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Paul Krugman - "Pacific Myths"

Following the convergence hypothesis, we would conclude that eventually many of the newly industrialized countries (NICs) of East Asia will achieve living standards enjoyed in Japan and The United States before settling into a steady-state level of growth. If current trends continue, China will emerge as the world's leading economic power before the middle of the twenty-first century. Other nations in the region such as Indonesia, Malaysia, and several others, will reside comfortably alongside the U.S. and Japan as economically powerful nations. As a region, Asia will dominate the world economy.

Throwing a wrench into the conclusions of the Asian miracle is Paul Krugman of Stanford University. Unlike others economist and analysts who forecast an eventual Asian ascendancy, Krugman believes that Asian economic growth rates will taper off significantly, well before a convergence with today's world economic leaders. Krugman concludes that rapid growth in the Asian NICs has been the result of three primary factors. First is the transition of labor from rural to industrial, the second is the education of these workers, and the third contributing factor is the catching-up effect in the capital stock. What is critically lacking, Krugman argues, is an ability to innovate in technology. We will now develop Krugman's argument in more detail.

Another way to express growth accounting shows that:

Economic Growth = Increases in Labor + Increases in Capital + Changes in Total Factor Productivity

Total factor productivity is the residual of growth that is not accounted for by increases in the labor force and capital stock. Total factor productivity looks at the interaction of technological progress with labor and capital. Improvements in technology increase the productivity of labor as it works with more advanced capital.

For practical purposes, while increases and labor and capital can be measured, there is no measure of total factor productivity. Instead it is counted as the residual of growth after accounting for increases in labor and capital.

Using growth accounting and empirical estimates, Krugman concludes that the Asian growth "miracle" of the past decades has primarily been the result of:

As workers leave the farms and enter urban areas, industrial worker participation rates have increased significantly during the past decades throughout Asia. The resulting higher labor force participation rates can are considered analogous to an increase in the labor force, which has been growing faster than the population as a whole. Eventually, labor force participation rates will even out and labor force growth will be consistent with population growth.
Asian countries have also invested heavily in their capital stock, both physical and human. Net investment has been relative high as these countries rapidly add to their capital stock.

According to Krugman's empirical estimates, almost all of the rapid growth in the developing economies of Asia can be accounted for by the above two factors: increased labor force participation rates and a building of the capital stock. Consequently, total factor productivity has shown little or no growth as increases in labor and capital account for the economic growth that has been occurring.

Increased labor force participation and additions to capital can only expand at a rapid pace for only so long. Eventually, Krugman argues, growth rates will taper off as participation rates steady and workers are equipped with current technology. Krugman argues:

To encourage high growth rates, given steady population growth rates, the Asian NICs must rely on a strong pace of technological improvement. Krugman's empirical work shows little progress in this area for these countries, as they primarily rely on the adoption of technology developed elsewhere.
Economic growth in these Asian nations will slow down to a level consistent to the steady state of population growth and the rate of technological change. This slowdown will occur well before parity of living standards to those found in Japan and the United States. As a result, convergence will not be attained.

In conclusion, Krugman argues that at current rates of total factor productivity improvement, the majority of Asian NICs will reach a steady-state growth level well before convergence of living standards found in the leading developed economies. Due to the lack of an established track record of at-home technological advancement, economic growth will primarily rely on population growth - a rate that many of these countries are trying to reduce. Only with an improvement in the rate of total factor productivity advancement will Asian economies reach the standard of living enjoyed in the United States.

Krugman uses the Soviet Union as an example. He returns to the era of Sputnik and the threat of rapid growth in the East, or Russia and its satellite states. The U.S. and its allies were alarmed by the rapid pace of Soviet economic growth and threatened by its growing military power. At the United Nations, Premier Nikita Khrushchev declared, "We will bury you," while pounding his shoe on the podium. Khrushchev was referring to the rapid pace of growth occurring in the U.S.S.R. at the time. During the 1950s the Soviet economy was growing at an 8% to 9% annual rate.

Russia and the Soviet countries reindustrialized after the post-World War II calamity. Economic growth rates tripled that of the United States. If they continued, the Soviet Union would rapidly move past the U.S. in economic might. Analysts praised the merits of the planned Soviet economy and the resulting efficiency in resource allocation. History has proven otherwise. Krugman and others assert that the rapid pace of Soviet growth during the 1950s was due to a mobilization of resources, especially in the form of labor, education, and reinvestment of output into physical capital. According to Krugman, the Soviets were effective in mobilizing resources, but not in using them efficiently.

Krugman does not predict the same fate for Asia as the recent collapse of the Soviet states, but he sees a parallel force contributing to East Asian growth. Krugman concludes that due to the reliance on the mobilization of resources and inputs used in production, Asian growth prospects are much more limited than most imagine.

In rebuttal to Krugman, there are several broad areas of disagreement:

Krugman relies on the mechanistic and mathematical treatment of growth as treated by economists and ignores history, geography, and common sense. Contrast the centralized and planned mobilization of resources in the Soviet Union to the market-orientated developments taking place in most Asian economies. It is widely agreed that the Soviet system failed to efficiently allocate resources, while Asian industry is growing in areas where the world demands goods and services.
The World Bank's 1994 report The East Asian Miracle finds that between 1960 and 1985, total factor productivity gains accounted for a third of the economic growth taking place in eight "High Performing Asian Economies (Hong Kong, Indonesia, Japan, Malaysia, Singapore, South Korea, Taiwan, and Thailand).

Krugman argues that the World Bank underestimates the return of capital. By using a lower rate of return on capital, the contribution of capital accumulation is less, leaving a greater residual economic growth than is accounted for by total factor productivity.
Even if the catching up of the past yields little in the way of total factor productivity, the future will. Most Asian economies are making additions to both physical and human capital. The increased educational level attained by its citizens will contribute to improvements in total factor productivity as greater innovation and technological improvements are achieved by the indigenous population. As total factor productivity increases, this gives a continued push on growth and the maintenance of high growth rates.
The high domestic savings rates found in many Asian economies, coupled with low public sector debt, keep interest rates low and encourages capital investment. High levels of net investment stimulate further growth.