The Economic Transformation of East Asia During the Past Thirty Years

Tel: (852)3550-7070; Fax: (852)2104-6938 Email: lawrence@lawrencejlau.hk; WebPages: www.igef.cuhk.edu.hk/ljl *All opinions expressed herein are the author s own and do not necessarily reflect the views of any of the organizations with which the author is affiliated. The Economic Transformation of East Asia During the Past Thirty Years Lawrence J. Lau 刘遵义 Chairman, CIC International (Hong Kong) Co., Limited Ralph and Claire Landau Professor of Economics, The Chinese Univ. of Hong Kong and Kwoh-Ting Li Professor in Economic Development, Emeritus, Stanford University Thirtieth Anniversary Symposium Asia-Pacific Research Center, Stanford University Stanford, 2 nd May 2013

Outline Introduction The Shifting Center of Gravity of the World and East Asian Economies The Evolving Sources of East Asian Economic Growth Economic Development with Surplus Labor The Importance of Openness Concluding Remarks Lawrence J. Lau 2

Introduction East Asia as used here is defined as the 10 Association of Southeast Asian Nations (ASEAN)--Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vietnam--plus 3 (China, including Hong Kong, Macao and Taiwan), Japan, and the Republic of Korea). The objective is to illustrate the transformations that have occurred in the East Asian economy since 1980. The center of gravity of the World economy has been and still is in the process of shifting from the United States and Europe towards East Asia. Within the East Asian economy Lawrence J. Lau itself, the center of gravity 3 has also been shifting from Japan towards China.

Introduction The principal sources of East Asian economic growth have also gradually evolved from the growth of tangible inputs such as tangible capital, enabled by their high saving rates, and labor, to the growth of intangible inputs such as human capital, R&D capital, and reputational capital (goodwill and branding). East Asian economic development has also essentially followed the dual economy model of W. Arthur Lewis, based on the transfer of the surplus labor in the agricultural sector to be utilized more productively in the expanding non-agricultural (manufacturing, construction and service) sector. The openness of the East Asian economies to international Lawrence J. Lau 4 trade and investment is a critical feature of their success.

The Shifting Center of Gravity of the World and East Asian Economies: GDP In 1980, the United States and Western Europe together accounted for over 60% of World GDP. By comparison, East Asia accounted for less than 15% of World GDP. By 2012, the share of United States and the Euro Zone combined in World GDP has declined to approximately 45% whereas the share of East Asia has risen to 25%. The Japanese share of World GDP declined from a peak of 18% in the mid-1990s to 8% in 2012 while the Chinese share of World GDP rose from less than 2% in 1980 to over 10% in 2012. Since 1980, the rate of growth of the East Asian real GDP has always exceeded those of the U.S. and the Euro Zone except during the East Asian currency crisis of 1997-1998. Lawrence J. Lau 5

The Distribution of World GDP in 1980 and 2011 1980 2011 Mainland China Hong Kong 1.7% 0.3% Indonesia Brunei 0.7% Malaysia 0.0% Korea 0.2% Taiwan 0.6% Philippines 0.4% 0.3% Japan Singapore 9.9% 0.1% Other Economies 60.2% Thailand 0.3% United States 25.3% Mainland China Cambodia 10.5% Hong Kong 0.0% 0.4% Indonesia Brunei 1.2% 0.0% Korea 1.6% Lao 0.0% Macao 0.1% Japan Malaysia 8.4% Philippines Other Economies 0.4% 36.6% 0.3% Singapore 0.3% Euro Zone 17.4% Vietnam Thailand 0.2% 0.5% Taiwan United States 0.7% 21.5% Lawrence J. Lau 6

The Shares of East Asia, China, Japan and South Korea in World GDP, 1980-present 26 The Shares of East Asia, China, Japan and South Korea in World GDP, 1980-present 24 22 20 18 16 14 12 10 8 6 4 2 0 Lawrence J. Lau 7 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Percent East Asian Economies China Japan Korea

The Rates of Growth of Real GDP of East Asia, U.S. and the Euro Zone 8.0 7.0 The Rates of Growth of Real GDP of East Asia, U.S. and the Euro Zone East Asia U.S. Euro Area 6.0 5.0 4.0 3.0 Percent 2.0 1.0 0.0-1.0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012-2.0-3.0-4.0 Lawrence J. Lau 8-5.0

The Shifting Economic Center of Gravity: Economic Growth It is interesting to compare the average annual rates of growth of different economies decade by decade. China, India, and South Korea were among the fastest growing economies during the past four decades. Brazil grew very fast during the past decade because of the world natural resource boom. Russia also grew at a very high rate during the past decade because of its significant oil production and the high world price of oil. However, all the developed economies the U.S., Euro Zone, Japan, and the U.K. had relatively low and declining growth rates during the past decades. Lawrence J. Lau 9

Average Annual Rates of Growth of Real GDP of Selected Economies 14 12 Average Annual Rates of Growth of Real GDP of Selected Economies 1970-1980 1980-1990 1990-2000 2000-2011 10 8 6 Percent 4 2 0-2 United States Euro Zone Japan China Russian Federation India Brazil United Kingdom Korea, Rep. of -4-6 Lawrence J. Lau 10

The Shifting Economic Center of Gravity: Economic Growth In the following charts, the levels of real GDP and real GDP per capita in 1980 and 2011 are compared across economies. As a whole, East Asia has made tremendous progress in terms of real GDP. Chinese real GDP has increased the most since 1980 amongst East Asian economies, whereas Brunei real GDP has increased the least, followed by Japan. However, in terms of real GDP per capita, Brunei has fallen when compared to 1980; the Philippines and Japan have made relatively little progress; Macau, with a population of approximately half a million, has the highest real GDP per capita. Exceeding even that of the U.S. Note that Chinese real GDP per capita still lags behind many East Asian economies and is ahead of only Cambodia, Indonesia, Laos, Myanmar, Philippines, Thailand and Vietnam. Lawrence J. Lau 11

The Growth of Real GDP in East Asian Economies, 1980-2011 8 Real GDP of East Asian Economies in 1980 and 2011, in 2011 USD trillions 7 1980 2011 6 5 USD trillions 4 3 2 1 0 Brunei Cambodia China Hong Kong Indonesia Japan Korea Laos Macao Lawrence J. Lau, The Lawrence Chinese J. University Lau of Hong Kong 12 Malaysia Philippines Singapore Thailand Vietnam Taiwan, China

The Growth of Real GDP in East Asian Economies, 1980-2011 (cont.) 1,200 Real GDP of East Asian Economies in 1980 and 2011, in 2011 USD billions 1,000 1980 2011 800 USD billions 600 400 200 0 Brunei Cambodia Hong Kong Indonesia Korea Laos Macao Malaysia Lawrence J. Lau, The Lawrence Chinese J. University Lau of Hong Kong 13 Philippines Singapore Thailand Vietnam Taiwan, China

The Growth of Real GDP per Capita in East Asian Economies, 1980-2011 80 Real GDP per Capita of East Asian Economies in 1980 and 2011, in 2011 USD thousands 70 1980 2011 60 50 USD thousands 40 30 20 10 0 Brunei Cambodia China Hong Kong Indonesia Japan Korea Laos Macao Lawrence J. Lau, The Lawrence Chinese J. University Lau of Hong Kong 14 Malaysia Philippines Singapore Thailand Vietnam Taiwan, China

The Shifting Economic Center of Gravity: International Trade In 1980, the United States and Western Europe together accounted for over 60% of World trade. By comparison, East Asia accounted for less than 10% of World trade. By 2011, the share of United States and Western Europe combined in World trade has declined to below 45% whereas the share of East Asia has risen to 30%. The Chinese share of World trade rose from less than 1% in 1980 (in fact, it was also 1% in 1950) to 10% in 2011. Chinese share of East Asian international trade also arose from 5% in 1980 to 40% in 2011. Lawrence J. Lau 15

The Distribution of Total International Trade in Goods and Services, 1980 The Distribution of Total International Trade in Goods and Services in 1980 United States 12.1% China 0.9% Hong Brunei 0.1% Kong 1.1% Japan 6.5% Indonesia 0.9% Korea 1.0% Malaysia 0.6% Philippines 0.4% Singapore 1.0% Thailand 0.4% Other Economies 75.1% Lawrence J. Lau 16

The Distribution of Total International Trade in Goods and Services, 2011 The Distribution of Total International Trade in Goods and Services in 2011 Euro Zone 22.8% Brunei 0.0% Cambodia 0.0% China 9.7% Hong Kong 2.5% Japan 4.2% Indonesia 1.0% Korea 2.8% Lao 0.0% Macao 0.1% Malaysia 1.1% United States 10.8% Other Economies 39.3% Philippines 0.3% Singapore 2.1% Taiwan, China 1.5% Vietnam 0.5% Thailand 1.2% Lawrence J. Lau 17

The Shifting Economic Center of Gravity: International Trade In the trade share charts, data are missing for the following East Asian economies and years: Brunei: 1984-1988; Cambodia: 1980-1987; Laos: 1980-1983; Macao: 1980-1981; Vietnam: 1980-1985; and Myanmar: no data. Lawrence J. Lau 18

The Rising Share of East Asian Trade in Total World Trade, 1960-present 35 The Rising Share of East Asian Trade in Total World Trade, 1960-present 30 25 20 Percent 15 10 Share of World Exports Share of World Imports Share of Total World Trade 5 0 Lawrence J. Lau 19 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

The Share of China in Total World Trade, 1950-present 12 11 10 9 The Share of Chinese Trade in Total World Trade, 1950-present The ratio of Chinese Exports to World Exports The ratio of Chinese Imports to World Imports The ratio of Chinese Total Trade to World Total Trade 8 7 Percent 6 5 4 3 2 1 0 Lawrence J. Lau 20 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

The Share of China in Total East Asian Trade, 1952-present 45 40 35 TheShare of Chinese Trade in Total East Asian Trade, 1952-present The Ratio of Chinese Exports to East Asian Exports The Ratio of Chinese Imports to East Asian Imports The Ratio of Chinese Total Trade to East Asian Total Trade 30 25 Percent 20 15 10 5 0 Lawrence J. Lau, The Lawrence Chinese J. University Lau of Hong Kong 21 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

The Shifting Economic Center of Gravity: Growth of International Trade South Korea, and more recently, China, India, Brazil and Russia, have had the highest rates of growth in international trade. Growth in Chinese international trade was particularly rapid during the past decade because of its accession to the World Trade Organisation (WTO) in 2000 and because of the expiration of the Multi-Fibre Arrangement governing world trade in textiles in 2005. Brazil, Russia, and India also had exceptionally high growth in their international trade during the past decade. However, all the developed economies the U.S., the Euro Zone, Japan, and the U.K. had relatively low and declining rates of growth of international trade during the Lawrence J. Lau 22 past decades.

Percent Average Annual Rate of Growth of Total International Trade in Goods and Services Average Annual Rates of Growth of Total Real Trade in Goods and Services, in 2000 USD 0 1971-1980 1980-1990 1990-2000 2000-2011 5 0 5 0 United States Euro Zone Japan China Russian Federation India Brazil United Kingdom Korea, Rep. of Lawrence J. Lau 23-5

The Shifting Economic Center of Gravity: Foreign Exchange Reserves Today, the People s Bank of China, China s central bank, has the World s largest official foreign exchange reserves, in excess of US$3.44 trillion, almost all of which has been acquired during the past decade, followed by Japan with US$1.22 trillion. The People s Bank of China is also currently the World s largest holder of U.S. Treasury securities, with not quite US$1.3 trillion (US$1.26 trillion in Jan. 2013), followed by Japan as a very close second (US$1.12 trillion in Jan. 2013). Lawrence J. Lau 24

Total Official Foreign Exchange Reserves minus Gold, East Asian Economies Total Official Foreign Exchange Reserves minus Gold, East Asian Economies, USD trillions 3.5 3.0 2.5 Brunei Hong Kong Indonesia Lao Myanmar Singapore Vietnam Mainland China Cambodia Macao Korea Malaysia Philippines Thailand Taiwan Japan 2.0 1.5 1.0 0.5 0.0 Lawrence J. Lau 25 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 USD trillions

Total Official Foreign Exchange Reserves minus Gold, East Asian Economies (cont.) 450 Total Official Foreign Exchange Reserves minus Gold, East Asian Economies, USD billions Brunei Cambodia USD billions 400 350 300 250 200 Hong Kong Indonesia Lao Myanmar Singapore Vietnam Macao Korea Malaysia Philippines Thailand Taiwan 150 100 50 0 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 Lawrence J. Lau 26 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

East Asian Central Banks Holdings of U.S. Treasury Securities 1,400 East Asian Central Bank's Holdings of U.S. Treasury Securities, USD billions 1,200 1,000 Brunei Mainland China Indonesia Korea Macau Philippines Taiwan Vietnam Cambodia Hong Kong Japan Laos Malaysia Singapore Thailand USD billions 800 600 400 200 0 Lawrence J. Lau 27 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Major Foreign Central Banks Holdings of U.S. Treasury Securities (cont.) East Asian Central Bank's Holdings of U.S. Treasury Securities, USD billions 250 Brunei Cambodia Hong Kong Indonesia Korea Laos 200 Macau Malaysia Philippines Singapore Taiwan Thailand Vietnam 150 USD billions 100 50 0 28

The Shifting Economic Center of Gravity: Stock Market Capitalization Today, the market capitalization of all East Asian stock exchanges combined is ahead of the market capitalization of all the European stock exchanges combined and equal to approximately 70% of the market capitalization of all U.S. stock exchanges. The market capitalization of the Japanese stock exchanges, which used to constitute the bulk of the market capitalization of East Asian stock exchanges, is now only its 30%. The market capitalization of Chinese stock exchanges have caught up with that of Japanese stock exchanges. Lawrence J. Lau 29

Exchanges: U.S.A.: NASDAQ and NYSE Europe: Athens Exchange, BME Spanish Exchanges, Budapest SE, Cyprus SE, Deutsche Borse, Irish SE, London SE group, Luxembourg SE, NYSE Euronext (Europe), Oslo Bors, SIX Swiss Exchange East Asia: Bursa Malaysia, Hong Kong Exchanges, Indonesia SE, Korea Exchange, Osaka SE, Philippine SE, Shanghai SE, Shenzhen SE, Singapore Exchange, Taiwan SE, Thailand SE, Tokyo SE Group Data source: World Federation of Exchanges Market Capitalization of Stock Exchanges Year End 2011 and 2012 (US$ trillion) 2011 2012 U.S.A. 15.6 18.7 Europe 9.5 10.4 East Asia 12.4 14.4

End of Year Market Capitalization of East Asian Stock Exchanges 6 5 End of Year Market Capitalisation of East Asian Stock Exchanges, USD trillions Bursa Malaysia Hong Kong Exchanges Indonesia SE Korean Exchange Philippine SE Singapore Exchange Taiwan SE Corp. Thailand SE Shanghai+Shenzhen SE Tokyo+Osaka SE 4 USD trillions 3 2 1 0 Lawrence J. Lau 31 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

The Shifting Economic Center of Gravity: The Partial De-Coupling Hypothesis Throughout the 2007-2009 global financial crisis, the East Asian economies and the economies of the BRICS countries (Brazil, Russia, India, China and South Africa) continued to do reasonably well. China, in particular, was able to maintain its real rate of growth above 7.5%, lending credence to the Partial De-Coupling Hypothesis, that is, the Chinese and East Asian economies can continue to grow, albeit at a slower rate, even as the U.S. and European economies go into economic recession. This partial de-coupling can occur because of the gradual shift in the economic center of gravity of the World economy from the United States and Western Europe to Asia (including both East Lawrence Asia J. Lau and South Asia) over the 32 past three decades.

The Evolving Sources of East Asian Economic Growth East Asian economic growth has been led by the industrialisation of Japan in the immediate post-world War II period, followed successively by Hong Kong, Singapore, Taiwan, South Korea and then Malaysia and Thailand and then China. Industrialisation has also begun to spread to Indonesia, Vietnam, Cambodia and even Myanmar. Kim and Lau (1994a, 1994b) found that the high rate of economic growth of the East Asian newly industrialized economies Hong Kong, South Korea, Singapore and Taiwan in the post-world War II period was mostly the result of the growth of tangible inputs--tangible capital and labor--and not technical progress or equivalently the increase in total factor productivity. Lawrence J. Lau 33

The Evolving Sources of East Asian Economic Growth By contrast, the economic growth of the developed Groupof-Five (G-5) countries France, West Germany, Japan, the United Kingdom and the United States--was mostly attributable to technical progress. These empirical results, as well as those of Alwyn Young s (1994, 1995), form the basis of Paul Krugman s (1994) provocative article on the The Myth of the East Asian Miracle. Krugman s interpretation of these results is very pessimistic according to Krugman, because of the absence of technical progress, economic growth in these East Asian NIEs is bound to slow down and come to a halt eventually as a result of the diminishing returns to additional capital accumulation. Lawrence J. Lau 34

The Evolving Sources of East Asian Economic Growth And of the tangible inputs, the growth of capital was the most important source. This has been enabled by the high domestic saving rates of the East Asian economies. Foreign direct investment (FDI), foreign aid and foreign loans were also helpful in augmenting the domestic savings at the beginning stage of the economic development of the East Asian economies. The initially low national saving rates of the East Asian economies rose quickly as real GDPs per capita increased in the East Asian economies, providing the resources for continued investment in their own economies (see the following charts). Lawrence J. Lau 35

Savings Rates of Selected Asian Economies (1952-present) Savings Rates of Selected East Asian Economies 60 China, Mainland Hong Kong India Indonesia Japan Korea Malaysia Philippines 50 Singapore Taiwan Thailand 40 Percent 30 20 10 0 Lawrence J. Lau 36 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Savings Rates of Selected Asian Economies (1980-present) Savings Rates of Selected Asian Economies 60 China,Mainland Hong Kong India Indonesia 55 Japan Korea Malaysia Philippines 50 Singapore Taiwan Thailand 45 40 Percent 35 30 25 20 15 10 Lawrence J. Lau 37 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

The Savings Rate and Real GDP per Capita: East Asian Economies 60 50 40 Percent 30 China Hong Kong Indonesia Japan Korea, Rep. Malaysia Philippines Singapore Taiwan Thailand National Savings Rate and Real GDP per Capita 20 10 0 10 100 Real GDP per 1,000 Capita, in 2000 US$ 10,000 100,000

The Evolving Sources of East Asian Economic Growth The absence of measured technical progress in the East Asian developing economies at the early stage of their development is the result of the lack of investment in intangible capital (including human capital and R&D capital). Since the 1980s, investment in intangible capital has risen sharply in some of the East Asian economies. This is reflected in rising enrolment rates at all levels of education as well as expenditures on R&D as a ratio of GDP. Beginning in the mid-1980s, evidence of positive measured technical progress can be found in the East Asian newly industrialized economies (NIEs), and that the measured technical progress can be largely attributed to the growth of stocks of human capital and R&D capital in these economies. Lawrence J. Lau 39

The Evolving Sources of East Asian Economic Growth Table 3.4: Growth Accounts: Contributions of the Sources of Growth (Two-Input Model) Tangible Capital Labor Technical Progress (1) Full Sample : 4 NIEs and G-5 Hong Kong 74.46 25.54 0.00 South Korea 78.20 21.80 0.00 Singapore 64.80 35.20 0.00 Taiwan 84.04 15.96 0.00 Japan 49.90 4.84 45.26 Non-Asian G-5 Countries 38.71 2.77 58.52 (2) Full Sample: 4 NIEs, 4 ASEAN, China and G-5 Hong Kong 74.61 25.39 0.00 South Korea 82.95 17.05 0.00 Singapore 63.41 36.59 0.00 Taiwan 86.60 13.40 0.00 Indonesia 88.79 11.21 0.00 Malaysia 66.68 33.32 0.00 Philippines 66.10 33.90 0.00 Thailand 83.73 16.27 0.00 China 94.84 5.16 0.00 Japan 55.01 3.70 41.29 Non-Asian G-5 Countries 41.51 1.97 Lawrence 56.53 J. Lau 40

Change from Tangible to Intangible Capital-Driven Growth In the late 1980s and early 1990s, the growth of intangible capital (human capital and R&D capital) has begun to be an important source of economic growth of South Korea, Singapore and Taiwan supplanting the growth of tangible capital. Lawrence J. Lau 41

The Evolving Sources of East Asian Economic Growth Table 6.4 Growth Accounts: Contributions of the Sources of Growth (Percent) (Four-Input Model with Human Capital and R&D Capital) Sample Period Tangible Capital Labor Human Capital R&D Capital Technical Progress South Korea 67-95 60.12 14.23 1.75 23.90 0.00 Singapore 77-95 50.44 23.90 1.30 24.35 0.00 Taiwan 78-95 55.85 11.25 1.14 31.76 0.00 Japan 64-94 42.40 5.24 0.72 17.08 34.56 Non-Asian G-7 Countries 65-94 32.52 3.72 1.16 14.90 47.69 Lawrence J. Lau 42

Intangible Capital-Driven Growth Sustained investment in research and development (R&D) is essential for technical progress in an economy. In the following chart, the ratio of R&D expenditure to GDP across economies are compared over time. It may be noted that the East Asian economies all started with a relatively low ratio in the early years, but these ratios have been rising over time. Japan, South Korea and Taiwan now invest a higher percentage of their GDP in R&D than the U.S. and other developed economies. Lawrence J. Lau 43

R&D Expenditures as a Ratio of GDP: G-7 Countries, 4 East Asian NIES & China 3.5 3 R&D Expenditures as a Percentage of GDP: G-7 Countries, 4 East Asian NIEs and China U.S. Japan W. Germany U.K. France Canada Italy South Korea Singapore Taiwan China Hong Kong 2.5 2 1.5 1 0.5 0 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Percent

Intangible Capital-Driven Growth One indicator of the potential for technical progress (national innovative capacity) is the number of patents created each year. In the following chart, the number of patents granted in the United States each year to the nationals of different countries, including the U.S. itself, over time is presented. The U.S. is the undisputed champion over the past forty years, with more than 120,000 patents granted in 2011, followed by Japan, with approximately 48,000. (Since these are patents granted in the U.S., the U.S. may have a home advantage; however, for all the other countries, the comparison across them should be fair.) Lawrence J. Lau 45

Patents Granted in the U. S.: G-7 Countries, 4 East Asian NIEs & China Patents Granted Annually in the United States: G7 Countries, 4 East Asian NIEs and China 1,000,000 100,000 10,000 1,000 100 10 1 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Number of Patents US Japan W. Germany U.K. France Canada Italy South Korea Hong Kong Singapore Taiwan China

Intangible Capital-Driven Growth The stock of R&D capital, defined as the cumulative past real investment in R&D less depreciation of 10% per year, can be shown to have a direct causal relationship to the number of patents granted (see the following chart, in which the number of patents granted is plotted against the R&D capital stock for each country and each year). Lawrence J. Lau 47

Patents Granted in the United States and R&D Capital Stocks, Selected Economies 1,000,000 The Number of U.S. Patents Granted Annually vs. R&D Capital Stocks 100,000 10,000 Number of Patents 1,000 100 10 US Japan West Germany UK France Canada Italy South Korea Singapore China Hong Kong Taiwan 1 0 1 10 100 1,000 10,000 Billions of 2005 Constant U.S. Dollars

Economic Development with Surplus Labor East Asian economic development proceeded along the lines of W. Arthur Lewis s model of surplus labor, first introduced in his 1954 article, "Economic Development with Unlimited Supplies of Labour, published in the Manchester School. In almost every successfully developed East Asian economy, from Japan to Hong Kong to Taiwan to South Korea to China and Southeast Asia, development began with the expanded employment of the surplus labor from the agricultural sector in the non-agricultural sectors. One important implication is that as the economy develops, the shares of GDP and employment originating from the nonagricultural sectors will rise and the corresponding shares of the agricultural sector will fall. And increased urbanization is likely to accompany the growth of the non-agricultural sectors. Chinese data are presented Lawrence as an J. example Lau below. 49

The Distribution of Chinese GDP by Sector Since 1952 The Distribution of GDP by Sector 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Lawrence J. Lau 50 Primary Sector Secondary Sector Tertiary Sector

The Distribution of Chinese Employment by Sector Since 1952 100% The Distribution of Employment by Sector since 1952 80% 60% 40% 20% 0% 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Lawrence J. Lau 51 Primary Sector Secondary Sector Tertiary Sector

The Shares of Rural and Urban Population in China, 1949-Present 100% The Shares of Rural and Urban Populations in China 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Urban population Rural Population

The Importance of Openness The successfully developed East Asian economies all adopted an economic policy of openness: Opening the economy to the World promoting both exports and imports of goods and services (and shifting from a purely import substitution development strategy); Rationalizing (devaluing) the exchange rate to a level that reflects relative productivities with competitors and potential competitors; Removing barriers to the imports of raw materials, components and parts and equipment used in export industries, thus enabling the growth of exports (exportprocessing zone, pioneered by Taiwan, is an often-used device); Adopting current accounts convertibility; Lawrence J. Lau 53

The Importance of Openness Attracting foreign direct investment (FDI), which brings with it not just capital, but also technology, markets, know-how and new business models. FDI also directly augments the initially low level of domestic savings. It can also augment aggregate demand and increase employment. The evolutions of exchange rates over time in Mainland China and Taiwan are presented in the charts below as illustrations of the devaluation at the beginning of the process of opening to the World. One implication of the adoption of the openness policy is the rising share of exports in GDP. Lawrence J. Lau 54

Nominal Exchange Rate of the Renminbi, Yuan/US$, 1978-present Nominal Exchange Rate of the Renminbi, Yuan/US$, 1978-present 10 9 8 7 6 5 4 3 2 1 0 Jan-78 Jul-78 Jan-79 Jul-79 Jan-80 Jul-80 Jan-81 Jul-81 Jan-82 Jul-82 Jan-83 Jul-83 Jan-84 Jul-84 Jan-85 Jul-85 Jan-86 Jul-86 Jan-87 Jul-87 Jan-88 Jul-88 Jan-89 Jul-89 Jan-90 Jul-90 Jan-91 Jul-91 Jan-92 Jul-92 Jan-93 Jul-93 Jan-94 Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 55 Jan-12 Jul-12

The New Taiwan Dollar/U.S. Dollar Nominal Exchange Rate, Annual Average 45 Annual Average Exchange Rate of New Taiwan Dollar versus the U.S. Dollar 40 35 30 25 20 15 10 5 0 Lawrence J. Lau 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 56

The Importance of Openness Maintaining an open economy has the following additional advantages: FDI and foreign loans can augment the domestic savings. Exporting also enhances the ability to attract foreign direct investment and foreign loans because the foreign exchange earnings derived from exports enables the eventual repatriation of the principal, interest and profits to the foreign direct investors and lenders. Exports generate the foreign exchange revenue that can be used to import raw materials, components and parts, and equipment needed for production and investment. Exports and imports can generate readily collectible revenue for the government that can be used for the construction of infrastructure and basic education. Lawrence J. Lau 57

Exports as a Share of GDP in East Asian Economies 250 Exports as a Share of GDP of East Asian Economies 1980 1990 2011 200 150 Percentage 100 50 0 Brunei Darussalam Cambodia China Hong Kong SAR, China Indonesia Japan Korea, Rep. Lao PDR Macao SAR, China Lawrence J. Lau Malaysia Myanmar Philippines Singapore Thailand Vietnam 58 Taiwan, China

Concluding Remarks The center of gravity of the World economy has been shifting towards East Asia. The center of gravity of the East Asian economy has been shifting towards China. The East Asian economy has been partially de-coupled from the United States and Europe. Intangible capital (human capital and R&D capital) has been gradually supplanting tangible inputs (physical capital and labor) as an important source of growth in some East Asian economies such as South Korea, Singapore and Taiwan. Openness to international trade and investment and the continuing expansion of the non-agricultural sectors through the utilization of surplus labor are common features of the development experience of successful East Asian economies. Lawrence J. Lau 59