Developmental state theory
The most important economic idea that has guided the growth of these economies over the last few decades can be categorised as the developmental state theory. This idea was born out of the study of Japan, which showed significant economic growth after World War Two, although the origin of the story would go back to Friedrich List, who guided Japanese government officials in the nineteenth century.
Chalmers Johnson wrote the seminal work articulating the current theory in 1982. This idea, with variations, spread in the 1980s and early 1990s. During this process, the theory has been used to explain the development of other successful East Asian economies dubbed as ‘Asian Miracles'. In 1989, Alice Amsden published a book explaining how the South Korean government ‘took prices wrong' intentionally, and in 1990, Robert Wade introduced the concept of Governing the Market, which discussed the Taiwanese case in detail.The developmental state theory of generating economic development claims that there is a critical role that the government can play in the development of a country's economy in a way that is very different from the traditional idea of socialist-style government intervention. Developmental state theory does not deny the role played by the market as, fundamentally, this theory is based on a capitalistic market economy. Yet, the role played by the government is much bigger than in a neoclassical model of a market economy, whose role there is defined mainly as regulatory and with minimal intervention in the economy.
The role of the government in developmental state theory can be summarised as an industrial policy. This prototypically consists of five stages. First, the government identifies industries that are expected to grow in the next one/two decades; second, the government identifies private companies that can achieve development in the identified industries; third, in order to make the companies competitive in the world market, the government encourages and supervises merger and acquisitions or suggests a specialisation of each company's products; fourth, the government provides support to the companies selected by setting up a consortium to develop critical technology, government research institutes and preferential loans or tax breaks; finally, the government judges the performance of each selected company, particularly in its export performance to the US market.
Based on a final evaluation, some companies continue to receive the government support while others lose such privileges. To enable this industrial policy and upgrade the industrial level of the country, the government establishes higher education institutions that specifically target technological aspects of industry.The economic rationale of this developmental state theory was drawn from several ideas. First, there is a role that the government can play in a developing country where financial industries are underdeveloped. For example, Japan's MITI (Ministry of International Trade and Industry) used its leverage of the allocation of foreign currency, which was still restricted in the 1950s, to manoeuvre private firms to join its efforts to participate in industrial policy schemes. Second, the developmental state theorists argue that ‘pure' comparative advantage based on trade theory in neoclassical economics is unrealistic, as investing in certain fields can actively create ‘competitive' advantage. This view reflects the idea that economic growth is fundamentally dynamic and not static like the equilibrium theory of neoclassical economics. This is an idea taken from Joseph Schumpeter’s notion of ‘creative destruction'.
What makes capitalism such a powerful mechanism for economic growth is not the narrow idea of allocative efficiency as explained by neoclassical economics, but the entrepreneurial ability to introduce very innovative products and technologies, and thus to destroy the existing equilibrium and engender dramatic change. Therefore, the developmental state theorists claim that so-called market ‘distortions’ created by government initiatives do not create a problem but are actually part of the solution to kick-starting development. Indeed, with many of the products that Japan or the Asian Tigers dominate, it cannot be considered that they would have a comparative advantage without government intervention. Various other economic ideas complement the validity of state intervention in developmental state theory.
For example, the idea of transaction costs, originally developed by Ronald Coase, suggests the important contribution of signalling effects, or credible commitments, by the government to industry.There was a major international debate on developmental state theory in the 1990s. The World Bank published a book called The East Asian Miracle in 1993, responding to various claims made, particularly by the Japanese government, that state intervention can promote economic growth. The majority of neo-liberal economists in the World Bank opposed this theory, and the 1993 book emphasized the importance of stable macroeconomic management based on neoclassical economics as a root of success, rather than government intervention. The 1997 World Development Report by the World Bank, however, conceded that there was a significant role that the state can play in economic development.
The 1997 Asian financial crisis that affected one of the Asian Tigers, South Korea, seriously but not others encouraged neoclassical economists to claim that developmental state theory was mistaken. However, various studies of the crisis suggested that it was not necessarily the fault of the developmental state. Indeed, the South Korean economy went back to its growth path within two years. The reason that the South Korean economy was more affected by this crisis was related to the nature of South Korean industrial organisation, which relies so much on a few giant chaebols (family-owned conglomerates) that focused on market share predominantly rather than profits. There are, however, significant failures of industrial policies even in Japan, in industries like petrochemicals and aluminium. Therefore, theoretical debates over developmental state theory have not yet ended.
Another issue is: how/why the government can identify industries for promotion and assess various technological needs, while it is not engaged in business itself. Although developmental state theory is different from socialist intervention, where governments create national/state corporations, there is still doubt about how bureaucrats can predict at the forefront of future industries.
To answer this, Peter Evans articulated the notion of ‘embedded autonomy’. The government bureaucrats face a dilemma. On the one hand, they need industrial information from a private sector that is making or losing money every day. On the other hand, they do not want to be ‘captured’ by these business interests, as these interests have incentives to lie in order to extract resources from the government: traditional industrial lobbying. Evans argues that there must be a mechanism for government bureaucrats to extract unbiased information from industries, yet not be affected by sectoral interests.To do so, the governments of a developmental state set up frequent meetings with corporations and let the corporations compete with each other, in order to avoid being captured by their provincial interests, and thereby remain autonomous. Evans argues that because the balance between ‘embeddedness’ and autonomy is extremely delicate, there have been few successful developmental states. Even among the Asian Tigers, only South Korea and Taiwan can be listed as successful cases, while Singapore is less a typical developmental state. Hong
Kong is clearly not an example. Evans' argument can be supported by various theories of collective action. Repeated communications among actors and the logic of the prisoner's dilemma made coordinated actions by industry to deceive the government difficult in the cases of South Korea and Taiwan, leading to developmental success.