–85.

Average for 1975–79.

Average for 1984–86.

While all countries under consideration have adopted industrialization as a strategy to develop their economy, the rate of industrialization of the newly industrializing economies has been quite remarkable. With the exception of Singapore and Hong Kong whose economies are largely nonagricultural, the share of manufacturing to total output rose sharply in the past three decades at the expense of agriculture. The proportion of manufacturing to gross domestic product (GDP) stood at 43.7 percent for Taiwan Province of China in 1987, and 35.1 percent for Korea in 1985, rising from the 1970-79 average of 36.2 and 24.6 percent, respectively (Table 3). The substantial increase in the manufacturing share of output was made possible by the high rate of growth of manufacturing output that outpaced the rate of increase in GDP. The Korean manufacturing sector grew at a remarkable rate of almost 18 percent a year during the period 1970–79, and almost 10 percent a year for the period 1980–87. Taiwan Province of China also had its manufacturing sector growing at a fairly high rate, registering over 13 percent a year in the 1970s and almost 9 percent a year in the 1980s. On the other hand, the importance of agriculture as measured by its share of GDP fell by about 50 percent in the past two decades. This is attributable to very low growth in their agricultural sector.

Table 3.Structure of Production: Percentage Share of Total Product
AgricultureManufacturingOther Industries
1970–791980–831984–871970–791980–831984–871970–791980–831984–87
Hong Kongnanananananananana
Taiwan Province of China12.037.355.8036.1740.0542.2851.8052.6051.93
Korea26.3017.9916.38124.5633.6835.42149.1248.3348.201
Singapore1.4120.970.6927.6727.6625.2070.92271.3774.10
Indonesia29.2724.4324.4739.1713.5716.35361.5762.0059.181
Malaysia29.9425.3123.50220.0024.2025.18250.0650.4951.312
Philippines27.3425.4128.6424.8524.9724.2047.8149.6247.16
Thailand24.4720.2618.9419.6821.5921.6555.8558.1359.41
Source Asian Development Bank. Key indicators.Note: na = not applicable

Average for 1984–85

Averaga for 1974–79.

Average for 1984–86

Source Asian Development Bank. Key indicators.Note: na = not applicable

Average for 1984–85

Averaga for 1974–79.

Average for 1984–86

Among the ASEAN-4, Indonesia attained the highest rate of industrialization, judging from the increase in the share of manufacturing in output over time. Starting with a small manufacturing base, Indonesia increased the importance of the manufacturing sector from a little over 9 percent of GDP in the 1970s to 16.4 percent in 1984–86. For others, the growth rate of the manufacturing sector outweighed that of GDP by only a small amount, thus the proportion of manufacturing output to GDP had not remarkably increased, compared with that of the newly industrializing economies. Malaysia, with the broadest industrial base among the ASEAN-4, appears to have slowed its pursuit of industrialization. The share of manufacturing output in total output stagnated in the 1980s to about 25 percent, as the growth of its manufacturing sector outpaced that of GDP only marginally. Despite a deceleration in the growth of the manufacturing sector in the 1980s, Thailand shows a trend of renewed industrialization in recent years.

The increase in manufacturing share of output in the ASEAN-4 had been at the expense of the agricultural sector whose share had a clear, declining trend. But in spite of that, the agricultural sector still remains important in the economies of the ASEAN-4—about equally important as the manufacturing sector when measured by share in total output. In Thailand, the share of agricultural sector in GDP was just outweighed by that of the manufacturing sector since the beginning of the 1980s, while in Malaysia this took place in the middle of the 1980s. For others, the agricultural sector is just behind but approaching the manufacturing sector in share of total output.

In the countries under consideration, sectoral share other than that of agriculture and manfacturing shows a striking increase only in Singapore and Thailand. This comes at the expense of their agricultural sector and is due to the growth rate of this “service” sector, which is high relative to GDP growth rate.

As the structure of production had undergone a rapid transformation, employment also registered a change associated with the change in structure. The percentage share of agricultural employment in total employment exhibits a fall, while nonagricultural sectors experienced an increase in the share (Table 4). Not only did the newly industrializing economies have a lower percentage of agricultural employment than the ASEAN-4, but their employment structure also changed in favor of nonagricultural activities at a faster rate. By the end of 1987, Korea, the most agricultural country among the newly industrializing economies had only less than a fourth of its labor force engaged in agricultural activities. As for the ASEAN-4, Malaysia has about one third of its employment in agricultural activities, the lowest percentage of agricultural employment in the region; Malaysia also experienced the fastest change in employment structure. On the other hand, about two thirds of Thai employment activities are still engaged in agriculture.

Table 4.Employment Structure: Percentage Share in Total Employment
AgricultureManufacturingOther Industries
1970–791980–831984–871970–791980–831984–871970–791980–831984–87
Hong Kong1.4411.481.4540.59239.2835.6556.75259.2462.91
Taiwan Province of China29.7518.9516.8426.7132.3134.1143.5448.7449.04
Korea45.3532.5224.2817.9921.4024.5736.6646.0851.15
Singapore2.2031.210.7927.16327.0524.1270.65371.7475.09
Indonesia61.99456.8654.9358.8049.188.91529.21433.9636.155
Malaysia47.4834.2331.4411.9015.5315.4240.6250.2453.14
Philippines52.8351.3449.46611.09710.319.75635.50738.3540.796
Thailand72.03870.0568.2857.4787.627.80520.50822.3223.925
Source: Asian Development Bank, Key Indicators.

1979

Average for 1975–79

Average for 1973–79.

Average for 1976–79.

Average for 1984–86

Average for 1984–85

Average for 1970–78

Average for 1972–79

Source: Asian Development Bank, Key Indicators.

1979

Average for 1975–79

Average for 1973–79.

Average for 1976–79.

Average for 1984–86

Average for 1984–85

Average for 1970–78

Average for 1972–79

The growth of exports of newly industrializing economies and the ASEAN-4 has been very fast and greater than the world total. Korea and Indonesia had an average rate of growth of almost 50 percent a year in the 1970s (Table 5). In the face of prolonged world recession in the 1980s, Korea and Hong Kong still maintained a high export growth, over 20 percent on average during 1980–87. Others performed twice better than the world average of about 5 percent in the 1980s. It should be noted that, other than for Indonesia in the mid-1980s, the growth of exports substantially outpaced that of GDP, leading to an increase in export share in GDP. Owing mainly to the softening of the oil market, Indonesian and, to a lesser extent, Malaysian exports were affected in the late 1980s.

Table 5.Growth of Exports(In percent)
Total ExportsFuelsOther Primary

Commodities
MachineryOther Manufacturing

Goods
1971–791980–831384–871971–791980–831984–871971–791980–831984–871971–791980–831984–871971–791980–831984–87
Hong Kong20.321.024.6na36.737.515.526.19.824.027.318.618.214.717.9
Taiwan Province
of China26.6115.014.434.7118.4-5.816.517.29.830.2118.320.828.0114.912.7
Korea46.727.819.841.7152.812.938.112.217.067.341.223.246.224.018.9
Singapore24.611.27.434.317.9−6.116.4−2.53.937.516.616.626.69.712.8
Indonesia47.920.90.2264.826.8−8.9235.03.819.1269.115.22.3291.242.835.0
Malaysia20.88.29.240.222.61.519.20.77.652.722.820.915.02.014.9
Philippines21.514.222.818.5133.321.317.65.512.972.048.255.435.014.526.8
Thailand26.08.519.830.921.7438.823.88.210.896.025.343.631.87.828.9
Source: Asian Development Bank. Key Indicators.Note: na = non applicable.

Average for 1972–79.

Average for 1984–86.

Source: Asian Development Bank. Key Indicators.Note: na = non applicable.

Average for 1972–79.

Average for 1984–86.

The high rate of growth of total exports was made possible by a rapid growth of manufacturing goods, especially so-called machinery and transport equipment for the newly industrializing economies and Malaysia in the recent period. In fact, an examination of export composition reveals that exports of the newly industrializing economies had increasingly comprised machinery and transport equipment (Table 6). Over one third of the merchandise exports of Korea and Singapore was in this category in 1984–87; the figure was only 15 percent for Korea and 21 percent for Singapore in the 1970s. Malaysia also enjoyed a rapid increase in machinery and transport equipment, whose export share rose to 22 percent in 1984–87, rising from 5 percent in the 1970s.

Table 6.Structure of Merchandise Exports: Percentage Share of Merchandise Exports
FuelsOther Primary

Commodities
Machinery and

Transportation Equipment
Other Manufacturing

Goods
1970–791980–831984–871970–791980–831984–871970–791980–831984–871970–791980–831984–87
Hong Kong0.010.090.162.401.981.5711.3312.8212.6863.3151.0241.16
Taiwan Province
of China1.3911.821.3614.8919.157.3122.01125.4729.3461.68163.5661.97
Korea1.251.202.3614.097.625.4814.7625.9735.6869.6764.9256.31
Singapore22.0830.4622.4229.3415.4813.3221.1127.7837.0119.8218.5220.56
Indonesia58.8378.8166.02236.4415.1918.7720.550.630.6523.174.9414.182
Malaysia10.7326.9125.8660.9243.9838.065.0514.1122.1622.3414.3813.33
Philippines1.071.101.4076.5751.4636.640.813.478.5614.5721.5223.96
Thailand0.510.030.7572.3763.2354.121.405.419.5225.7131.3335.61
Source: Asian Development Bank. Key indicators.

Average for 1972–79.

Average for 1984–86.

Source: Asian Development Bank. Key indicators.

Average for 1972–79.

Average for 1984–86.

Primary exports consisted of over half of non-oil exports in the 1980s for Malaysia and Indonesia, discounting oil trade. For Indonesia, the figure for primary commodity exports was 55.6 percent of all non-oil exports in 1984–87, down from 88 percent in the 1970s. While the importance of primary exports for Thailand is declining, it still constitutes a significant source of foreign exchange earnings for the country, accounting for over half of all merchandise trade.

In sum, despite the unfavorable international setting, developing economies in east Asia have a remarkable performance in terms of growth and transformation. Variations in the development performance among economies under consideration seem to depend on the extent to which exports are relied upon as an engine of growth, among other things. A positive association exists between export growth and the aggregate income growth among economies involved. 1 Moreover, there is a high positive correlation between rate of structural transformation and export growth.2 High rate of growth is also associated with a switch of agricultural labor force to industrial activities. A high and steady rate of growth could be better maintained if the industrialization process were accompanied by sturdy growth in the service and agricultural sectors. While the world environment was not conducive to trade, economies that diversified their exports to cover wide ranges of products were able to withstand the external impact better than others. Thus, it is the domestic economic structure and international developments that determine to a large extent how an economy performs.

EFFECTS OF EXTERNAL DISTURBANCES

Underlying the economic performance of the countries under analysis is a whole slew of developments, both positive and negative, and both domestic and international. The domestic factors influencing the performance include policy measures adopted by the authorities in an effort to develop the economy and in response to external disturbances. This will be dealt with in the next section. In this section, attempts will be made to decompose and quantify various external factors that have an effect on the economic performance of countries.

To proximate the extent of a changing world economic environment, the “shock and response” model utilized by the World Bank3 in a series of studies will be adopted here. Although the model is fairly simple and straightforward, and not without weaknesses, it can conveniently describe the impact of changing world economic conditions on a country's economy as reflected in the developments of its current account, and at the same time, it aptly provides an overview of how the country responds to the disturbances.

The model attempts to decompose the external shocks or the overall impact of changing world economic conditions on the domestic economy into three components: the terms of trade effect, export volume effect, and interest rate effect. Tables 7 and 8 provide the calculation results for the economies under consideration for the period between 1973 and 1987.

Table 7.Total Shocks as Percentage of GDP
1973–791980–831984–87
Hong Kong−8.9−5.8−1.31
Taiwan Province
of China0.9−0.46.1
Korea−0.0−4.42.0
Singapore−24.9−31.1−7.4
Indonesia8.98.27.21
Malaysia3.60.54.81
Philippines−3.4−5.8−1.6
Thailand−2.6−7.5−5.4

Average for 1984–86.

Average for 1984–86.

Table 8.Balance of Payments Effects of External Shocks(In percentage of total shocks)
Terms of Trade

Effect
Export Volume

Effect
Interest Rate

Effect
Hong Kong
1973–79−27.3−70.8−1.9
1980–83−78.6−15.6−5.7
1984–8645.5−135.8−9.6
Taiwan Province of China
1973–79−146.3261.3−15.0
1980–83−1116.91342.5−325.5
1984–87112.3−5.9−6.3
Korea
1973–79−2380.42514.7−234.4
1980–83−119.157.9−38.8
1984–8762.689.9−52.5
Singapore
1973–79−52.6−46.9−0.5
1980–83−77.0−21.5−1.5
1984–87−59.7−34.2−6.1
Indonesia
1973–79100.88.3−9.0
1980–83114.03.2−17.1
1984–86117.89.8−27.6
Malaysia
1973–79157.9−49.4−8.5
1980–83466.6−244.7−121.9
1984–86118.217.2−35.4
Philippines
1973–79−123.216.07.2
1980–83−123.510.113.5
1984–87−176.53.673.0
Thailand
1973–79−137.345.8−8.5
1980–83−105.616.4−10.8
1984–87−104.718.0−13.3
Note: Negative sign indicates unfavorable effect. Figures may not add up owing to rounding.
Note: Negative sign indicates unfavorable effect. Figures may not add up owing to rounding.

For oil exporting countries, external shocks were favorable. The effects of shocks on Indonesia amounted to 8 percent of its GDP on average during the period 1973–86. The effect accounted for 3 percent of GDP for Malaysia during the same period. In 1986, when the international oil market collapsed, the beneficial effect of world conditions on oil exporting countries was reduced somewhat. For oil importing countries and regions, Korea and Taiwan Province of China apparently suffered from the two oil price increases but the favorable effects from the increase in both prices and quantity of their exports quickly outweighed the effect from the oil price rises. While the external shocks average out positively for Taiwan Province of China during the period 1973–87, they were unfavorable for Korea, amounting to about 2 percent of GDP.

Singapore, whose economy is fairly open, was the most affected by the external disturbances, with a magnitude amounting to over one fourth of GDP. For Hong Kong, the Philippines, and Thailand, the average adverse effects of external disturbances ranged between 4 percent and 6 percent of GDP. Regardless whether the countries are oil importing, the external shocks seem to be more intensive in the 1980s than in the earlier period.

The chief cause of external shocks appears to come from changes in the terms of trade and, in more recent years, the increase in the rate of interest. The oil price increases, and the world inflation that followed, affected the terms of trade of the countries and regions under consideration. While the effect was favorable to oil exporting countries, it outweighed the increase in export prices of others for the period up to 1983, resulting in adverse developments in the terms of trade. In recent years, when world inflation subsided and oil prices declined, the terms of trade effect turned out to be favorable for the newly industrializing economies, except Singapore.

With the exception of the Philippines, the high and increasing rate of interest, especially in the 1980s, negatively affected all countries and regions under consideration. The interest effect ranges from 2 percent of total shocks for Singapore to over 100 percent of total shocks for Korea for the 15-year period ended in 1987.

Hong Kong, Singapore, and Malaysia in the early period under analysis suffered from sluggish demand for their exports. On the other hand, Taiwan Province of China and Korea had been able to enjoy increasing world demand for their products to the extent that the negative terms of trade effect was either outweighed or mostly offset. Indonesia, the Philippines, Thailand, and Malaysia in recent years also gained substantially from increasing world demand for their exports. Thus, contrary to the widely held view that the prolonged recession in the developed countries and the increased adoption of a protectionist stance had been responsible for the recent payments difficulties of developing countries, the figures provided in Table 8 indicate that the negative effect was not experienced by all countries in their balance of payments developments but was felt most by those with large entrepôt trade.

POLICY RESPONSES

Depending on the seriousness of the problem and the constraint imposed on the economy by its structure and the like, a combination of policies was adopted to counteract unfavorable developments.

In the model, five possible responses to disturbances are identified, namely, expending greater effort to increase export share, import substitution, import savings, debt adjustment, and finally, additional external financing to withstand the disturbances. Table 9 summarizes the extent to which these various strategies were utilized in response to external shocks.

Table 9.Balance of Payments Effects of Policy Responses(In percentage of total shocks)
Increase in

Export Share
Import

Savings
Import

Substitution
Debt

Adjustment
Additional

Financing
Hong Kong
1973–79−47.534.944.34.763.5
1980–83−16.8−26.014.41.7126.6
1984–86143.289.1−80.32.7−54.7
Taiwan Province of China
1973–792.6−125.6−82.13.2102.0
1980–83−649.1208.8−127.254.9612.6
1984–8710.831.77.613.7−163.8
Korea
1973–794.8−1033.5−70.8−214.41413.9
1980–833.0−16.9−3.3−17.6134.8
1984–87−2.4−24.43.5−21.7−55.0
Singapore
1973–79−3.941.217.1−0.145.7
1980–831.714.5−0.3−0.184.1
1984–87−1.560.2−8.9−0.951.1
Indonesia
1973–79−0.7−32.817.2−1.6−82.1
1980–83−0.9−28.73.4−1.4−72.3
1984–861.4−4.5−7.2−3.3−86.5
Malaysia
1973–7913.145.431.7−1.7−188.5
1980–33−269.882.0−128.7−109.1325.7
1984–86−0.132.74.3−17.9−119.1
Philippines
1973–79−2.0−36.83.26.1129.5
1980–834.6−13.4−4.03.9108.9
1984–87−4.9−2.16.7−52.4152.8
Thailand
1973–79−0.914.2−3.06.183.6
1980–83−3.82.20.4−1.1102.4
1984–872.63.11.0−0.393.6
Note: Negative sign indicates negative responses. Figures may not add up owing to rounding.
Note: Negative sign indicates negative responses. Figures may not add up owing to rounding.

It appears that, in general, greater weight was given to external financing in response to the shocks. This may be because the real adjustment fell short of the need to adjust or the shocks were perceived to be temporary. On the other hand, adjustment in external indebtedness was not a measure generally adopted in the face of rising world interest rates. This may be because the effect of high and fluctuating interest rates was small compared with other external shocks or because a good proportion of external debt was concessionary with fixed rates of interest and long grace periods. Dependence on external financing and failure to adjust external indebtedness would lead to accumulation of foreign debt.

In real adjustment, the authorities resorted to either a reduction of domestic demand that lead to import savings or import substitution rather than an increase export share. Singapore, Thailand, and Taiwan Province of China when faced with unfavorable external shocks relied mainly on belt-tightening by moderating the growth rate to reduce demand for imports. Although enjoying favorable external developments, Malaysia opted also for a moderation in its growth process. The adjustment in income in response to shocks, or the lack of it, was basically the result of a combined exercise of fiscal and monetary policies. Detailed discussion on macroeconomic management is given in the next section.

Import substitution strategy was adopted on occasion by all countries and regions under examination but to a lesser extent than import savings strategy. While policy measures associated with the strategy will be discussed in more detail in the next section, it should be noted here in passing that import substitution can take place through the market mechanism without policy interference. This is because as import costs in terms of foreign currency rise as a result of inflation abroad, domestic production becomes feasible and may be expanded, with demand deviating toward local products.

Increase in export share was also adopted on occasion but to a lower order of importance; Korea was the exception; export penetration was the only real adjustment taken when faced with negative external disturbances. Hong Kong also adopted this strategy together with import savings in the early 1980s.

ALTERNATIVE STRATEGIES FOR ADJUSTMENT

Developing countries usually start their industrialization by introducing an import substitution policy. The policy operates normally through a structure of protection and other tax incentive systems. This has an effect of generating a gap between domestic and foreign costs, enabling the local industry to enter into or to sustain the operation. The cost-price difference can also result from a depreciation of a currency, which increases the import cost in terms of domestic currency unit. Import substitution can also take place through the market mechanism without policy interference. As import cost in terms of foreign currency rises as a result of inflation abroad, domestic production becomes feasible and can expand, while demand deviates toward local products.

Theoretically, when goods, which were previously imported, are domestically produced, there should be import savings amounting to factor costs used in production. These savings would contribute to an improvement in the balance of payments. However, in actual practice, import substitution policy almost always leads to a deterioration in the balance of payments of the country adopting the policy. This is because in the early stage of import substitution, there could be a sharp increase in imports of plants and equipment leading to a current account deficit. The problem may not be serious insofar as the deficit is financed by a surplus in the capital account. The only time that a payments deficit could become a problem is when import substitution entails an investment beyond the capacity of the country to raise foreign capital or when the imported plants and equipment do not function smoothly as expected.

Under import substitution, the balance of payments could also deteriorate owing to a rapid increase in domestic demand, which leads to an increase in imports over and above the savings of the import substitutes. As industrialization through import substitution involves typically assembling imported components and raw materials, the value added in the production process is small. On the other hand, the industrialization process has an effect of raising domestic consumption to a level higher than before. Thus, it is likely that the import savings from the substituted products could be little compared with the increase in overall imports resulting from an increase in income.

The newly industrializing economies and the ASEAN-4 have all engaged in import substitution to industrialize, but the extent of engagement and the kind of industry has varied in each. Table 10 shows the average duties imposed on imports of ASEAN countries. Although the degree of protection can be better described by other statistics, such as effective rate of protection, the simple average tariff rate can also reflect the degree of protectionism to a certain extent. Indonesia had the highest tariff rate in the region, averaging almost 33 percent in 1980. Being an open economy pursuing a free trade policy, Singapore levied only a minimal average rate of 6 percent on its imports. In comparison, Malaysia had low import duties on average; its tariff rate for consumer goods was second highest in the region.

Table 10.Simple Average of Import Duties in ASEAN(In percent)
IndonesiaMalaysiaPhilippinesSingaporeThailand
19801982198219831983
Primary goods14.93.523.60.119.8
Intermediate goods24.917.026.68.627.0
Capital goods20.06.522.00.323.7
Consumer goods65.663.842.29.549.4
Transport equipment27.419.320.92.022.4
Other17.210.627.70.013.1
Total32.625.029.26.430.7
Source: Philippines Tariff Commission. Tariff Profiles in ASEAN: An Update.
Source: Philippines Tariff Commission. Tariff Profiles in ASEAN: An Update.

From the structure of import tariffs, the rate applied to consumer products appeared to be the highest for all countries. These high tariff rates reflect the degrees of protection enjoyed by industries producing consumer products. As import substitutability of consumer goods is exhausted, countries have moved to the next stage of import substitution by getting into production of goods other than consumer goods. This is especially true for the Philippines and, to a certain extent, Thailand and Indonesia. The tariff structure indicates that industries other than light manufacturing also receive a fairly high degree of protection.

As noted earlier, increasing dependence on an industrialization strategy that uses import-accompanied import substitution has resulted in deficits in the current account balance of oil importing countries. To the extent that the deficits can be financed by capital inflows, the pressure on the balance of payments is released; however, this may not be the case. As the ability to borrow abroad depends on the estimates of the debt-servicing capacity of the country, authorities tend to control foreign exchange and limit imports. This was true for the Philippines and Thailand in the early 1980s. The measure caused further distortion in their economies, leading to a shaky investment climate.

Recognizing that substitution possibilities have been exhausted, policymakers have adopted more of an outward-looking export promotion strategy. However, the main issue in promoting export industries is to identify those industries in which the country has or could develop comparative advantages vis-à-vis the rest of the world. In most developing countries with well-endowed natural and human resources, it goes without saying that the comparative advantages should lie in industries utilizing those resources to the utmost; however, to find out which industries have the greatest comparative advantages as export industries, one has to convert all prices into international prices and compare per-worker income industry by industry.

As comparative advantages are determined by international prices, any policy measures that create domestic price distortion have an effect on the comparative position of the country in the world market. Such policy measures are commonly found in most developing countries. If these policy distortions could be removed or corrected, then it is conceivable that the list of potential export industries would be enlarged.

Normally, policy measures adversely distorting comparative cost advantages include trade restrictions, overvalued exchange rates, and factor prices that have been set artificially above the market prices. In general, these policy instruments exist in support of an import-substitution policy, as in the case of trade restriction and overvalued exchange rate, or for political reasons, as in the case of a high wage rate. To effectively pursue an outward-looking export orientation strategy, it is necessary to dismantle or at least to offset these measures, as they are biased against exports.

By reducing the demand for imports, trade restrictions through tariffs and quotas would raise domestic prices of import-competing products relative to nontradables and exportables, thus, encouraging a switch away from production for exports and home goods. Thus, the reduction or removal of tariff and quantitative restrictions imposed on foreign trade would provide incentive for the production of export goods.

On the exchange rate, overvaluation of domestic currency weakens the competitiveness of domestic products in the world market and encourages imports. Through its effect on user cost, overvaluation paves ways to an increase in investment with high import content, which is not likely to be commensurate with the country's factor endowment. Moreover, overvaluation would lead to aggregate dissaving as it induces purchases of imported consumer goods. It also weakens the confidence of domestic currency holders, leading to capital flight in one form or the other. Thus, an adjustment in the exchange rate to better reflect its appropriate value would not only encourage exports but would also set an economic environment in its proper perspective.

The World Bank reported the extent of various price distortions existing in selected countries in the decade of the 1970s (Table 11). Although exchange rates were generally free from distortion, developments in the 1980s indicate that several countries were not able to adjust their exchange rate in line with their trading partners in a timely manner. For instance, by mid-1983 it was long recognized that the Thai baht had been out of line, but it took until the end of 1984 for the Thai authorities to realign the currency. Their experience in devaluating the baht two years earlier involved a change of the government. Meanwhile, stop-gap measures, such as credit control, were employed against deterioration in the current accounts. As a result, many businesses were denied formal sources of funds and the investment climate deteriorated sharply.4

Table 11.Price Distortions
ExchangeFactor PricingProduct Pricing
RateCapitalLabor(Inflation)
KoreaLMLM
IndonesiaMMLM
MalaysiaLMML
PhilippinesLMLL
ThailandLLLL
Source: World Bank, World Development Report 1983 (New York: Oxford University Press, 1983).Note: L = Low distortion; M = Medium distortion.
Source: World Bank, World Development Report 1983 (New York: Oxford University Press, 1983).Note: L = Low distortion; M = Medium distortion.

In pursuing export-oriented strategies, a macroeconomic environment conducive to industrialization and growth is a requisite. This is because trade liberalization and promotional measures cannot be effective in encouraging exports and raising growth if macroeconomic policies are inconsistent and destabilizing. Once the economic environment is conducive to investment and growth and liberalization has taken place, promotional measures in favor of export industries could then be effectively implemented.

It should be mentioned that there has been some skepticism with regard to the appropriateness of outward-looking, export-oriented strategies in an unstable world environment. The prolonged world recession in the early 1980s and the weak recovery through the mid-1980s seem to support the skepticism. On the other hand, uncertainty with regard to world developments, as many more developed economies are facing domestic economic difficulties, coupled with increasing protectionism on the part of more developed economies in recent years, would make the export-led strategy unreliable for developing countries.

It cannot be denied that export-led strategy depends, as the name implies, on world developments. The performance of countries adopting this strategy during world economic turmoil shows that they fared better in terms of growth and stability than those who did not. Performance varied among the countries themselves, but this is attributable to the extent of structural rigidities existing in the economy and the ability of the economy to take advantage of positive developments during the world recession, for example, low world inflation, abundant supplies of raw materials, and declining interest rates.

The success of an adjustment program depends on how well supply responds to the incentive given by the program. Thus, macroeconomic variables, such as interest rate, wage rate, and exchange rate are important in this respect.

In the economies under analysis, domestic capital markets are commonly segmented, as accessibility to credit by, and cost of credit to, borrowers varies. Large firms and investors with established credit ratings are normally able to secure funds from formal financial institutions. Small-scale investors depend largely on informal sources of funds for needed capital. Higher risk and administrative cost per loan are often cited as reasons for market segmentation.

Capital costs in formal and informal markets also vary. In the formal banking system, there exist interest rate ceilings and credit controls designed to keep the cost of borrowing low as a stimulus to investment. On the other hand, in the informal financial sector the cost of funds reflects market forces.

Capital market segmentation tends to result in large firms making investment decisions toward capital-intensive products and a production structure of the economy with a rise in capital/labor ratio as firm size increases. While this may not be appropriate for countries that depend on imported capital goods and are short of foreign exchange, the policies that lead to a rise in capital cost for large firms or a subsidy to small firms may also have drawbacks.

It is true that raising the official interest rate or the cost of capital may induce more efficient use of scarce capital resources and at the same time encourage a shift toward labor, but it is not clear whether such benefit would outweigh the loss that would be incurred from a poor investment climate and restrictive policy resulting from the rise in the interest rate itself. On the other hand, subsidization or direct allocation of capital to small firms or investors may not lead to an increase in output, as the capacity to efficiently utilize capital of small firms may be limited. The end result may be a sheer increase in capital/output ratio with no significant increment in output.

The appropriate policies here would be to facilitate and strengthen linkages between formal and informal money markets. Suggestions in this regard include a penetration of banking services in the area where such services do not exist, a credit guarantee scheme to insure loans to small and risky borrowers, greater acceptance of credit instruments of the informal sector, and promotion of various discount houses and leasing activities. Once strengthened, these linkages would also act as effective transmission mechanisms of financial and monetary policies.

Resembling capital market segmentation, the existence of wage differentials between formal and informal sectors tends to reinforce factor market distortion and leads to a rise in the capital/labor ratio as firm size increases. Evidence indicates that labor market intervention through minimum wage requirement and mandated fringe benefit affects by and large the formal and large-scale enterprises, while small and informal enterprises escape through lax enforcement. Thus, the wages of large industries are consistently above those of small enterprises whose wages are more likely to respond to market forces and closely approximate the opportunity cost of labor. The distortion would lead to lower large-firm employment than would be the case in a neutral policy environment.

In a study of employment growth in seven countries adopting export-led strategy,5 it was found that Barbados, Jamaica, and Trinidad and Tobago had little employment growth induced by the growth of their export. On the other hand, the newly industrializing economies, which had maintained a tight wage policy, had substantial export-led employment growth, and hence, had been able to utilize the “unlimited” supply of labor in the growth process.

As countries adopt industrialization as a means to promote growth and development, the importance of their agricultural sector tends to be overlooked. The treatment applied to agriculture in many developing countries is a paradox: while advanced countries subsidize and protect their agricultural sector, other developing countries not only tax the sector but also subject it to low prices. Where agriculture accounts for a large share of the overall production, there is a positive relationship between economic growth and agricultural growth. Thus, it is unlikely that sustained economic growth can be achieved without expansion in the agricultural sector.

Development based on agriculture could benefit not only from growth in itself but also from increased employment that agriculture would generate and from the income redistribution that would result. Moreover, the agricultural sector could provide input to the manufacturing sector while demanding in return input for its own production. Of equal importance, the sector as a whole constitutes a household demand for industrial consumer goods and services, upon which the manufacturing sector could flourish. Also, in view of a much lower import content of agricultural production compared with manufacturing production, scarce foreign exchange can be conserved with development based on agriculture. And as noted, agricultural growth with its intersectoral linkage with the rest of the economy could generate broad-based and self-sustained economic development.

While it is true that agricultural exports are subjected to developed country protectionism, manufacturing exports, as seen earlier, are also dependent on the international business cycle. In view of the adverse external environment experienced in recent years, foreign trade in manufacturing goods alone cannot be reliably counted on as an engine of growth. Thus, diversified exports that include agricultural goods could ensure better export performance and sustained growth in trade.

CONCLUDING REMARKS

Country experiences have indicated that successful structural transformation has been associated with the adoption of export-oriented industrialization. It is, however, dangerous to generalize that an outward-looking strategy is the one that should be adopted by developing countries. This is because the world economy may not be able to support the increased volume of trade. The entry to the world market may not be as easy as experienced by such countries as the newly industrializing economies. Not only is total demand likely to grow slowly, but stiff competition among countries will make market penetration more difficult than before. Moreover, new protectionism through nontariff barriers in more developed countries has been increasing. This will make it increasingly difficult for countries to enter markets in developed countries.

Although export can still be regarded as an engine of growth, it may not be applicable to all at the same time. Thus, growth may partly have to be internally driven; the importance of internally generated growth should not be overlooked. As noted, in countries where agriculture has an overwhelming weight in the economy, growth may be sought by developing agricultural activities and agro-based industrialization. While export-oriented strategy involves a selection of potential industries and a specific set of industrial policy measures to help make winners out of those industries, the reliance on internally generated growth requires a broader industrial policy. This is what may be called the policy for general industrialization as against an export-oriented industrialization policy.

It should be noted that the export-oriented strategy, like the import substitution strategy, involves a high degree of government intervention, starting from the selection of industries, providing support, and guiding and directing their development. This is a big task for the government. The success of the stragety depends partly on how well the government can manage the complexity of industrial development. In the face of increasing competition in the world market and the need for broader industrialization, greater participation of private activities may be required. This calls for a market-oriented approach and greater reliance on private initiatives.

A successful adoption of an outward-looking strategy is associated with dismantling trade barriers, reducing price distortions, and stabilizing the macroeconomic environment. Thus, the role of the government in promoting growth and facilitating transformation should concentrate on setting up the stage as required in the adoption of export-oriented strategy and on maintaining sound and flexible macroeconomic policies.

SELECTED BIBLIOGRAPHY

    AhnChoong-Yong“Economic Development of South Korea, 1945–1985: Strategies and Performance,”paper presented at TDRI-KDI Joint Economic Seminar on Structural Adjustment and Trade Policy (Bangkok1987).

    BalassaBela“The New Industrializing Developing Countries After the Oil Crisis,”World Bank Staff Working Paper No. 437 (Washington: World BankOctober1980).

    BalassaBela“The Policy Experience of Twelve Less Developed Countries, 1973–1978,”World Bank Staff Working Paper No. 449 (Washington: World BankAugust1981).

    BalassaBelaand othersThe Balance of Payments Effects of External Shocks and of Policy Responses to these Shocks in Non-OPEC Developing Countries (Paris: OECD, Development Center Studies1981).

    ChandavarkarA.G.“The Informal Financial Sector in Developing Countries: Analysis, Evidence and Policy Implication”in Report on the Seminar on Unorganized Money Market in the SEACEN Countries (Malaysia1986).

    DervisKemal andP.A.Petri“The Macroeconomics of Successful Development: What are the Lessons?”Macroeconomics Annual (National Bureau of Economic Research1987).

    FieldsG.S.“Employment, Income Distribution and Economic Growth in Seven Small Open Economies,”Economic Journal (Oxford, England) Vol. 94 (March 1984) pp. 7483.

    JamesW.E.S.Naya andG.M.MeierAsian Development: Economic Success and Policy Lessons (Madison, Wisconsin: University of Wisconsin Press1987).

    KaplinskyRaphaeled.Third World Industrialization in the 1980s (Frank Cass1984).

    LeeJungsoo“Domestic Adjustment to External Shocks in Developing Asia,”Asian Development Bank Economic Staff Paper No. 39 (October1987).

    UathavikulPhaichitrD.Patmasiriwat andC.Kamheangpatiyooth“Economic Policy Management in Thailand: Response to Changes in the World Economy 1973-87”a paper presented at the 1987 TDRI Year-End Conference (Thailand Development Research Institute1987).

    WhangIn-Joung“Korea's Economic Management for Structural Adjustment in the 1980s.”paper presented at TDRI-KDI Joint Economic Seminar on Structural Adjustment and Trade Policy (Bangkok1987).

    World BankWorld Development Report (New York: Oxford University Pressvarious issues).

Participants, Panelists, and Observers*

  • MODERATOR

    • Royal Professor Ungku A. Aziz

    • Former Vice-Chancellor

    • University of Malaya

    • Selangor, Malaysia

  • PARTICIPANTS

  • International Monetary Fund

    • Azizali F. Mohammed

    • Director

    • External Relations Department

    • Richard Hemming

    • Adviser

    • Fiscal Affairs Department

    • Jorge Marquez-Ruarte

    • Adviser

    • Asian Department

    • Peter J. Quirk

    • Adviser

    • Western Hemisphere Department

  • Hong Kong

    • Philip Bowring

    • Editor

    • Far Eastern Economic Review

  • Indonesia

    • Suhadi Mangkusuwondo

    • Professor of Economics

    • University of Indonesia

  • Korea

    • Bongsung Oum

    • Fellow

    • Korea Development Institute

    • Noh-Choong Huh

    • Director

    • Securities Administration and Audit Division

    • Ministry of Finance

  • Malaysia

    • Mokhzani Abdul Rahim

    • Chief Executive

    • Innovest Berhad

    • Tan Tat Wai

    • Chief Executive

    • Southern Iron and Steel Works Sdn. Bhd.

    • Mohamed Ariff Abdul Kareem

    • Faculty of Economics and Administration

    • University of Malaya

    • Mohammed Munir Abdul Majid

    • Chief Executive/Executive Director

    • Commerce International Merchant Bankers Berhad

    • Noordin Sopiee

    • Director-General

    • Institute of Strategic and International Studies

    • G.M. Abayaratna

    • Assistant Director

    • The South-East Asian Central Banks (SEACEN) Research and Training Center

    • Fong Chan Onn

    • Faculty of Economics and Administration

    • University of Malaya

    • Suresh Narayanan

    • School of Social Studies

    • Universiti Sains Malaysia

    • Haji Mohammad Haji Alias

    • Faculty of Economics

    • Universiti Kebangsaan Malaysia

    • Nasaruddin Arshad

    • Associate Professor

    • Dean

    • School of Economics and Public Administration

    • Universiti Utara Malaysia

    • Yee Mee Fah

    • Business Editor

    • New Straits Times

    • Hardev Kaur

    • Associate Editor

    • Business Times

    • S. Jayasankaran

    • Staff Writer

    • Malaysian Business

    • Martin Khor Kok Peng

    • Research Director

    • Consumers' Association of Penang

    • Clifford F. Herbert

    • Secretary

    • Economics Division

    • Ministry of Finance

    • V.N. Gnanathurai

    • Principal Assistant Director

    • Macroeconomics Section

    • Economic Planning Unit

    • Mohd. Yusof Ismail

    • Deputy Director

    • Industrial Master Plan

    • Ministry of Trade and Industry

    • Ahmad Zaini Muhamad

    • Undersecretary

    • International Relations and Minerals Division

    • Ministry of Primary Industries

    • Jaafar Ahmad

    • Adviser

    • Economics Department

    • Bank Negara Malaysia

    • Awang Adek Hussin

    • Senior Assistant Manager

    • Economics Department

    • Bank Negara Malaysia

  • Philippines

    • Bernardo M. Villegas

    • Senior Vice-President

    • Center for Research and Communication

  • Singapore

    • Mukul Asher

    • Associate Professor

    • Department of Economics and Statistics

    • National University of Singapore

    • V.V.I. Bhanogi Rao

    • Department of Economics and Statistics

    • National University of Singapore

  • Thailand

    • Gosah Arya

    • Program Director

    • Thailand Development Research Institute Foundation

    • Tanya Sirivedhin

    • Deputy Director

    • Department of Economic Research

    • Bank of Thailand

  • PANELISTS

    • Il Sakong (Chairman)

    • Former Minister of Finance

    • Korea

    • Lin See Yan

    • Deputy Governor

    • Bank Negara Malaysia

    • Azizali F. Mohammed

    • Director

    • External Relations Department

    • International Monetary Fund

    • Ungku A. Aziz

    • Former Vice-Chancellor

    • University of Malaya

    • Teh Kok Peng

    • Deputy Managing Director

    • Monetary Authority of Singapore

    • Vijit Supinit

    • Assistant Governor

    • Bank of Thailand

  • OBSERVERS

  • Malaysia

    • Steven Wong

    • Senior Analyst

    • Institute of Strategic and International Studies

    • Tan Bok Huat

    • Analyst

    • Institute of Strategic and International Studies

    • Lim Kok Cheong

    • Associate Professor

    • Faculty of Economics and Administration

    • University of Malaya

    • Nik Mustapha Haji Nik Hassan

    • Associate Professor

    • Dean

    • Faculty of Economics

    • International Islamic University

    • Chan Kwan Hoi

    • Executive Editor

    • Economic Service

    • Pertubuhan Berita Nasional Malaysia

    • (Malaysian National News Agency)

    • P.Y. Chin

    • Business Editor

    • The Star

    • Ismail Md. Salleh

    • Associate Professor

    • Faculty of Economics

    • Universiti Kebangsaan Malaysia

    • Chamil Wariya

    • Editorial Writer

    • Utusan Malaysia

    • Yong Ming Wan

    • Business Reporter

    • Nanyang Siang Pau

    • Tumnong Dasri

    • Research Economist

    • The South-East Asian Central Banks (SEACEN) Research and Training Center

    • Chan Lai Har

    • Principal Assistant Secretary

    • Economics Division

    • Ministry of Finance

    • Samsudin Hitam

    • Director

    • Macro Division

    • Economic Planning Unit

    • Zahid Zakaria

    • Principal Assistant Director

    • Ministry of Trade and Industry

    • Rosli Haji Mohamed

    • Assistant Secretary

    • International Relations and Minerals Division

    • Ministry of Primary Industries

    • Liliana Fidel Hamilton

    • Former Assistant Editor—IMF Survey

    • Embassy of Spain

  • Bank Negara Malaysia

    • Kwan Kwong Seong

    • Deputy Manager

    • Economics Department

    • Tan Wai Kuen

    • Deputy Manager

    • Economics Department

    • Tan Sook Peng

    • Deputy Manager

    • Economics Department

    • Latifah Merican

    • Deputy Manager

    • Economics Department

    • Fatimah Wati Mohammad

    • Assistant Manager

    • Economics Department

The author acknowledges the assistance of Chotechuang Teerakajornchote in data gathering and Chanpen Lawsiripaiboon for secretarial help.

The simple correlation between average export and income growth is 0.92.

The rate of structural transformation is taken to be the ratio of percentage change in the share of nonagricultural value added in GDP and the growth of GDP. The correlation of the average rate of transformation over the period 1971–87 and the average rate of growth of export over the same period among the economies under analysis is 0.7025.

Fields (1984), pp. 74–83.

The titles and affiliations listed for participants are those they had at the time of the seminar (June 28–July 1, 1989).

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