The earlier hubris, even conceit, following the apparent success of the 'East Asian Miracle' - the sustained rapid economic growth for several decades - has given way to a loss of confidence, and very importantly, an intellectual and policy surrender in recent years.

This has followed the 1997-98 East Asian debacle, which came several years after the disastrous 'Japanese Big Bang', also due to ill-considered financial liberalisation.

It is extremely important that we reflect upon and learn lessons from recent history in order that we do not commit the errors and mistakes of the past. A wise man once said that tragedy becomes farce when repeated, certainly something we can ill afford.

Let me move straight to discussing the East Asian Miracle, for which there are three competing explanations.

In the 1970s, the dominant version presented sustained rapid growth in the East Asian region as essentially due to unfettered market forces. The obvious policy implication was to liberalise, open up or globalise, and so on and so forth. In the 1980s, this gave way to an almost opposite so-called 'dirigiste' position, which emphasised the role of the so-called 'developmental state'.

The most influential study on the subject came about due to a rather fortuitous change of circumstances. Most importantly, the devaluation of the US dollar and the appreciation of the Japanese yen following September 1985 which made Japan aid or official development assistance (ODA) the single largest contributor of ODA.

Rather gently, Japan insisted that the World Bank might reflect on the fact that those who had followed the World Bank's structural adjustment prescriptions of the 1980s were languishing in slow growth and greater inequality, as in much of Latin America.

High growth

In contrast, East Asia, which had adopted more heterodox policies, had experienced sustained high growth, often with little worsening inequality until some switched to financial liberalisation from the 1980s.

The World Bank tried to 'co-opt' the potential theoretical challenge by distinguishing between 'functional' and 'strategic' state interventions. There were, of course, other efforts to explain the 'East Asian Miracle', including heterodox perspectives such as institutionalist, evolutionary, or post-Keynesian perspectives, but these were far less influential.
The World Bank's functional interventions were then justified by the concept of market failure. In the face of market failures, governments needed to intervene by providing sound macro-economic management, physical infrastructure, social services, particularly in health and education, and other basic state functions such as ensuring the rule of law.

But the World Bank also took the view that since strategic interventions were not justifiable in terms of market failure, they were bound to fail, and therefore, should not be pursued. Using moot methodologies, it proceeded to argue that trade policies as well as industrial policies had basically failed.

Responding to this very influential volume, some heterodox economists from the region dissented, arguing that the World Bank's East Asian Miracle volume failed to acknowledge Southeast Asia's inferior achievements. The World Bank had instead insisted on Northeast Asian exceptionalism, attributed to unique cultural ('Confucianism') and historical circumstances (eg Cold War). Hence, Northeast Asia was deemed not suitable for emulation, but instead, Southeast Asia was promoted as the model for emulation by other developing countries, especially after the 'MIT' (Malaysia, Indonesia, and Thailand) economies' adoption of some economic liberalisation from the mid-1980s.

Our dissenting volume (Jomo et al. 1997) was published the day before the East Asian financial crisis broke in Bangkok on July 2, 1997, and has been wrongly credited for having predicted the debacle, which it certainly did not do.

Instead, we argued that the Southeast Asian success was much more modest than that of the rest of the region, and that the lessons being drawn from the region's experience were misleading, especially by its denigration of the role of government interventions in the region's economies. Furthermore, the average growth rate of the MIT economies, was about six percent, compared to the average of eight percent for the East Asian newly industrialising economies before the 1990s.

Also, there was far higher population growth in Southeast Asia, and hence, the actual difference in per capita terms over the two or three decades before the 1990s was about three percent, or about 50 percent more than the two percent suggested by the GDP growth rate differential.

In Northeast Asia, domestic financial resources were much more important, and foreign direct investment (FDI) accounted for less than two percent of gross domestic capital formation or capital investment, whereas in Southeast Asia, FDI was far more important than in most other developing countries.

Perhaps as a consequence, no significant industrial entrepreneurial class has emerged in Southeast Asia, which in turn accounts for the dominance of so-called 'rentier' elements, particularly those associated with finance capital. Southeast Asia has also been far more unequal than Northeast Asia. Of course, many reforms undertaken in Northeast Asia were anti-communist in inspiration, such as Japanese 'stakeholder capitalism' and the land reforms in Japan, South Korea and Taiwan. Such 'initial conditions' helped create more egalitarian fast growing economies in which more people felt they had a stake.

There have been important policy differences within the East Asian region. For instance, there have been very few trade policy interventions in Singapore and Hong Kong. Not surprisingly then, Hong Kong has been de-industrialising for well over two decades. As a consequence of the relative insignificance of trade policies, recent 'free trade agreements' have actually had little to do with traditional trade issues per se, but have had much more to do with strengthening intellectual property rights, investment incentives and other privileges which have mixed consequences for economic development.

Southeast Asia has encouraged industrial dualism, where earlier attempts to promote import substituting industries have been followed by the promotion of unconnected export processing zones and licensed manufacturing warehouses. There is little connection between these two manufacturing sub-sectors, quite different from Northeast Asia, where 'effective protection' has often been conditional on 'export promotion'-in other words, industries and firms have been provided with protection and other subsidies, but have also been required to export, so that production for the domestic market leads to production for export, unlike the situation in Southeast Asia where there is little connection between the two.

Industrial policy

It is important to recognise the role of industrial policy, or selective government interventions in promoting desired structural transformation. The concept of market failure in economics assumes an inexorable systemic tendency to achieve equilibrium. But even if this is the case, achieving equilibrium has little to do with economic development. The concept of efficient market allocation is based on comparative statics, and not on structural transformation to achieve new comparative advantage in a dynamic sense.

In the real world, economies of scale are important, especially for economic development, rather than the constant, or declining returns assumed in economic models. The challenge is to identify and promote economic activities offering increasing returns to scale - as opposed to those only offering decreasing returns such as agriculture. This has been the premise for favouring industrialisation and for promoting 'infant industries'.

Over the 20th century, there was a secular long-term tendency for primary commodities' terms of trade to decline against manufactured goods-as suggested over half a century ago by Hans Singer and Raul Presbisch. The decline in the terms of trade of tropical primary commodities against their temperate counterparts - observed by Arthur Lewis, eg cotton versus wool - has also persisted over recent decades.

More recently, in the last three or four decades, there has also been a significant decline in the terms of trade of 'generic manufactures', i.e produced by industries with few strong entry barriers compared to products strongly protected by 'intellectual property rights'.

The success of well considered government intervention and its crucial role in 'late industrialisation' and economic development all over the world are important reasons for insisting on industrial policy, or what some now prefer to call investment policy. Besides trade, there are other areas in which such policies have been important in East Asia, such as promoting new technology, improving human resources, offering appropriate investment incentives conditional on meeting performance criteria, in other words, providing carrots together with sticks, or at least, yardsticks.

Preferential credit for desired economic activities and the converse for undesirable activities have been justified theoretically by the idea of 'financial restraint' - rather than 'financial repression' as well as 'financial liberalisation'.

The ostensible philosophical basis for the 'neo-liberal' Washington Consensus-among the US government and the two Bretton Woods institutions, the International Monetary Fund and the World Bank - is associated with 19th century English economic liberalism. But at the advent of the 20th century, the great English liberal economist John Hobson recognised that the world had changed.

The emergence of monopoly power and its political influence on public policy were the basis for his theory of imperialism, which Lenin subsequently insisted was an inevitable consequence of capitalist development.

If the academic economists' presumption of perfect competition is really make-believe, and we actually live in a world of 'imperfect competition', then profit maximisation inevitably involves 'rent seeking'.

The analytical challenge for policy makers then becomes very different. Rather than trying hopelessly to transform the economy into this lost or mythical state of 'perfect competition', the key policy challenge becomes one of managing rents, of minimising waste in the creation and distribution of rents, not only on a short-term basis, but also in the long term.

Note: Part 2 will be posted tomorrow.

JOMO KS recently retired as an economics professor at Universiti Malaya to take up the post of United Nations assistant secretary-general. This article is based on a lecture he gave in November at the National University of Singapore's Asian Research Institute.