Revisiting the Growth of Hong Kong, Singapore, South Korea, and Taiwan, From the Perspective of a Neoclassical Model

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1 Revisiing he Growh of Hong Kong, Singapore, Souh Korea, and Taiwan, From he Perspecive of a Neoclassical Model Shu-shiuan Lu * Naional Tsing Hua Univereseiy December, 2008 Absrac This paper sudies he sources of growh for he Eas Asian Newly- Indusrializing Counries (NICs Hong Kong, Singapore, Souh Korea and Taiwan ( using a diagnosic procedure, similar o Business Cycle Accouning, which has recenly been developed in he business cycle lieraure. This diagnosic procedure provides a complee characerizaion of agens ineracions wihin hese NICs from a neoclassical perspecive and sheds ligh on why hese NICs quickly accumulaed capial and labor, and experienced rapid growh. The growh dynamics show ha oal facor produciviy (TFP improvemen is crucial o he capial boom and oupu growh in Taiwan and Souh Korea. Moreover, he counry-specific, ime-varying capial marke condiions induce he growh of oupu in Singapore and Hong Kong, and he capial and labor boom in all of he NICs. Therefore, he long-erm growh is mainly aribuable o he combined effec of produciviy improvemen and changes in capial marke condiions. Keywords: Sources of Growh, Eas Asian NICs, Neoclassical, Produciviy JEL Classificaion: E3, O3, O47, R * This paper is an exension o he firs chaper of my disseraion, Revisiing Taiwanese Economic Growh from 96 o 2002 hrough he Lens of a Neoclassical Model. I am exremely graeful o my advisor, Lee Ohanian for his advice and suppor. I would also like o hank Gary Hansen, Mahias Doepke, Harold Cole, and Anonio Bernardo and he paricipans a he UCLA Proseminar in Moneary and Macroeconomics, he 2008 Annual Meeing of SED, seminar a TKU and Academia Sinica, and my colleagues a NTHU for helpful commens. This projec is suppored by NSC: H MY2. Please direc correspondence o Shu-shiuan Lu, 0, Secion 2, Kuang-Fu Road, Hsinchu, Taiwan, R.O.C shusanlu@ucla.edu

2 . Inroducion The focal poin of his paper is is use of a neoclassical diagnosic procedure o sudy he rapid growh of he Eas Asian Newly-Indusrializing Counries (NICs Hong Kong (HKG, Singapore, (SGP, Souh Korea (KOR, and Taiwan (TWN from 978 o The procedure is an exension of he previous focus ha is solely on he producion process (i.e., Growh Accouning o one involving ineracions among he agens in he economy. Through he lens of he neoclassical model, I show he major channel hrough which hese NICs have rapidly accumulaed capial and labor, and he criical momenum ha has been driving he specacular growh rend. The issue as o why he Eas Asian NICs grew rapidly afer WWII was discussed in he lieraure from he perspecive of Growh Accouning (e.g., Young 994, 995, 998; Hsieh 999. Mos scholars now believe in Young s resul ha facor accumulaion he labor and capial boom was an imporan explanaion for he sources of growh of he Eas Asian NICs, while sill keeping in mind Hsieh s reminder 2 ha echnology may have played a bigger role han Young suggesed. However, Growh Accouning is no sufficien in accouning for hese growh miracles. I only focuses on he producion side and shows he percenage conribuion from facor inpus, i.e., labor and capial, and from oal facor produciviy. Consequenly, he old mehodology Young (995, in his paper The Tyranny of Numbers: Confroning he Saisical Realiies of he Eas Asian Growh Experience, adoped growh accouning and carefully analyzed he growh paerns of oupu produciviy and facor accumulaion for hese NICs. He found ha boh he labor and capial inpus (excep for Hong Kong grew rapidly. As a resul, he high economic growh in hese NICs did no resul from abnormally high oal facor produciviy bu from a rising paricipaion rae, inersecoral ransfers of labour, improving levels of educaion, and expanding invesmen raes. (p Hsieh (999, in his paper Produciviy Growh and Facor Prices in Eas Asia suggesed he use of facor prices raher han quaniies for growh accouning exercises because prices can be easily observed. The mos sriking finding in he paper is ha he dual esimae by Hsieh resuled in compleely differen inferences for he growh in Singapore: he primal esimae resuled in negaive TFP growh (as shown in Young 995, whereas he dual esimae resuled in posiive TFP growh (as shown in Hsieh 999. Moreover, he annual growh raes of TFP were higher under he dual han under he primal esimaes. He emphasized ha he is no saying facor accumulaion was no imporan in accouning for he sources of growh in hese NICs. Insead, he proposed ha echnology may have played a much larger role in he economic ransformaion of Singapore han he primal esimaes would have one believe. (p.38 2

3 ignores he ineracion among agens and provides no explanaion as o why here is a capial and labor boom. As Young suggesed 3 (995, o beer undersand he sources of he growh, resoring o he Neoclassical growh heory which focuses on he quaniaive framework can explain why hese NICs grew faser han he res of he economies. Before consrucing any deailed neoclassical model o explain he long-erm growh in hese NICs, I propose o adop a neoclassical diagnosic procedure, which is similar o Business Cycle Accouning, o preliminarily idenify he mechanism which is quaniaively imporan in accouning for he growh of hese NICs. This procedure is developed based on he neoclassical growh model logic. By consrucion, i preliminarily manifess he ypes of ime-varying wedges (i.e., TFP, labor wedges and invesmen wedges, represening produciviy, labor and capial marke condiions, respecively ha are criical in deermining he rend and level of oupu, labor and capial. Business Cycle Accouning, which has been developed in he recen business cycle lieraure, has been adoped o idenify he mos relevan fricion leading o he Grea Depression of (Cole and Ohanian, 999, 2002; Chari, Kehoe and McGraan 2002, In addiion o lierally demonsraing wha ypes of fricions are quaniaively imporan in accouning for he Grea Depression, Chari e al. (2007 demonsraed ha many models are equivalen o a prooype growh model wih ime-varying wedges ha resemble produciviy, labor and invesmen axes and governmen consumpion. (p. 78 Therefore, in he business cycle lieraure, Business Cycle Accouning preliminarily idenifies he fricion ha is quaniaively imporan and guides researchers in building a sophisicaed and relevan model o accoun for he business cycle. 3 Young (995 concluded, Neo-classical growh heory, wih is emphasis on level changes in income and is well-ariculaed quaniaive framework, can explain mos of he difference beween he performance of he NICs and ha of oher pos-war economies. (p

4 I apply a procedure similar o Business Cycle Accouning o diagnose he long-erm growh of hese Eas Asian NICs. The applicaion is moivaed by he fac ha long-erm growh and business cycles share a common focus on level changes and he dynamics of economic ransiion. The neoclassical diagnosic procedure enables me o idenify he criical momenum driving he growh and provides guidance on how o consruc a sophisicaed model wih a relevan mechanism explaining he growh. Therefore, he new procedure can serve as an inermediae sep o move from he observaion of Growh Accouning o Neoclassical-ype quaniaive analysis. To he exen ha oupu growh is being driven by more capial and labor, as suggesed by Young (995 and Hsieh (999, my analysis is he nex sep in helping researchers o undersand why he Eas Asian NICs rapidly accumulaed so much capial and labor. This new procedure has a leas hree advanages when sudying long-erm growh. Firs, i is also an accouning approach which akes ino accoun agens ineracions and sudies he economy as a whole. Thus i improves Growh Accouning in he sense ha i exends he focus from producion o he general equilibrium of a simplified economy. Second, he procedure allows researchers o differeniae he growh aribue o changes in capial and labor marke condiions or TFP improvemen and explains why here is more capial and labor. Finally, he procedure provides a guideline for consrucing a deailed model wih relevan feaures o quaniaively sudy he sources of Eas Asian growh. In applying his procedure, I firs documen hose deviaions in he capial and labor markes i.e., he invesmen wedge and labor wedge, and he TFP using he Solow procedure relaive o a benchmark model. Second, hese ime-varying wedges are fed ino he model one a a ime o demonsrae he marginal conribuion of TFP improvemen, as well as he impac of he changes in capial and labor marke condiions on he growh of capial, labor and oupu in hese 4

5 NICs. Finally, I idenify he wedge creaing he larges marginal conribuion in forming he realized rajecory, and ha paricular wedge is he criical source of growh. The preliminary diagnosic resuls show ha he role of TFP improvemen is more imporan han wha is lierally shown by Growh Accouning. TFP improvemen conribues o growh from wo channels 4 : i direcly eners he producion process and indirecly riggers more capial accumulaion and hus more oupu. Therefore, I quaniaively suppor he idea ha TFP improvemen has more of an influence on growh han Growh Accouning would sugges. Similarly, since invesmen wedges induce more labor and a higher oupu level, he changes in capial marke condiions (represened by invesmen wedges play a larger role han ha suggesed by Growh Accouning. The combined effecs of changes in capial marke condiions and TFP improvemen resul in hese growh miracles. To be specific, I find ha he growh paerns differ among hese NICs. The TFP improvemen is crucial in deermining he capial and oupu level aained oday by Souh Korea and Taiwan. The impac of TFP on capial accumulaion and oupu growh is more influenial in Taiwan han in Souh Korea. For Hong Kong, TFP is crucial in explaining he rend (rapid growh in he 980s and a slowing down in he lae 990s for boh oupu and capial. Despie he fac ha he impac of TFP on growh can no be ignored, invesmen and labor wedges ogeher already accoun for he oupu and capial level aained oday by Hong Kong. For Singapore, TFP demonsraes only a rivial conribuion in accouning for is long-erm rend. Therefore, my resul suppors Young s finding ha TFP improvemen is no imporan in accouning for he growh in Singapore. Finally, changes in facor marke (i.e., capial and labor marke condiions drive he labor choice dynamics for all he NICs. In paricular, he changes in capial marke condiions enhanced he observed labor boom. 4 This phenomenon can be easily observed from he cases of Souh Korea and Taiwan. 5

6 The remainder of his paper is organized as follows. Firs, I briefly describe how o use he neoclassical diagnosic procedure in he long-run growh conex. Second, I describe he parameers chosen, he benchmark model used for he diagnosis, and he measured wedges. Nex, I conduc a simulaion conrolling he presence of differen combinaions of wedges and analyze he marginal effec of differen wedges on he growh of hese Eas Asian NICs. Finally, I presen he concluding remarks in he las secion. 2. Neoclassical Diagnosic Procedure for Long-erm Growh In he lieraure on he U.S. Grea Depression, Cole and Ohanian (999, 2002, and Chari, Kehoe and McGraan (2002, 2007 suggesed he adopion of a neoclassical diagnosic procedure, namely, Business Cycle Accouning, o diagnose he causes of economic downurns. Since longerm growh and business cycle sudies share a common focus in erms of changes in oupu level and ransiional dynamics, I adop a similar procedure o diagnose he causes of economic booms. I closely follow he procedure suggesed by Cole and Ohanian (2002. The accouning procedure begins wih he equilibrium condiions of an economy under a Ramsey-Cass- Koopmans ype of deerminisic, discree-ime growh model. The model can be augmened wih assored shocks, which cause he economy o deviae away from is balanced growh pah. The model is composed of an infiniively-lived represenaive family wih a log uiliy funcion and Cobb-Douglas producion echnology. Therefore, afer derending all he variables, he economy wihou shocks can be characerized by six equaions 5 as follows: ~ ~ θ θ Y = k ( x0 h ( ~ w~ C = (2 ( h φ ~ C+ {( + γ ~ } = + r + δ (3 C β 5 The deailed seup for he neoclassical growh model represening he undisored economy is shown in Appendix. 6

7 ~ ~ ~ ~ Y = C + ( + v( + γ k + k (4 Y r ~ k ~ Y w~ θ ( δ = θ (5 = ( (6 h The above sysem of equaions (-6 defines he general equilibrium of he simplified economic sysem. However, alhough he equaliy of hese equaions holds under a simplified economic sysem, he equaliy does no necessarily hold in realiy. When he daa are plugged ino hese equaions, and he righ- and lef-hand sides of he equaions are no equal o each oher, he differences are defined as wedges. These wedges gauge he discrepancy beween he wo sides of he equaions. I follow Chari e al. (2002, 2007 and refer o he wedges 6 for equaion ( as produciviy (Z/TFP. Moreover, he wedges for equaion (2 are referred o as labor wedges ( τ l, and he wedges for equaion (3 are referred o as invesmen (Euler Equaion wedges ( τ k. While Chari e al. regard hese ime-varying labor and invesmen wedges as labor axes and invesmen axes, under he conex of long-erm growh, I inerpre hese wedges as counry-specific labor and capial marke condiions. Finally, he wedges for equaion (4 are referred o as income wedges. Wihin he conex of he business cycle, hese wedges are he ypes of fricions ha drive he business cycle. Therefore, under Chari e al. s applicaion, heir focus is on he magniude of hese wedges (deviaions and hey invesigae how hese wedges drive he economy away from is balanced growh pah, which resuls in he observed business cycle. Likewise, wihin he conex of long-erm growh, I inerpre he labor wedge as an indicaor of he labor marke condiions, and he invesmen wedge as an indicaor of he capial 6 The deailed discussion regarding he wedges is in Appendix 2. 7

8 marke condiion. For example, I inerpre he declining labor (invesmen wedge series as represening an improvemen in labor (capial marke condiions over ime. Similarly, a rising TFP implies an improvemen in he producion echnology. Therefore, under my applicaion, I focus on he rend of hese wedges and invesigae how hese ime-varying wedge series drive he economy o ransi from a low seady sae o a high seady sae. If he counry-specific marke condiion changes dramaically and have a long-erm effec on economic performance, large and rending wedges, resembling permanen shocks, will be observed. In his case, he wedges reflec he size of he impac on growh from produciviy improvemens (Z, labor marke condiions (he labor wedge or he capial marke condiions (he invesmen wedge. These wedges are defined as follows 7 : producivi y ( TFP : Z = ~ k ~ Y θ θ ( x0 h ~ C φ labor wedges( wedges in labor marke :: l w~ ( τ h ~ C+ invesmen wedges( wedges in capial marke :{( + γ ~ + δ} r C β ~ ~ ~ ~ income wedges : gap = Y C ( + v( + γ k + ( δ k y + + ( τ Ideally, inroducing all he wedges above will well mimic he rajecory of economic ransiion since I endogenize facor prices in he model. k, + 3. The Procedure for Implemening he Neoclassical Diagnosic Procedure To implemen he neoclassical diagnosic procedure in relaion o he sources of long-erm growh, I need o deermine all he parameers and he wedges and hen begin he neoclassical 7 My Euler equaion wedge is slighly differen from ha of Chari e al. (2002, I define he capial wedge as capial income ax raher han invesmen ax. 8

9 diagnosis. I describe he parameers and he benchmark model I use in Secion 3., he wedges in Secion 3.2, and hen explain he diagnosic procedure in Secion Parameers and he benchmark model The main purpose in diagnosing he long-run growh is o show why hese NICs grew faser han he res of he world. Consequenly, I apply he sandard parameer values for he following parameers 8 : he populaion growh rae (ν=2%, he echnological improvemen rae (γ=2%, he labor share (θ=/3, he discoun facor (β=0.95, and he depreciaion rae (δ = 5%. I choose a ime allocaion parameer of 2 (φ=2 so ha he share of ime a household spends on work is around 0.3. Finally, I choose an efficiency scalar for labor in producion echnology of 200 (x 0= 200 so ha he oupu a he seady sae is rounded up o 00. Given hese parameers, a fricionless benchmark model can be derived (wih zero labor, invesmen and income wedges and wih TFP equal o one forever o generae he rajecories represening he economy which grows a 4% each year. I assume his benchmark model represen he simplified economy of he world. Any economy ha grows a a rae faser or slower han 4% can aribue such growh o changes in labor wedges, invesmen wedges, produciviy and income wedges. The changes in hese wedges reflec he evoluion of he counry-specific marke condiions and can be used o explain why some counries grow rapidly and some grow slowly. Finally, I assume ha all hese NICs aain heir seady saes by From 2007 onward, he economy remains on he seady sae wih he same counry-specific wedges as in 2006 forever. 8 I assume ha he balanced growh rae of he economy equals he average world growh rae (g=2%. Similarly, he average working age populaion (5-64 in he world grows a a rae of.9408%. Therefore, I adop 0.02 as he populaion growh (ν =2% in he model. 9

10 3.2 The wedges Each NIC has differen counry-specific TFP improvemen, capial and labor marke condiions (represened by TFP, invesmen wedges and labor wedges. Compared wih he benchmark economy, he specacular growhs (faser han he benchmark economy of hese NICs are mainly aribuable o changes in hese wedges, namely, labor wedges, invesmen wedges, produciviy and income wedges, all of which are counry-specific characerisics. In his secion, I describe hese wedges, namely, labor wedges (labor marke condiions, invesmen wedges (capial marke condiions, and produciviy (TFP for four cases: ΗΚG, SGP, KOR, and TWN 9. These wedges capure how he Eas Asian NICs deviae from he benchmark balanced growh pah. I show hese wedges and compare hem across hese NICs. Figure depics he produciviy (TFP/Z characerisic. As can be seen, TWN and KOR experienced he greaes produciviy improvemen. For HKG, produciviy improved before 988, and remained above.25 unil 995. By 2006, he TFP equaled.38. Finally, for SGP, produciviy did no significanly differ over he period from 978 and 2006 and flucuaed beween.7 and.36 during he period being sudied. Figure 2 focuses on he invesmen wedges. As can be seen, he fricions in he capial marke negaively impaced 0 he agens decisions regarding saving and invesmen in he earlier periods. In addiion, one ineresing phenomenon ha can be observed is he impac of he Eas Asian Currency Crisis in 997 on hese NICs. The corresponding invesmen wedges reveal a large amoun of fricion (posiive wedges in he capial marke, whereas he magniude for TWN is small. This may due o he fac ha he impac of he Eas Asian Currency Crisis on Taiwan is minor, whereas he impac on Souh Korea is significan. In oher words, he diagnosic 9 The income wedge plays a small role in deermining he equilibrium pahs. For simpliciy, I do no discuss how income wedges affec he growh of hese NICs. (For Singapore, he income wedge is more volaile han in he cases of he oher NICs and plays a slighly larger role in deermining he growh rajecory. However, adding he income wedge does no affec my conclusion. Therefore, I only discuss TFP, as well as he labor and invesmen wedges. 0 This is implied by he posiive invesmen wedges. 0

11 procedure successfully capures major capial marke fricion such as a financial crisis and is refleced as invesmen wedges wih he righ sign. Figure 3 shows he labor wedges. As can be seen, HKG and SGP follow a similar paern which has been declining over ime. On he conrary, KOR and TWN follow anoher paern which has been increasing over ime, bu by a smaller amoun han in he cases of HKG and SGP. The wo differen paerns may arise due o he fac ha HKG and SGP are ciy saes. Therefore, he labor migraion paerns in Hong Kong and Singapore differ from hose in Souh Korea and Taiwan. 3.3 The Diagnosic Procedure The diagnosic procedure sars by assuming ha he agens in he economy have perfec foresigh. Then, I simulae he ransiion rajecories for oupu, capial and labor adding in he wedge series one a a ime. I begin wih he model wih no change in wedges and by fixing all he wedges a heir level in 978 up o he end of he simulaion. Then, I sequenially add in he series of labor wedges, invesmen wedges, TFP, and hen income wedges one a a ime o show he marginal conribuion of each wedge series o oupu, capial and labor. Finally, by defaul of he model, inroducing all he wedges in he model will resul in he rajecories being he same as he daa would show. By including one series of wedges a a ime, I can visualize he marginal effec of each wedge in erms of conribuing o he oupu growh, capial and labor boom. The logic behind his applicaion is as follows. The invesmen and labor wedges represen he capial and labor marke condiions, whereas TFP represens produciviy. When considering he inclusion of a For all he scenarios, he wedge values assumed in 2006 are he wedges for he economy afer Tha is, he wedges do no change from 2006 onward for all he scenarios.

12 paricular wedge in he model 2, i is implied ha I ake ha counry-specific marke condiion ino accoun. Please noe ha he counry-specific condiion can be an inferior marke condiion (i.e., a resricion, a fricionless marke condiion, a superior marke condiion, or a ransiion from a resriced economy o one wih less fricion. Therefore, he diagnosic procedure involves a process of decomposiion. To begin wih, I predic he ransiion pah based on a Model wihou changes in wedges (he wedges are fixed a heir value in 978. This couner-facual scenario assumes ha he capial and labor marke condiions remain he same from 978 onwards. The rajecories for his case represen he counry s iniial sae and he economic performance wihou here being any changes in he capial and labor marke condiions, nor produciviy. When I simulae he rajecories by adding one wedge a a ime, he differences beween he Model wihou changes in wedges and he daa will be decomposed ino he marginal conribuion of labor wedges, invesmen wedges, TFP and income wedges. For he decomposiion, I firs invesigae he Model wih changes in labor wedges only. This case shows how he changes in he labor marke condiions from 978 o 2006 conribue o he growh in hese NICs. The differences beween he rajecories generaed by he Model wih changes in labor wedges only and by he Model wihou changes in wedges represen he marginal conribuion of labor wedges (changes in labor marke condiions on he growh of oupu, capial and he labor boom. Second, I show he rajecories generaed by he Model wih changes in invesmen and labor wedges. This case shows wha he growh rajecories would have looked like when he capial and labor marke are allowed o evolve as was he acual case during he period of sudy. Therefore, he marginal conribuion of invesmen wedges is he difference beween he rajecories generaed by he Model wih 2 Since he model presened is for derended per capia variables, he simulaed daa should show no growh a all if he economy is iniially a he seady sae, remains on he balanced growh pah and grows by 4% annually given my parameers. (The populaion growh rae and he growh rae of echnological advance are 2%, respecively. 2

13 changes in labor wedges only and hose by he Model wih changes in invesmen and labor wedges. Third, I generae he rajecories under he Model wih changes in TFP, invesmen and labor wedges. The differences beween he rajecories prediced by his scenario and hose prediced by he Model wih invesmen and labor wedges are he marginal conribuion aribuable o TFP improvemen. Finally, I show he pahs generaed for he Model wih all wedges. The pahs coincide wih he daa, i.e., Daa, by defaul. The differences beween he rajecories of he daa and hose generaed by he Model wih TFP, invesmen and labor wedges represen he marginal conribuion of income wedges. 4. The diagnosic resuls In his secion, I idenify he momenum driving he growh in he Eas Asian NICs using he model and procedure se up in Secion 3. By conrolling he presence of differen wedges under differen scenarios, he simulaion resuls idenify he marginal conribuion of hese imevarying wedges in he capial and labor markes and TFP on oupu growh, as well as he dynamics of capial and labor accumulaion. In his secion, I will answer wo quesions. Firs, from he neoclassical perspecive, wha are he major forces ha drive he oupu o grow? (Which wedge leads o he larges marginal conribuion? Second, wha are he counry-specific characerisics (e.g., labor wedge, invesmen wedge and TFP ha drive he mass accumulaion of capial and labor and hen conribue o he growh in hese NICs? For each scenario, I show four cases: HKG, SGP, KOR and TWN, which use labor hours as he labor inpu. For each case, I sequenially include one series of wedges a a ime so as o demonsrae he marginal conribuion of labor wedges, invesmen wedges, TFP and income wedges on he dynamics of oupu, capial and labor accumulaion. 3

14 In all he figures (Figure 4 o Figure 6, he resuls for Hong Kong (HKG are in he upper lef panel; he resuls for Singapore (SGP are in he upper righ panel; he resuls for Souh Korea (KOR are in he lower lef panel; and he resuls for Taiwan (TWN are in he lower righ panel. 4. Decomposiion for oupu growh: Idenifying he major conribuors o oupu growh Figure 4 shows he rajecories for oupu prediced by models wih differen combinaions of wedges. As can be seen, for HKG, he marginal conribuion of he invesmen wedge is subsanial, since he rajecory prediced by he Model wih changes in invesmen and labor wedges significanly raises he rajecory prediced by he Model wih changes in labor wedges only. However, he Model wih changes in invesmen and labor wedges does no capure he rapid growh from he mid-980s o he mid-990s, nor does i capure he slow down since he mid-990s. Therefore, invesmen wedges and TFP improvemen are he wo major forces driving he oupu growh in Hong Kong. Finally, he rajecory prediced by he Model wih changes in labor wedges only falls below ha prediced by he Model wihou changes in wedges. This implies ha he labor marke condiions in Hong Kong are no favorable o growh from he 970s o he 990s. For SGP, he marginal conribuion of he invesmen wedge is subsanial as well, since he rajecory prediced by he Model wih changes in invesmen and labor wedges significanly raises he rajecory prediced by he Model wih changes in labor wedges only. Moreover, he pah generaed by he Model wih changes in invesmen and labor wedges moves by following a similar rend o Daa up o he 990s. Therefore, he changes in capial and labor marke condiions (represened by invesmen wedges and labor wedges are he wo major forces driving he growh in Singapore. Finally, TFP has a small marginal conribuion o growh since he pah prediced by he Model wih changes in invesmen and labor wedges and 4

15 by he Model wih changes in TFP, invesmen and labor wedges follows he same rend wih relaively small differences. For KOR, he marginal conribuion from he TFP improvemen is significan since he rajecory prediced by he Model wih changes in TFP, invesmen and labor wedges significanly raises he rajecory prediced by he Model wih changes in invesmen and labor wedges. Wihou TFP improvemen bu wih all oher wedges, he oupu level in Souh Korea could have been 65% of wha i realized in However, he equilibrium pah wih is upward rend generaed by he Model wih changes in invesmen and labor wedges suggess ha, wihou TFP, KOR could have coninued o grow from 978 o 200 (wih a few excepions 3, bu would no have grown ha fas. Finally, he figure shows ha he pah prediced by he Model wih changes in labor wedges only was slighly higher han Daa during and hen began o fall below he pah prediced by he Model wihou changes in wedges. This may imply ha, during is early developmen period, he changes in labor marke condiions posiively conribued o he oupu growh in Souh Korea. Neverheless, he changes in labor marke condiions have no favored growh since 983. For TWN, he marginal conribuion of an improvemen in TFP is enormous since he rajecory prediced by he Model wih changes in TFP, invesmen and labor wedges significanly raises he rajecory prediced by he Model wih changes in invesmen and labor wedges. Wihou an improvemen in TFP bu wih all oher wedges, he oupu level in Taiwan could have been 54% of wha i realized in Finally, he equilibrium prediced by he Model wih changes in invesmen and labor wedges shows ha Taiwan would have sopped growing since he 980s if here had been no changes in TFP. Moreover, if changes in he capial 3 The years ha are excepions are 979, , 988, 990 and

16 and labor markes had been he only economic condiions allowed o change in Taiwan, Taiwan s oupu would have revered back o an oupu level lower han ha of he 980s. To sum up, TFP improvemen is imporan in accouning for he oupu dynamics in Hong Kong, Souh Korea and Taiwan. I is also crucial in deermining he oupu level aained oday by Souh Korea and Taiwan bu no by Hong Kong. Finally, for Singapore, he changes in capial and labor marke condiions are he major forces driving he growh in Singapore. 4.2 Decomposiion of he capial boom: Idenifying he major conribuors o he capial boom When here is more capial inpu, he economy will give rise o more oupu. Therefore, in his secion, I would like o address wha wedges drive he excess capial accumulaion in hese NICs. Are invesmen wedges he only wedges ha play a significan role in riggering he rapid capial accumulaion? Figure 5 shows he rajecories for capial accumulaion prediced by models wih differen combinaion of wedges. As can be seen, for all hese NICs, in erms of he marginal conribuion of wedges o he capial boom, he role played by changes in labor marke condiions is rivial 4. In addiion, he role played by changes in capial marke condiions ogeher wih TFP improvemen is influenial 5, excep for Singapore. From he above analysis, I find he conribuion of TFP o growh is greaer han wha Growh Accouning suggess, for Growh Accouning can only show wha percenage of oupu growh resuls from a TFP improvemen. The neoclassical diagnosic procedure, however, shows more han ha. Through he lens of he neoclassical model, he ransiion dynamics reveals ha TFP improvemen also induces more capial accumulaion and hus more oupu. In oher words, 4 This is because he difference beween he rajecory prediced by he Model wihou changes in wedges and ha by he Model wih changes in labor wedges only is eiher small or has a negaive impac on he capial boom. 5 This is because he difference beween he rajecory prediced by he Model wih changes in labor wedges only and ha by he Model wih changes in TFP, invesmen and labor wedges is significan and he laer is generaed by a pah much closer o Daa. 6

17 he impac of TFP on growh is wofold. Firs, TFP direcly eners he producion process and resuls in more oupu. Second, TFP indirecly induces more capial accumulaion hrough he dynamics of he agens desire o accumulae more capial and hus more oupu. The laer is he new insigh regarding growh from he neoclassical perspecive. Therefore, based on he capial accumulaion dynamics, I find ha TFP is also behind he scenes driving he capial boom, especially in Souh Korea and Taiwan. 4.3 Decomposiion of he labor boom: Idenifying he major conribuors o he labor boom When here is more labor inpu, he economy will resul in more oupu. Therefore, in his secion, I would like o address he wedges ha drive he labor boom in hese NICs. Are labor wedges he only wedges ha play a significan role in riggering he labor boom? Figure 6 shows he rajecories for labor choice prediced by models wih differen combinaions of wedges. As can be seen, for all he NICs, he marginal conribuion of TFP o he labor boom is minor since he difference beween he rajecory prediced by he Model wih changes in TFP, invesmen and labor wedges and ha by he Model wih changes in invesmen and labor wedges is relaively rivial 6. This implies ha TFP improvemen has a relaively small effec in inducing agens o devoe more labor hours o work in hese NICs. Moreover, he evoluionary paern of labor choices over ime is mainly driven by labor wedges. Finally, invesmen wedges also play some role in inducing more labor. In addiion, for HKG, KOR and TWN, he Model wihou changes in wedges resuls in a rajecory ha is higher han ha prediced by he Model wih changes in labor wedges only, bu lower han ha prediced by he Model wih changes in invesmen and labor wedges for some years. This implies ha he labor marke condiions in Hong Kong, Souh Korea and 6 This is because he difference beween he rajecory prediced by he Model wih changes in invesmen and labor wedges and ha prediced by he Model wih changes in TFP, invesmen and labor wedges is eiher small or has a negaive impac on he labor boom. 7

18 Taiwan do no favor he growh performance during cerain periods of ime, and he evoluion of capial marke condiions has been an imporan facor enhancing he labor boom during hese periods, e.g., Hong Kong from 979 o 993, Souh Korea since 983, and Taiwan from 98 o 99. Therefore, he effecs of TFP improvemen on labor choices are obscure. The labor marke equilibrium is mainly affeced by facor marke wedges (i.e., invesmen and labor wedges, and, in paricular, labor wedges deermine he rend of labor choice. Finally, since he labor wedges do no favor he growh performance during cerain periods of ime, he changes in capial marke condiions (i.e., invesmen wedges are also imporan in accouning for he dynamic of labor choices. 5. Conclusion In his paper, in aemping o answer he quesion regarding he sources of growh for he Eas Asian NICs, I inroduce a neoclassical diagnosic procedure, similar o Business Cycle Accouning (e.g., Cole and Ohanian, 999; Chari, Kehoe and McGraan, 2002, 2007, o idenify he major sources of growh. Compared wih he radiional Growh Accouning used in he lieraure (which focuses on inpus and oupus in producion, he new mehod idenifies he sources of growh by analyzing he dynamics of he economy, which akes ino accoun agens and firms decisions in equilibrium in addiion o he producion funcion. Thus, he neoclassical diagnosic procedure allows researchers no only o show why hese economies grew fas, bu also shows why here is a labor and capial boom. The diagnosic approach sheds new ligh on undersanding he specacular growh in he Eas Asian NICs from a leas hree perspecives. Firs, i sudies growh from he perspecive of he economy as a whole raher han only focusing on he producion process. Therefore, i enables researchers o ake ino accoun he agens ineracion when analyzing sources of growh 8

19 and reveals more insighs han Growh Accouning. Second, by means of idenifying he marginal conribuion of all he wedges o growh, he new procedure reveals why he oupu grew so rapidly in hese NICs, and i also shows he forces behind he scenes ha are driving he capial and labor boom. Finally, he procedure provides guidelines for consrucing a model o quaniaively analyze he sources of he Eas Asian growh. In oher words, he neoclassical diagnosic procedure is also a decomposiion mehodology. I provides deeper implicaions han Growh Accouning as i exends he focus o he whole economy raher han solely concenraing on he producion process. Moreover, he new approach quaniaively shows wha ype of fricion/changes are needed for deailed model consrucion so o generae a growh model suiable for sudying he growh dynamics in hese NICs. Therefore, he neoclassical diagnosic approach serves as an inermediae procedure which decomposes he sources of growh and guides researchers in model consrucion. The resuls of he preliminary diagnosis show ha produciviy improvemen is a crucial momenum driving he long-erm growh in Souh Korea and Taiwan. Wihou produciviy improvemen, he oupu level oday in hese NICs would have been much lower; hese NICs can grow for a cerain ime, bu a a lower rae. For Hong Kong, he improvemen in TFP is crucial in capuring is rapid growh in he 980s and is slow down in he lae 990s. Finally, for Singapore, changes in he capial and labor marke condiions are he mos imporan forces driving is long-erm growh. This finding is consisen wih Young s ha he improvemen in TFP does no accoun for he growh in Singapore. I also invesigaed he origin of he labor and capial boom in hese NICs. Through he neoclassical analysis, I found ha he TFP improvemen also induces more capial accumulaion, especially in Souh Korea and Taiwan. Therefore, he conribuion of TFP o growh is greaer han he Growh Accouning would sugges. On he oher hand, he evoluion of he capial marke condiions also accouns for he labor boom in hese NICs. Therefore, he conribuion of 9

20 he changes in capial marke condiions is greaer han Growh Accouning would sugges as i plays a role in accouning for he labor choice dynamics. To sum up, he improvemen in TFP is crucial in explaining he oupu growh as well as he rapid capial accumulaion in Souh Korea and Taiwan. For Hong Kong, he combined effec of he TFP improvemen and he change in capial marke condiions co-deermines he rend and level of he oupu growh and capial accumulaion. For Singapore, he evoluion of he capial marke condiions is imporan in accouning for he oupu growh and he capial accumulaion here. Finally, for all he NICs, changes in labor marke condiions deermine he rend of labor choice and he changes in capial marke condiions enhance he labor boom. As he diagnosic procedure is preliminary, he resuls of his paper can guide researchers consrucing relaed models o explicily sudy he cause of he specacular growh in hese NICs. A few puzzles remain for his preliminary diagnosis. For example, wha are he causes of he evoluion of he capial and labor marke condiions? Wha are he forces driving he TFP improvemen? I can be promising o consruc a model wih a mechanism incorporaing TFP as well as allowing changes in capial marke condiions. A muli-secor model (which can endogenize he TFP improvemen hrough labor migraion from a low o a high produciviy secor wih a mechanism (which generae changes in capial marke condiions, e.g., financial developmen/liberalizaion in he 980s may shed ligh on he origin of he growh. Finally, i will be ineresing o sudy he source of he unexplained growh rae (4% assumed in he diagnosic procedure and o provide some heoreical explanaion for i. 20

21 References Chari, V. V., Kehoe, P. J., and McGraan, E. R., Accouning for he Grea Depression, American Economic Review 92, Chari, V. V., Kehoe, P. J., and McGraan, E. R., Business Cycle Accouning, Economerica 75 (3, Cole, H. L., Ohanian, L. E., 999. The Grea Depression in he Unied Saes from a Neoclassical Perspecive, Federal Reserve Bank of Minneapolis Quarerly Review Winer 999, 23 (, 2-24 Cole, H. L., Ohanian, L. E., The U.S. and U.K. Grea Depression hrough he Lens of Neoclassical Growh Theory, American Economic Review 92 (2, Harberger, A. C., 978. Perspecives on Capial and Technology in Less-Developed Counries. In Aris, M.J., Nobay, A. R. (Eds, Conemporary Economic Analysis, Croom Helm Ld., London Harberger, A. C., 998. Reflecions on Economic Growh in Asia and he Pacific, Asian Economic Sudies 8, 2-4 Hsieh, C.-T., 999. Produciviy Growh and Facor Prices in Eas Asia, American Economic Review 89 (2, Young, A., 994. Lessons from he Eas Asia NICs: A Conrarian View, European Economic Review 38, Young, A., 995. The Tyranny of Numbers: Confroning he Saisical Realiies of he Eas Asian Growh Experience, Quarerly Journal of Economics 0(3, Young, A., 998. Alernaive Esimaes of Produciviy Growh in he NIC s: A Commen on he Findings of Chang-Tai Hsieh, NBER Working Paper 6657 CSD, Census and Saisics Deparmen, The Governmen of he Hong Kong Special Adminisraive Region hp:// 2

22 DGBAS, Direcorae-General of Budge, Accouning and Saisics Execuive Yuan, Republic of China, hp://eng.sa.gov.w/mp.asp?mp=5 DaaSream ECOS, Economic Saisics Sysem, Bank of Korea, hp://ecos.bok.or.kr/ IFS, IMF Inernaional Financial Saisics KNOS, Korea Naional Saisical Office, hp:// LABORSTA, Inernaional Labor Organizaion, hp://laborsa.ilo.org/ STS, Singsa Time Series Online, hps://app.ss.singsa.gov.sg/dos_index.asp Taiwan Saisical Daa Book, 2002, 2007, Council for Economic Planning and Developmen (CEPD, Execuive Yuan World Developmen Indicaors 22

23 Appendix : The Model for Neoclassical Diagnoses In his secion, I describe he model used for he neoclassical diagnosic procedure. A. The Economy The economy of he model is composed of a represenaive family, and producers in an environmen characerized by perfec foresigh. Individuals may face shocks bu he shocks only las for one period. A.. The Represenaive Family I adop a special form of he CES uiliy funcion for he family in his economy. Agens value leisure. There is one uni of labor available each period. In addiion, hey are infiniely lived. Hence, he preferences are as follows: Max = u( C β {log( C + log( ˆ φ h } =0 where C is he family s consumpion, and ĥ is he oal labor he family provides. The discoun facor is represened by β. Finally, he populaion grows deerminisically a he rae ν, and hus populaion n a can be expressed as follows: n = ( + v A..2 Producion Secor Firms in his economy adop labor-augmened Cobb-Douglas producion echnology. For θ θ a single firm, y = k ( x l, x = ( + γ x0, where y is oupu, k is he capial inpu, and l is he labor inpu. In addiion, θ is he capial share and γ is he growh rae of he labor-augmened echnology. Based on he propery of he Cobb-Douglas producion funcion, he producion echnology for he whole secor can be expressed as in equaion ( below: 23

24 24 θ θ = ˆ ( L x K Y (A. In equaion (, Y is he aggregae oupu, K is he aggregae capial inpu, and L is he aggregae labor inpu. A.2 The Equilibrium A compeiive equilibrium is derived as follows (from A o D: A Given ha he populaion grows deerminisically a he rae ν, and v n ( + =, I divide all he variables by v n ( + = in order o ge rid of he growh effec from he populaion. B Given he labor-augmened echnology which grows a he rae γ, I derend all he variables by ( γ +. C The saionary version of he model as a compeiive equilibrium is presened below afer defining he derended per capia variables as follows: w w v I I v C C v Y Y v L L v h h v K K v k k ( ~ ; ( ( ~ ( ( ~ ; ( ( ~ ( ˆ ; ( ˆ ( ( ~ ; ( ( ~ γ γ γ γ γ γ + = + + = + + = + + = + = + = + + = + + = D To obain he compeiive equilibrium, I ake he following seps (from a o f : a Given } =0, { r w, K and L solve he firm s problem: { } L K L Y L x K Z w L Y K Y L x K Z r K Y K r w L L x K Z Max ( ( ( ( (, θ θ θ θ θ θ θ θ θ θ θ = = = =

25 b The represenaive family maximizes uiliy given { w, r } =0 = Max u( C β {log( C + φ log( h } h, k + = 0 s.. C + I w h + r k F. O. C.: = K + ( δ I K w : h C ~ k + c The marke clearance condiions are: C : C K L φ = h + = k = h = β ( + r There are wo facor-markes in his economy, namely, he capial marke and labor marke. Therefore, I se wo marke clearing condiions in equilibrium. The capial marke clears a price r, he labor marke clears a wage w and he resource consrain is saisfied. + δ d Resource Consrain e Law of Moion C + I Z K θ θ ( x L ( + v( + γ K + x = ( + γ ~ ~ = I ~ + ( δ K f The Sysem of Equaions Therefore, a compeiive equilibrium for an undisored sysem consiss of a sequence of quaniies { h, k, Y, C} =0, and a sequence of prices { w, r } =0, such ha he represenaive family and firm opimize heir producion and markes clear. The sysem of equaions (equaions A.2 o A.7 ha characerize he equilibrium in erms of he derended variables is as follows: ~ ~ θ θ Y = k ( x0 h (A.2 ~ w~ C = (A.3 ( h φ 25

26 ~ C+ {( + γ ~ } = + r + δ (A.4 C β ~ ~ ~ ~ Y = C + ( + v( + γ k + ( k (A.5 Y r θ ~ k ~ Y w~ θ δ = (A.6 = ( (A.7 h The sysem of equaions (A.2-A.7 has 6 equaions and 6 unknowns. The sysem expresses he seady sae condiions of he economy along he balanced growh pah. Appendix 2: Inerpreaions of he wedges The above sysem of equaions (A.2-A.7 is he general equilibrium of he simplified economic sysem. If all variables remain he same for an economy (if here is any rend, one can derend he variables and make he rend saionary, we say he economy is a he seady sae and his rajecory is referred o as he balanced growh pah. However, he economy does no always say on his pah. From he perspecive of business cycle analysis, if here are shocks, he economy will deviae away from is balanced growh pah and we will observe booms and buss. From he perspecive of long-erm growh, if he marke condiions are beer han hose of he res of he world or have been improving over ime, or if he economy has more rapid TFP improvemen han he res of he world, he economy will grow a a faser rae and hen depar from he balanced growh pah of he res of he world. A2. Inerpreaion of he wedges in he conex of he business cycle In he conex of he business cycle, Chari e al. define wedges (axes or gaps o gauge he righ- and lef-hand side of each equaion (A.2 A.5. These wedges hen quanify he exen o which an economy deviaes away from he balanced growh pah and hey represen he sources of shocks ha drive business cycles. They characerize hese wedges as produciviy 26

27 (Z for equaion (A.2, labor wages or labor axes ( τ l for equaion (A.3, invesmen wedges or capial axes ( τ k for equaion (A.4, and governmen consumpion wedges for equaion (A.5. These wedges reflec he sizes of he shocks o produciviy, he labor marke, he capial marke and domesic resources ha cause he economy o deviae from he balanced growh pah. The economy faces a posiive shock o produciviy if Z is greaer han one, whereas i faces a posiive shock o he labor and capial markes when axes ( τ l and τ k are negaive. By consrucion, inroducing all he wedges above will accoun for he observed dynamics of he business cycle. A2.2 Inerpreaion of he wedges in he conex of long-erm growh Wihin he conex of long-erm growh, I inerpre he labor wedge as an indicaor of he labor marke condiions and he invesmen wedge as an indicaor of he capial marke condiions. For example, I inerpre he declining labor (invesmen wedge series as improving he labor (capial marke condiions over ime. Similarly, a rising TFP implies ha he producion echnology has been improving. To implemen his diagnosic approach o sudy economic developmen raher han he business cycle, I regard Z as oal facor produciviy (TFP. I inerpre labor wedges ( τ l as an indicaor of labor marke condiions ha drive he economy away from he balanced growh pah for he res of he world (eiher higher or lower. As he diagnosic approach is preliminary, higher labor paricipaion over ime is regarded as negaive labor wedges in his exercise. Similarly, I inerpre invesmen wedges ( τ k as he capial marke condiions. Therefore, all he fricions in he capial marke, e.g., financial repression which impedes saving and invesmen aciviies, are couned as posiive invesmen wedges. Ideally, inroducing all he wedges above 27

28 will well mimic he rajecory of he economic ransiion since I endogenize facor prices in he model. Appendix 3: Daa Treamen In his secion, I briefly describe he daa used in he analysis: For all he NICs, as o he oupu (Y, I chose GDP as my base value for oupu since he economic shocks generally impac an economy according o geographical regions, raher han being based on naional boundaries. In addiion, he oupu I used in he analysis ha follows excludes he ne indirec ax (equivalen o Naional Income plus depreciaion since axes are no paymens for facor inpus. Thus, for real per capia oupu I used GDP minus indirec ax divided by working age populaion. For per capia consumpion, I used privae consumpion divided by working age populaion. For he capial sock, I used he perpeual invenory echnique for he sub-caegory of fixed capial formaion and adop he sub-caegory depreciaion rae assumed in Young (998:.3% for residenial srucure, 2.8% for non-residenial srucure, 3.4% for oher consrucion, 8.3% for ransporaion equipmen, and 4.0% for machinery. (p.30 To esimae he iniial capial sock, I followed he equaion I = ( δ + γ K. To avoid random bias, I ook he average of he gross fixed capial formaion in real erms for he firs hree years for which daa were available. The underlying assumpion is ha differen capial socks grow a he same rae as GDP in he iniial years and are represenaive of he invesmen prior o he ime series 7. I chose hree years raher han five years for he average so as o minimize he use of daa and allow longer periods of deprecaion for he iniial sock before 978. I also included ne foreign invesmen Gross Naional Saving minus Gross Domesic Fixed Capial Formaion in 7 This mehod is used in Harberger (

29 accumulaing he capial sock. The depreciaion rae I used for his ime series is 5% since his porion of capial is inernaional invesmen and would depreciae a a rae similar o capial in he res of he world. For he labor inpu, I used labor hours as he labor inpu in he model. In addiion o he absolue number of labor hours, an increase in he qualiy of human capial may mark up he effecive labor inpu. In he diagnosis, such an effec is viewed as a ax subsidy in he labor marke (negaive labor wedges. Anoher issue ha one may encouner when alking abou labor inpu concerns inersecoral ransfers of labor. The preliminary diagnosis will view ha as a produciviy improvemen. The daa for Hong Kong were aken from he Census and Saisics Deparmen (CSD, Hong Kong, Inernaional Labor Saisics (ILO, and he World Developmen Indicaors (WDI. There are some self-esimaed proxies for he daa for HKG: indirec ax, fixed capial formaion for ransporaion goods, and labor hours. The daa for indirec ax begins in 980. To exend he series o 978, I assumed ha he indirec ax rae was 4.04% 8 of GDP from 978 o 979. I also calculaed he domesic fixed capial formaion of ransporaion for HKG. I requesed he subcaegories of fixed capial formaion from CSD and he daa hey provided only included he daa for four subcaegories: residenial buildings, non-residenial buildings, oher consrucion, machinery and equipmen. I also obained he daa for domesic fixed capial formaion from WDI. I ook he difference beween domesic fixed capial formaion and he sum of he four caegories menioned above as he domesic fixed capial formaion for ransporaion equipmen. For he hours worked in he case of Hong Kong, I adoped he series from 985 o 2006 based on he daa from CSD. To exend he series o as early as 978, I referred o he daabase 8 This is he average raio of indirec ax o GDP from 980 o