THE MYTH OF ASIAS MIRACLE By Paul Krugman A CAUTIONARY FABLE Once upon a time, Western opinion leaders found themselves both impressed and frightened by the extraordinary growth rates achieved by a set of Eastern economies Although those economies were still substantially poorer and smaller than those of the West, the speed with which they had transformed themselves from peasant societies into industrial powerhouses, their continuing ability to achieve growth rates several times higher than the advanced nations, and their increasing ability to challenge or even surpass American and European technology in certain areas seemed to call into question the dominance not only of Western power but of Western ideology. The leaders of those nations did not share our faith in free markets or unlimited civil liberties. They asserted with increasing serf-confidence that their system was superior: societies that accepted strong, even authoritarian governments and were willing to limit individual liberties in the interest of the common good, take charge of their economies, and sacrifice short-run consumer interests for the sake of long-run growth would eventually outperform the increasingly chaotic societies of the West. And a growing minority of Western intellectuals agreed The gap between Western and Eastern economic performance eventually became a olitical issue. The Democrats recaptured the White House under the leadership of a young, energetic new president who pledged to"get the country moving again"--a pledge that, to him and his closest advisers, meant accelerating America's economic growth to meet the Eastern challenge The time, of course, was the early 1960s. The dynamic young president was John E Kennedy. The technological feats that so alarmed the West were the launch of Sputnik and the early Soviet lead in space. And the rapidly growing Eastern economies were those of the soviet union and its satellite nations While the growth of communist economies was the subject of innumerable alarmist books and polemical articles in the 1950s, some economists who looked seriously at the oots of that growth were putting together a picture that differed substantially from most popular assumptions. Communist growth rates were certainly impressive, but not magical. The rapid growth in output could be fully explained by rapid growth in inputs expansion of employment, increases in education levels, and, above all, massive investment in physical capital. Once those inputs were taken into account, the growth in output was unsurprising--or, to put it differently, the big surprise about Soviet growth was that when closely examined it posed no mystery This economic analysis had two crucial implications. First, most of the speculation about the superiority of the communist system--including the popular view that Western economies could painlessly accelerate their own growth by borrowing some aspects of
1 THE MYTH OF ASIA'S MIRACLE By Paul Krugman A CAUTIONARY FABLE Once upon a time, Western opinion leaders found themselves both impressed and frightened by the extraordinary growth rates achieved by a set of Eastern economies. Although those economies were still substantially poorer and smaller than those of the West, the speed with which they had transformed themselves from peasant societies into industrial powerhouses, their continuing ability to achieve growth rates several times higher than the advanced nations, and their increasing ability to challenge or even surpass American and European technology in certain areas seemed to call into question the dominance not only of Western power but of Western ideology. The leaders of those nations did not share our faith in free markets or unlimited civil liberties. They asserted with increasing serf-confidence that their system was superior: societies that accepted strong, even authoritarian governments and were willing to limit individual liberties in the interest of the common good, take charge of their economies, and sacrifice short-run consumer interests for the sake of long-run growth would eventually outperform the increasingly chaotic societies of the West. And a growing minority of Western intellectuals agreed. The gap between Western and Eastern economic performance eventually became a political issue. The Democrats recaptured the White House under the leadership of a young, energetic new president who pledged to "get the country moving again"--a pledge that, to him and his closest advisers, meant accelerating America's economic growth to meet the Eastern challenge. The time, of course, was the early 1960s. The dynamic young president was John E Kennedy. The technological feats that so alarmed the West were the launch of Sputnik and the early Soviet lead in space. And the rapidly growing Eastern economies were those of the Soviet Union and its satellite nations. While the growth of communist economies was the subject of innumerable alarmist books and polemical articles in the 1950s, some economists who looked seriously at the roots of that growth were putting together a picture that differed substantially from most popular assumptions. Communist growth rates were certainly impressive, but not magical. The rapid growth in output could be fully explained by rapid growth in inputs: expansion of employment, increases in education levels, and, above all, massive investment in physical capital. Once those inputs were taken into account, the growth in output was unsurprising--or, to put it differently, the big surprise about Soviet growth was that when closely examined it posed no mystery. This economic analysis had two crucial implications. First, most of the speculation about the superiority of the communist system--including the popular view that Western economies could painlessly accelerate their own growth by borrowing some aspects of
that system--was off base. Rapid Soviet economic growth was based entirely on one attribute: the willingness to save, to sacrifice current consumption for the sake of future production. The communist example offered no hint of a free lunch Second, the economic analysis of communist countries' growth implied some future limits to their industrial expansion--in other words, implied that a naive projection of their past growth rates into the future was likely to greatly overstate their real prospects Economic growth that is based on expansion of inputs, rather than on growth in output per unit of input, is inevitably subject to diminishing returns. It was simply not possible for the Soviet economies to sustain the rates of growth of labor force participation, average education levels, and above all the physical capital stock that had prevailed in previous years. Communist growth would predictably slow down, perhaps drastically and the spectacular Asian growth that now preoccupies policy intellectuals? At some Can there really be any parallel between the growth of Warsaw Pact nations in the 19 like the Soviet Union in the 1950s, and Singapore's Lee Kuan Yew bears little ok much levels, of course, the parallel is far-fetched: Singapore in the 1990s does not lo resemblance to the U.S.S.R.'s Nikita Khrushchev and less to Joseph Stalin. Yet the results of recent economic research into the sources of Pacific Rim growth give the few people who recall the great debate over Soviet growth a strong sense of deja vu. Now, as then the contrast between popular hype and realistic prospects, between conventional wisdom and hard numbers, remains so great that sensible economic analysis is not only widely ignored, but when it does get aired, it is usually dismissed as grossly implausible ular enthusiasm about Asia's boom deserves to have some cold water thrown on it Rapid asian growth is less of a model for the West than many writers claim, and the future prospects for that growth are more limited than almost anyone now imagines. Any such assault on almost universally held beliefs must, of course, overcome a barrier of incredulity. This article began with a disguised account of the Soviet growth debate of 30 years ago to try to gain a hearing for the proposition that we may be revisiting an old error. We have been here before. The problem with this literary device, however, is that so few people now remember how impressive and terrifying the Soviet empire's economic performance once seemed. Before turning to Asian growth, then, it may be useful to review an important but largely forgotten piece of economic history WE WILL BURY YOU' iving in a world strewn with the wreckage of the Soviet empire, it is hard for most people to realize that there was a time when the Soviet economy, far from being a byword for the failure of socialism, was one of the wonders of the world--that when Khrushchev pounded his shoe on the U N. podium and declared, "We will bury you, "it was an economic rather than a military boast. It is therefore a shock to browse through say, issues of Foreign Affairs from the mid-1950s through the early 1960s and discove that at least one article a year dealt with the implications of growing Soviet industrial might
2 that system--was off base. Rapid Soviet economic growth was based entirely on one attribute: the willingness to save, to sacrifice current consumption for the sake of future production. The communist example offered no hint of a free lunch. Second, the economic analysis of communist countries' growth implied some future limits to their industrial expansion--in other words, implied that a naive projection of their past growth rates into the future was likely to greatly overstate their real prospects. Economic growth that is based on expansion of inputs, rather than on growth in output per unit of input, is inevitably subject to diminishing returns. It was simply not possible for the Soviet economies to sustain the rates of growth of labor force participation, average education levels, and above all the physical capital stock that had prevailed in previous years. Communist growth would predictably slow down, perhaps drastically. Can there really be any parallel between the growth of Warsaw Pact nations in the 1950s and the spectacular Asian growth that now preoccupies policy intellectuals? At some levels, of course, the parallel is far-fetched: Singapore in the 1990s does not look much like the Soviet Union in the 1950s, and Singapore's Lee Kuan Yew bears little resemblance to the U.S.S.R.'s Nikita Khrushchev and less to Joseph Stalin. Yet the results of recent economic research into the sources of Pacific Rim growth give the few people who recall the great debate over Soviet growth a strong sense of deja vu. Now, as then, the contrast between popular hype and realistic prospects, between conventional wisdom and hard numbers, remains so great that sensible economic analysis is not only widely ignored, but when it does get aired, it is usually dismissed as grossly implausible. Popular enthusiasm about Asia's boom deserves to have some cold water thrown on it. Rapid Asian growth is less of a model for the West than many writers claim, and the future prospects for that growth are more limited than almost anyone now imagines. Any such assault on almost universally held beliefs must, of course, overcome a barrier of incredulity. This article began with a disguised account of the Soviet growth debate of 30 years ago to try to gain a hearing for the proposition that we may be revisiting an old error. We have been here before. The problem with this literary device, however, is that so few people now remember how impressive and terrifying the Soviet empire's economic performance once seemed. Before turning to Asian growth, then, it may be useful to review an important but largely forgotten piece of economic history. 'WE WILL BURY YOU' Living in a world strewn with the wreckage of the Soviet empire, it is hard for most people to realize that there was a time when the Soviet economy, far from being a byword for the failure of socialism, was one of the wonders of the world--that when Khrushchev pounded his shoe on the U.N. podium and declared, "We will bury you," it was an economic rather than a military boast. It is therefore a shock to browse through, say, issues of Foreign Affairs from the mid-1950s through the early 1960s and discover that at least one article a year dealt with the implications of growing Soviet industrial might
Illustrative of the tone of discussion was a 1957 article by Calvin B. Hoover. Like many Western economists, Hoover criticized official Soviet statistics, arguing that they exaggerated the true growth rate. Nonetheless, he concluded that Soviet claims of astonishing achievement were fully justified their economy was achieving a rate of growth"twice as high as that attained by any important capitalistic country over any considerable number of years [and] three times as high as the average annual rate of increase in the United States. He concluded that it was probable that"a collectivist, authoritarian state"was inherently better at achieving economic growth than free-market democracies and projected that the Soviet economy might outstrip that of the United States by the early 1970s These views were not considered outlandish at the time. On the contrary, the general mage of Soviet central planning was that it might be brutal, and might not do a ver good job of providing consumer goods, but that it was very effective at promoting directed with determined ruthless skill"-and did so without supporting argumerl a industrial growth. In 1960 Wassily Leontief described the Soviet economy as bein confident he was expressing a view shared by his readers Yet many economists studying Soviet growth were gradually coming to a very different conclusion. Although they did not dispute the fact of past Soviet growth, they offered new interpretation of the nature of that growth, one that implied a reconsideration of future Soviet prospects. To understand this reinterpretation, it is necessary to make a brief detour into economic theory to discuss a seemingly abstruse, but in fact intensely practical, concept: growth accounting ACCOUNTING FOR THE SOVIET SLOWDOWN It is a tautology that economic expansion represents the sum of two sources of growth On one side are increases in"inputs": growth in employment, in the education level of workers, and in the stock of physical capital(machines, buildings, roads, and so on). Or the other side are increases in the output per unit of input; such increases may result from better management or better economic policy, but in the long run are primarily due to increases in knowledge The basic idea of growth accounting is to give life to this formula by calculating explicit measures of both. The accounting can then tell us how much of growth is due to each input--say, capital as opposed to labor and how much is due to increased efficiency I Hoover's tone--critical of Soviet data but nonetheless accepting the fact of extraordinary achievement- was typical of much of the commentary of the time(see, for example, a series of articles in The Atlantic Monthly by Edward Crankshaw, beginning with"Soviet Industry"in the November 1955 issue). Anxiety about the political implications of Soviet growth reached its high-water mark in 1959, the year Khrushchev visited America. Newsweek took Khrushchev's boasts seriously enough to warn that the Soviet Union might well be"on the high road to economic domination of the world. "And in hearings held by the Joint Economic Committee late that year, CIA Director Allen Dulles warned, "If the Soviet industrial growth rate persists at eight or nine percent per annum over the next decade, as is forecast, the gap between our two economies. will be dangerously narrowed
3 Illustrative of the tone of discussion was a 1957 article by Calvin B. Hoover.1 Like many Western economists, Hoover criticized official Soviet statistics, arguing that they exaggerated the true growth rate. Nonetheless, he concluded that Soviet claims of astonishing achievement were fully justified: their economy was achieving a rate of growth "twice as high as that attained by any important capitalistic country over any considerable number of years [and] three times as high as the average annual rate of increase in the United States." He concluded that it was probable that "a collectivist, authoritarian state" was inherently better at achieving economic growth than free-market democracies and projected that the Soviet economy might outstrip that of the United States by the early 1970s. These views were not considered outlandish at the time. On the contrary, the general image of Soviet central planning was that it might be brutal, and might not do a very good job of providing consumer goods, but that it was very effective at promoting industrial growth. In 1960 Wassily Leontief described the Soviet economy as being "directed with determined ruthless skill"--and did so without supporting argument, confident he was expressing a view shared by his readers. Yet many economists studying Soviet growth were gradually coming to a very different conclusion. Although they did not dispute the fact of past Soviet growth, they offered a new interpretation of the nature of that growth, one that implied a reconsideration of future Soviet prospects. To understand this reinterpretation, it is necessary to make a brief detour into economic theory to discuss a seemingly abstruse, but in fact intensely practical, concept: growth accounting. ACCOUNTING FOR THE SOVIET SLOWDOWN It is a tautology that economic expansion represents the sum of two sources of growth. On one side are increases in "inputs": growth in employment, in the education level of workers, and in the stock of physical capital (machines, buildings, roads, and so on). On the other side are increases in the output per unit of input; such increases may result from better management or better economic policy, but in the long run are primarily due to increases in knowledge. The basic idea of growth accounting is to give life to this formula by calculating explicit measures of both. The accounting can then tell us how much of growth is due to each input--say, capital as opposed to labor and how much is due to increased efficiency. 1 Hoover's tone--critical of Soviet data but nonetheless accepting the fact of extraordinary achievement-- was typical of much of the commentary of the time (see, for example, a series of articles in The Atlantic Monthly by Edward Crankshaw, beginning with "Soviet Industry" in the November 1955 issue). Anxiety about the political implications of Soviet growth reached its high-water mark in 1959, the year Khrushchev visited America. Newsweek took Khrushchev's boasts seriously enough to warn that the Soviet Union might well be "on the high road to economic domination of the world." And in hearings held by the Joint Economic Committee late that year, CIA Director Allen Dulles warned, "If the Soviet industrial growth rate persists at eight or nine percent per annum over the next decade, as is forecast, the gap between our two economies . . . will be dangerously narrowed
We all do a primitive form of growth accounting every time we talk about labo productivity; in so doing we are implicitly distinguishing between the part of overall national growth due to the growth in the supply of labor and the part due to an increase in the value of goods produced by the average worker. Increases in labor productivity, however, are not always caused by the increased efficiency of workers. labor is only one of a number of inputs, workers may produce more, not because they are better managed or have more technological knowledge but simply because they have better machinery a man with a bulldozer can dig a ditch faster than one with only a shovel, but he is not more efficient; he just has more capital to work with. The aim of growth accounting is to produce an index that combines all measurable inputs and to measure the rate of growth of national income relative to that index to estimate what is known as "total factor productivit So far this may seem like a purely academic exercise. As soon as one starts to think in terms of growth accounting, however, one arrives at a crucial insight about the process of economic growth: sustained growth in a nation s per capita income can only occur if there is a rise in output per unit of input 2 At first, creating an index of all inputs may seem like comparing apples and oranges, that is, trying to add together noncomparable items like the hours a worker puts in and the cost of the new machine he use How does one determine the weights for the different components? The economists answer is to use market returns. If the average worker earns $15 an hour, give each person-hour in the index a weight of $15; if a machine that costs $100,000 on average earns $10,000 in profits each year(a 10 percent rate of return), then give each such machine a weight of $10, 000; and so on 3 To see why, let's consider a hypothetical example. To keep matters simple, let's assume that the country has a stationary population and labor force, so that all increases in the investment in machinery, etc, raise the amount of capital per worker in the country. Let us finally make up some arbitrary numbers Specifically, let us assume that initially each worker is equipped with $10, 000 worth of equipment; that each worker produces goods and services worth $10,000, and that capital initially earns a 40 percent rate of return, that is, each $10,000 of machinery earns annual profits of $4, 000. Suppose, now, that this country consistently invests 20 percent of its output, that is, uses 20 percent of its income to add to its capital stock How rapidly will the economy grow? Initially, very fast indeed. In the first year, the capital stock per worker will rise by 20 percent of $10,000 that is, by $2,000. At a 40 percent rate of return, that will increase output by $800: an 8 percent rate of But this high rate of growth will not be sustainable. Consider the situation of the economy by the time that capital per worker has doubled to $20,000. First, output per worker will not have increased in the same proportion, because capital stock is only one input. Even with the additions to capital stock up to that point achieving a 40 percent rate of return, output per worker will have increased only to $14,000. And the rate of return is also certain to decline-say to 30 or even 25 percent. (One bulldozer added to a construction project can make a huge difference to productivity. By the time a dozen are on-site, one more may not make that much difference. The combination of those factors means that if the investment share of output is the same, the growth rate will sharply decline. Taking 20 percent of $14,000 gives us $2, 800; at a 30 percent rate of return, this will raise output by only $840, that is, generate a growth rate of only 6 percent; at a 25 percent rate of return it will generate a growth rate of only 5 percent. As capital continues to accumulate, the rate of return and hence the rate of growth will continue to decline
4 We all do a primitive form of growth accounting every time we talk about labor productivity; in so doing we are implicitly distinguishing between the part of overall national growth due to the growth in the supply of labor and the part due to an increase in the value of goods produced by the average worker. Increases in labor productivity, however, are not always caused by the increased efficiency of workers. Labor is only one of a number of inputs; workers may produce more, not because they are better managed or have more technological knowledge, but simply because they have better machinery. A man with a bulldozer can dig a ditch faster than one with only a shovel, but he is not more efficient; he just has more capital to work with. The aim of growth accounting is to produce an index that combines all measurable inputs and to measure the rate of growth of national income relative to that index to estimate what is known as "total factor productivity."2 So far this may seem like a purely academic exercise. As soon as one starts to think in terms of growth accounting, however, one arrives at a crucial insight about the process of economic growth: sustained growth in a nation's per capita income can only occur if there is a rise in output per unit of input.3 2 At first, creating an index of all inputs may seem like comparing apples and oranges, that is, trying to add together noncomparable items like the hours a worker puts in and the cost of the new machine he uses. How does one determine the weights for the different components? The economists' answer is to use market returns. If the average worker earns $15 an hour, give each person-hour in the index a weight of $15; if a machine that costs $100,000 on average earns $10,000 in profits each year (a 10 percent rate of return), then give each such machine a weight of $10,000; and so on. 3 To see why, let's consider a hypothetical example. To keep matters simple, let's assume that the country has a stationary population and labor force, so that all increases in the investment in machinery, etc., raise the amount of capital per worker in the country. Let us finally make up some arbitrary numbers. Specifically, let us assume that initially each worker is equipped with $10,000 worth of equipment; that each worker produces goods and services worth $10,000; and that capital initially earns a 40 percent rate of return, that is, each $10,000 of machinery earns annual profits of $4,000. Suppose, now, that this country consistently invests 20 percent of its output, that is, uses 20 percent of its income to add to its capital stock. How rapidly will the economy grow? Initially, very fast indeed. In the first year, the capital stock per worker will rise by 20 percent of $10,000, that is, by $2,000. At a 40 percent rate of return, that will increase output by $800: an 8 percent rate of growth. But this high rate of growth will not be sustainable. Consider the situation of the economy by the time that capital per worker has doubled to $20,000. First, output per worker will not have increased in the same proportion, because capital stock is only one input. Even with the additions to capital stock up to that point achieving a 40 percent rate of return, output per worker will have increased only to $14,000. And the rate of return is also certain to decline-say to 30 or even 25 percent. (One bulldozer added to a construction project can make a huge difference to productivity. By the time a dozen are on-site, one more may not make that much difference.) The combination of those factors means that if the investment share of output is the same, the growth rate will sharply decline. Taking 20 percent of $14,000 gives us $2,800; at a 30 percent rate of return, this will raise output by only $840, that is, generate a growth rate of only 6 percent; at a 25 percent rate of return it will generate a growth rate of only 5 percent. As capital continues to accumulate, the rate of return and hence the rate of growth will continue to decline
Mere increases in inputs, without an increase in the efficiency with which those inputs are used investing in more machinery and infra-structure--must run into diminishing returns: input-driven growth is inevitably limited How, then, have today's advanced nations been able to achieve sustained growth in per capita income over the past 150 years? The answer is that technological advances have led to a continual increase in total factor productivity a continual rise in national income for each unit of input. In a famous estimate, MIT Professor Robert Solow concluded that technological progress has accounted for 80 percent of the long-term rise in U.S. per capita income, with increased investment in capital explaining only the remaining 20 ercent When economists began to study the growth of the Soviet economy, they did so using the tools of growth accounting. Of course, Soviet data posed some, problems. Not only was it hard to piece together usable estimates of output and input( Raymond Powell, a Yale professor, wrote that the job"in many ways resembled an archaeological dig ) but there were philosophical difficulties as well. In a socialist economy one could hardly measure capital input using market returns, so researchers were forced to impute returns based on those in market economies at similar levels of development. Still, when the efforts began researchers were pretty sure about what they would find. Just as capitalist growth had been based on growth in both inputs and efficiency, with efficiency the main source of rising per capita income, they expected to find that rapid Soviet growth reflected both rapid input growth and rapid growth in efficiency But what they actually found was that Soviet growth was based on rapid growth in inputs--end of story. The rate of efficiency growth was not only unspectacular, it was well below the rates achieved in Western economies. Indeed, by some estimates, it was virtually nonexistent The immense Soviet efforts to mobilize economic resources were hardly news. Stalinist planners had moved millions of workers from farms to cities, pushed millions of women into the labor force and millions of men into longer hours, pursued massive programs of education, and above all plowed an ever-growing proportion of the country s industrial output back into the construction of new factories. Still, the big surprise was that once one had taken the effects of these more or less measurable inputs into account, there was nothing left to explain. The most shocking thing about Soviet growth was its bility This comprehensibility implied two crucial conclusions. First, claims about the superiority of planned over market economies turned out to be based on a misapprehension. If the Soviet economy had a special strength, it was its ability to mobilize resources, not its ability to use them efficiently. It was obvious to everyone that the Soviet Union in 1960 was much less efficient than the United States. The surprise was that it showed no signs of closing the gap This work was summarized by Raymond Powell, " Economic Growth in the U.S.S.R., Scientific American. December 1968
5 Mere increases in inputs, without an increase in the efficiency with which those inputs are used investing in more machinery and infra-structure--must run into diminishing returns; input-driven growth is inevitably limited. How, then, have today's advanced nations been able to achieve sustained growth in per capita income over the past 150 years? The answer is that technological advances have led to a continual increase in total factor productivity a continual rise in national income for each unit of input. In a famous estimate, MIT Professor Robert Solow concluded that technological progress has accounted for 80 percent of the long-term rise in U.S. per capita income, with increased investment in capital explaining only the remaining 20 percent. When economists began to study the growth of the Soviet economy, they did so using the tools of growth accounting. Of course, Soviet data posed some, problems. Not only was it hard to piece together usable estimates of output and input (Raymond Powell, a Yale professor, wrote that the job "in many ways resembled an archaeological dig"), but there were philosophical difficulties as well. In a socialist economy one could hardly measure capital input using market returns, so researchers were forced to impute returns based on those in market economies at similar levels of development. Still, when the efforts began, researchers were pretty sure about what they would find. Just as capitalist growth had been based on growth in both inputs and efficiency, with efficiency the main source of rising per capita income, they expected to find that rapid Soviet growth reflected both rapid input growth and rapid growth in efficiency. But what they actually found was that Soviet growth was based on rapid growth in inputs--end of story. The rate of efficiency growth was not only unspectacular, it was well below the rates achieved in Western economies. Indeed, by some estimates, it was virtually nonexistent.4 The immense Soviet efforts to mobilize economic resources were hardly news. Stalinist planners had moved millions of workers from farms to cities, pushed millions of women into the labor force and millions of men into longer hours, pursued massive programs of education, and above all plowed an ever-growing proportion of the country's industrial output back into the construction of new factories. Still, the big surprise was that once one had taken the effects of these more or less measurable inputs into account, there was nothing left to explain. The most shocking thing about Soviet growth was its comprehensibility. This comprehensibility implied two crucial conclusions. First, claims about the superiority of planned over market economies turned out to be based on a misapprehension. If the Soviet economy had a special strength, it was its ability to mobilize resources, not its ability to use them efficiently. It was obvious to everyone that the Soviet Union in 1960 was much less efficient than the United States. The surprise was that it showed no signs of closing the gap. 4 This work was summarized by Raymond Powell, "Economic Growth in the U.S.S.R.," Scientific American, December 1968