○ 인사말씀 : 비교경제학회 회장 강정모 교수(경희대)

일시 : 2003년 8월 29일

장소 : 전경련회관 제1회의실

프 로 그 램

제1부 (13:30 ­ 14:20) : Opening Session

○ 인사말씀 : 비교경제학회 회장 강정모 교수(경희대)

○ 환 영 사 : 한국경제연구원 좌승희 원장

○ 기조연설 : 권진균 교수 (Northern Illinois University)

제2부 (14:20 ­ 15:40) : (좌장 - 정갑영 교수, 연세대)

○ 1주제 : Issues in Japanese Corporate Governance

발 표 : Peter Drysdale (Australian National University) 토 론 : 박상수 교수(경희대)

○ 2주제 : 중국의 기업지배구조 발 표 : 홍인기 고문(증권연구원) 토 론 : 한동훈 교수(카톨릭대)

휴식 및 Coffee Break (15:40 ­ 16:00)

제3부 (16:00 ­ 17:20) : (좌장 - 박광작 교수, 성균관대)

○ 1주제 : 북한의 기업지배구조

발 표 : 이석기 연구위원(산업연구원) 토 론 : 양문수 교수(경남대)

○ 2주제 : 한중일 기업의 소유구조와 기술적 효율성

발 표 : 박승록 선임연구위원(한국경제연구원)

토 론 : 김용열 박사(산업연구원)

CONFERENCE PROGRAM

I. OPENING SESSION (13:30 – 14:20)

○ Opening Address: Professor Jung Mo Kang

President, Korea Association for Comparative Economics (KACE)

○ Welcome Remarks: Dr. Sung Hee Jwa

President, Korea Economic Research Institute (KERI)

○ Keynote Address: Professor Jene Kwon (Northern Illinois University) East Asian Economic Development Model: Restatement

II. SESSION I (14:20 – 15:40)

Session Chair: Professor Kab Young Jeong (Yonsei Universiy)

○ Professor Peter Drysdale (Australian National University) Issues in Japanese Corporate Governance

Discussion: Professor Sang Soo Park (Kyunghee University)

○ Mr. In Ki Hong (Advisor, Korea Securities Research Institute) Corporate Governance of China

Discussion: Professor Dong Hoon Hahn (Catholic University) COFFEE BREAK (15:40 – 16:00)

III. SESSION II (16:00 – 17:20)

Session Chair: Professor Kwang Jack Park (Sungkyunkwan University)

○ Dr. Seog Ki Lee (Korea Institute for International Economics and Trade) Corporate Governance of North Korea

Discussion: Professor Moon Soo Yang (Kyungnam University)

○ Dr. Seung Rok Park (Korea Economic Research Institute)

Ownership Concentration and Corporate Performance in the Northeast Asian Countries

Discussion: Dr. Yong Yul Kim (Korea Institute for International Economics and Trade)

【 목 차 】

◈ 인사말씀

◈ 환 영 사

◈ 기조연설

East Asian Economic Development Model: Restatement

◈ 주제발표

1. Issues in Japanese Corporate Governance

2. 중국의 기업지배구조

3. 북한의 1990년대 경제위기와 기업지배구조의 변화

4. Ownership Concentration and Corporate Performance

인 사 말 씀

안녕하십니까? 바쁘신데도 불구하고 한국비교경제학회와 한국경제연구원이 공동으로 주최하는 국제학술대회에 참석하여 주신 귀빈들께 진심으로 감사 드립니다. 특히 학술대회에서 논문을 발표하기 위하여 외국에서 오신 권진균 교수님과 Peter Drysdale교수께 감사하게 생각합니다. 아울러 논문을 발표하 시는 홍인기고문님, 이석기연구위원님 및 박승록선임연구위원께도 감사드립 니다. 또한 사회와 토론 요청을 흔쾌히 받아 주신 선생님들께 고마운 말씀드 립니다. 그리고 학술회의를 지원하여 주신 한국경제연구원, 아시아기금 및 학술진흥재단에 깊은 감사를 드립니다.

최근 우리나라 뿐 아니라 선진국, 개발도상국 및 신생국에서도 기업지배구조 에 대한 관심이 커지고 있습니다. 특히 1997년 금융위기 이후 아시아의 전통 적 기업들은 현대적인 기업관행과 잘 맞지 않는다는 지적이 많아 동아시아 국가들은 기업의 지배구조를 개혁하기 위하여 노력하고 있습니다. 이는 기업 의 지배구조가 한 국가경제의 주요한 제도적 장치로서 경제질서의 중요한 축을 구성할 뿐만 아니라 경제운용의 투명성, 공정성 및 경쟁의 촉진 등 시 장경제를 발전시키고 확산시키는 데 중요한 역할을 하기 때문이다. 특히 동 북아시아의 여러 국가는 경제체제와 그 운용의 다양성이 크므로 기업의 지 배구조가 어떻게 다른가를 비교연구하는 것이 시의적절하고 큰 의의가 있다 고 할 수 있습니다.

한국은 IMF 체제하에서 감사위원회, 사외이사제의 도입, 소액주주권의 강화, 결합재무제표의 도입 의무화 등 기업지배구조를 개선하였으나 개선의 여지 가 있고, 기업경영진에 대한 감독이 효율적이지 못하다는 비판을 받고 있습 니다. 금년 3월의 SK글로벌의 대형 회계부정사태는 한국의 기업지배구조가 여전히 취약함을 보여주는 사례라고 할 수 있습니다.

현 정부는 증권집단소송제의 조기도입, 금융회사 계열분리청구제의 추진, 상 속 및 증여세법의 완전포괄주의 규정 신설 등을 한국의 기업지배구조의 핵

심과제로 제시하였습니다. 기업의 지배구조를 개선하는 것은 경제의 경쟁력 을 높이고 나아가 경제발전의 잠재력을 확대시키는데 중요합니다.

한국비교경제학회에서는 기업의 지배구조가 경제체제와 어떻게 연계되고 또 한 유사한 경제체제 내에서도 상이한 모습을 보이는 경제질서와 어떻게 연 계되는지를 살펴봄으로써 경제체제와 경제제도의 운용에 대한 이해를 넓히 는 데 기여할 수 있다고 판단하여 제12차 학술대회의 주제를 『경제체제와 지배구조』로 하였습니다. 동북아시아의 한국, 북한, 일본, 중국의 경제는 20 세기에 서로 상이한 경제체제 하에서 운영되어 왔으며, 동일한 경제체제내에 서도 그 속성이 서로 다른 모습을 보여 왔습니다. 일본경제의 쇠락과 중국경 제의 부흥, 한국 경제의 도전 그리고 북한경제의 개혁 등 다양한 최근 동향 을 기업지배구조의 상이함과 특성 속에서 살펴보고 앞으로 이들 국가에서의 경제질서의 운용과 성과를 전망하고자 하는 것은 아주 중요하며 한국경제가 선진단계로 발전하는데 기여할 수 있을 것으로 생각합니다.

특히 한국이 1인당 국민소득 20,000달러 시대에 진입하기 위해서는 기업의 역할이 무엇보다 중요하나 최근의 여론조사에 의하면 한국 국민들의 기업가 들에 대한 부정적 이미지가 위험한 수준까지 간 것은 아주 걱정스러운 일이 라 할 수 있습니다. 따라서 한국기업들이 한국민의 정서와 문화에 부합하는 건전하고 효율적인 지배구조를 정립하고 발전시키는 것이 시급하다고 할 수 있읍니다. 아무쪼록 이번의 학술대회가 한국의 기업지배구조를 개선하여 발 전시키는데 기여할 수 있기를 바랍니다.

다시 한 번 학술회의를 지원하고 후원하여 주신 기관과 학술회의의 발표자, 사회자 및 토론자들께 학회를 대표하여 깊은 감사를 드립니다.

2003년 8월 29일

한국비교경제학회 회장 강 정 모

Opening Remarks

Jung M o Kang

President, The Korea Association for Comparative Economics Professor of Kyung Hee University

Professor Jene Kyun Kwon, Professor Peter Drysdale, President Sung Hee Jwa, distinguished scholars, ladies and gentlemen.

It is my great honor and pleasure to greet you all who participate in International Conference on Economic System and Corporate Governance organized by the Korea Association for Comparative Economics (KACE) and the Korea Economic Research Institute (KERI). I wish to express my sincere gratitude to the Korea Research Foundation, The Asia Research Fund and the Korea Economic Research Institute (KERI) for their thoughtful support in preparing for this conference. Also, I would like to express my deep appreciation to the presenters of the papers, the session chairs and the commentators. Especially, I would like to make a special note of the presence of both Professor Jene Kyun Kwon, a keynote speaker from the U.S., Professor Peter Drysdale from Australia, Professor Kab Young Jeong, Dirctor of the Asia Research Fund and M r. In Ki Hong, the advisor of the Korea Securities Research Institute.

The rapid rehabilitation of the Korean economy to its pre-crisis level was largely attributable to the active reform policies carried out by in both the financial and

corporate sectors. The structural reforms, especially, corporate restructuring, contributed a lot to facilitate the rapid recovery.

In order to solve the inherent problems of the corporate governance and ownership structure, which would result in inefficiency and low firm valuation, policy measures were applied to deal with the reforms of four major areas such as improving transparency of corporate management, strengthening the responsibility of the controlling shareholders and management, strengthening the rights of minority shareholders, and improving intra-group relations.

In spite of restructuring efforts, corporate sector still remains highly leveraged by international standards and continues to suffer from low profitability. Although there have been considerable improvements in corporate governance, some areas such as disclosure, outside directors and minority shareholders’ rights need to improve further.

Thus, to ensure sustainable development of Korean economy, corporate restructuring must be continuously pursued.

This Conference, I hope, will contribute to considerably improving the system of corporate governance, which is very important for sustainable economic development.

Thank you.

환 영 사

안녕하십니까? 이제 새 학기를 앞두고 여러 가지로 바쁘실텐데 한국비교경 제학회와 저희 한국경제연구원이 공동으로 주최하는 국제학술대회에 참석하 신 여러분을 환영하는 바입니다. 이번 학술대회를 위해서 멀리서 오신 미국 Northern Illinois 대학의 권진균 교수님과 호주 ANU의 Peter Drysdale 교수 님을 특히 환영합니다. 뿐만 아니라 오늘 귀한 논문을 발표해 주시는 존경하 는 홍인기 전 증권거래소 이사장님, 산업연구원의 이석기 박사님, 본 연구원 의 박승록 박사에게도 감사의 말씀을 드립니다. 아울러 토론과 좌장을 맡으 시게 된 여러 분들의 수고에 감사드립니다.

어느 나라나 고유한 문화적 전통과 법적 장치 그리고 특별한 제도적 환경이 있습니다. 경제를 운용하는 방식, 경제생활을 주도하는 사람들의 사고방식 등도 다 다릅니다. 기업지배구조도 궁극적으로는 이러한 경제적 특성들을 반 영하여 내생적으로 진화하기 마련입니다. 그래서 이러한 원리를 무시한 채 획일적으로 특정 기업지배구조를 원용하거나 각 경제의 특성을 무시한 채 이른바 글로벌 스탠더드를 획일적으로 적용하는 것은 오히려 많은 부작용을 가져 올 수 있다고 생각합니다.

겉으로는 동일한 경제체제를 채택하고 있는 경우에도 이러한 문화적, 제도적 특성의 차이가 큰 영향을 미치고 있는 것 같습니다. 특히 과거 사회주의 경 제의 한 축이었던 중국과 북한은 현재 전혀 다른 모습의 경제운용과 기업 혹은 국가지배구조의 모습을 보이고 있는 것으로 보여집니다. 과거 우리가 많이 배워왔던 일본식 경제모형과 기업지배구조도 최근 일본 경제의 침체와 함께 많은 비판이 제기되는 것이 사실입니다. 우리나라는 외환위기 이후에 직접금융의 비중이 커지고 소액주주의 기능이 강화되면서 기업의 지배구조 도 보다 투명해지고 있으며 특히 정부의 글로벌스탠더드 도입 규제로 기업 지배구조의 글로벌화가 크게 진전되고 있습니다. 그러나 일각에서는 우리나 라 경제의 고유한 특성을 무시한 채 글로벌 스탠더드를 무리하게 도입하고 있다는 비판의 목소리도 있고, 또한 우리나라에만 유독 적용되는 지배구조와

관련된 기업규제도 많은 것이 사실입니다.

이처럼 기업지배구조에 대한 관심이 높은 시점에서 동북아 여러 국가의 기 업지배구조를 비교해보고 살펴보는 이번의 공동학술대회는 큰 의의가 있다 고 생각됩니다. 서로 유사한 것 같으면서도 경제체제와 기업문화 그리고 자 본주의 시장경제의 성숙도가 상이한 우리나라, 중국, 일본 그리고 북한을 비 교해 보는 것은 밖으로는 동북아시대를 새롭게 조망해 보고 안으로는 우리 나라의 바람직한 기업지배구조를 모색해 보는 좋은 거울이 될 것으로 생각 됩니다.

아무쪼록 이 자리가 왕성한 토론과 의견교환을 통하여 동북아의 상이한 경 제체제하에서 나타나는 여러 국가의 기업지배구조에 대한 관심과 이해를 증 진시킬 수 있는 기회가 되기를 기대합니다.

감사합니다.

2003년 8월 29일

한국경제연구원 원장 좌 승 희

The East Asian Model: Restatement

Jene K. Kwon

(Northern Illinois University)

I. Introduction

In the aftermath of the economic crises in the East Asian economies and the prolonged stagnation of the Japanese economy, a melancholy afterglow is hanging over the region, despite its extraordinary achievement. For the skeptics of the EA version of economic development, recent economic set backs can be viewed as a vindication of their skepticism. Especially for advocates of the orthodox theory, the 1997-98 crisis and prolonged stagnation of the Japanese economy are another example of government failure. However, it is premature to write off the EA phenomenon merely as another forgettable episode in the long history of vicissitude of economic fortunes. We need to be reminded that with every economy the path of growth has been punctuated by fluctuations in income and employment – the fluctuations ranging from mild to catastrophic.

I believe that in spite of recent demythification of the EA “miracle,” the meteoric rise of EA economies deserves further investigation. The EA growth experience provides a fascinating case study of what makes a backward and stagnant economy suddenly start to grow rapidly and reach the status of an industrial economy within 30 years.

Per capita product of EA (Japan, Korea, Taiwan, and Singapore in particular) grew at the average rate of 5.7% during the twenty-three year period between 1962 and 1985.

The growth rate of the West during 160 year period (1820-1980) that comprised the Industrial Revolution (Madison, 1982) was only 1.6%.

The growth path that EA economies have traveled is remarkable; no one had ever predicted the possibility of remarkable economic development of non-European culture. Rather, mainstream western economists shared a pessimistic view. For example, Kuznets (1973), among others, noted that “(e)mergence of a modern framework for economic growth may be especially difficult if it involves elements peculiar to European civilization for which substitutes are not easily found.” (p.254).

East Asia’s rapid growth is especially striking in that it occurred at the time when roughly 70% of all developing economies grew more slowly than the average high income economies (The World Bank Report, 1993). Clearly, the growth path of the EA economies – its process and speed – is in stark contrast to that of the Western Industrial Revolution.

In many ways it would be more appropriate to designate the rapid rise of the EA economies as Industrial Revolution and re-label the Western Industrial Revolution as

“Industrial Evolution.” Beyond the rapid growth of the East vs. the gradualism in the West, two additional fundamental differences are worth noting. The first relates to innovation in the West versus imitative technology in the East as the engine of growth, and the second relates to unfettered market in the West compared to the market that is fettered in one sense but largely guided and enhanced by effective government policies.

A fundamental question is this. Can a backward economy follow a growth path somewhat different from the traditional path traveled by the West, and generate sustained economic growth successfully? The answer is “yes.” This paper addresses this question. It puts forth a set of propositions: among all the factor endowments, it is human capital, augmented by effective industrial policy that primarily determines the direction of trade and product specialization.

The EA model presented in this paper is a synthesis and restatement of a set of economic theories and hypotheses advanced by Schultz (1962: a, and b), Wade (1990), Amsden (1989), Krugman ((1979,1983, 1984), Shinohara (1982), Stiglitz (1988), Dixit and Stiglitz (1977), Akamatsu (1961), Vernon (1970), Kuznets (1971), Romer (1986, 1994), and 1990), Lucas (1988), Rebelo (1991), and the World Bank (1993), that have evolved to explain the economic development of EA nations (especially Japan, South Korea, Taiwan, Hong Kong and Singapore), and provides more logical account of EA growth. Much of recent theorizing of economic development builds on the pioneering works of Rosenstein-Rodan (1943), Mandelbaum (1945), Singer (1952) and Nurkse (1953), Lewis (1954), Hirschman (1958), Rostow (1960), among others.

The different outcomes of EA and neoclassical models is as profound as the outcomes of Keynesian and neoclassical models. In the EA model, the role of government goes well beyond Keynesian macroeconomic policy. I claim that “policy-augmented human capital” separates the EA model from the neoclassical and Keynesian models respectively.

II. The Model

The EA model is intended as a transitional model that explains economic transition from a backward economy to an industrial economy with particular emphasis on the underpinnings of the initial stage of the transition. I offer five propositions that provide theoretical underpinnings of the economic development of the EA economies.

Proposition 1. Human capital determines the nature and direction of product specialization and trade, and the speed of economic growth. Consider a world where physical capital moves almost freely. In this setting, a country’s specialization in production is limited neither by its initial endowment of physical factor nor the size of domestic markets, but by the level (the quality and quantity) of human capital – abilities to recognize and to seize economic opportunities, to absorb technology, to adapt to new technology, to formulate industrial policy, and so forth – elements that are embodied in entrepreneurs, worker/managers and policy makers.

More specific to EA model is the concept of policy-augmented human capital. That is human capital with a road map for economic development consisting of the direction for trade and product specialization as well as economic incentives for entrepreneurial risk taking. As such the EA model treats the ability to formulate and execute appropriate development strategies as a component of human capital. Another salient feature is that while the model recognizes the accumulation of physical capital as an important source of growth it puts more emphasis on the human capital that operates behind the investment in physical capital--assimilation and learning by doing that underlay assimilation, entrepreneurship, and innovation, all encouraged by the policy regime as stressed by Nelson and Pack (1999), Pack and Westphal (1968), Rodrik (1995), Stiglitz (1996), and Westphal et al (1985).

At the dawn of industrialization, EA economies had little in terms of physical capital or natural resources, but had a significant head start in human capital relative to other less developed economies (LDCs). It is this initial advantage in human capital endowment, despite initial lack of natural resources, the scarcity of physical capital, and the limited size of the domestic market, that helped them achieving rapid growth.

Perhaps, one may suggest that Proposition 1 is no more than Hecksher-Ohlin-Vanek’s

(HOV) factor endowment theory of comparative advantage in which human capital is one of several factors, but, strictly speaking, policy-augmented human capital does not neatly fit into HOV model because the role of government violates neoclassical assumptions.

Proposition 2. (a) The national wealth is determined by the size of the portfolio of diverse productive industries, the size and composition of which is a function of the level of human capital. Unlike the static version of Hechsher-Ohlin’s (1919, 1933) trade dichotomy (namely, specialization in either labor intensive product or capital intensive product based on the initial endowment of labor and physical capital), the diversification of the portfolio, i.e., investment in a number of dissimilar industries ranging from labor intensive (low value added) to capital/skill intensive (high value added) industries, is based on a risk aversion and expected return maximization strategy. The perennial concern over deteriorating terms of trade of primary products in LDCs is a prime example of the lack of diversification on the part of backward economy.

(b) There is a natural tendency for LDCs to diversify toward capital/knowledge intensive industries. First, this is because higher level of human capital enables a country to use more capital/knowledge intensive technology; second, capital/knowledge intensive technology offers: a higher value added while absorbing surplus labor (in the initial stage of transition); and given a Lewisian (1954) low wage rate, the lower private cost of production, scale economies, and externalities, all serving as a potential source of benefits. Bliss (1987) notes that rates of return on capital in LDCs are not very different from the returns in advanced countries, while real wages are markedly lower in the former.

Proposition 3. (a) Over time, changing size and composition of a country’s portfolio of productive industries are not entirely spontaneous but an intended outcome of industrial policy. Through industrial policy a country can strategically restructure its comparative advantage by altering the composition of industry to accelerate economic growth. The basic premise underlying industrial policy is that an economy has a better chance of breaking away from the vicious circle of poverty if it has some sort of road map (plan and direction) for development and if the road map involves a range of

cooperative endeavors between business and government – i.e., pooling human resources and coordinating large number of economic activities (Aoki, 1996 and Matsuyama, 1996) private and public – to achieve a common goal of accelerating economic growth.

(b) At a certain threshold level of human capital, a country can accelerate industrialization through industrial policy, by initiating a “virtually” parallel (or simultaneous) development of both labor and capital intensive industries. It is noteworthy to recall the case of Japan during both Meiji and post-WWII periods, Germany in mid-19^th century and beyond, and South Korea, Taiwan, Singapore, Hong Kong in 1960s and 1970s.

Proposition 4. A prosperous economy has a better chance of achieving democracy than the democracy leading to economic prosperity.

Proposition 5. High human capital is not a sufficient condition for successful industrial policy. In countries with a high level of human capital, inappropriate industrial policy, political instability and social conflict among competing groups are the major factors retarding economic progress.

Given these propositions should a country finds itself stuck in a labor intensive mode of production over time, this is not necessarily due to the relative abundance of its labor supply (hence low wages), but because, given the level of human capital, labor intensive technology is all it is able to “muster.” Indeed, if a country is unable to develop capital/skill intensive industry, it is not necessarily due to a lack of physical capital, since capital can be imported and technology can be borrowed, but it may be because the existing level of human capital is not up to the task of capital intensive technology. This may explain why some early attempts at developing capital intensive (or heavy) industries have failed. Either the ambitious industrial policy by the government, was not in step with the existing level of human capital or the level of human capital was inadequate, or a combination of both.

III. Human Capital

Schultz (1962: a, and b) was one of the first to pioneer the concept and importance of human capital. If unsuccessful attempts for rapid accumulation of physical capital suggests the necessity for due attention to human capital, the success of EA economies present itself as a prime example of the importance of human capital.

Lately, human capital, accumulated through education and learning-by-doing, has received more attention in the growth model as developed by Romer (1986, 1990, 1994), Lucas (1988), and Rebelo (1991) among others. The key property of the endogenous-growth models is the absence of diminishing returns to broadly defined capital including human capital. Knowledge spillovers across producers and external benefits from human capital are central to this process that help avoid the tendency for diminishing returns to the accumulation of capital. For the society as a whole the speed and scope of the diffusion of technology is a function of human capital; the cost of diffusion of technology will be lower the higher the level of human capital in the borrower country. Yet these spillovers constitute a form of externality that does not lead to Pareto optimal. Hence, endogenous growth model based on these assumptions have possible policy implications, i.e., the necessity for an industrial policy.

The most commonly used measure of human capital is the rate of enrollment in primary and secondary school. As mentioned in the World Bank Reports: The East Asian Miracle (1993), the EA economies had a head start in human capital. This initial comparative advantage in human capital stock along with the rapid growth of human capital that followed played a key role in the dramatic transition of EA economies. The Figures 1.1 and 1.2 reveal that, in 1965, the early period of economic transition, both primary and secondary enrollment rate for Hong Kong, Korea, Taiwan, and Singapore were markedly higher than predicted for their level of income. The growth rate of education in the ensuing decades following the benchmark year (1965) was no less spectacular. Moreover, as Birdsall and Sabor (1993b) show, the expenditures per pupil, used as a proxy measure of educational quality for Korea rose by 355 percent between the1970 and 1989 period as compared with 64 percent for Mexico, 38 for Kenya, 13 for Pakistan during the same period.

(Figure 1.1 and Figure 1.2)

These dramatic differences in educational standard between the EA and other developing economies seem largely responsible for the difference in income between the East Asia and other developing economies. Unfortunately, any attempt to quantify human capital becomes an elusive exercise given the complex conglomeration of knowledge, ability, and desire that the term connotes. Perhaps, these complications

explain the difficulty of isolating the role of human capital in endogenous growth model (for example, estimating a constant or increasing return production function).

And the inherent simultaneity bias between human capital and physical capital compounds the problem.

IV. Forward Looking Restructuring of Comparative Advantage

It is rather safe to assume that, in the absence of political chaos or natural disaster, opportunity for economic growth is there to be exploited. Especially, in the context of an open economy, economic opportunities are not as exogenous as they are endogenous, depending largely upon the level of human capital in the system.

However, even if the opportunity is recognized, entrepreneurs will not exploit the opportunity if the incentive is lacking. That is, if the benefits from the endeavor are too small or too uncertain compared with risks. A key ingredient of industrial policy is to provide a correct set of economic incentives.

The basic premise of the forward looking strategy is to restructure industries in such a way as to capitalize on the initial endowment as well as the rapid growth of human capital and to promote industries that “showed future potentials of achieving comparative advantage.” (Shinohara, 1982).

The first and most logical step toward industrialization has been that of identifying an industry (or a group of industries) for import substitution (IS) of primary goods requiring labor intensive technology. The selection criteria (i.e., picking the winners) consists of (a) domestic demand for the goods to be produced by the new plant, (b) the feasibility of technology transfer, (c) adaptability to new technology, (d) absorption of surplus labor, (e) scale economies and potential for spillover effect, and so on. Linder argued in 1961 that in the world of imperfect knowledge a country will first produce goods for which there is a strong domestic demand. Nearly a Century before Linnder’s, Meiji Japan had already put this idea into practice.

In practice, once the industry is identified for IS, industrial policy calls for government subsidies for the targeted industry and protection for new (infant)

industry through import restrictions, e.g., tariffs and quotas. The policy also entails coordination by the government of various economic activities. As the new industry continues to grow, the primary IS regime switches to an export promotion (EP) regime since IS opportunities may evaporate due to the limited size of the domestic market, and also due to the increased demand for foreign exchange to finance further industrialization. Under EP regime, government provides various forms of subsidies to promote exports. The primary goods IS/EP is then followed by the secondary goods IS/EP strategy involving the production of more capital/skill intensive goods (i.e., steel mills, large shipyards, and petrochemical plants) which, through various linkages, will generate rapid development of the entire economy. For EA economies with limited size of domestic markets, the exploitation of scale economies necessitated the development of an export market. Otherwise, capital-intensive technology accompanied by scale economies would have caused a serious unemployment problem. This process of changing structure is not only consistent with catching up product cycle hypothesis put forth by Akamatsu (1961) and Vernon (1964) but also with the strategic restructuring of comparative advantage (Krugman, 1979, Dixit and Norman, 1980, Lancster, 1980, Shinohara, 1982, Helpman and Krugman, 1985, Spencer, 1987 among others), where government and firms are seen as being engaged in a strategic game to gain profits in world markets. But, in broader sense, it is the process of portfolio diversification of industries as well as diversification of firms within the industry to minimize risks while maximizing expected returns.

Skeptics of industrial policy have questioned the ability of government to “pick winners.” From a long term perspective, the EA governments have been quite successful in picking the winners. The government was able to work with business through policy coordination. Even if entrepreneurs and policy makers may have had different objective functions, they were able to work together smoothly. This is the case of “incentive compatible” in the “principle-agent” literature. It is possible to assume government as the principal whose objective is to maximize its country’s growth by using a set of policy instruments, and entrepreneurs as the agents who respond to government policy in order to maximize their profits. This is one of many ways of formulating business-government relationships in the EA economies. It is also possible to view government as an endogenous (not exogenous) element of the

system with the same informational and incentive constraints as other economic agents in the system. (Aoki, 1996).

Without exception, in a backward economy market failure is prevalent and pervasive.

However, market failure per se is not a sufficient condition for government intervention. It is the public goods generating capacity and capability (i.e., formulation of sound industrial policy and provision of economic infrastructure) of the government that justifies government intervention. As pointed out by Gerschenkron the economic role of government is proportional to the degree of backwardness of the economy because the degree of popular dependence on government is proportional to its economic backwardness: (Gerschenkron, 1962, p354). This is primarily because government has (a) access over more economic resources and more information internally as well as externally; (b) better macroeconomic overview of the economy because of its easy access to businesses and academics; (c) macroeconomic policy instruments at its disposal which enable it to allocate resources.

V. Free Market, Democracy, and Economic Development

Provided economic development and development of democracy do not occur concurrently, a nation has to make a choice. In a poverty-stricken economy, given the high time preference, consumers, if given the choice, (although much of the time they have no choice) are likely to choose the relief from hunger over democracy. Naturally, the choice depends also on the degree of political oppression they are subjected to. In the meantime, history shows that democracy rarely blossoms in an environment of economic backwardness, and if it does it is usually short lived. In fact, evidence points to the precedence of economic development over the development of democracy. For example, the Meiji era, the early period of Japanese modernization, was a period of imperial rule. The political system of the rest of the EA countries had ranged from authoritarian to autocracy in the early state of development. Taking the argument one stop further, a cogent case can also be made that at least in the early stage of economic development, democracy may not necessarily be the most efficient form of governance. In EA, democracy was ushered in by economic success not vice versa.

If Western capitalism is identified with democracy, in the EA, imperfect democracy coexisted with its own brand of capitalism where markets were not only imperfect but also “thin” (whether for risks, capital, or products) or nonexistent. These along with other conditions, i.e., externalities, imperfect information, and increasing returns render the Fundamental Theorem of Welfare Economics inapplicable, especially in the early stage of development. (Stiglitz, 1988). The market failure is not limited to externalities (spillovers) and public goods, but also to the paucity of experienced entrepreneurs, lack of skilled workers, risk and uncertainties, and lack of economic incentives, and errant administrative policies. The market in which failure is pervasive is also ill-equipped for self-generation of the industrial process.

In the EA economies a rapid growth of capital stocks was accompanied by massive investment subsidies granted to business. The low-interest policy, for example in Korea, contributed to considerable degree of market distortions in favor of capital by reducing the rental price of capital drastically below the market price causing a 3.4 fold increase in the wage-rental ratio during 1969-75. (Kim and Romer, 1979).

Hong’s (1990) computation of Korea’s real interest rate in the 1960 and 1970s shows negative figures ----5.3% (1962-66), 5.7% (1967-71), -6.2% (1972-76) and -3.5%

(1977-79). But this is only one aspect of Korea’s incentive policy. The role of tax incentives in resource allocation is also well documented. (Kwack, 1988). In this sense Amsden (1989 and 1991) was quite correct in pointing out that government has intentionally “set the price wrong” in a static sense, but set the price “correct” in dynamic sense as a means of efficient allocation of resources. The obvious consequence of the factor market distortion would have been, from neoclassical stand point, a loss of allocative efficiency in a static sense – output falling inside the nondistorted ppc. In spite of the lofty position conferred upon allocative efficiency in neoclassical welfare theory, empirical evidence has, in general, failed to support the theory. Estimates by Kwon and Paik (1995) on the welfare cost of both labor and capital market distortions in Korea using a computable general equilibrium model produces a negligible effect of the distortions on economic efficiency. This concurs with the results for other countries.

One of the problems with the static welfare theory is that it ignores the dynamic effect of the rapid accumulation induced by the low rental price of capital—economies of

scale and technological change. An estimate by Kwon and Williams (1982) on seven subsectors of Korean manufacturing reveals substantial economies of scale. In addition, an estimate by Kwon (1986) shows that technology and scale economies have accounted for 44.6 and 8.1% of the total factor productivity, respectively, in Korean manufacturing (1961-80). Economies of scale and technological change are also interrelated. For example, economies of scale relate to increasing possibilities of division of and specialization of labor, and increasing possibilities represent a very important explanation of the increasing efficiency of larger plant size. In Korea with its limited domestic market, the exploitation of scale economies has necessitated the development of export markets. Otherwise, capital-intensive technology accompanied by scale economies would have caused a serious unemployment problem.

VI. Meiji Model as a Precursor to the EA Model

It was during Meiji period that Japan entered the phase of Kuznets’ “modern economic growth.” Ohkawa and Rosovsky (1965) note 1868-85 as the period of transition to modern economic growth. The phase of modern economic growth consists of four conditions: (a) the application of modern technology; (b) a sustained rapid increase in real product per capita; (c) a rapid transformation of the industrial structure; and (c) expanded international contacts (Kuznets 1959; lecture 1).

The origin of the EA model can be traced to Meiji, Japan (1862-1912). Although Meiji Japan borrowed technology and scientific knowledge from the West, the manner in which it initially conceived, organized and executed their development was largely unencumbered by any particular strain of Western (British and American in particular) economic thoughts. To a great extent the Meiji model is a prototype of the EA model. First, the role of government was an essential part of its growth process.

Unlike the Western mode of spontaneous economic development, in Meiji Japan, economic development was an integral part of nation building (Morishima, 1982).

The archaic structure of Tokugawa feudalism was supplanted by a strong, but outward looking, central government. It abolished the class system, allowed private ownership of land and freedom of movement and choice of career. It invested heavily to modernize economic infrastructure, introducing telegraph, postal services, and built

railroad. Government actively introduced foreign technology to a variety of industrial sectors including agriculture. An institutional framework was set for the establishment of various financial and educational institutions.

Compulsory education was introduced in 1879. (Ito, 1992), and compliance with the law was quite rapid. The primary school enrollment rate was 28.1 percent in 1873, and 41.1percent in 1880; by 1905 it reached 95.6 percent. (Yasuba and Dhiravegin, in Ohkawa and Ranis, 1985). The government made a concerted effort to learn Western ways and to adapt and develop it on an indigenous basis. (Lockwood, 1954). The group missions and individual students in large number were sent to the West to study science, administration, and the industrial arts. The government also hired hundreds of Western experts in almost every branch of technical skill. (Rockwood, 1954)

Second, the urgency to catch up with the West in the economic setting where experienced capitalist were scarce, forced the Meiji government, to assume, initially the role of industrialist by setting up and managing modern factories (e.g., textiles, ship-building, cement, steel, and glass), while promoting private investors. The government underwrote risks that would have been too costly for private investors.

Third, the government identified industries for import substitution, which could be viewed as an early example of “industry policy”. This helped promote quick import substitution to counter the widening external resource gap.

Early on, the government identified cotton textile as an industry for import substitution in view of increasing import demand for textile goods. Faced with lack of private capital and entrepreneurs, initially government took upon itself to import cotton-spinning plants and operated the “model factories.” New private firms learned a great deal from the government-run operations even though government factories failed to make a profit. Private firms imported plants powered by steam instead of water capturing economies of scale, and quickly adapted imported technology to their own needs by introducing night-shift. The two 12-hour shifts per day contributed to a more efficient utilization of resources, while absorbing surplus labor. The upsurge in imports was quickly followed by an increase in domestic production. The import substitution was soon followed by export promotion. By 1920, Japan surpassed the U.K. as the world’s leading exporter of cotton textiles. External

economies generated by the imported technology soon paved the way towards secondary goods import substitution, i.e., domestic production of spinning tools, machinery and dry stuffs, which ultimately led to export promotion of these products at later stage.

The fourth major element in the modernization of the Japanese economy is early Japanese militarism. Unlike the development of the cotton spinning industry, the military build up, by nature, was a secondary good import substitution from the beginning; but as in the case of textile, new technology was imported from the West.

This means that in Meiji, Japan, industrialization of light industry had occurred hand in hand with that of heavy industry.

Like the 19^th Century Germany, Meiji Japan saw a symbiosis in “rich nation” and a

“strong military.” Besides national defense, a strong army was essential for extraterritorial expansion and access to overseas markets. In a short period, a military- business nexus of a defense industry had emerged. Over the long run, the external economies from the technology imported for military build up served as a catalyst for subsequent development of steel, machinery, shipbuilding and chemical industries.

Fifth, Meiji policy of strategic restructuring of industries through import substitution and export promotion of textile and high tech military industries was a portent for the latter day model of IS/EP and strategic restructuring cum industrial policy. All in all the Meiji government succeeded in laying the political and socio-economics foundations for economics growth and creating economic incentives to which the private sector responded vigorously.

VII. Industrial Policy and Changing Pattern of the EA Economies: Post WWII Japan

Contrary to traditional (two inputs and two product) theory of comparative advantage, Japan followed a virtually parallel development in both labor intensive and capital intensive industry. If the parallelism was dictated by the military necessity during Meiji and post-Meiji period of extraterritorial expansion of Japan into Korea and

China, the parallelism after WWII was based on a pure economic rational. Whereas the pre WWII development in capital intensive industry was primarily that of import substitution of the military hardware, the post WWII development of the heavy industry was that of IS/EP strategy based on economic rational. But the rational was contrary to the theory of comparative advantage in a sense that policy makers put major emphasis on the development of capital intensive industries, (i.e., steel and petrochemicals) in spite of the fact that, at the time, the unit costs and product prices were substantially higher than those of the foreign competitors. (Shinohara, 1982).

What was MITI’s rational for pushing capital intensive industry at the time when Japan had comparative disadvantage in it? Shinohara points out that government not only pushed for it but also protected it because (a) the industry showed future potential for achieving an advantage, which, Shinohara labeled as “dynamized comparative advantage”; and (b) of the potential for externalities on related industries (i.e., automobile, machinery, plastics, synthetic rubber and synthetic fibers).

Japan made a quick advance in heavy industry. By the end of 1970s Japanese industries have, by and large, caught up with advanced economies both in the levels of production and in technology, thus fulfilling its ultimate goal of international competitiveness.

The question then is what made it possible for Japan to succeed in this seemingly questionable undertaking—the parallel development of both labor intensive and capital intensive industries-- when many others have failed? First of all, the post WWII period of rapid growth would have been less likely without the cumulative knowledge in business and technology acquired during the period spanning nearly a century starting with Meiji period. Through the experience culminating in the WWII preparation, as pointed out by Morishima (1987) the Japanese government, industrialist, and workers all learned how to work together, how to be flexible, how quickly to adapt to new technologies, to achieve industrialization.

In other words, it was the comparative advantage in human capital – superb entrepreneurial ability, forward looking government, and their ability to work together toward a common goal – that explains the rapid rise of the Japanese economy. The high level of human capital enabled Japanese to engage in the process of innovating

the “borrowed” technology to a higher level. The consensus-based industrial policy offered incentives to entrepreneurs who made the best of their human capital. Indeed, in Japan, industrial policy complemented comparative advantage without stifling the market system.

VIII. South Korea, Taiwan, Hong Kong and Singapore

The economic success of Japan, Korea, Taiwan, Hong Kong, and Singapore presents itself as the most powerful support of the importance of human capital. In the early 1960, the period of economic transition in East Asia, the prevailing theory was that of Hecksher-Ohlin’s narrowly focussing on two factors inputs, physical capital and labor, along with the notion that given the nature of increasing returns to scale technology, a smallness of domestic market may pose an impediment to an import substitution strategy. These prevailing views had failed to recognize the fact that it is the human capital, not the lack of initial endowment of physical capital, or the limited size of domestic market that ultimately determined the direction of production and trade and the speed of growth.

Given the high level of human capital, by the end of 1950s, the economic development was overdue for these countries.

In Korea and Taiwan, the improvement in human capital that had occurred during the Japanese colonial period (roughly half century up to 1945), and the adjustment periods (1945- 1950s) became a foundation of their subsequent development. The literacy rate in Korea in 1945 was 13.4%, compared with 21.3% in Taiwan by 1940.

Since then, most illiteracy has been eradicated in both countries, and today, Taiwan and Korea provide nine and six years, respectively, of free compulsory education. In fact, by the 1950s, the level of human resource development in both countries was comparable to that of countries with per capita GDPs two to three times those of Korea and Taiwan (Cole and Lyman, 1971 and Scitovsky, 1986).

On top of this, the comprehensive land reforms undertaken in Korea (1947 and 1949) and Taiwan (1949-1955) played an equally important role—that of eliminating the vested interest, the land-owing class, that may have resisted (or vetoed)

industrialization. Land reforms proved to be successful in (a) directing rural landlords into urban businesses and giving tenants and small farmers the opportunity to purchase property of their own, (b) giving former landlords and small farmers an incentive to use their financial and physical resources efficiently, while (c) improving the distribution of income. In a nutshell, the land reforms have succeeded in preempting class warfare that had stifled industrialization effort elsewhere.

What was lacking in the two economies until 1960 or thereabout was the direction – a road map either to jump start economic development (in Korea) or to sustain growth (in Taiwan). By the early1960s the road map started to emerge in the form of industrial policy. The development models adopted by Korea and Taiwan in the 1960s and 1970s were the hybrid of the Meiji model and post-war Japanese model. Their models shared elements of the Meiji model in that both countries were driven by the deepest fears about national security: the military threat from the north of the border for South Korea and from the mainland for Taiwan. Accordingly, economic development was almost inseparable from the national defense --providing one of several rationales for the development of defense related heavy industries. Like Japan they chose to industrialize through borrowed technology. As Meiji Japan, which felt the urgency to catch up with the West while lacking experienced capitalists, Korea and Taiwan faced the same predicament--the urgent need (or desire) to catch up with Japan but lacking in experienced entrepreneurs and physical capital. This forced government to assume the role of industrialist by constructing and managing modern industries, especially, in the early stage of their development.

As in Meiji Japan, at times, government investment exceeded private investment in Taiwan and Korea. Also the circumstances surrounding the emergence of Korea’s Jaebol (business conglomerates) and their cooperative relationship with the government were similar to the pre-WWII Japanese Zaibatsu. As such the industrialization was a cooperative venture between business and government.

One major difference between Japan and other EA economies, however, is the difference in the size of their domestic markets. These latecomers had to work harder to overcome the smallness of their domestic markets; so the export policy played a larger role than in Japan to exploit scale economies. With little of the domestic

experience that increasing returns technology/mass production technology requires, and with fewer opportunities to market-test their products domestically, producers in these economies absorbed higher risks of having to start up as competitors in the global market (Song, 1990). Without the policy directed incentive system, along with high quality of human capital and cheap labor this would not have been possible.

What were initial economic conditions in Korea and Taiwan at the time of their economic take off in and around 1960? Just before the economic take-off, Korea was among the lowest income countries, with a per capita GNP of $82 (in 1961 U.S.

dollars), as compared with $151 for Taiwan, and both countries depended on the US economic aid for their economic stability. In 196l the secondary sector (manufacturing, mining and construction) accounted for 17.0% of GNP in Korea and 23.5% in Taiwan. In 1961 exports accounted for 1-2% of Korea’s GNP as compared with 8.6 % for Taiwan in 1958 (Taiwan Statistical Data Book, 1987). As such the structural characteristics of Korea represented a modest advance while Taiwan’s represented a significant advance over the lowest-level countries’ characteristics enumerated by Kuznets (1956 and 1957).

In the early 1960s, for both countries, import substitution of primary goods had nearly run its course becoming less effective as a source of growth at an aggregate level due to the limited size of the domestic market. This forced the policy makers in both nations to revise their growth strategy. The desperate need to generate growth in a poverty stricken economy as in Korea and the necessity to maintain the favorable growth rate for Taiwan, led policy makers of both economies to reach basically similar policy conclusions independently. Korea and Taiwan adopted a strategy of export promotion (EP) of primary goods (non-durable consumer goods) in conjunction with a secondary phase of import substitution (IS) (i.e., the production of intermediate and capital goods), followed by export promotion (EP) of secondary goods.

Numerous measures went into effect to encourage IS/EP policy both in Korea and Taiwan. In order to develop shipbuilding, automobile, steel, and petrochemical industries and products, the Korean government resorted to a 4.7-fold increase (from

$4.3 billion in 1973 to $20.3 billion in 1979) in external finance to supplement

internal resources. Korea’s strategic alteration of industrial structure was truly unmatched in speed and intensity. By far the most notable example of this intense effort was to the construct POSCO (the Pohang Integrated Steel Mill) during the 1968-73 periods. This plan was initially opposed by the World Bank. Of all government actions in Korea, nothing is more controversial than the Heavy and Chemical Industry (HCI) development policy launched in 1973 – an ambitious long- term strategy to shift the direction of product specialization and trade from that of labor intensive (light industry) product to capital/skill intensive product. The plan involves a host of incentives with myriad of tax concessions, high tariffs, low interest rate on bank loans, and above all preferential allocation of investment funds.

“Between 1973 and 1977, the share of credit allocated to the six priority sectors was 60 percent” (Kwon, 1994). A number of conflicting appraisals of the efficacy of the HCI policy have emerged depending on the evaluation criteria applied. Yoo (1990) argued that “… the HCI policy had a net negative effect on the export competitiveness of the manufacturing sector as a whole…” because the policy had adversely affected the growth of light industry while conferring neither positive effective nor negative effect on the HC industry in term of export competitiveness. But using Yoo’s (1990) data, Chau (2001) shows that the world market share of “HCI products increased consistently and rapidly, a 10- fold increase between 1970 and 1978, and doubled again by 1983.

However, a stronger evidence of the success of the HCI policy can be found in Table 1, which shows a dramatic growth of the exports of machinery, transport equipment and precision instrument as a ratio of total exports which jumped from mere 7.4 percent in 1970 to 20.3 percent in 1980 and to 36.6 percent in 1990.

In the case of Taiwan, to entice foreign investment the government drafted laws allowing foreign exchange remittance of up to 15% of the total sum invested, and set up an export-processing zone for the production of electric components, machinery, precision optics, leather, clothing, and leisure goods. It also established an industrial park for Chinese and foreign high-technology firms, providing a duty-free environment in the production of minicomputers, integrated circuits, and laser optics.

In 1974, Taiwan initiated a set of infrastructure projects including construction of a north-south freeway, an international airport, a nuclear power plant, an integrated

steel mill, and a naphtha-cracking plant for the state-run Chinese petroleum company, as well as expanding the productive capacity of existing petrochemical facilities and electrifying the railway system.

The rapid transformation of Korea and Taiwan economies is clearly discernible in the changing share of machinery and transport in the total exports, the often used barometer of industrialization, which increased from a mere 0.3% in 1960 to 35.7 in 1987 for Korea and 0.6% in 1960 to 23.8% in 1984 for Taiwan.

TABLE 1

Exports of Machinery, Transport Equipment and Precision Instruments (% of total exports)

1955 1960 1970 1980 1990

Japan 13.7 25.5 46.3 62.7 75.0 Korea 0.3 7.4 20.3 36.6 Taiwan 0.6 16.4 25.2 38.0 Hong Kong 3.3 13.5 22.2

Singapore 6.7 11.0 26.8 50.1

Sources: Japan Statistical Year Book, 1986, Statistics Bureau, Management and Coordination Agency, Japan.

Major Statistics of Korean Economy, (various issues), Economic Planning Board, Korea.

Taiwan Statistical Data Book, 1984, Council for Economic Planning and Development, Taiwan.

Yearbook of Statistics, Singapore, 1970, Department of Statistics, Singapore

It is important to point out that, in Hong Kong, industrialization occurred in the free market environment. Its industrialization was helped initially by the influx of entrepreneurs from Chinese mainland right after the World War II, especially the cotton mill operators from Shanghai who brought along not only business expertise, scarce capital, skilled workers, but also export market net works, thus laying a foundation for a thriving textile-clothing industry and subsequent transformation.

With abundance of human capital and inflow of foreign capital and technology, Hong Kong wasted no time to diversify its economy by switching its emphasis to the production of technology intensive goods, especially electronic goods in the 1970s and the first half of 1980s.

In the beginning (1960s and the first half of1970s), like the West, the role of government was confined to that of providing basic infrastructure. Nevertheless, the government played quite active role in promoting trade and education. It embarked on a major program to expand and improve technical education. It set up new technical institutes, secondary technical and prevocational schools, and expanded universities and polytechnics. (Nyaw and Chan, 1982). In view of uncertain future in textiles and apparel exports the government adopted a policy of industrial diversification in 1977 that included the provision of industrial support facilities. The Industrial Development Board was established to plan, monitor, and advised industrial development—a sign of departure from the “non-interventionism.”

In Singapore a brief period of import-substitution policy (1959-66) was followed by export-oriented, labor intensive industrialization strategy. The Economic Development Board (EDP) was set up and it began formulating and implementing the industrial policy. Direct foreign investment was encouraged both to help to penetrate export markets and to bring in advanced technology. (Zhang). Later in 1979, the policy emphasis shifted to restructure industry toward a more skill-and technology intensive, higher value-added mode of production. The EDP’s effort led to machinery industry emerging in the forefront of technological innovation—computer controlled production, industrial robots, and flexible manufacturing system to name a few.

IX. Why Some High Human Capital Countries Are Not Growing?

A set of hypotheses put forth in this paper postulates that it is the quality of policy- augmented human capital that determines the direction of product specialization and trade. In these hypotheses while both entrepreneurial ability and policy making ability are keys to successful industrialization, the high quality of human capital is not a sufficient condition for effective industrial policy. Also included in the hypotheses are

the conditions that political stability and/or absence of social conflict are crucial to the success of industrialization. With the two main criteria— the level of human capital augmented by effective industrial policy, and socio-political stability, with few exception, we are able explain why some countries are failing while others are succeeding. Latin American economies, e.g., Argentina and Brazil, have performed below expectation (relative to their levels of human capital) largely because of poor industrial policy—inward looking (import substitution) as opposed to outward looking policies of the EA economies and too much dependence on the domestic endowment of natural resources, and not sufficient industrial diversification on one hand and class conflict—socio-economic inequality on the other. Fishlow (1990) argues that in Latin America, (a) the exchange rate overvaluation induced by import substitution policy has discriminated against exports giving rise to balance of payment deficits, (b) an increase in government spending unmatched by tax revenues gave rise to budget deficits financed by accelerating inflation, and (c) the emphasis on industrialization at the expense of parallel agricultural development left significant pockets of rural poverty contributing to social conflict, all culminating in retardation of growth.

The same criteria can also explain the lack luster performance of India. Datta- Chaudhuri (1990) blamed India’s bureaucratic management (i.e., use of rationing as predominant mode of regulation for the manufacturing industries), as primary cause of the slow pace of India’s industrialization. Contrary to the Korean approach where the government intervention had tended to support and promote market economy, the Indian approach stifled market economy. Also in India the heterogeneity of the country, hence the pervasiveness of vetoes by interest groups, prevented a single homogenous group from dominating the polity and the state (Datta-Chaudhuri, 1990).

In Philippines, the dominance of the landed aristocracy has hindered the emergence of dynamic capitalist economy.

Sideri (1970) notes that Portugal’s trade policies that resulted in its specialization in zero-feedback industries (i.e., agriculture) played a significant role in Portugal’s failure to converge to the wealthier European neighbors. Elmslie and Milberg (1996) attribute the technological gap between Portugal and the rest of the Western Europe today to the failure of the Portugal government to promote textile sector that could

have served as the leading sector of industrialization process in the middle of the 18th Century. The 1703 signing of the Methuen Treaty reopened Portugal to English woolen cloth and wool manufactures in exchange for Portugal’s wine – eventually forfeiting promising industrialization efforts in textile in exchange for the import substitution of agriculture.

Vernon (1970) explains how 19^th century Russia missed the opportunities for industrialization while Japan and Germany were able to exploit the opportunity.

Vernon attributes laggard performance of the 19^th century Imperial Russia to coercive and suppressive form of the state governance. Russian leaders were ambivalent about a strong state role in the industrialization process. Whereas in Meiji Japan the state sale of l2 enterprises in 1880 had, at least, in part, contributed to the growth of mercantilist class, this was not the case in Russia. The government’s surrender of a number of its factories and mines after the death of Peter the Great went mainly to court favorites rather than the aspiring entrepreneurs. The institutions that took over the state-owned facilities and that managed many other Russian factories were not private enterprises of the Western model. Owners acted like absentee landlords and factories were treated as serfdoms operated by forced laborers, and factories run under strict military discipline which discouraged innovation and adaptation. Russian entrepreneurs were also restrained by a complex and extensive system of guild – a network of monopolies bent on excluding competition. Above all, the arbitrary use of the state’s power, mostly suppressive, was the key deterrent to its industrialization.

X. Conclusion

The objective of this paper is to present a theoretical framework that helps understanding the experiences of economic development in the East Asia. This study posits that policy-augmented human capital is the foundation of the East Asian economic development. The policy augmented-human capital is the human capital with a road map for economic development. In this model the ability to formulate and execute effective economic policy is treated as a part of human capital. A country is poor because of the deficiency of human capital or the absence of coherent road map, or due to misleading road map. The East Asian economies were successful because of the high level of human capital guided by an effective road map.

Once this key proposition is accepted, other propositions fall into place: that is, industrialization can be viewed as a process of portfolio diversification strategy in which the size and composition of diverse productive industries is a function of the level of human capital. And, over time, changing size and composition of a country’s portfolio of productive industries are not entirely spontaneous but an intended outcome of industrial policy.

This study also proposes that a prosperous economy has a better chance of achieving democracy than the other way around, but human capital is not a sufficient condition for successful industrial policy. In other words, the effectiveness of government in promoting the efficiency of market coordination cannot be taken for granted.

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