East Asia proves World Bank theory wrong

By Chakravarthi Raghavan, Third World Network Features,
22 May 1996

Contrary to the World Bank argument that rapid liberalisation of developing country economies is essential for fast growth, the East Asian economies' success is due to their measured pace of trade liberalisation.

Midrand, South Africa: Economies that have been 'fast integrators' into the world economy have grown faster and have benefited more from the globalisation process which is underpinned by liberalisation of economies (liberalising trade and foreign direct investment, or FDI), technological advances that facilitate transport and communication networks.

This is the theme, and the thrust of the policy advice to developing countries from the World Bank in its publication Global Economic Prospects and the Developing Countries which was released here at a press conference by Mr Masood Ahmad, Director of the International Economic Department of the World Bank, who is credited in the report as having provided the general direction for the Bank staff in preparing the report.

The Global Economic Prospects 1996, sixth in a series of annual reports by the Bank, provides the Bank staff's annual assessment of global economic prospects as they affect developing countries and analyses the links between developing countries and the world economy, particularly in the areas of trade, FDI and other capital flows and commodity markets, according to the Bank's chief economist, Mr Michael Bruno.

The report purports to show that the faster countries 'integrate' into the world economy(as in the case of the East Asian economies) through liberalisation of trade and FDI, the faster they grow, with per capita incomes of their peoples increasing rapidly. Conversely, it claims, the slower integrators are also growing slowly.

The integration pace and proportion is sought to be judged through indicators about trade to gross domestic product(GDP) and FDI to GDP, and credit ratings in international markets.

The Bank's argument, by confusing effects and causes, that faster integration in East Asia (both first-and second-tier NICs and China) produced faster growth, is like arguing that spotted owls in North America produce the forests in which they live.

The report has been unable to establish any causal link between trade and FDI liberalisation and 'openness' of the economy to the world markets and growth, but suggests such a link through a purported correlation of statistical data.

Correlation through statistical data is a tricky enough exercise, and can be quite misleading for the unwary. Interpretations of this correlation are even more tricky.

Even if one assumes the statistical data and correlation cited by the Bank's report to be accurate and reliable, in terms of indicators chosen, does it mean that faster integrators grow fast or does it mean those who grow fast tend to integrate faster in the world eonomy?

One could as easily argue that increasing the number of spotted owls increases the rate of growth of its habitat, the forests.

But even this correlation or attempt at correlation seems to break down when one examines the facts cited in terms of trade liberalisation (judged by the average unweighted tariff rates, over the period 1985- 93, and the FDI/GDP ratios over 1981-93).

To show that East Asia liberalised over the decade faster, the report engages in some statistical jugglery. It excludes China from the East Asia grouping and the tariff rates, but includes China in the East Asia category for the FDI/GDP ratios.

No explanation was forthcoming from Mr Ahmad when this discrepancy was pointed out at the UNCTAD-World Bank colloquium held as a side event at UNCTAD-9.

The fact is that, while liberalising its foreign trade and lowering its tariffs and inviting FDI, China does these slowly and cautiously, and justifiably in terms of trying to manage the transition without too many shocks. As a result it has some of the highest tariffs, and on FDI has a restrictive regime, where the foreign investors are subjected to many restrictions. Nevertheless, the FDI keeps flowing into China, and its trade too is growing.

The East Asian economies, too, while generally liberalising their external sectors and investment regimes, have been adopting a cautious and gradual approach, but continue to attract more FDI and keep growing fast.

There is a valid explanation for all these (as the reports and studies by the UNCTAD's Global Interdependence Division have brought out over the years -- in its Trade and Development Reports and the more recent papers and reports for the Kuala Lumpur meeting on the East Asian economies).

The UNCTAD views are shared by a growing number of mainstream economists in academia. But these contrary reports don't figure in the bibliography of the World Bank report.

China in the Far East, according to the Bank's own index, falls into the category of 'weak integrators', and thus challenges the Bank thesis. The report gets around this by noting that this downgrading of China is due to the drop in its capital market rating (said to be due to the fall in its institutional investor credit rating), and when this indicator is disregarded, China becomes a fast integrator, and proves the Bank thesis about East Asia's faster integration producing faster growth!

Asked about the Bank's views of the economic policies and measures for the success of East Asian economies, which appeared to be quite different from what the countries concerned said (at the Japanese-organised symposium in Tokyo on the Bank's East Asia miracle study) had been their policies, or the conclusion of the recent UNCTAD seminar on East Asian experience, Mr Ahmad side-stepped the question, and then went on to speak about the East Asian successes as being due to sound macro-economic policies and export-led growth.

However, the facts seem to run counter to the Bank thesis.

Some of the most successful East Asian and South-East Asian economies, during the period 1971-1980 show a small ratio of FDI to total investment. It was only 0.1% for Japan, 5% for Hong Kong, 1.2% for the Republic of Korea, 1.3% for Taiwan, and 14% for Malaysia. China, which is less integrated into the world economy than Korea, had a 10.4% ratio of FDI to total investment.

Developing countries in seeking greater integration into the world economy hope among other things to promote exports as an engine of growth, and receive more FDI and technology. Many developing countries, on their own or pushed by the International Monetary Fund and World Bank, have undertaken policy reforms to attain these objectives -liberalisation of trade, FDI regimes and capital account.

Other studies and reports, in the academia and in UNCTAD, show that liberalisation of trade and FDI inflows has not always resulted in better performance in exports, FDI or financial flows. And greater benefits of integration have not always been associated with greater liberalisation.

A number of countries that have liberalised their FDI regimes and offer incentives to foreign investors have not succeeded in getting significant amounts of FDI. Nor have countries that have liberalised their capital markets to foreigners and removed restrictions on private sector borrowing abroad received any significant inflows of finance. And several who liberalised trade extensively to improve efficiency and start an export-led growth, have witnessed rising imports and deteriorating balance of payments. As a result they have been forced to cut imports by devaluations, restriction of domestic demands or reintroduction of high tariffs.

The success of the East Asian economies on the other hand has been due to their measured pace of trade liberalisation, reducing tariffs selectively to enable their exporters to get inputs at internationally competitive prices. They have attracted FDI which they directed to specific areas and sectors. Their differing degrees of openness to the global economy has been a deliberate process. They did not adopt a hand-off approach to FDI.

On the other hand, Latin American countries, who opened themselves up to FDI, and liberalised their external trade sectors as well as financial sectors, have not been able to grow as fast as the East Asians nor achieve greater integration into the world economy.