THE TEMASEK REVIEW

By Paul Krugman writing for MIT

A CAUTIONARY FABLE

ONCE UPON a time, Western opinion leaders found themselves both impressed and frightened by the extraordinary growth rates achieved by a set of Eastern economies. Although those economies were still substantially poorer and smaller than those of the West, the speed with which they had transformed themselves from peasant societies into industrial powerhouses, their continuing ability to achieve growth rates several times higher than the advanced nations, and their increasing ability to challenge or even surpass American and European technology in certain areas seemed to call into question the dominance not only of Western power but of Western ideology. The leaders of those nations did not share our faith in free markets or unlimited civil liberties. They asserted with increasing self confidence that their system was superior: societies that accepted strong, even authoritarian governments and were willing to limit individual liberties in the interest of the common good, take charge of their economics, and sacrifice short-run consumer interests for the sake of long-run growth would eventually outperform the increasingly chaotic societies of the West. And a growing minority of Western intellectuals agreed.

The gap between Western and Eastern economic performance eventually became a political issue. The Democrats recaptured the White House under the leadership of a young, energetic new president who pledged to “get the country moving again”–a pledge that, to him and his closest advisers, meant accelerating America’s economic growth to meet the Eastern challenge.

The time, of course, was the early 1960s. The dynamic young president was John F. Kennedy. The technological feats that so alarmed the West were the launch of Sputnik and the early Soviet lead in space. And the rapidly growing Eastern economies were those of the Soviet Union and its satellite nations.

While the growth of communist economics was the subject of innumerable alarmist books and polemical articles in the 1950s, Some economists who looked seriously at the roots of that growth were putting together a picture that differed substantially from most popular assumptions. Communist growth rates were certainly impressive, but not magical. The rapid growth in output could be fully explained by rapid growth in inputs: expansion of employment, increases in education levels, and, above all, massive investment in physical capital. Once those inputs were taken into account, the growth in output was unsurprising–or, to put it differently, the big surprise about Soviet growth was that when closely examined it posed no mystery.

This economic analysis had two crucial implications. First, most of the speculation about the superiority of the communist system including the popular view that Western economics could painlessly accelerate their own growth by borrowing some aspects of that system–was off base. Rapid Soviet economic growth was based entirely on one attribute: the willingness to save, to sacrifice current consumption for the sake of future production. The communist example offered no hint of a free lunch.

Second, the economic analysis of communist countries’ growth implied some future limits to their industrial expansion–in other words, implied that a naive projection of their past growth rates into the future was likely to greatly overstate their real prospects. Economic growth that is based on expansion of inputs, rather than on growth in output per unit of input, is inevitably subject to diminishing returns. It was simply not possible for the Soviet economies to sustain the rates of growth of labor force participation, average education levels, and above all the physical capital stock that had prevailed in previous years. Communist growth would predictably slow down, perhaps drastically.

Can there really be any parallel between the growth of Warsaw Pact nations in the 1950s and the spectacular Asian growth that now preoccupies policy intellectuals? At some levels, of course, the parallel is far-fetched: Singapore in the 1990s does not look much like the Soviet Union in the 1950s, and Singapore’s Lee Kuan Yew bears little resemblance to the U.S.S.R.’s Nikita Khrushchev and less to Joseph Stalin. Yet the results of recent economic research into the sources of Pacific Rim growth give the few people who recall the great debate over Soviet growth a strong sense of déjà vu. Now, as then, the contrast between popular hype and realistic prospects, between conventional wisdom and hard numbers, remains so great that sensible economic analysis is not only widely ignored, but when it does get aired, it is usually dismissed as grossly implausible.

Popular enthusiasm about Asia’s boom deserves to have some cold water thrown on it. Rapid Asian growth is less of a model for the West than many writers claim, and the future prospects for that growth are more limited than almost anyone now imagines. Any such assault on almost universally held beliefs must, of course, overcome a barrier of incredulity. This article began with a disguised account of the Soviet growth debate of 30 years ago to try to gain a hearing for the proposition that we may be revisiting an old error. We have been here before. The problem with this literary device, however, is that so few people now remember how impressive and terrifying the Soviet empire’s economic performance once seemed. Before turning to Asian growth, then, it may be useful to review an important but largely forgotten piece of economic history.

‘WE WILL BURY YOU’

LIVING IN a world strewn with the wreckage of the Soviet empire, it is hard for most people to realize that there was a time when the Soviet economy, far from being a byword for the failure of socialism, was one of the wonders of the world–that when Khrushchev pounded his shoe on the U.N. podium and declared, “We will bury you,” it was an economic rather than a military boast. It is therefore a shock to browse through, say, issues of Foreign Affairs from the mid 1950s through the early 1960s and discover that at least one article a year dealt with the implications of growing Soviet industrial might.

Illustrative of the tone of discussion was a 1957 article by Calvin B. Hoover. Like many Western economists, Hoover criticized official Soviet statistics, arguing that they exaggerated the true growth rate. Nonetheless, he concluded that Soviet claims of astonishing achievement were fully justified: their economy was achieving a rate of growth “twice as high as that attained by any important capitalistic country over any considerable number of years [and] three times as high as the average annual rate of increase in the United States.” He concluded that it was probable that “a collectivist, authoritarian state” was inherently better at achieving economic growth than free-market democracies and projected that the Soviet economy might outstrip that of the United States by the early 1970s.

These views were not considered outlandish at the time. On the contrary, the general image of Soviet central planning was that it might be brutal, and might not do a very good job of providing consumer goods, but that it was very effective at promoting industrial growth. In 1960 Wassily Leontief described the Soviet economy as being “directed with determined ruthless skill”–and did so without supporting argument, confident he was expressing a view shared by his readers.

Yet many economists studying Soviet growth were gradually coming to a very different conclusion. Although they did not dispute the fact of past Soviet growth, they offered a new interpretation of the nature of that growth, one that implied a reconsideration of future Soviet prospects. To understand this reinterpretation, it is necessary to make a brief detour into economic theory to discuss a seemingly abstruse, but in fact intensely practical, concept: growth accounting.

ACCOUNTING FOR THE SOVIET SLOWDOWN

IT IS A TAUTOLOGY that economic expansion represents the sum of two sources of growth. On one side are increases in “inputs”: growth in employment, in the education level of workers, and in the stock of physical capital (machines, buildings, roads, and so on). On the other side are increases in the output per unit of input; such increases may result from better management or better economic policy, but in the long run are primarily due to increases in knowledge.

The basic idea of growth accounting is to give life to this formula by calculating explicit measures of both. The accounting can then tell us how much of growth is due to each input–say, capital as opposed to labor–and how much is due to increased efficiency.

We all do a primitive form of growth accounting every time we talk about labor productivity; in so doing we are implicitly distinguishing between the part of overall national growth due to the growth in the supply of labor and the part due to an increase in the value of goods produced by the average worker. Increases in labor productivity, however, are not always caused by the increased efficiency of workers. Labor is only one of a number of inputs; workers may produce more, not because they are better managed or have more technological knowledge, but simply because they have better machinery. A man with a bulldozer can dig a ditch faster than one with only a shovel, but he is not more efficient; he just has more capital to work with. The aim of growth accounting is to produce an index that combines all measurable inputs and to measure the rate of growth of national income relative to that index–to estimate what is known as “total factor productivity.”

So far this may seem like a purely academic exercise. As soon as one starts to think in terms of growth accounting, however, one arrives at a crucial insight about the process of economic growth: sustained growth in a nation’s per capita income can only occur if there is a rise in output per unit of input.

Mere increases in inputs, without an increase in the efficiency with which those inputs are used–investing in more machinery and infrastructure–must run into diminishing returns; input-driven growth is inevitably limited.

How, then, have today’s advanced nations been able to achieve sustained growth in per capita income over the past 150 years? The answer is that technological advances have lead to a continual increase in total factor productivity–a continual rise in national income for each unit of input. In a famous estimate, MIT Professor Robert Solow concluded that technological progress has accounted for 80 percent of the long-term rise in U.S. per capita income, with increased investment in capital explaining only the remaining 20 percent.

When economists began to study the growth of the Soviet economy, they did so using the tools of growth accounting. Of course, Soviet data posed some problems. Not only was it hard to piece together usable estimates of output and input (Raymond Powell, a Yale professor, wrote that the job “in may ways resembled an archaeological dig”), but there were philosophical difficulties as well. In a socialist economy one could hardly measure capital input using market returns, so researchers were forced to impute returns based on those in market economies at similar levels of development. Still, when efforts began, researchers were pretty sure about what they would find. Just as capitalist growth had been based on growth in both inputs and efficiency, with efficiency the main source of rising per capita income, they expected to find that rapid Soviet growth reflected both rapid input growth and rapid growth in efficiency.

But what they actually found was that Soviet growth was based on rapid growth inputs–end of story. The rate of efficiency growth was not only unspectacular, it was well below the rates achieved in Western economies. Indeed, by some estimates, it was virtually nonexistent.

The immense Soviet efforts to mobilize economic resources were hardly news. Stalinist planners had moved millions of workers from farms to cities, pushed millions of women into the labor force and millions of men into longer hours, pursued massive programs of education, and above all plowed an ever-growing proportion of the country’s industrial output back into the construction of new factories. Still, the big surprise was that once one had taken the effects of these more or less measurable inputs into account, there was nothing left to explain. The most shocking thing about Soviet growth was its comprehensibility.

This comprehensibility implied two crucial conclusions. First, claims about the superiority of planned over market economies turned out to be based on a misapprehension. If the Soviet economy had a special strength, it was its ability to mobilize resources, not its ability to use them efficiently. It was obvious to everyone that the Soviet Union in 1960 was much less efficient than the United States. The surprise was that it showed no signs of closing the gap.

Second, because input-driven growth is an inherently limited process, Soviet growth was virtually certain to slow down. Long before the slowing of Soviet growth became obvious, it was predicted on the basis of growth accounting. (Economists did not predict the implosion of the Soviet economy a generation later, but that is a whole different problem.)

It’s an interesting story and a useful cautionary tale about the dangers of naive extrapolation of past trends. But is it relevant to the modern world?

PAPER TIGERS

AT FIRST, it is hard to see anything in common between the Asian success stories of recent years and the Soviet Union of three decades ago. Indeed, it is safe to say that the typical business traveler to, say, Singapore, ensconced in one of that city’s gleaming hotels, never even thinks of any parallel to its roach-infested counterparts in Moscow. How can the slick exuberance of the Asian boom be compared with the Soviet Union’s grim drive to industrialize?

And yet there are surprising similarities. The newly industrializing countries of Asia, like the Soviet Union of the 1950s, have achieved rapid growth in large part through an astonishing mobilization of resources. Once one accounts for the role of rapidly growing inputs in these countries’ growth, one finds little left to explain, Asian growth, like that of the Soviet Union in its high-growth era, seems to be driven by extraordinary growth in inputs like labor and capital rather than by gains in efficiency.

Consider, in particular, the case of Singapore. Between 1966 and 1990, the Singaporean economy grew a remarkable 8.5 percent per annum, three times as fast as the United States; per capita income grew at a 6.6 percent rate, roughly doubling every decade. This achievement seems to be a kind of economic miracle. But the miracle turns out to have been based on perspiration rather than inspiration: Singapore grew through a mobilization of resources that would have done Stalin proud. The employed share of the population surged from 27 to 51 percent. The educational standards of that work force were dramatically upgraded: while in 1966 more than half the workers had no formal education at all, by 1990 two-thirds had completed secondary education. Above all, the country had made an awesome investment in physical capital: investment as a share of output rose from 11 to more than 40 percent.

Even without going through the formal exercise of growth accounting, these numbers should make it obvious that Singapore’s growth has been based largely on one-time changes in behavior that cannot be repeated. Over the past generation the percentage of people employed has almost doubled; it cannot double again. A half-educated work force has been replaced by one in which the bulk of workers has high school diplomas; it is unlikely that a generation from now most Singaporeans will have Ph.D’s. And an investment share of 40 percent is amazingly high by any standard; a share of 7O percent would be ridiculous. So one can immediately conclude that Singapore is unlikely to achieve future growth rates comparable to those of the past.

But it is only when one actually does the quantitative accounting that the astonishing result emerges: all of Singapore’s growth can be explained by increases in measured inputs. There is no sign at all of increased efficiency. In this sense, the growth of Lee Kuan Yew’s Singapore is an economic twin of the growth of Stalin’s Soviet Union growth achieved purely through mobilization of resources. Of course, Singapore today is far more prosperous than the U.S.S.R. ever was–even at its peak in the Brezhnev years–because Singapore is closer to, though still below, the efficiency of Western economies. The point, however, is that Singapore’s economy has always been relatively efficient; it just used to be starved of capital and educated workers.

Singapore’s case is admittedly, the most extreme. Other rapidly growing East Asian economics have not increased their labor force participation as much, made such dramatic improvements in educational levels, or raised investment rates quite as far. Nonetheless, the basic conclusion is the same: there is startlingly little evidence of improvements in efficiency. Kim and Lau conclude of the four Asian “tigers” that “the hypothesis that there has been no technical progress during the postwar period cannot be rejected for the four East Asian newly industrialized countries.” Young, more poetically, notes that once one allows for their rapid growth of inputs, the productivity performance of the “Tigers” falls “from the heights of Olympus to the plains of Thessaly.

This conclusion runs so counter to conventional wisdom that it is extremely difficult for the economists who have reached it to get a hearing. As early as 1982 a Harvard graduate student, Yuan Tsao.) found little evidence of efficiency growth in her dissertation on Singapore, but her work was, as Young puts it, “ignored or dismissed as unbelievable.” When Kim and Lau presented their work at a 1992 conference in Taipei, it received a more respectful hearing, but had little immediate impact But when Young tried to make the case for input-driven Asian growth at the 1993 meetings of the European Economic Association, he was met with a stone wall of disbelief.

In Young’s most recent paper there is an evident tone of exasperation with this insistence on clinging to the conventional wisdom in the teeth of the evidence. He titles the paper “The Tyranny of Numbers”–by which he means that you may not want to believe this, buster, but there’s just no way around the data. He begins with an ironic introduction, written in a deadpan, Sergeant Friday, “Just the facts, ma’am” style: “This is a fairly boring and tedious paper, and is intentionally so. This paper provides no new interpretations of the East Asian experience to interest the historian, derives no new theoretical implications of the forces behind the East Asian growth process to motivate the theorist, and draws no new policy implications from the subtleties of East Asian government intervention to excite the policy activist. Instead, this paper concentrates its energies on providing a careful analysis of the historical patterns of output growth, factor accumulation, and productivity growth in the newly industrializing countries of East Asia.”

Of course, he is being disingenuous. His conclusion undermines most of the conventional wisdom about the future role of Asian nations in the world economy and, as a consequence, in international politics. But readers will have noticed that the statistical analysis that puts such a different interpretation on Asian growth focuses on the “tigers,” the relatively small countries to whom the name “newly industrializing countries” was first applied. But what about the large countries? What about Japan and China?

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