Hong Kong ; Singapore ; Pacific Area ; Technology ; Industrial policy

Kenneth Kasa

English

Research Papers in Economics

FRBSF WEEKLY lETTER
Number 94-36, October 21, 1994
,
Growth and Government Policy:
Lessons from Hong Kong and Singapore
An important current policy debate within the
United States has centered on the government's
role in encouraging investment in new technolo-
gies. Whether itbe electric automobiles, flat-panel
display technologies, or the "information super-
highway;' the current administration has demon-
strated an increased willingness to subsidize
applied nondefense technology development.
Economists have tended to regard these sorts of
"high tech" industrial policies as the same old
pork barrel politics in new packaging. However,
recent developments in growth theory suggest
that these programs may have merit after all,
depending on the nature and relative importance
of various potential sources ofeconomic growth.
This Letter briefly outlines the circumstances
under which it makes sense to have a national
"technology policy;' and then goes on to discuss
a case study involving Hong Kong and Singa-
pore, which sheds light on the empirical validity
of these circumstances.
Growth models
Models of the growth process link an economy's
output to its use offactors of production, like
capital and labor. Therefore, if an economy is to
grow it must either accumulate factors of pro-
duction or learn to use its existing factors more
efficiently. The mechanisms governing factor
accumulation are clear. To accumulate capital
aneconomy must invest To accumulate labor an
economy must either add to its population or in-
crease the percentage ofits population that works
in the market. Empirical evidence has shown,
however, that for developed countries like the
United States factor accumulation has played a
relatively minor role in generating growth in (per
capita) income. Instead, most of the growth has
come from the second source, that is, from im-
provements in productivity.
Unfortunately, unlike factor accumulation, pro-
ductivity is not well understood by economists.
In fact, until the recent work of Romer (1986) and
Lucas (1988), economists simply viewed produc-
tivity as being "exogenous;' that.is, determined
outside the economic system. In contrast, the
models of Romer and Lucas make productivity
"endogenous" by assuming that factor accumu-
lation is itself a source of productivity growth.
Specifically, in their models 'positive externali-
ties' accompany the processes of physical and
human capital accumulation. Such externalities
occur when improvements in knowledge, ac- .
quired either in school or on the job, conferben-
efits to other individuals in a way that makes it
difficult to collect a fee for them. Because no
market price is attached to these benefits, they
are notreflected in the value of inputs. Instead,
they show up in the data as productivity
increases.
The presence of externalities associated with
capital accumulation has two important implica-
tions for growth theory. First, such externalities
provide an explanation for how a competitive
economy can overcome the forces of diminishing
returns to factor inputs andthus sustain growth
in percapita income. Productivity continually
improves as a by-product of capital accumu-
lation. Second, the existence ofexternalities
impliesthatthe growth process is inefficient.
Because individuals do not receive the full re-
turns from their investments,. there will be too
little investment and too Iowa growth rate in the
economy. Asa result the government can im-
prove matters by adopting policies that encour-
age investment.
Unfortunately, putting this type of program into
practice is besetby difficulties.First and fore-
most, economists lack the requisite empirical
PACIFIC BASin nOTES Pacific Basin Notes appears on an occasional
basis. It is prepared underthe auspices of the Center for Pacific Basin MQnetary and Economic Studies
within the FRBSF's Economic Research Department. .FRBSF
knowledgewith which to conclude that a given
economy invests too little, and that a given sub-
sidy istherefore justified. Ideally, one would like
to runa series of controlled experiments in which
economies that are alike in all dimensions except
government policy are followed over time, and
their performance monitored and compared. One
would then know ifa policy is beneficial. Of
course, economics is not physics, and controlled
experiments are not possible. Nonetheless, his-
tory occasionally offers examples of country-pairs
that come close to being controlled experiments
in the effectiveness ofgovernment policy.
Recently, Young (1992) hasexamined one such
country-pair that has particular relevance for
evaluatingalternative growth theories. Specifi-
cally, he compares and contrasts the policy and
growth experiences of Hong Kong and Singapore
during the postwar period.
Similarities
The similarities between Hong Kong and Singa-
pore are striking. Both are small city-states that
began as British colonies, each serving as an en-
trepot trading post for the British empire. Hong
Kong processed trade between China and the
outside world, while Singapore served as a con-
duit for western trade with Malaysia and Indo-
nesia. Given their historical origins as British
colonies, .both countries began the postwar pe-
riod with relatively developed political institu-
tions. Moreover, the political climate in each
country was relatively calm.
Demographically, both countries began the post-
war period with populations that consisted pri-
marilyof immigrants from Southern China,
although Singapore had a fairly significant minor-
ity population of Malays, Indians, and Pakistanis.
In terms of population density, both countries are
off the scale. Singapore currently boasts a popu-
lation density of about 15,000 per square mile,
while Hong Kong somehow managesto support
over 200,000 people per square mile.
With the exception of fine natural harbors, nei-
ther country contains much in the way of natural
resources, and in particular, neither country has
ever had a significant agricultural sector. Instead,
residents of these countries earned their living by
trading and, increasingly, by manufacturing. Both
are highly dependent on exports and, by interna-
tional standards, are extremely open to trade.
Interestingly, HQngKong and Singapore under-
went very similar processes of industrialtransfor-
mation. Both started by manufacturing textiles,
and then shifted in successive stages to clothing,
plastics, and electronics. Recently, both countries
have emerged as major financial centers, with
employment rapidly moving into banking and
other financial services.
Finally, the growth performance of both countries
was spectacular-and nearly identical. In 1960,
GOP per capita was roughly the same-$2323
in Hong Kong and $2409 in Singapore (both ex-
pressed in terms of 1985 U.s. dollars). Then, dur-
ing the ensuing 30 years, annual growth in real
GOP per capita averaged 6.0 percent in Hong
Kong and 6.2 percentin Singapore.
Differences
Despite their similarities, Hong Kong and Singa-
pore differed in three important ways, and these
three differences reveal the most about the nature
ofthe growth process. First, theirtiming and
pace of industrial restructuring were quite differ-
ent. Hong Kong started up the ladder of manu-
facturing sophistication earlier. Explosive growth
in manufacturing began in the early 1950s in
Hong Kong, as Shanghainese refugees flooded
into the peninsula and opened textile factories.
When developed countriesbegan to impose
quotas on textiles inthe late 1950s, Hong Kong
moved up-market and began producing clothing.
In the 1960s, Hong Kong began to manufacture
plastics, eventually becoming the world's leading
toy manufacturer. The 1970s was a period of
rapid growth in electronics manufacturing, led by
digital quartz watches. The electronics boom
continued into the mid-1980s, when Hong Kong
began shifting into financial services.
This same sequence of industrial transformation
also occurred in Singapore; but it started ten to
fifteen years later, and proceeded much more
rapidly. To getan idea of the breathtaking pace at
which industrial transformation took place, con-
sider that (1) Between 1971 and 1980 annual pro-
duction oftelevisions increased by a factor of 56,
and (2) in 1980 Singapore did not produce any
computer components or peripherals, but by
1983 Singapore had become the world's largest
exporter of disk drives!
How did Singapore achieve such phenomenal
restructuring? The answer is found in the second
key difference between Hong Kong and Singa-
pore, which concerns the government's role in
the economy. In contrast to the avowed laissez-
faire policy of Hong Kong, the Singaporean gov-
ernment pursued an aggressive policyofindustrial
targeting that focused on imported technological
know-how. Inward foreign direct investmentwas
actively courted by Singapore's government via
generous tax breaks toforeign corporations. This
investment was financed by a combination offoreign borrowing and a domestic "forced sav-
ings" policy. For example, during much ofthe
1960s and 1970s Singapore ran current account
deficits of between 10 and 20 percent of GDP. In
contrast, Hong Kong's current account remained
roughly in balance.
Finally, although income in Hong Kong and Sing-
apore grew at nearly the same rate, the under-
lying sources of this growth differed. As noted
earlier, a nationcan grow either because it can
accumulate factors of production or because it
can learn to use its existing factors more effi·
ciently. Singapore followed the first route, while
Hong Kong followed the second. For example, in-
vestment as a share of GDP skyrocketed in Sing-
apore, rising from under 10 percent in 1960 to
over 40 percent in the mid-1980s, while in Hong
Kong the investment rate remained relatively
constant at about 20 percent. How did Hong
Kong keep up? Simply put, entrepreneurs in
Hong Kong were more efficient than their Singa-
porean counterparts. Improvements in productiv-
ity contributed over 50 percent of the growth in
Hong Kong, whereas they contributed next to
nothing in Singapore.
lessons
These differences between Hong Kong and Sing-
apore provide evidence on the nature of growth.
Specifically, they cast doubt on externality-driven
endogenous growth models. If capital accumula-
tion confers positive externalities, then Singapore
should have exhibited a higher rate of productiv-
ity growth, given its more rapid accumulation of
capital. Instead, the country that invested less
had a higher productivity growth rate.
Young (1992) argues that this apparent paradox is
explained by Singapore's overzealous policy of
industrial targeting. Although a persistently high
investment rate enabled Singapore to sustain a
high growth rate, the investment took the form of
a rapid succession of new technology acquisi-
tions. As soon as managers and workers began to
getused to a given manufacturing process, the
government introduced a new one. Asa result,
the usual processes of "learning by doing" and
"knowledge spillovers" were stunted in Singa-
pore, and this adversely affected its productivity.
Young goes on to conjecture that, ifcontinued,
Singapore's growth strategy ultimately will prove
to be unsustainable.
In contrast, Young argues thatHongKong's
growth was supported by productivity improve":
ments that had their roots ina highlyeducated
and highly skilled labor force. Of course, to a
certain extent,Hong Kong's "human capital" ad-
vantage was an historical accident. Following the
Communisttakeoverin China, Hong Kongexpe-
rienceda massive influxofMainland refugees.
Fortunately for Hong Kong, these refugees were
highly educated and highly skilled. Inprinciple,
this infusion of human capital could be consid-
ered factor accumulation. In practice, however,
growth in human capital tends to be reflected
in productivity increases.
The lesson appears to be that, if a government
wants to foster growth, it shouId do so by sup-
porting education rather than by attempting to
funnel resources into "sunrise" industries. One
indicator of the superiorityofthis strategy comes
from comparing consumption growth in Hong
Kong and Singapore. Ultimately, countries grow
so that their citizens can enjoy a greater level
of consumption, either in the form ofmaterial
goods, or in the form of such goods as leisure
and environmental quality. Tellingly, while output
growth was nearly identical in both countries,
consumption growth in Hong Kong nearly
matched output growth, whereas consumption
growth in Singapore was only about half of out-
put growth. This suggests that the citizens of
Hong Kong benefited more from their economy's
growth than did the citizens of Singapore.
Kenneth Kasa
Economist
References
Lucas, Robert E., Jr. 1988. "Onthe Mechanics of Eco-
nomic Development." Journal of Monetary
Economics 22, pp. 3--42.
Romer, Paul M, 1986. "Increasing Returns and Long-
Run Growth:' Journal ofpolitical Economy 94, pp.
1002-1037.
Young, Alwyn. 1992. "A Tale of Two Cities: Factor
Accumulation and Technical Change in HongKong
and Singapore:' In NBER Macroeconomics Annual
1992, eds. Olivier Blanchard and Stanley Fischer.
Cambridge, Mass: MIT Press.
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Growth and government policy: lessons from Hong Kong and Singapore

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