Comments on Paul Krugman and Alwyn Young on The Myth of Asia's

Miracle - why 'quantity' may be more important than 'quality' in economics

By John Ross

Preparing for a panel discussion with Paul Krugman at Jiao Tong University in Shanghai led
to reflection on how different the parameters of practical policy making are from those of
academic economics. The questions asked and point of approach are frequently divergent

In policy making all theoretical and other arguments have to be aligned and concentrated
around one settling one decisive issue - ‘what should be done’. That is, what is involved is a
synthetic decision – assembling issues, and giving them their specific weights, around one
point. In academic discussion exploration of distinctions and points can be pursued without
settling the decisive practical question of what difference it makes to what should be done.

This particular reflection was reinforced by re-reading, to prepare the debate, Paul Krugman’s
well known 1995 paper, ‘The Myth of Asia’s Miracle’. This analysis, arguments from which
are still frequently used today, drew heavily on two quantitative papers by Alwyn Young on
growth in the four Asian Tigers/Newly Industrialised Economies (NICs) of South Korea,
Singapore, Taiwan and Hong Kong.[1]

In analysing the Asian Tiger economies Young/Krugman were attempting to deal with a
theoretical/analytical issue. Was the rapid rate of growth of the South East Asian Tigers
based on, or substantially contributed to, by a particularly high rate of growth of productivity
– whether of labour, capital, or total factor productivity? Or to what degree was it based on
quantitative growth of factors of production – i.e. accumulation of labour and capital?

It should be noted that the quantitative results of Young’s work has come under criticism -
notably from Chang-Tai Hsieh. However, for the moment, leave statistical criticism aside and
assume, for the sake of argument, that Young’s quantitative conclusions were correct –
although, to be clear, this is done as a hypothesis and is not an acceptance of Young’s
calculations per se. Then what follows?

Writing in 1995 Young noted that for the period 1960-85 the four Asian Tigers constituted
four out of the five countries with the fastest growth of GDP per capita in the world - the
fifth, Botswana, was an economy sufficiently small that no general conclusions would be
drawn from it. However, after subtracting growth due to the increase in labour input
(including increased participation in the workforce, higher educational achievement etc) and
the rate of additions and improvements to capital, Young concluded that the growth of total
factor productivity in the Asian Tiger economies was not remarkable. Summarising his
article, Young wrote that he:

‘presents estimates of “total factor productivity” in the sample economies... the ranks of
Taiwan and South Korea [among economies placed in descending order of growth of total
factor productivity] are now reduced to 21st and 24th, respectively. While this remains a
strong performance, it is no longer dramatically differentiated from that of the rest of the
world economy. Fully 81 of the 118 sample economies lie within one standard deviation… of
Taiwan and South Korea. Surprisingly, economies such as Bangladesh, Uganda, Iceland and
Norway are now seen to have outperformed Korea and Taiwan, whose productivity growth is
only 0.5% greater than that of a renowned laggard, the United Kingdom. Singapore, where
participation and investment rates have risen faster than any of the NICs, is reduced to a rank
of 63rd in the world economy.’

So, therefore, Young finds the growth of productivity in the NICs was average or slightly
above average and their rapid growth was not primarily due to extraordinary growth in total
factor productivity but was due to large scale quantitative inputs of capital and labour. To
which the appropriate answer, from the point of view of economic growth, is: ‘yes, that is
quite adequate, even very encouraging. For it shows that if it is possible to combine average
productivity growth with very large quantitative inputs, then the economy’s rate of growth
will be far higher than the average and very rapid in absolute terms – enough to industrialise
a country in a single generation (which is what the NICs achieved).’

The point is a simple arithmetic one. The effectiveness of the contribution of investment, for
example, to economic growth depends on the combination of its quantity and how efficiently
the economy utilises it. This blog has noted on numerous occasions that there is a
fundamental logical error in judging an economy’s growth potential by economic approaches
which concentrate only on the efficiency of the use of investment rather than also analysing
the quantity of investment. The quantitative relation of the relative scale of investment and
the relative efficiency of investment is the critical one. If, for example, economy A utilises
investment 20% more efficiently from the point of view of generating growth than economy
B, but nevertheless economy B invests 50% more as a proportion of GDP, then economy B
will grow more rapidly than A despite the fact that economy A uses its investment more
efficiently.[2]

Young/Krugman demonstrate that the rate of productivity growth of the Asian Tiger
economies is not below average, but only average, as a result of which these economies
quantitative advantage in growth of inputs of investment and labour ensures much more rapid
growth that economies with higher rates of total factor productivity growth but much lower
rates of input growth.

This is why, for example, criticisms that countries such as South Korea, during their phases
of rapid growth, allegedly allocated capital inefficiently compared to more ‘liberal’
economies such as Britain or the United States entirely miss the point. An economy such as
South Korea invested so much more as a proportion of GDP, almost double the rate of the
US, that unless, from the point of view of growth, its' efficiency of investment was only half
that of the US the South Korean economy would still have grown more rapidly than the US.

Put in properly formulated economic terms the quantitative level of macro-economic

allocation of resources to investment may be more important from the point of view of
economic growth than the marginal efficiency of investment. Put crudely, when it comes to
investment and growth, 'quantity' may simply be more important than 'quality'. That, for
example, would by itself be enough to vindicate the present very high rates of investment in
India and China.

Whether it has proved in practice a more viable growth strategy to have an average rate of
growth of productivity, combined with very high quantitative inputs of investment and
labour, or whether it is more effective to aim at the highest rate of growth of total factor
productivity, with much smaller quantitative inputs of investment and labour, may be
illustrated rather graphically by showing the rank order of countries produced by Young’s
calculation.
Young found that the top five countries in terms of growth of total factor productivity, after
he has carried out his adjustments, were as set out in Table 1. 

Table 1

In short, if highest possible growth in total factor productivity is the variable that should be
targeted, then Egypt, Pakistan, Congo and Malta, together with Botswana, should be taken as
the most successful economies in the world – the economic models to be emulated.

If, however, the key criteria of success is increase in GDP per capita, achieved, according to
Young’s calculation, by the Asian Tiger economies combining average rate of growth in total
factor productivity with massive quantitative inputs of investment and labour, then in contrast
Table 2 shows the world ranking of economies.

Table 2

Which economic variable is in practice decisive in determining real economic outcomes may
be shown graphically by taking the case of by far the worst performing case of total factor
productivity according to Young/Krugman’s account – Singapore.

Singapore, poorly performing in terms of total factor productivity, has today, in Parity
Purchasing Power terms, the 5th highest GDP per capita in the world – a level 9% higher than
the United States. Egypt, which is better performing in terms of growth of total factor
productivity, ranks 101st in the world with a GDP per capita only 13% that of the United
States. While the second ranking, from the point of view of total factor productivity growth,
Pakistan ranks 130th in the world with a GDP per capital 6% that of the US.

In short, taking for arguments sake Young and Krugman's calculations as entirely correct,
then the route to actual economic success, in terms of economic growth and a high living
standard, lay in the average rate of increase of total factor productivity, combined with
massive quantitative inputs of capital and labour, of Singapore rather than in the high total
factor productivity, combined with far lower quantitative growth of inputs, of Egypt, Congo
and Pakistan. Or, put in deliberately shocking terms, 'quantity' (growth of factor inputs) was
much more successful in determining growth in GDP per capita than 'quality' (growth in total
factor productivity)!

It is, of course, possible to have a rate of growth of total factor productivity that is so low
(potentially a negative number) that even the greatest increases in quantitative inputs cannot
produce viable growth – the USSR in its final period represents such a case. But the case of
the Asian Tiger economies showed that provided close to average increases in total factor
productivity can be achieved then quantitative increases were the decisive ones. Put formally,
the evidence is that provided an average, or near to average, rate of total factor productivity
growth can be achieved then ensuring very large quantitative inputs proved a more viable
growth strategy than aiming to maximise efficiency – i.e. total factor productivity
growth.This is simply the arithmetical outcome of multiplying the rate of growth of factor
productivity by the rate of growth of inputs. The criteria which must decide the strategy
chosen is therefore that which maximises the rate of growth of GDP per capita, not the
abstract theoretical one of maximising rate of growth of factor productivity.

Turning to India and China this has an immediate practical consequence. It means that even if
it were to be assumed, for the sake of argument, that the efficiency of their use of investment
were average, or even somewhat below average, then they might well be right to concentrate
on massive inputs – to take the Singapore route. That, in turn, evidently raises the question of
whether investment in India and China actually is inefficient – which goes beyond the scope
of the present article, but will be returned to in a future article. But it should be noted from
the above that even if, for the sake of argument, it were assumed that Krugman and Young’s
quantitative premises are correct then this does not constitute a valid argument, from the
point of view of the key variable of maximising the rate of growth of per capita GDP, against
the effectiveness of the growth model followed by either the South East Asian Tiger
economies or current policies pursued by India or China.

As stated at the beginning of this article, in economics quantity in some cases may simply be
more important than quality.

* * *

This article originally appeared on the blog Key Trends in Globalisation on 29 May 2009.

Notes

[1] The argument of all three papers by young and Krugman was that the rapid growth of the
NICs was based on quantitative accumulation of inputs of labour and capital and not on any
productivity growth that was remarkable by international standards. The same analysis was
then applied to China in Young’s 2003 paper ‘Gold into Base Metals: Productivity Growth in
the People’ Republic of China during the Reform Period’.

[2] Ideally, of course, a combination of the maximum level of efficiency of investment from
the point of view of economic growth and the maximum level of inputs would be achieved.
However, while this is optimal in a purely abstract theoretical model in practice it may be
necessary to chose between the two. An evident case of this is heavily state influenced
financial systems aimed to maximise savings, as for example existed in Japan and South
Korea during periods of rapid growth, versus those which are aimed to maximise the
efficiency of use of savings. General discussion of this point, however, goes beyond the
scope of this article.