How Asia Works

How Asia Works Plot Summary

Introduction

In the aftermath of World War II, a remarkable transformation began in East Asia that would challenge conventional economic wisdom and reshape global power dynamics. From the rice paddies of Japan to the rural villages of South Korea and Taiwan, a distinctive development model emerged that would lift hundreds of millions out of poverty and create some of the world's most dynamic economies. What made this "miracle" possible wasn't just industrialization, but a carefully sequenced strategy that began with agricultural reform and maintained strict control over financial systems while gradually building manufacturing capabilities. The East Asian development story offers crucial insights that contradict many standard economic prescriptions. While Western advisors often recommended rapid liberalization, privatization, and financial deregulation, successful East Asian economies followed a different path - one that combined strategic state intervention with market incentives. They demonstrated that land reform could create broad-based rural prosperity, that infant industries could become globally competitive through export discipline, and that controlled financial systems could direct capital toward productive investment rather than speculation. For policymakers, business leaders, and anyone interested in economic development, these lessons provide a powerful alternative to conventional models and reveal how nations can build sustainable prosperity from modest beginnings.

Chapter 1: Land Reform: The Cornerstone of Northeast Asian Development (1945-1960)

The story of East Asia's economic rise begins not with factories but with farms. In the aftermath of World War II, Japan, South Korea, and Taiwan implemented radical land reforms that fundamentally restructured their rural economies and laid the groundwork for subsequent industrialization. These reforms weren't merely administrative changes but represented a complete reimagining of agricultural production and rural society. The core principle behind these successful land reforms was remarkably simple yet revolutionary: take available agricultural land and divide it equitably among the farming population. In Japan, the American occupation under General MacArthur pushed through reforms that limited landholdings to 3 hectares, expropriating over one million landlords and creating approximately 2 million new landowners. South Korea followed a similar path after the Korean War, redistributing land from large landowners to small farmers with a 3-hectare limit per household. In Taiwan, the Kuomintang government implemented "land to the tiller" programs between 1949 and 1953, transferring ownership to those who actually worked the soil. The results were transformative. Agricultural productivity soared as farmers, now working their own land, had powerful incentives to maximize yields. Rice production in Taiwan increased by 40% in the decade following reform, while South Korean agriculture showed similar gains. This productivity explosion created rural purchasing power that fueled demand for basic manufactured goods, generated export earnings, and reduced the need for food imports. Taiwan's success was particularly remarkable - its agricultural goods dominated exports at the beginning of the country's development process, with farming households achieving yields 50% higher than plantation economies elsewhere in Asia. What made these reforms work wasn't just land redistribution but comprehensive government support. States invested heavily in rural infrastructure, agricultural extension services, and marketing support. The Japanese government provided an average of one agricultural extension worker per village. In Taiwan, the Joint Commission on Rural Reconstruction handled one-third of US aid between 1951 and 1965, running 6,000 projects that accounted for over half of net investment in farming. The contrast with Southeast Asia could not be more stark. Countries like the Philippines, Indonesia, Malaysia, and Thailand talked about land reform but never fundamentally restructured their rural economies. The Philippines produced more plans for land reform than any other Asian country, yet implementation was consistently undermined by powerful landowners. By 2006, compulsory land acquisition had affected just 300,000 hectares - only 2.5% of the country's cultivable land. The result has been persistent rural poverty, stagnant agricultural yields, and social instability that continues to this day. This divergence in agricultural policy would shape the development trajectories of Northeast and Southeast Asia for decades to come. Countries that created productive, equitable farming sectors established the essential foundation for subsequent industrial success. As economist Michael Lipton noted: "If you wish for industrialization, prepare to develop agriculture."

Chapter 2: Garden Economies: Small Farms and High Productivity (1950-1970)

The agricultural transformation of Northeast Asia challenges conventional economic wisdom about efficiency and scale. Traditional economic theory suggests that larger farms should be more efficient, yet the experience of Japan, Korea, Taiwan, and later China demonstrated the opposite - that small-scale, labor-intensive farming could achieve remarkably high yields and provide the foundation for rapid industrialization. These "garden-style" farms employed techniques that maximized output per unit of land rather than output per worker. Farmers planted crops densely, used targeted fertilization, practiced intercropping of plants with different maturities, and employed intensive manual cultivation methods. The results were yields that far exceeded those of larger plantations. In Taiwan, surveys before and after land reform showed an increase of more than 50% in work days invested in each hectare of land, translating directly to higher production. This approach proved effective even for cash crops traditionally associated with plantations. Sugar yield on small household farms in Taiwan or China was typically 50% higher than on plantations in the Philippines or Indonesia. In colonial Malaysia, surveys in the 1920s revealed that smallholder rubber yields were consistently higher than plantation ones - often by more than 50%. When British officials were forced to conduct yield surveys, they discovered smallholder rubber yields ranging between 600 and 1,200 pounds per acre per year, compared to plantation averages of around 400 pounds. The small farm model also provided crucial welfare benefits. In periods of economic downturn, laid-off factory workers could return to family farms. In Taiwan, an estimated 200,000 factory workers returned to farming during the first oil crisis in the mid-1970s. Similar temporary migrations occurred in Japan and later in China during economic slowdowns. This safety net function helped Northeast Asian countries avoid the squatter camps and urban poverty that characterized nations with larger-scale farming. Agricultural economist Klaus Deininger has spent decades assembling data showing how the nature of land distribution in poor countries predicts future economic performance. His research demonstrates that only one significant developing country has managed a long-term growth rate over 2.5% with very unequal land distribution - Brazil, which eventually collapsed in a debt crisis in the 1980s partly because of its failure to increase agricultural output. For Northeast Asian countries, the household farming model eventually reached its limits as industrial development progressed. As workers moved to better-paid industrial jobs, farming needed to shift toward larger, more mechanized operations. Japan, Korea, and Taiwan failed to make this transition smoothly, instead paying increasing subsidies to farmers to maintain rural incomes. By the 1970s, the Japanese government was paying farmers double the market price for rice, and by the mid-1970s, the average rural family was earning more than the average urban one. Despite these later policy missteps, the initial agricultural transformation provided the essential foundation for the region's industrial takeoff.

Chapter 3: Manufacturing Discipline: Export Requirements and Industrial Policy (1960-1980)

The second phase of East Asia's economic transformation centered on manufacturing. After agricultural reforms created rural prosperity and domestic markets for basic goods, governments in Japan, South Korea, Taiwan, and later China systematically directed investment and entrepreneurial talent toward industrial production - particularly manufacturing for export markets. This approach was not invented from thin air but borrowed from historical examples. Meiji Japan studied and copied the industrial policies of Germany, which had itself learned from the United States and Britain. The Japanese model then spread to Korea and Taiwan through colonial influence, and later to China. What these countries discovered was that manufacturing offered unique advantages for developing economies: it allowed a small number of entrepreneurs and technicians to employ large numbers of unskilled workers who could add value through machines, and it provided access to global markets where products could be sold freely. The key to success was what might be called "export discipline" - a policy of continually testing and benchmarking domestic manufacturers by forcing them to export their goods and face global competition. In Japan, tax breaks were determined by export performance. In Korea, firms reported export results monthly, which determined their access to bank credit. In Taiwan, everything from cash subsidies to preferential exchange rates was used to encourage exporters. This export requirement created a feedback mechanism that revealed which firms were approaching global standards and which were falling behind. Governments then improved returns on industrial policy through a second intervention - culling underperforming firms. In Japan, Korea, and Taiwan, the state didn't so much pick winners as weed out losers. Most of South Korea's top ten conglomerates (chaebol) of the mid-1960s had disappeared through forced mergers and bankruptcy by the mid-1970s, and half of the new group had vanished by the early 1980s. This Darwinian process ensured that only the most competitive firms survived and received continued state support. A third crucial intervention was bureaucratic support for successful exporters. Governments provided assistance with technology acquisition, often forcing foreign firms to transfer know-how in exchange for market access. When Japan's Ministry of International Trade and Industry told IBM in the late 1950s that it would block the company's business unless it licensed technology to local firms at a maximum 5% royalty, the American giant complied to maintain access to the Japanese market. The results were extraordinary. From 1952, Japanese manufacturing and mining output increased more than tenfold in just two decades. South Korea and Taiwan went from being the world's 33rd and 28th leading exporters in 1965 to 13th and 10th respectively twenty years later. Their exports exceeded those of all Latin American countries combined, and the ratio of light to heavy manufacturing shifted from 4:1 to 1:1 in just fifteen years. This industrial transformation established the foundation for East Asia's continued economic rise and demonstrated that developing countries could compete in global manufacturing markets through strategic policy intervention.

Chapter 4: State vs Entrepreneurs: Korea's Success and Malaysia's Failure (1970-1990)

The contrasting experiences of South Korea and Malaysia during the 1970s and 1980s illustrate the crucial difference between effective and ineffective industrial policy. Both countries started from similar positions in the early 1970s with comparable economic structures, yet their development paths diverged dramatically due to fundamentally different approaches to managing entrepreneurs and industrial learning. In South Korea, General Park Chung Hee seized power in 1961 and immediately established a new relationship between the state and business. Twelve days after his coup, Park began arresting scores of the country's leading entrepreneurs under a "Special Measure for the Control of Illicit Profiteering." Imprisoned businessmen were required to sign agreements stating: "I will donate all my property when the government requires it for national construction." This dramatic action established Park's authority and forced entrepreneurs to align with national development goals. Park then directed these entrepreneurs toward manufacturing for export, providing subsidies, protection, and credit to those who complied. The case of Chung Ju Yung, founder of Hyundai, exemplifies this transformation. Before Park's coup, Chung was merely a construction contractor who had never manufactured anything. Under Park's direction, he established his first factory in 1962, producing cement not just for domestic use but for export to Vietnam. By 1967, Chung had moved into automobile assembly and later shipbuilding, steel, and electronics - all with strong export orientation. The Korean state maintained relentless pressure on firms to export and improve technologically. When Chung promised to export 5,000 cars in Hyundai's first full production year (1976), he committed to a target that seemed impossible to his foreign managers. Yet this export discipline forced technological upgrades that would never have happened if the company manufactured only for protected domestic consumption. The government also fostered competition by licensing multiple firms in key sectors - Korea had three car manufacturers in 1973 despite a domestic market of just 30,000 vehicles annually. Malaysia under Mahathir Mohamad attempted to emulate Northeast Asia's success but made critical policy errors. After becoming prime minister in 1981, Mahathir announced a "Look East" policy to copy Japanese and Korean industrial development. He created the Heavy Industries Corporation of Malaysia (HICOM) to pursue investments in cement, steel, cars, motorcycles, shipbuilding, and other sectors. However, Mahathir neglected export discipline - the essential feedback mechanism that had driven Northeast Asian success. Without export requirements, Malaysian firms had no incentive to achieve global competitiveness. Instead of licensing multiple competing private firms, Mahathir preferred one-off investments in state enterprises, depriving himself of the power to cull underperformers. He also forced national champions into equity joint ventures with multinational firms, creating technological dependencies rather than indigenous capabilities. The results were disastrous. Malaysia's national steel company, Perwaja, absorbed billions of dollars in public money but never produced high-quality steel for industrial applications. The national car company, Proton, remained dependent on its Japanese partner Mitsubishi and struggled to compete internationally. Meanwhile, Malaysia's most capable private entrepreneurs were allowed to focus on protected domestic service sectors like telecommunications, power generation, and real estate rather than manufacturing for export. By the time of the Asian financial crisis in 1997, the contrast was stark: Korea had created globally competitive manufacturing giants like Hyundai, Samsung, and POSCO, while Malaysia had produced inefficient state enterprises and billionaire tycoons who contributed little to the country's technological development. This divergence demonstrates that industrial policy requires not just state support but also rigorous performance standards and competitive pressure.

Chapter 5: Financial Controls: Banking Systems That Served Development (1950-1997)

The financial systems of Northeast Asia played a crucial role in their developmental success, functioning not as independent profit centers but as tools for national economic transformation. From the 1950s through the 1990s, Japan, South Korea, and Taiwan all maintained strict control over their banking systems, directing capital toward strategic industrial priorities rather than short-term profit maximization. In Japan, the Ministry of Finance and the Bank of Japan worked in close coordination with MITI to ensure that capital flowed to priority sectors. Commercial banks were organized into keiretsu groups centered around the Bank of Japan's "window guidance" system, which allocated credit quotas to different sectors. Interest rates were kept artificially low for industrial borrowers, effectively subsidizing their growth. The system created what economists called "patient capital" - long-term financing that allowed companies to make investments with payback periods measured in decades rather than quarters. South Korea's financial controls were even more direct. After Park Chung Hee's 1961 coup, his government nationalized all commercial banks and used them as instruments of industrial policy. The Korean Development Bank became the primary channel for industrial financing, providing subsidized loans to chaebol that met export targets. Interest rates for exporters were often negative in real terms - effectively paying companies to borrow if they exported successfully. As one Korean economist noted, "The state used the banking system as a 'carrot and stick' to discipline private entrepreneurs." Taiwan maintained similar controls, though with greater emphasis on directing credit to state-owned enterprises. The Bank of Taiwan and other state-controlled financial institutions allocated capital according to the priorities established in successive industrial plans. Private banks existed but operated under strict government oversight. Capital controls prevented money from flowing abroad in search of higher returns, ensuring domestic savings remained available for industrial development. All three countries maintained strict capital controls that insulated their economies from volatile international financial flows. Foreign direct investment was carefully managed, with approval contingent on technology transfer and export commitments. Portfolio investment was severely restricted. These controls allowed Northeast Asian countries to maintain undervalued exchange rates that supported export competitiveness without fear of speculative attacks. The financial systems of Southeast Asia followed a dramatically different path. In the Philippines, banks were privatized in the 1950s and quickly became captive to powerful business families. The central bank's rediscounting facility, intended to support priority sectors, instead became a source of cheap funding for politically connected conglomerates. Under Ferdinand Marcos, banks owned by presidential cronies received preferential access to central bank funding without any performance requirements. Indonesia and Malaysia maintained greater state control over their banking systems but failed to impose the discipline that characterized Northeast Asian finance. Indonesian state banks directed credit to politically favored businesses rather than competitive exporters. Malaysia's development banks funded ambitious industrial projects without requiring export performance. In both countries, banks increasingly directed credit toward property development and stock market speculation rather than manufacturing. By the mid-1990s, the divergence between Northeast and Southeast Asian financial systems had created vastly different economic structures. In South Korea, 40% of bank lending went to manufacturing. In Malaysia and Thailand, the figure was less than 25%, with property development absorbing an ever-larger share. This difference would prove critical when financial crisis struck in 1997, revealing the fundamental weaknesses of premature financial liberalization.

Chapter 6: The Asian Financial Crisis: Testing Development Models (1997-2000)

The Asian Financial Crisis that erupted in July 1997 represented a watershed moment in East Asian development, exposing the fundamental weaknesses of premature financial liberalization while testing the resilience of different development models. What began as a currency crisis in Thailand quickly spread throughout Southeast Asia and eventually reached South Korea, triggering the region's worst economic downturn since World War II. The crisis had its roots in the financial liberalization policies that Southeast Asian countries had implemented since the late 1980s under pressure from the International Monetary Fund and the World Bank. Thailand, Indonesia, and Malaysia had all dismantled capital controls, deregulated their banking systems, and allowed massive inflows of short-term foreign capital. By 1997, Thailand's short-term foreign debt had reached alarming levels, while its current account deficit exceeded 8% of GDP. Indonesia had accumulated over $55 billion in short-term foreign debt, much of it unhedged against currency fluctuations. When speculative attacks forced Thailand to float the baht on July 2, 1997, the currency immediately lost 20% of its value. Panic spread to Indonesia, where the rupiah eventually lost 80% of its value, and to Malaysia, where the ringgit depreciated by 40%. The crisis revealed how financial liberalization without adequate regulatory frameworks had created banking systems dominated by connected lending, property speculation, and unsustainable foreign borrowing. In Indonesia, the crisis exposed the fragility of Suharto's crony capitalism. Banks owned by politically connected businessmen had directed the bulk of their lending to affiliated companies and real estate projects. When these loans went bad, the entire banking system collapsed. The Indonesian economy contracted by 13% in 1998, and social unrest eventually forced Suharto from power after 32 years of rule. South Korea, despite its stronger industrial base, was not immune to the crisis. Korean chaebol had borrowed heavily in foreign currency to fund aggressive expansion, often circumventing domestic credit controls through offshore subsidiaries. When foreign lenders refused to roll over short-term loans, Korea faced a severe liquidity crisis that forced it to seek an IMF bailout. The Korean economy contracted by 5.8% in 1998, and several major chaebol, including Daewoo, collapsed. The IMF's response to the crisis proved highly controversial. Its initial prescriptions - high interest rates, fiscal austerity, and accelerated financial liberalization - seemed to deepen rather than alleviate the crisis. Malaysia broke ranks with the IMF consensus by imposing capital controls in September 1998, a move that was widely criticized at the time but later acknowledged as having helped stabilize its economy. Taiwan, with its more conservative financial system and substantial foreign exchange reserves, weathered the storm with minimal damage. The Taiwanese economy continued to grow throughout the crisis, albeit at a reduced rate. This resilience validated Taiwan's cautious approach to financial liberalization and its emphasis on maintaining substantial foreign exchange reserves as insurance against external shocks. The crisis marked the end of Southeast Asia's high-growth era and forced a reassessment of development strategies throughout the region. It demonstrated that financial liberalization without strong regulatory institutions and a competitive manufacturing base created vulnerability rather than resilience. Countries like South Korea, which had built genuine industrial capabilities despite financial sector weaknesses, recovered more quickly than those whose growth had been driven primarily by real estate and services. The crisis thus reinforced the importance of building robust manufacturing sectors and maintaining prudent control over financial systems - core principles of the Northeast Asian development model.

Chapter 7: China's Path: Adapting the Northeast Asian Model (1978-2010)

China's economic transformation since 1978 represents the most recent and perhaps most significant variation on the East Asian development model. Under Deng Xiaoping's leadership, China embarked on a pragmatic reform path that combined elements of state direction with market incentives, creating what Chinese officials called a "socialist market economy" while drawing heavily on the experiences of its Northeast Asian neighbors. The foundation of China's economic miracle, like that of its Northeast Asian neighbors, began with agricultural reform. In the late 1970s, China dismantled the commune system and returned to household farming through what was called the "household responsibility system." Farmers were allowed to sell their surplus production after meeting state quotas, creating powerful incentives to increase productivity. Between 1978 and 1984, grain production increased by over 30%, releasing millions of workers for industrial employment while generating rural savings that could be channeled into investment. China's industrial development followed a more complex path than that of Japan or South Korea. Rather than focusing exclusively on large national champions, China pursued a multi-track approach. Township and Village Enterprises (TVEs) - collectively owned but entrepreneurially managed - drove the first wave of industrialization in the 1980s. These rural enterprises, often producing simple consumer goods and construction materials, created millions of jobs and demonstrated the productivity potential of market incentives. State-owned enterprises (SOEs) underwent gradual reform rather than wholesale privatization. Under Premier Zhu Rongji in the 1990s, China implemented a strategy of "grasp the large, let go of the small," consolidating strategic industries like steel, telecommunications, and energy into large state-controlled corporations while privatizing or closing thousands of smaller, inefficient SOEs. This pragmatic approach avoided the economic collapse that accompanied shock therapy in the former Soviet Union. China's financial system remained firmly under state control, with the "big four" state-owned commercial banks dominating the banking sector. The People's Bank of China and later the China Banking Regulatory Commission maintained strict oversight of lending practices and capital flows. Like its Northeast Asian predecessors, China used the banking system as a policy tool, directing credit toward strategic industries while maintaining capital controls that insulated the economy from volatile international flows. Foreign investment played a larger role in China's development than in Japan or South Korea, but was carefully managed to serve national objectives. Foreign companies were initially restricted to joint ventures and export processing zones, with approval contingent on technology transfer commitments. China leveraged its enormous domestic market to extract concessions from multinational corporations, requiring them to establish R&D centers and develop local supply chains. China's export discipline was enforced through a combination of incentives and requirements. Export-oriented firms received preferential access to credit, tax rebates, and subsidized land and utilities. The undervalued exchange rate effectively subsidized all exporters. State-owned trading companies coordinated export marketing and distribution, particularly in the early reform period. By the 2000s, China had emerged as the "world's factory," with manufacturing accounting for over 40% of GDP - a higher share than Japan or South Korea ever achieved. Chinese exports grew from $18 billion in 1980 to over $1.2 trillion by 2007. The country accumulated the world's largest foreign exchange reserves, reaching $2.4 trillion by 2009. Yet China's development model also created significant imbalances - rising inequality, environmental degradation, and excessive investment in heavy industry and infrastructure. These challenges have prompted ongoing reforms aimed at creating a more balanced and sustainable growth model while maintaining the core elements of state guidance that have driven China's remarkable rise.

Summary

The East Asian development experience reveals a remarkably consistent three-part formula for successful economic transformation that challenges conventional economic wisdom. This formula - beginning with agricultural reform that creates broad-based rural prosperity, followed by export-oriented manufacturing under strategic industrial policy, and supported by controlled financial systems that direct capital toward productive investment - has proven far more effective than the Washington Consensus policies of liberalization, privatization, and deregulation that dominated development thinking in the late 20th century. What distinguishes this approach from failed development strategies elsewhere is its pragmatic balance between state direction and market incentives. The state sets priorities and creates frameworks, but harnesses the energy and initiative of farmers and entrepreneurs to achieve its goals. Export discipline ensures that protected industries face international competition and continuously improve their capabilities. Financial controls prevent speculative bubbles and channel savings toward productive investment rather than consumption or real estate. For developing countries seeking paths to prosperity in the 21st century, the East Asian experience offers a powerful alternative to both state socialism and free-market fundamentalism - demonstrating that effective development requires not ideological purity but pragmatic policies tailored to each country's specific circumstances and stage of development.

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Joe Studwell

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