The proximate cause of poverty is low productivity. Poor people are poor because their labor produces too little to adequately feed and house them, let alone provide adequately for other needs such as health care and education.
Low productivity, in turn, has diverse and multiple causes. It may be the result of lack of credit, lack of access to new and better technologies, or lack of skills, knowledge or job opportunities. It may be the consequence of small market size—or exploitative elites, in cahoots with the government, who block any improvement in economic conditions that would threaten their power.
Globalization promises to give everyone access to markets, capital and technology, and to foster good governance. In other words, globalization has the potential to remove all of the deficiencies that create and sustain poverty. As such, globalization ought to be a powerful engine for economic catch-up in the lagging regions of the world.
And yet, the past two centuries of globalization have witnessed massive economic divergence on a global scale. How is that possible?
This question has preoccupied economists and policy makers for a long time. The answers they have produced coalesce around two opposing narratives.
One says the problem is “too little globalization,” while the other blames “too much globalization.” The debate on globalization and development ultimately always comes back to the conundrum framed by these competing narratives: if we want to increase our economic growth in order to lift people out of poverty, should we throw ourselves open to the world economy or protect ourselves from it?
Unfortunately, neither narrative offers much help in explaining why some countries have done better than others, and therefore neither is a very good guide for policy.
The truth lies in an uncomfortable place: the middle. It’s a point best illustrated by the country that has contributed the most—given its overall size—to the reduction of poverty globally: China. China, in turn, learned from Japan’s example, as did other successful Asian countries.
In the aftermath of the Industrial Revolution, globalization enabled new technologies to disseminate in areas with the right preconditions, but also entrenched and accentuated a long-term division between the core and the periphery. Once the lines were drawn between industrializing and commodity-producing countries, strong economic dynamics reinforced the division.
Commodity-based economies faced little incentive or opportunity to diversify. This was very good for the small number of people who reaped the windfall from the mines and plantations that produced commodities, but not very good for manufacturing industries that were squeezed as a result.1 The countries of the periphery not only failed to industrialize; they actually lost whatever industry they had. They deindustrialized.
Geography and natural endowments largely determined nations’ economic fates under the first era of globalization, until 1914. One major exception to this rule would ultimately become an inspiration to all commodity-dependent countries intent on breaking the “curse.” The exception was Japan, the only non-Western society to industrialize prior to 1914.
Japan had many of the features of the economies of the periphery. It exported primarily raw materials—raw silk, yarn, tea, fish—in exchange for manufactures, and this trade had boomed in the aftermath of the opening to free trade imposed by Commodore Matthew Perry in 1854. Left to its own devices, the economy would have likely followed the same path as so many others in the periphery.
But Japan had a local group of well-educated, patriotic businessmen and merchants, and even more important, a government—following the Meiji Restoration of 1868—that was single-mindedly focused on economic (and political) modernization. That government was little moved by the laissez-faire ideas prevailing among Western policy elites at the time. Japanese officials made clear that the state had a significant role to play in developing the economy, even though its actions “might interfere with individual freedom and with the gains of speculators.”2
Many of the reforms introduced by the Meiji bureaucrats were aimed at creating the infrastructure of a modern national economy: a unified currency, railroads, public education, banking laws, and other legislation. Considerable effort also went into what today would be called industrial policy—state initiatives targeted at promoting new industries.
The Japanese government built and ran state-owned plants in a wide range of industries, including cotton textiles and shipbuilding. Even though many of these enterprises failed, they produced important demonstration effects. They also trained many skilled artisans and managers who would subsequently ply their trade in private establishments.
Eventually privatized, these enterprises enabled the private sector to build on the foundations established by the state. The government also paid to employ foreign technicians and technology in manufacturing industries and financed training abroad for Japanese students. In addition, as Japan regained tariff autonomy from international treaties, the government raised import tariffs on many industrial products to encourage domestic production.
These efforts paid off most remarkably in cotton textiles. By 1914, Japan had established a world-class textile industry that was able to displace British exports not just from the Japanese markets, but from neighboring Asian markets as well.3
While Japan’s militarist and expansionist policies in the run up to the Second World War tarred these accomplishments, its achievements on the economic front demonstrated it was possible to steer an economy away from its natural specialization in raw materials. Economic growth was achievable, even if a country started at the wrong end of the international division of labor, if you combined the efforts of a determined government with the energies of a vibrant private sector.
The Global Rise of East Asia
The experience of Asian tigers after the Second World War—South Korea, Taiwan, Hong Kong, Singapore, Malaysia, Thailand, and Indonesia—reinforced the lesson. All of these countries benefited enormously from exports, and hence from globalization. But none, with the exception of British colony Hong Kong, came even close to being free-market economies. The state played an important guiding and coordinating role in all of them.
Consider two of the most successful countries of the region: South Korea and Taiwan.
In the late 1950s, neither of these economies was much richer than the countries of Sub-Saharan Africa. South Korea was mired in political instability and had virtually no industry, having lost whatever it had to the more developed North Korea. Taiwan, too, was a predominantly agricultural economy, with sugar and rice as its main exports. The transformation that the two economies began to experience in the early 1960s placed them on a path that would turn them into major industrial powers.
In many ways, their strategies mirrored Japan’s. They required, first, a government that was single-mindedly focused on economic growth. Prior land reform in both countries had established some space for governments to act independently from landed elites.
Both countries also possessed an overarching geo-political motive. South Korea needed to grow so it could counter any possible threats from North Korea. Taiwan, having given up on the idea of reconquest of mainland China, wanted to forestall any possible challenge from the Communists. The governments in South Korea and Taiwan understood that achieving their political and military goals required rapid economic growth. Developing industrial capabilities and a strong manufactured exports base became their predominant objective.
This objective was accomplished by unleashing the energies of private business.
Even though both governments invested heavily in public enterprises during the 1960s, the investment was designed to facilitate private enterprise—by providing cheap intermediate inputs, for example—and not to supplant it. One plank of the strategy called for removing the obstacles to private investment that stifled other low-income countries: excessive taxation, red tape and bureaucratic corruption, inadequate infrastructure, and high inflation. These were improvements in what today would be called the “investment climate.”
Equally important were interventionist policies—government incentives designed to stimulate investments in modern manufactures. Both governments designated such industries as “priority sectors” and provided businesses with generous subsidies. In South Korea, these largely took the form of subsidized loans administered through the banking sector. In Taiwan, they came in the form of tax incentives for investments in designated sectors.
In both countries, bureaucrats often played the role of midwife to new industries: they coordinated private firms’ investments, supplied the inputs, twisted arms when needed, and provided sweeteners when necessary. Even though they removed some of the most egregious import restrictions, neither country exposed its nascent industries to much import competition until well into the 1980s.
While they enjoyed protection from international competition, these infant industries were goaded to export almost from day one. This was achieved by a combination of explicit export subsidies and intense pressure from bureaucrats to ensure that export targets were met. In effect, private businesses were offered a quid pro quo: they would be the beneficiaries of state largesse, but only as long as they exported, and did so in increasing amounts.
If gaining a beachhead in international markets required loss-making prices early on, these could be recouped by the subsidies and profits on the home market. But importantly, these policies gave private firms a strong incentive to improve their productivity so they could hold their own against established competitors abroad.4
Marching to its Own Beat: China and Globalization
China’s experience offers compelling evidence that globalization can be a great boon for poor nations. Yet it also presents the strongest argument against the reigning orthodoxy in globalization, which emphasizes financial globalization and deep integration through the World Trade Organization (WTO). China’s ability to shield itself from the global economy proved critical to its efforts to build a modern industrial base, which would in turn be leveraged through world markets.
Since 1978, income per capita in China has grown at an average rate of 8.3 percent per annum—a rate that implies a doubling of incomes every nine years. Thanks to this rapid economic growth, between 1981 and 2008 the poverty rate in China (the percent of the population below the $1.25-a-day poverty line) fell from 84 percent to 13 percent, much of it from reducing rural poverty.5 This meant a whopping 662 million fewer Chinese in extreme poverty, a number that accounts for virtually the entire drop in global poverty over the same period.
During the same period, China transformed itself from near autarky to the most feared competitor on world markets. That this happened in a country with a complete lack of private property rights (until recently) and run by the Communist Party only deepens the mystery.
China’s big break came when Deng Xiaoping and other post-Mao leaders decided to trust markets instead of central planning. But their real genius lay in their recognition that the market-supporting institutions they built, most of which were sorely lacking at the time, would have to possess distinctly Chinese characteristics.
China’s economy was predominantly rural in 1978. A Western-trained economist would have recommended abolishing central planning and removing all price controls. Yet without a central plan urban workers would have been deprived of their cheap rations and the government of an important source of revenue, resulting in masses of disgruntled workers in the cities and the risk of hyperinflation.
The Chinese solution to this conundrum was to graft a market system on top of the plan.
Communes were abolished and family farming restored, but land remained state property. Obligatory grain deliveries at controlled prices were kept in place, but once farmers had fulfilled their state quota they were now free to sell their surplus at market-determined prices. This dual-track regime gave farmers market-based incentives and yet did not deprive the state of revenue nor deprive urban workers of cheap food.6 Agricultural productivity rose sharply, setting off the first phase of China’s post-1978 growth.
Another challenge was how to provide a semblance of property rights when the state remained the ultimate owner of all property. Privatization would have been the conventional route, but it was ruled out by the Chinese Communist Party’s ideology.
Once again, an innovation came to the rescue. Township and village enterprises (TVEs) proved remarkably adept at stimulating domestic private investment. They were owned not by private entities or the central government, but by local governments (townships or villages). TVEs produced virtually the full gamut of products, everything from consumer goods to capital goods, and spearheaded Chinese economic growth from the mid-1980s until the mid-1990s. The key to the success of TVEs was the self-interest of local governments, which would reap substantial income from their equity stake in the enterprises.
China’s strategy to open its economy to the world also diverged from received theory. The Chinese leadership resisted the conventional advice to remove trade barriers. Such an action would have forced many state enterprises to close without doing much to stimulate new investments in industrial activities. Employment and economic growth would have suffered, threatening social stability.
The Chinese decided to experiment with alternative mechanisms that would not create too much pressure on existing industrial structures. While state trading monopolies were dismantled relatively early (starting in the late 1970s), what took their place was a complex and highly restrictive set of tariffs, nontariff barriers and licenses restricting imports. These were not substantially relaxed until the early 1990s.
In particular, China relied on Special Economic Zones (SEZs) to generate exports and attract foreign investment. Enterprises in these zones operated under different rules than those that applied in the rest of the country; they had access to better infrastructure and could import inputs duty free. The SEZs generated incentives for export-oriented investments without pulling the rug out from under state enterprises.
What fueled China’s growth, along with these institutional innovations, was a dramatic productive transformation.
The Chinese economy latched on to advanced, high-productivity products that no one would expect a poor, labor-abundant country to produce, let alone export. By the end of the 1990s, China’s export portfolio resembled that of a country with an income-per-capita level at least three times higher than China’s.7
Foreign investors played a key role in the evolution of China’s industries. They created the most productive firms, introduced new technology to the economy, and became the drivers of the export boom. The SEZs, where foreign producers could operate with good infrastructure and with a minimum of hassles, deserve considerable credit.
But if China welcomed foreign companies, it always did so with the objective of fostering domestic capabilities. It used a number of policies to ensure that technology transfer would take place and that strong domestic players would emerge. Early on, they relied predominantly on state-owned national champions. Later, the government used a variety of incentives and disincentives to foster joint ventures with domestic firms (as in mobile phones and computers) and expand local content (as in autos). Cities and provinces were given substantial freedoms to fashion their own policies of stimulation and support, which led to the creation of industrial clusters in Shanghai, Shenzhen, Hangzhou, and elsewhere.8
Many of these early policies would have run afoul of WTO rules that ban export subsidies and prohibit discrimination in favor of domestic firms—if China had been a member of the organization. Chinese policy makers were not constrained by any external rules in their conduct of trade and industrial policies and could act freely to promote industrialization.
By the time China did join the WTO, in 2001, it had created a strong industrial base, much of which did not need protection or nurturing. China substantially reduced its tariffs in preparation for WTO membership, bringing them down from the high levels of the early 1990s (averaging around 40 percent) to single digits in 2001. Many other industrial policies were also phased out.
However, China was not yet ready to let the push and pull of global markets determine the fate of its industries. It began to rely increasingly on a competitive exchange rate to effectively subsidize these industries. By intervening in currency markets and keeping short-term capital flows out, the government prevented its currency (renminbi) from appreciating, which would have been the natural consequence of China’s rapid economic growth.
Explicit industrial policies gave way to an implicit industrial policy conducted by way of currency policy.
Asia’s economic experience violates stereotypes and yet offers something for everyone. In effect, it acts as a reflecting pool for the biases of the observer. If you think unleashing markets is the best way to foster economic development, you will find plenty of evidence for that. If you think markets need the firm, commanding hand of the government, well, there is much evidence for that too.
Globalization as an engine for growth? East Asian countries are a case in point. Globalization needs to be tamed? Ditto. However, if you leave aside these stale arguments and listen to the real message that emanates from the success of the region, you find that what works is a combination of states and markets. Globalization is a tremendously positive force, but only if you are able to domesticate it to work for you rather than against you.
The Diversification Imperative
You become what you produce.
That is the inevitable fate of nations. Specialize in commodities and raw materials, and you will get stuck in the periphery of the world economy. You will remain hostage to fluctuations in world prices and suffer under the rule of a small group of domestic elites.
If you can push your way into manufactured and other modern tradable products, you may pave a path toward convergence with the world’s rich countries. You will have greater ability to withstand swings in world markets, and you will acquire the broad based, representative institutions that a growing middle class demands, instead of the repressive ones that elites need to hide behind.
Globalization accentuates the dilemma because it makes it easier for countries to fall into the commodities trap.
The international division of labor makes it possible for you to produce little else besides commodities, if that is what you choose to do. At the same time, globalization greatly increases the rewards of the alternative strategy, as the experiences of Japan, South Korea, Taiwan, and China amply show.
Sustained poverty reduction requires economic growth. A government committed to economic diversification and capable of energizing its private sector can spur growth rates that would have been unthinkable in a world untouched by globalization. The trick is to leverage globalization through a domestic process of productive transformation and capacity-building.
This article is adapted from the author’s book The Globalization Paradox: Democracy and the World Economy, Norton, 2011.
1. Jeffrey G. Williamson, “Globalization and Under-development in the Pre-Modern Third World,” The Luca d’Agliano Lecture, Turin, Italy, March 31, 2006.
2. Ichirou Inukai and Arlon R. Tussing, “Kogyo Iken: Japan’s Ten Year Plan, 1884,” Economic Development and Cultural Change, 16(1) (October 1967): 53.
3. For varying accounts of the role played by the state and private industry in the take-off of cotton spinning in Japan, see W. Miles Fletcher, “The Japan Spinners Association: Creating Industrial Policy in Meiji Japan,” Journal of Japanese Studies, 22(1) (1996): 49-75; and Gary Saxonhouse, “A Tale of Japanese Technological Diffusion in the Meiji Period,” The Journal of Economic History, 34(1) (1974): 149-165.
4. My interpretation of these two countries’ take-off is in Dani Rodrik, "Getting Interventions Right: How South Korea and Taiwan Grew Rich," Economic Policy, 20 (1995): 55-107. The two best books on the subject remain Robert Wade, Governing the Market: Economic Theory and the Role of Government in East Asian Industrialization (Princeton: Princeton University Press, 1990), and Alice H. Amsden, Asia’s Next Giant: South Korea and Late Industrialization (New York: Oxford University Press, 1989).
5. “An Update to the World Bank’s Estimates of Global Consumption Poverty Estimates,” http://siteresources.worldbank.org/INTPOVCALNET/Resources/Global_Poverty...
6. Lawrence J. Lau, Yingyi Qian, and Gerard Roland, “Reform Without Losers: An Interpretation of China's Dual-Track Approach to Transition,” The Journal of Political Economy, 108(1) (2000): 120-143.
7. Dani Rodrik, “What’s So Special About China’s Exports?,” China & World Economy, 14(5) (2006): 1-19.
8. Jean-Francois Huchet characterizes China’s policies as of the mid-1990s thus: “China’s technological acquisition strategy is clear: It allows foreign firms access to the domestic market in exchange for technology transfer through joint production or joint ventures.” Jean-Francois Huchet, “The China Circle and Technological Development in the Chinese Electronics Industry,” in Barry Naughton, ed., The China Circle: Economics and Electronics in the PRC, Taiwan, and Hong Kong (Washington, DC: Brookings Institution Press, 1997), 270.