ECONOMIC TRENDS & PROSPECTS IN DEVELOPING ASIA

Global Economic Uncertainties

Failure of Global Investment to Revive. Investment in the OECD could remain weak given the weight of low equity prices, geopolitical uncertainties, and higher oil prices. In previous recoveries in the US, for example, equity prices rebounded quite strongly following the end of the recession as measured by the bottom of the trough. In the current recovery, however, this trend has been strongly reversed. Equity prices fell by 19.4% (to 31 March 2003) from the end of the recession (i.e., 31 January 2002). The conflict in Iraq appears to be the main reason for possibly low stock prices in the next year according to a survey of European retail investors conducted by Gallup and the Swiss bank, UBS. However, investor uncertainty has also increased because of the series of accounting and other examples of corporate malfeasance, as well as concerns about oil prices and the growth potential of industrial countries. Should these developments, plus low capacity utilization and weakening consumption demand, lead the industrial countries to put off capital spending, it would have a depressing effect on economic growth in these countries with knock-on effects for developing Asia.

Deflation. There has been growing concern in several countries about the problem of deflation a general fall in the price level for some sustained period of time. Among industrial countries, Japan has been in such a situation on and off for the past few years and both Hong Kong, China and the PRC have experienced deflationary pressure. There are several possible negative effects of deflation. Some of them are psychological while others have real effects on the economy. From the psychological point of view, if lower prices are anticipated in the future, consumers may hold off consuming until a later date. That will have a depressing effect on aggregate demand and contribute to a possible acceleration in a downward spiral of decreasing prices. In a country with a large debt overhang, deflation increases the cost of servicing as well as the real value of debt. It makes fiscal consolidation difficult and jeopardizes the loan portfolios of the financial system as corporations experience difficulty in servicing debt. The burden of addressing the problem of deflation is complicated when normal policy options such as devaluing the currency, increasing the money supply, lowering interest rates, and undertaking fiscal stimulus are limited. This could occur in circumstances where the banking system is already burdened with a large volume of nonperforming loans, where government deficits and existing debt are already high or legally constrained, and where the exchange rate is fixed.

Rapid Adjustment in the US Current Account Balance and Dollar Exchange Rate. The problem of the so-called "twin deficits" of the US fiscal and current account balances has been cited as a risk in previous ADO forecasts as well as by the World Bank, IMF, and others. However, these risks have not materialized. In 2002, the value of the dollar fell by 2.6% against a trade-weighted basket of currencies which should, other things equal, result in a tendency for the US current account deficit to narrow. After posting a surplus in the last years of the Clinton administration, the fiscal position of the US has recently deteriorated substantially following the onset of the recession at the end of 2000 and in the early months of 2001, as a result of higher spending following the events of September 11, 2001, and more recently the conflict in Iraq.

Has the twin deficit challenge reemerged as a significant risk? First, the chances of a downward spiraling of the dollar following capital flight are low. This scenario is unlikely because it would create a situation from which none of the major regions of the world economy would benefit, in particular Europe and Japan. Flight from the dollar would require a major reassessment of the risk-return trade off in holding US assets. This appears unlikely, as US assets seem an even stronger safe haven in a period of increasing global uncertainty, even factoring in the threat of international terrorism. A flight from the dollar would help make US manufacturing more competitive in international markets and that would promote US exports. However, it would have strong negative domestic effects, putting upward pressure on prices and interest rates and possibly discouraging investment. It would also hurt the exports of Japan and the EU and their stock markets, and thus their growth prospects. Developing countries would also be adversely affected. Particularly in Asia, exchange rates of several currencies could come under severe pressure. For these reasons it is unlikely that the required adjustments in external and domestic imbalances in the US will take place sharply.

A more likely outcome is that the recent downward adjustment in equity prices will have a dampening effect on consumption, leading to a greater balance between the forces of investment and consumption sustaining growth. However, if very large unexpected fiscal deficits, partly resulting from tax cuts, add to the already high US federal debt held by the public ($3,711 billion, as of 31 March 2003), upward pressure on interest rates will intensify, possibly affecting a revival in investment and pulling down growth.

Geopolitical Uncertainties

Terrorism and Shortfall in Tourism. As the attack on the Indonesian island of Bali showed, terrorism can have a significant impact on tourism in Asia. For many DMCs, tourism is a major source of external revenue and economic growth. Tourism accounts for about 9% of developing Asia's GDP and 7% of employment. In Southeast Asia, tourism accounts for nearly 11% of GDP (9.9% in Indonesia, 11.5% in Malaysia, 10.8% in Singapore, and 13.0% in Thailand). In South Asia, over 50% of the Maldives' GDP depends on tourism while for the Pacific it averages 22.2% of GDP. Similarly, employment in the tourism industry is sizable in many DMCs.

Terrorist activities could thus significantly impact many economies in the Asia-Pacific region, with GDP, employment, and the balance of payments directly affected. In the case of Indonesia, estimates of the impact of the Bali bombing on the economy range from 0.5% of GDP in 2002 to 0.5-2% of GDP in 2003, depending on the effectiveness of the government response to the security threat and the repercussions on consumer and investment confidence.

 

Impact of Conflict in Iraq. The conflict could affect DMCs in a number of ways. Certainly, one is the risk of terrorism and its impact as discussed above. In addition, the economic impact could be felt through three other channels: (i) a significant oil price increase; (ii) a fall in overseas worker remittances; and (iii) a sharp fall in export demand from industrial countries, the US in particular, as well as from Middle Eastern countries.

While the Asia-Pacific region includes several oil exporters (Azerbaijan, Indonesia, Kazakhstan, Malaysia, Turkmenistan), most of the DMCs are oil importers—PRC, India, and Korea particularly so. Hence, a significantly higher oil price lasting several quarters would have a substantial direct impact on the DMCs' oil importers, in terms of higher imports and inflation. For instance, a $2.50 average increase in oil prices would cost Korea—the world's fourth largest importer of oil—over $2 billion a year in higher imports. Model simulations based on the Oxford Economic Forecasting World Macroeconomic model indicate that an oil price increase of about 20% over the 2003 baseline would cost, depending on the economies concerned, 0.2-0.3% in terms of GDP growth in 2003, and 0.3-0.5% GDP growth in 2004, even if prices returned to an average of $26/bbl by 2004. However, while somewhat higher oil prices are already factored into the baseline forecast, it appears that with the conflict unwinding, the oil market situation is such that neither significant supply disturbances nor high oil prices are expected. But high volatility might remain in the oil market.

The conflict might significantly affect the remittances of DMC workers in the Middle East. About half of Pakistan's overseas worker remittances originate in the Middle East, and so does a significant proportion of remittances to Bangladesh and Sri Lanka (India's remittances are more diversified). Remittances from the Middle East to the Philippines are also substantial (about 10% of total remittances, or about $700 million).

The conflict and its aftermath might seriously impact many of the DMCs' economies the greatest risk appears to be that beyond a certain length of time, it will adversely impact consumer (and mainly investor) confidence in industrial economies, thus further retarding a recovery that by all measures is already anticipated to be weak. Also, the conflict will have a direct impact on the exports of DMCs to the Middle East. Some DMCs depend on the Middle Eastern markets, and on Iraq in particular, for a significant share of their exports. For instance, Iraq alone absorbs about one third of Viet Nam's exports of rice and tea (which are among Viet Nam's leading primary exports).

It is noteworthy that estimates of the impact on the overall balance of payments from the first Gulf crisis (August 1990-February 1991) point to relatively modest losses of 1-2% of GDP for Bangladesh, India, Pakistan, and Philippines; the loss was over 4% for Sri Lanka, resulting from a combination of a fall in tourist arrivals, loss of remittances, and higher oil prices.

Uncertainties Related to SARS

Increasingly, a major risk to economic growth in developing Asia, particularly East and Southeast Asia, relates to the spread of SARS. Already, the epidemic is significantly affecting travel and tourism in several countries of the region, as well as several other services subsectors, such as hotels and restaurants, retail trade, and transport—particularly air transport within the region. While it is too early to evaluate the impact of the epidemic on regional economic activity, since much will depend on how long it lasts, certain economies— PRC; Hong Kong, China; Indonesia; Malaysia; and Singapore—will be affected, even if the impact is of short duration (2-3 months). Hence GDP growth forecasts for these economies for 2003 have already been lowered.

However, if the epidemic is not brought under control by about mid-May, the economic impact on developing Asia will be much broader and deeper, for two main reasons. First, bookings for the major tourism season associated with summer holidays in Europe and elsewhere in the northern hemisphere will be lost. Second, the reduction in business travel and other transport-related cutbacks could start to affect manufacturing export orders, such that the impact of the epidemic would be felt across a broader swathe of the economies affected.

In response to these uncertainties, several governments in Southeast Asia, e.g., those of Singapore and Thailand, are considering support packages for those sectors of their economies most affected by the epidemic.

II.  Economic Trends and prospects in the Philippines

Philippines

In 2002, GDP grew faster than in 2001, supported by strong growth in industry and by increased services sector activity. However, the fiscal deficit deteriorated sharply, and measures to increase revenues are needed urgently. The passage of the Special Purpose Vehicle Act offers a promising start to reducing banking NPLs. While governance needs to be improved, peace and order (especially in the south) are also crucial to attract investment and facilitate economic development.

Macroeconomic Assessment

In 2002, GDP growth strengthened to 4.6% from 3.2% in 2001, while GNP growth accelerated to 5.2% from 3.4% over the same period. Industrial growth strengthened to 4.1% from 1.3% in 2001, largely as a result of a recovery in manufacturing, in turn due to stronger external demand for electronics and garments. The services sector, which grew strongly by 5.4%, remained the main pillar of economic growth, driven by the transport and communications subsectors. While agricultural growth decelerated, to 3.5% from 3.7% in 2001, it picked up strongly toward the end of the year.

On the demand side, personal consumption expenditure continued to be the main driver of rising GDP. Propelled by strong demand for household furnishing, transport, and communications, personal consumption expenditure rose by 3.9%. Investment grew by 2.1, after a 2.2% decline in 2001. Benefiting from the gradual recovery of the world economy, exports and imports increased in 2002, by 12.2% and 4.6%, respectively, after a contraction in 2001. In spite of budget constraints, government consumption expenditures grew by 1.8%, compared with 0.3% in 2001.

The total labor force in 2002 of 33.9 million rose by 3.4% from the prior year's level. Employment growth, though, was only 3.1%, compared with 6.2% in 2001. With employment growing slowly, unemployment remained high at 11.4% in 2002, edging up from 9.8% in the previous year. The unemployment rate remains one of the highest among ASEAN members, and has been exacerbated by the rapid growth in the labor force and by relatively slow economic growth in recent years. This has led to fewer job opportunities in urban areas, despite additional jobs created by the services sector.

In 2002, the fiscal deficit deteriorated sharply to reach P212.7 billion, or 64% above the revised full-year target of P130 billion and equivalent to 5.4% of GDP. In 2001, the budget deficit of P147 billion (4.0% of GDP) only slightly exceeded the fiscal deficit target of P145 billion. The principal reason for the wider deficit was a shortfall in tax collections. The lack of incentives for tax officers to monitor and follow up with taxpayers, a complicated tax system, the effect of unexpected low interest rates on withholding tax, and a noninflation-indexed rate for excise tax were among the main reasons for the revenue shortfalls.

However, efforts to improve tax revenues were made in the last quarter of 2002. The performance of the Bureau of Internal Revenue (BIR) improved as reflected in the higher tax collections on net income and profits as well as in VAT, which increased by 12.5% and 21.0%, respectively, compared with the corresponding period of the previous year. Measures to enhance tax revenues by BIR included tightening collection measures; setting up a tax payment warning system; charging VAT on professionals; and sanctioning some firms once the expiration of the 5-day VAT compliance notice takes effect. An electronic filing and payment system was expanded for all types of tax payments at BIR. A rise in revenues in the last quarter of 2002 showed that the enhancement measures were taking effect, but not enough to reduce the sizable deficit accumulated in the first three quarters of the year.

Disbursements of the central Government for the whole of 2002 grew by 8.2% from the 2001 level. Public expenditures are estimated to have remained at about 19.0% of GDP during 2002, with the wage bill and other mandated expenditures, such as interest payments and allocations to local government units (LGUs), accounting for a large part of total central government expenditures. However, personal services and maintenance expenditures in general contracted in 2002 due to government expenditure-reduction measures. During the year, internal revenue allotment to LGUs grew by 16.4%, largely due to the need to support LGUs in their poverty reduction and peace and order programs. Capital outlays likewise continued to increase, by 29.9%, as a result of the faster implementation of foreign-assisted projects. The disbursement rate of foreign loans against the target disbursement rate rose to 80% in 2002, compared with 74% in 2001.

Growth in the money supply slowed somewhat in 2002 as a result of weak credit demand and an increase in the reserve requirement. Domestic liquidity (M3) grew by 9.5%, compared with 6.8% growth in 2001. Growth was especially slow in the first half of 2002, but accelerated during the second half, largely due to an increase in net foreign assets in the banking system The sale of dollars by the nonbanking sector, including remittances from overseas workers during the Christmas holiday season, helped boost the net foreign asset position of banks in the second half of the year.

Interest rates remained generally stable over 2002. At the beginning of the year, Bangko Sentral ng Pilipinas (BSP) reduced the overnight borrowing rate and overnight lending rate by 75 basis points to 7.0% and 9.25%, respectively, from 7.75% and 10.0% in 2001; these interest rates remained unchanged until the end of 2002. Following the repeated downward adjustment in interest rates by the US Federal Reserve in 2001, Philippine interest rate policy was calibrated carefully, to maintain price stability while taking into account the risks associated with exchange rate movements and their impact on inflation. Treasury bill rates also fell during the year, to an average of 5.5% from 9.9% in 2001. With BSP's reduction of its policy rates to the lowest levels since 1995, the benchmark 91-day treasury bills fell to a historical low of around 4.0% in December 2002.

The Philippine financial system is dominated by the banking sector, in which 44 major commercial banks account for the major part of the market. Since the Asian financial crisis, the banking sector has become cautious about extending new credits to commercial borrowers. Together with a lack of investor confidence, this kept lending levels in 2002 low. Since 1997, the banking sector has weakened, as characterized by low profitability, a steady increase in the level of NPLs and nonperforming assets (NPAs, defined as NPLs plus properties owned or acquired), and stagnation in credit growth. Banks with excess liquidity have been a major source of demand for government securities at public auctions, helping drive interest rates down. At the same time, mainly due to reclassification of NPLs, the nominal NPL ratio in commercial banks declined to 16.4% of the total loan portfolio in 2002, from 17.4% in 2001. It is hoped that the passage of the Special Purpose Vehicle Act at the end of 2002 will encourage private asset management companies to acquire, turn around, and resell the financial sector's NPLs and NPAs.

After a contraction of 16.2% in 2001, merchandise exports rose by 12.2% in 2002, boosted by some recovery in global demand for electronics, which account for half total exports. Exports were also helped by improved markets for garments and agricultural products. On the back of stronger domestic demand, merchandise imports also swung into growth, at 4.6%, from a 4.5% contraction in 2001. As a result, the trade balance registered a surplus in 2002. Remittances of overseas workers for the year of $6.9 billion also helped bring the current account into surplus at 1.6% of GNP, slightly higher than the 0.4% surplus in 2001. The overall balance-of-payments surplus was about $750 million in 2002, compared with a deficit of $1.3 billion in 2001. This development was mainly the result of the improvement in the current account.

The country's gross international reserves at the end of 2002 stood at $16.2 billion or 5 months of imports of goods and services, up slightly from the $15.7 billion recorded at the end of 2001. Reserves rose following the deposit by the National Power Corporation (NPC) of the proceeds of the flotation of its zero coupon notes and the Power Sector Assets and Liabilities Management Corporation's bond issuance in Japanese yen to fund the NPC's 2003 foreign exchange requirements. The increase in reserves was partly offset, however, by the debt service requirements of the central Government.

At the end of December 2002, outstanding external debt amounted to about $54.0 billion, up from $52.4 billion at the end of 2001. The increase in debt arose largely from government borrowings to meet its financial requirements during the year and from the upward revaluation adjustments of liabilities and net obligations by nonbank borrowers from the public and private sectors. The structure of the external debt has shifted toward longer maturities in recent years—long-term debt now accounts for 89% of total debt. The debt service ratio was 17.0% in 2002. Public sector obligations (including official public debts and debts of government-owned and controlled corporations) made up 64.6% of total external debt and official public debts accounted for 48.7% of total external debts. The bulk of the country's external debt is denominated in dollars (56.2%) and yen (26.0%).

Policy Developments

Since 1998, the fiscal deficit has been large and increasing. The main problem lies with the shortfalls in tax revenues, and indeed the Government has focused on reforms directed at improving the revenue base and tax effort, mainly in the following four areas: rationalization and simplification of tax systems (which are currently complicated and difficult to implement and monitor); using ICT to make the tax system more streamlined and offer transparency for tax collection; organizational reform to restructure BIR into a taxpayer-focused organization; and capacity building and human resources development at BIR. Despite these measures, the enhancement of certain administrative actions is needed to improve revenue collection, including strengthening the monitoring of large taxpayers, more intensive audits on tax payments, indexation of excise taxes to inflation, redefinition of automobiles to remove tax loopholes (i.e., classification of vehicles for tax purposes), improvement of VAT collection, and rationalization of fiscal incentives to encourage investment.

Policy measures and incentives need to be formulated to minimize tax evasion, particularly to minimize underdeclaration of income taxes by companies and self-employed professionals. In this regard, a legal framework to prevent tax evasion already exists, but implementation has been poor. In the short term, the Government will need to strengthen its efforts to enhance tax revenues through a review in excise taxes, which requires legal support, and the imposition of a limit on taxpayers' expenses that are deducted from taxable income.

The current monetary policy stance remains supportive of noninflationary economic growth. In the near term, the Government will need to take account of pending increases in user charges (such as those for electricity, transport, and water), and the impact of the conflict in Iraq on international oil prices as well as the challenges on the fiscal front.

The approval of the Special Purpose Vehicle Act at the end of 2002 is an encouraging move to solve the problem of NPLs and NPAs in the banking sector. The Act provides for the creation of private sector asset management companies (AMCs) to acquire commercial banks' NPLs and NPAs; it stresses an approach toward the resolution of bank's NPLs with adequate safeguards. Compared with other Asian countries hit by the financial crisis, the amount of banks' NPLs and NPAs in the Philippines is moderate, and estimated at roughly P500 billion. While the Government is keen to attract foreign companies specializing in asset management, it expects local companies to take the lead in purchasing the bad loans. The sale of NPLs and NPAs may trigger banking sector consolidation in the long run because banks will face more competition and higher turnover costs. The key challenge is the recovery of lending activities in the banking sector, which has been saddled by these NPLs and NPAs. Further reducing NPLs and NPAs must remain the focus of financial policy, while BSP's capability to detect, avert, and respond to potential bank failures should be strengthened.

The Government's commitment to maintain structural reforms and promote good governance, as well as its pursuance of sound macroeconomic policies should encourage capital inflows. The Anti-Money Laundering Act (AMLA), which was passed in September 2001, will improve the business climate. Under the law, an Anti-Money Laundering Council was set up to monitor banks and suspicious accounts. However, a subsequent assessment of the law by the OECD's Financial Action Task Force (FATF) identified several deficiencies, which were addressed in amendments to the AMLA approved by congress in March 2003. To help stamp out corrupt practices, a new procurement law was enacted in January 2003, which led to the computerization of government procurement transactions and processes.

Peace and order are among the primary prerequisites for sustaining economic growth and development, as they remain a major concern for investors in the country. Conflicts in Mindanao, the second-largest island in the south of the country, have contributed to a loss of business confidence. This has had a negative impact on economic growth and development prospects, as well as on investment. However, in a difficult environment, the Government is taking the steps it can to help restore investor confidence, including proposing an Anti-Terrorism Act.

Outlook for 2003–2004

The following forecasts are based on the assumption that the conflict in Iraq will have only short-term negative impacts on the world economy, and that the SARS epidemic can quickly be brought under control. In 2003, GDP is expected to grow by 4.0%, driven by domestic consumption, improved exports, and public investment. Agricultural growth is expected to moderate because of continuing effects from El Niño, while growth in the industry sector should remain at the same level as in 2002, due to an expected moderate strengthening in the global economy, somewhat offset by continued weakness in domestic industry and sluggish investment demand.

Growth in services should continue at a higher rate than the other sectors, following a trend established in recent years of the economy moving slowly toward greater services orientation featuring more high-technology services, including computer software and other ICT elements. Imports will likely rise more slowly than exports, and thus net exports will contribute more strongly to GDP growth. In spite of higher oil prices at the beginning of the year, inflation should remain at a low level.

In 2004, GDP growth is expected to accelerate to about 4.5%. Agricultural growth is expected to pick up slightly, moving toward historical rates of growth while investment is projected to strengthen as the external climate improves further, offsetting contractionary forces resulting from a reduced fiscal deficit. The services sector will continue to do well.

On the demand side, consumption and net exports will likely continue to lead aggregate demand. The trade and current account balances should improve further as export growth continues to outpace import growth. Without a stronger recovery in investment, though, unemployment is likely to remain at around 10% in 2003-2004.

Inflation is projected to be higher than in 2002, reflecting partly the effect of the weaker peso on import prices, though the Government's target of 4.5% should be met. Domestic liquidity is expected to grow faster over the next 2 years if inflation remains moderate.

It is expected that the budget deficit will be contained to around 4.5% of GDP for 2003, in view of forceful measures to be taken by BIR and the Bureau of Customs in raising tax revenues. For 2004, with more reforms in the tax system and tax collection to be implemented, the budget deficit is projected to fall slightly to 4.0% of GDP.

The overall balance of payments is forecast to be in surplus in 2003. An increase in the current account surplus will more than offset capital outflows. In 2004, the current account surplus is expected to rise to 2.5% of GNP. Capital outflows are likely to reverse direction as the effect of higher investment incentives and financial reforms starts to be felt.

III.  Competitiveness in Developing Asia

A.  Taking Advantage of Globalization, Technology, and Competition

This part of Asian Development Outlook 2003 provides an analysis of competitiveness in developing Asia and shows how it is vital for productivity, national growth, and development. Competitiveness can be defined as a firm's ability to stay in business and achieve some desired result in terms of profit, price, rate of return, or quality of its products; and to have the capacity to exploit existing market opportunities and generate new markets.

During the last decade, there has been considerable interest in identifying the factors that can improve competitiveness, which is thought by many to be an important piece of the growth and development puzzle, perhaps the latest elixir in the quest for growth. Behind this quest is a complex interaction among a number of factors—or the "drivers of change"—which are globalization, technology, and competition. These factors are raising a whole spectrum of new challenges and opportunities in an irreversible process of rapid change. The Asian financial crisis that began in 1997 has added more variables to the equation. Although it brought serious disruption to the region, it demonstrated the need for an improvement in corporate and banking governance. Those countries that have learned the lessons will experience rapid growth again, while those that have not will stagnate. Recently, the emergence of the People's Republic of China (PRC) as an economic powerhouse, particularly in manufacturing, has come to be regarded with reservation among some East and Southeast Asian countries.

Governments and policy makers are especially interested in the issue of competitiveness, particularly the policies that can improve it. Governments have set up councils and competitiveness committees, have written white papers, and have organized conferences on the subject. In this way, the idea of national competitiveness has become one of the key themes in the current debate about national economic performance. Whether or not a country is seen as competitive depends on where it comes in the rankings of a variety of indicators used across countries. Unfortunately, national competitiveness has become something of a buzzword: in common parlance, competitiveness is used to cover almost any aspect of market performance and its overuse may detract from its importance. In fact, the key variable for the economic analysis of competitiveness is the growth of labor productivity since this, ultimately, is the main determinant in raising living standards. This is what competitiveness is about.

The role of industrial policy, which may have been successful in the past, is greatly diminished in the context of globalization. However, there are other areas, such as education, technology, and physical infrastructure, where responsibilities can be shared between the government and private sector. The other important component of this government-private sector partnership is the development of institutions, a difficult task since they cannot be transferred easily as they are country specific and have to be developed gradually.

        B.  Drivers of Change: Globalization, Technology, and Competition

The two most significant drivers of change in the world today are globalization and technological innovation. Both factors of growth are, in fact, the basis for a new division of labor between countries and firms that has emerged during the last few decades. Countries and firms are divided by their attitude toward globalization and by their capacity to innovate and/or adopt new technologies.

Globalization is defined as a process of economic integration of the entire world through the removal of barriers to free trade and capital mobility, as well as through the diffusion of knowledge and information. It is a historical process moving at different speeds in different countries and in different sectors. One of the results is that firms, whose output was previously significantly more limited by the size of their domestic market, now have the chance to reap greater advantages from economies of scale by "going global." The revolution in information and communications technology (ICT) in the last 10-15 years has also made communication much cheaper and faster. The transaction costs of transferring ideas and information has decreased enormously and the arrival of the Internet has accelerated this trend. This implies that countries with advanced technologies are best placed to innovate further. Moreover, unlike in the past when inventions and innovations were considered breakthroughs, today they are a regular occurrence. This implies that the transformation process is continuous, and this has important consequences both for the overall organization of firms and for policy making. Global firms rely on technological innovation to enhance their capabilities. In this sense, technology is both driven by and is a driver of globalization, so that it is possible to speak of the new "technologically driven character" of the global economy.

Two other factors of change have become significant in the Asia-Pacific region, especially after the financial crisis that began in 1997. The first is the rise of the PRC as a significant industrial powerhouse in the region. The second is the cyclical overcapacity that has arisen in several key electronics sectors, such as dynamic random-access memory (DRAM), personal computers, and mobile telephones. The combination of these two factors has led to fierce competition in the region, resulting in low profit margins and excess capacity in some industries.

In addition to globalization, technology, and competition, there are two other factors of change in Asia at present. These are the rapid growth of the PRC, and the existence of large, if cyclical, overcapacity in certain key export sectors. On the first point, East and Southeast Asian firms are very concerned with their loss of price competitiveness with respect to enterprises in the PRC. The argument is that the PRC has built excess capacity in many of its industries and has flooded international markets with low-cost goods at the expense of East and Southeast Asia's exporters. Indeed, during the last decade, the PRC's impressive export performance and ability to attract substantial FDI have turned it into the "world's factory." The country now makes more than half of the world's cameras, about a third of its air conditioners, one fourth of its washing machines, and nearly one fifth of all refrigerators. This concern may be termed the "China syndrome," though the fear of losing out to the PRC is often overstated.

C.  National Competitiveness: A Dangerous Obsession?

Today, many products in supermarkets and department stores carry the label "Made in PRC." Moreover, many markets in industrial countries, such as consumer electronics, have been dominated for years by products from previously less developed countries (e.g., Korea). This has led to the question as to whether nations themselves can be considered competitive or uncompetitive, analogously to firms. In other words, is the concept of "national competitiveness" a relevant issue? It could be argued that this is because the output of a country is the summation of the production of firms located there. Some authors therefore regard as legitimate, the discussion of the concept of national competitiveness, if only as a reflection of the competitiveness of the nation's firms.

National competitiveness has been defined as the "ability of a country to produce goods and services that meet the test of international markets and simultaneously to maintain and expand the real income of its citizens."2 And again: "National competitiveness refers to a country's ability to create, produce, distribute and/or service products in international trade while earning rising returns on its resources" (Buckley et al. 1988, p.177). These definitions are consistent with the term "international competitiveness," which brings to mind the idea that each nation is viewed "like a big corporation competing in the global market place" (Krugman 1996a, p.4).

It is from this perspective that commentators in some Asian countries have voiced their concern over the consequences of the rapid development of certain industries in the PRC, such as textiles and electronics, as these industries are seen as posing a threat to existing domestic industries. Moreover, this alleged competition is often seen as unfair, to the extent that the PRC benefits from low wages and hence from low unit costs. The conclusion has often been drawn that unless governments take action, perhaps through some form of protection or public policies to increase the competitiveness of the threatened industries, the PRC poses a serious menace to the prosperity of these countries. The irony is that, while the benefits of competition are widely understood and accepted by most people, it is competition from abroad that tends to cause concern among domestic firms and governments. This has led to discussion in terms of economic competition between countries, in much the same terms as competition between products, such as Coca Cola and Pepsi Cola (e.g., Thurow 1993).

However, the definition and use of the term competitiveness at the national level in this manner is far from uncontroversial, as some economists have expressed very serious reservations about its meaning as they believe the idea to be very elusive. In a series of papers, Paul Krugman (1994, 1996a, 1996b) argued that defining national competitiveness, in the specific context of trade (i.e., as export competitiveness), is a futile exercise, and is dangerous both because it implicitly proves a misunderstanding of the theory of comparative advantage and the benefits of free trade, and because it implies a mercantilist view of the world. Krugman contended that it is firms that compete for exports, not countries (although it is true that trade statistics are presented as an aggregate). National economies are not in direct competition with one another and nations do not go bankrupt in the way firms do. Krugman argued that the notion of competitiveness at the national level makes no sense, and claimed that the term was becoming, in fact, a "dangerous obsession."

While Krugman's argument has a great deal of validity, its limitations should also be appreciated. First, the conclusions of the neoclassical trade model depend on extremely restrictive and unrealistic assumptions, such as perfect competition with efficient markets, homogeneous products, universal access to technology with no learning costs, no externalities or scale economies, technically efficient firms, and, especially, fully employed resources. Trade patterns are much less responsive to changing factor prices than commonly assumed. They are the outcome of a long, cumulative process of learning, agglomeration, and increasing returns; institution building; and the overall business culture. This means that the world's pattern of specialization and trade is the result of history, accidents, and past government policies. It is not only dictated by comparative advantage, which is determined by tastes, resources, and technology. Moving from a low-technology (labor-intensive) structure to a high-technology (capital- and knowledge-intensive) one is a difficult and far from straightforward process, involving many policy interventions. In Lall's view, national competitiveness is, in fact, a real issue that can be defined and measured.

The above discussion clearly indicates that the very notion of national competitiveness is controversial, and, in the final analysis, the debate over whether the term has any meaning and substance has its roots in the appropriate role and extent of government policy. Given that it is firms that compete, the real question from the national point of view is: How can government policies ensure that firms are competitive? Despite the arguments about whether or not nations compete, undoubtedly, governments play a critical role in shaping the competitive environment and behavior of firms through a variety of policies.

D.  Aggregate Measures of Competitiveness

Although the idea of competitiveness, understood as the capacity to compete with rivals, does not fit in well in terms of countries, at the national level, economists use several indicators (apart from labor productivity) that are referred to as measures of national competitiveness.

First, national competitiveness has been used to mean labor productivity. This is coherent with the argument that the key variable to achieve long-run growth is productivity. However, if productivity is used to measure competitiveness, then the term national competitiveness is simply "a poetic way of saying productivity without actually implying that international competition has anything to do with it" (Krugman 1996a, p.10).

Second, national competitiveness has been used to mean price competitiveness (Hooper and Larin 1989, Durand et al. 1992, McCombie and Thirlwall 1994, Turner and Golub 1997, Turner and Van 't dack 1993). The most widely used and well-known measures are the real effective exchange rate (REER) and unit labor cost (ULC).4

Third, a rise in a country's ULC relative to that in other countries should lead to a decline in its competitiveness, which would translate into a lower global market share. However, empirical evidence has shown that, over the long term, market share for exports and relative unit costs or prices, of industrial countries especially, tend to move together—the "Kaldor paradox" (McCombie and Thirlwall 1994, Fagerberg 1996).5 Likewise, it is clear from the historical evidence that the substantial exchange rate movements that have taken place since the early 1970s have not rectified balance-of-payments disequilibria. Speculative capital flows, rather than changes in economic fundamentals, have often driven these movements.

Fourth, a rise in either the REER or ULC can be accompanied by strong economic performance. For example, if firms in a country become more successful in terms of non-price competitiveness because they are innovative, flexible, produce high-quality goods, etc., then the REER would probably strengthen.

Finally, both measures can be calculated in different ways, thus potentially leading to different results.

From a policy perspective and in pursuit of overall competitiveness, some economies may become price competitive by keeping their currencies undervalued through nominal depreciations. For short periods of time there can be important gains in price competitiveness due to exchange rate fluctuations, largely resulting from short-term speculative capital flows. These exchange rate changes are much more volatile than productivity. The result is that there can be sudden dramatic changes in price competitiveness without any change in the fundamentals. A strategy of keeping a currency undervalued, however, will most likely be unsuccessful in the long run since it may only mask and perpetuate a lack of productivity in the country's firms. It may also lead to competitive devaluations and beggar-thy-neighbor trade policies. Countries that systematically rely on devaluations to maintain competitiveness often fail to pay appropriate heed to quality and innovation.

Other economists have used Balassa's index of revealed comparative advantage (Drysdale 1988), defined as the share of a commodity group in the economy's total exports, divided by that commodity's share of world exports, so that the higher the ratio is above (below) unity, the stronger (weaker) that economy's comparative advantage in that commodity group, provided that government policies have not grossly distorted the composition of exports.

There is finally, another way of examining national competitiveness based on the construction of composite indices. In fact, the popularity of the idea of international competitiveness has been enhanced by the construction of a competitiveness index by the World Economic Forum (WEF), which is published in the Global Competitiveness Report. The 2001-2002 Report encompasses 75 countries, among them 13 in the Asia-Pacific region. It produces two indices, the growth competitiveness index (GCI), and the current competitiveness index (CCI). The GCI aims to measure the capacity of the national economy to achieve sustained economic growth over the medium term. It looks at the macroeconomic sources of GDP per capita growth, and generates predictions of the ability of a country to improve its per capita income over time.

The GCI is made up of three factors, namely technological capacity, quality of public institutions, and quality of macroeconomic environment. In each of these three factors, the Global Competitiveness Report constructs indices based on a combination of objective information and opinions of business leaders based on surveys (around 4,600 respondents).

The CCI, on the other hand, examines the microeconomic bases of a nation's GDP per capita and provides insights into the level of GDP per capita that is sustainable in the long term. The CCI is made up of two subindices, the quality of the national business environment and the degree of company sophistication (Table 3.2). The data used come primarily from a survey of senior business leaders and government officials. To compute an overall measure of the CCI, all the individual dimensions are combined using common factor analysis.

The CCI is largely based on Michael Porter's (1990) framework, known as the "competitiveness diamond," where the idea of competitive advantages—as opposed to comparative advantage—is introduced. These arise from firm-level efforts to develop new products, make improvements, develop better brands or delivery methods and so on, in other words, to innovate in a broad sense of the term. Innovation, in turn, is influenced by conditions given by four elements of the diamond: factor conditions, demand conditions, related and supporting industries, and the context for firm strategy and rivalry.

The CPI measures the ability of countries to produce and export manufactures competitively. It is constructed from four indicators: manufacturing value added per capita, manufactured exports per capita, share of medium and high-technology products in manufacturing value added, and share of medium- and high-technology products in manufactured exports. The first two indicators provide information about industrial capacity, while the other two reflect technological complexity and industrial upgrading of a country. The index is constructed as the average of the four indicators, and is calculated for a total of 87 economies with values for 1985 and 1998, including 14 Asia-Pacific economies.

Industrial performance, on the other hand, is the outcome of many social, political, and economic factors interacting in complex and dynamic ways. The purpose is to benchmark economies on their key structural variables, called drivers. UNIDO focuses on five proxy variables: skills, technological effort, inward FDI, royalty and technical payments abroad, and modern infrastructure. UNIDO's work has the important advantage with respect to the WEF indices that it is much more simple. Likewise, all the variables considered by UNIDO's CPI and drivers, unlike many of the variables that constitute the WEF indices, are very appropriate. The major drawback in the UNIDO approach is also the aggregation of these four indicators into a composite number via a simple average, namely, the CPI. While the individual components of the index convey important information, their ad hoc weights in a single number can lead to a dubious ranking of countries, which is dependent on the exact weights chosen. Consequently, it is difficult to determine unambiguously the implications of such an index.

Summing up, these indices must be treated with caution. Much of the information provided in these reports through the individual variables (such as about innovation capacity) used to construct the indices can be very valuable for purposes of, for example, establishing priorities and policy responses. The Government of Singapore, for example, posts the results of the rankings in its web site (www.psb.gov.sg) and, for policy purposes, it focuses on those areas where it ranks poorly, and outlines steps to address these weaknesses. Nevertheless, as has been seen, the usefulness of the indices themselves is rather limited.

E.  Exploiting Global Value Chains for Economic Development: Ten NIE Entry Strategies

Firms in the NIEs have been participating in GVCs for several decades and their experience can be very useful for firms in other Asia-Pacific countries. GVCs encouraged local firms to learn technology and overcome the barriers to entry into export markets. Ten common GVC entry strategies for firms in the NIEs have been the following:

1. foreign direct investment (FDI)
2. joint ventures
3. foreign and local buyers
4. licensing
5. subcontracting
6. informal means (e.g., overseas training, hiring, returnees)
7. original equipment manufacture (OEM)
8. own design and manufacture (ODM)
9. strategic partnerships for technology
10. overseas acquisition of equity.

Each of the 10 strategies enabled latecomer firms to enter GVCs at progressively more advanced stages of development, though they had to expand both technological and market opportunities. Indeed, GVCs are not always easy to enter and it can be decades before the latecomer gains a strong position. These entry strategies are not new, although some have expanded greatly due to globalization of production. Numbers 1 to 7 represent early-stage strategies; 8 to 10 are highly advanced methods for latecomers to initiate their own GVCs. Each strategy has evolved through time as latecomers acquired greater technological capabilities and marketing skills.

1. Foreign Direct Investment. The significant expansion of FDI in the Asia-Pacific region, and that it is highly concentrated in the more advanced economies of East Asia as well as the PRC. This concentration worries the Southeast Asian countries, which have traditionally depended on FDI for their exports and for technology transfer. In less developed countries of the region, FDI has stagnated, except in India, where it is picking up.

Historically, FDI was an important export starting point for many firms in East and Southeast Asia, and sometimes led to joint ventures and OEM. As Schive (1990) and Fok (1991) show, foreign subsidiaries acted as "demonstrators" for local firms. Some foreign firms (e.g., the American Singer Company, which produced sewing machines in Taipei,China) directly assisted local firms to develop by training local subcontractors. Most MNCs trained local technicians, engineers, and managers in their subsidiaries, upgrading the capabilities and experience of the workforce. While the overall contribution of FDI to capital formation in economies such as Korea and Taipei,China was very small, it accounted for a large share of exports and employment (James 1990, Dahlman and Sananikone 1990). For example, in Taipei,China, FDI contributed about 2.2% of total domestic capital formation between 1965 and 1968, rising to 4.3% between 1969 and 1972. This fell to 1.4% between 1977 and 1980, and again rose to 2.5% between 1984 and 1986. Foreign firms accounted for around 20% of the economy's total exports between 1974 and 1982, falling to 16% in 1985 as local firms assumed greater significance. MNCs accounted for around 16% of manufacturing employment in 1975, increasing to 17% in 1979, and declining to 9% in 1985 (Hobday 1995a, pp.108-109). In Taipei,China, individual MNC investments gave rise to a Schumpeterian process of "swarming" as local firms rushed to supply basic services and simple components.

2. Joint Ventures. In the early stages of Korean export development, the Government permitted firms such as Hyundai, Daewoo, Lucky Goldstar, and Samsung to form joint ventures with Japanese and US firms (Amsden 1989). Samsung Electronics began by assembling simple transistor radios and black-and-white televisions under a joint venture with Sanyo Electric in 1969. According to Bloom (1991), the Government later encouraged Japanese firms to leave, once local companies had acquired the necessary know-how. In electronics, now the largest GVC, of the 691 firms registered in Korea as producers back in 1977, 480 were Korean owned (mostly small companies), 167 were joint ventures, and 44 were wholly foreign-owned ventures.


3. Foreign and Local Buyers. Foreign and local buyers were a key entry point into GVCs for NIE firms and an essential source of marketing and technological knowledge. Hone (1974) shows that many Asian firms initially sold their goods to the large buying houses from Japan and the US. Foreign buyers would typically place orders of between 60% to 100% of the annual capacity of local firms in sectors such as clothing, electronics, and plastics. The Japanese buyers (e.g., Mitsubishi, Mitsui, Marubeni-Ida, and Nichimen) located themselves in the NIEs to purchase cheap goods as wages started rising in Japan in the early-1960s. In the late-1960s, these buyers purchased more than US$1.4 billion a year of low-cost East Asian manufactured goods, 75% of which were then sold to the US. This led to a host of Japanese manufacturers moving directly to Korea; Singapore; and Taipei,China; many American retail companies (e.g., J.C. Penney, Macy's, Bloomingdales, Marcor, and Sears Roebuck) also set up offices there (Hone 1974). The buyers enabled local firms to obtain the credit needed to expand. Without these guaranteed forward export orders, many firms would not have been able to gain the necessary credit facilities.

Foreign buyers supplied technology in various forms. They provided information on product design and advice on both quality and cost accounting procedures. The larger buyers visited factories and supervised the start-up of new operations, assisting with the purchase of essential materials and capital equipment. Rhee et al. (1984) show that around 50% of a sample of 113 firms in Korea benefited directly from buyers through plant visits by foreign engineers. Buyers supplied latecomers with blueprints, specifications, information on competing goods, production techniques, and guidance on design and quality. About 75% of firms received assistance with product design, style, and detailed specifications. In electronics, American retail chains and importers were the most important buyers during the 1970s in Korea.

4. Licensing. Under licensing contracts, local firms paid for the right to manufacture goods usually for the local market and the MNC would transfer the necessary technology for this to be undertaken. Usually, licensing required a higher level of technological capability on the part of the latecomer than say a joint venture, in which a "senior partner" would normally provide the necessary expertise for the local firm to undertake the production. In Taipei,China, between 1952 and 1988 the authorities approved more than 3,000 licensing agreements, many including formal technology transfer clauses (Dahlman and Sananikone 1990). Companies often secured licenses in the early stages to gain access to technology and markets, leading on to OEM. This continued into the 1970s and 1980s.

5. Subcontracting. Sometimes, MNCs trained local firms under long-term subcontracting relationships. Under these, the latecomer firm would be granted access to training and engineering support and, in return, would produce a component or subsystem, which would then be incorporated into the final equipment by the purchaser. Subcontracting usually took place in lower-value products and systems and was mostly oriented toward the export market, via the MNC buyer.

6. Informal Means. Complementing the formal means for entering GVCs, firms often deployed informal or unofficial strategies, including the copying of products and reverse engineering. It was common to hire foreign engineers on short-term contracts, who were sometimes retired, and recruited local staff already trained by foreign MNCs located in the home economy. Also, many East Asian engineers were educated in foreign universities or worked abroad in foreign companies and some were employed by well known R&D institutes, such as Bell Laboratories in the US. The flow of technically trained Taipei,China nationals returning home rose from just 250 in 1985, to 750 in 1989 to more than 1,000 in 1991.

7. Original Equipment Manufacture. OEM is a specific form of subcontracting that developed out of the joint operations of MNCs and local suppliers, becoming the most important channel for export marketing during the 1980s. This was especially true in electronics, which was the leading export sector in the NIEs. OEM, which began in semiconductors and computer products, is similar to subcontracting in other sectors such as bicycles and footwear. The term OEM originated in the 1950s among people in the computer industry who used subcontractors to assemble equipment for them. In the 1960s, it was adopted by American semiconductor companies that used local firms to assemble and test semiconductors. Under OEM, the latecomer would produce a completed product according to an exact specification provided by the foreign MNC. The MNC would then market the product under its own brand name, through its own distribution channels. This enabled the latecomer to avoid investing in export marketing and distribution channels. OEM often involved the foreign partner in the selection of capital equipment and the training of managers and engineers as well as advice on production and management. Sometimes (e.g. Korea; Hong Kong, China; and Taipei,China) OEM grew out of licensing deals, as the partners got to know each other. Initial success in OEM often led to long-term technological relationships between partner companies because the MNC depended on the quality, delivery, and price of the final output from reliable and trusted suppliers.

8. Own Design and Manufacture. ODM was first reported by Johnstone (1989) and applies mainly to the electronics sector. As the OEM system evolved during the early 1980s, Taipei,China companies such as Acer and RJP began to specify and design the electronic products purchased under OEM, usually beginning with simple products. In 1988 and 1989 this began to be called ODM in Taipei,China but the term was not used in Korea until a decade or so later. However, Korean firms also made equivalent progress in carrying out some or all of the product design, usually according to a general design layout supplied by the foreign buyer, which was often a MNC. In some cases the buyer cooperated with the latecomer on the design. In other cases the buyer was presented with a range of finished products to choose from. These were defined and designed by the latecomer firm based on its growing knowledge of the international market. As with OEM, the goods were then sold under the MNC's or buyer's brand name. ODM offered a means for latecomer firms to capture more of the value added while avoiding the risk associated with the launching of its own-brand products. In the early stages, ODM applied mainly to incremental changes to existing products rather than to new products that were developed by the leading firms based on R&D.

9. Strategic Partnerships for Technology. Strategic partnerships for technology are non-equity joint ventures carried out by Asian firms on an equal basis with foreign MNCs. In recent years, this strategy has enabled the largest latecomer firms to enhance their position in GVCs by developing highly advanced new products and processes jointly with foreign companies. Samsung, for example, entered into an 8-year agreement with Toshiba of Japan in 1992 to develop flash memory chips and with Texas Instruments of the US to make semiconductors in Portugal in 1993. More recently, Lucky Goldstar (LG) of Korea formed a joint venture with Philips of the Netherlands (LG-Philips) in 1999. In this venture, LG provided Philips with advanced manufacturing process know-how for liquid crystal display monitors for desktop and notebook computers, while Philips provided financial capital and access to its basic research facilities in Eindhoven. The combination of LG and Philips enabled LG to recover quickly from the financial crisis in Korea in 1997, and then to forge ahead to become the world leader in the manufacture of thin-film transistor/liquid crystal display screens.

10. Overseas Acquisition of Equity. At their most advanced stage, former latecomer firms operate as "leaders" on the international stage, initiating their own GVCs. Companies such as Samsung and Hyundai have bought several high-technology firms in industrial countries to gain distribution channels, technology, and production facilities. For example, in 1986 Samsung acquired Micron Technology to enter the semiconductor market. In 1988, the same firm took an equity stake in Micro Five Corp to acquire computer technology and invested in Comport in the US to gain hard disk drive technology. Similarly, in 1986 Daewoo acquired a majority holding in Zymos to gain wafer fabrication capabilities. In 1986, Daewoo took over Cordata Tech to gain know-how in IBM-compatible personal computers, as well as manufacturing and marketing facilities. In 1986, Lucky Goldstar acquired Fonetek, a radio communication company, to gain technology. These types of acquisitions enabled the most advanced latecomer firms to dominate their own GVCs and compete with GVCs dominated by US, Japanese, and European firms (Bloom 1989).

F.  Difficulties, Risks, and Threats Within Global Value Chains

Up to this point, this section has stressed the potential benefits for enterprises engaging in GVCs. These include the ability of local enterprises to (i) begin production with its existing level of capability, (ii) access technological knowledge, (iii) access large export markets, (iv) exploit economies of scale, (v) progressively upgrade capabilities in manufacturing with the help of foreign enterprises, (vi) learn process and product innovation skills, and (vii) eventually catch up with advanced firms.16 Within the GVC, there is pressure to adapt to market demand in industrial countries, resulting in more flexible and competitive enterprises. The willingness and ability of latecomers to learn rapidly from leading GVC players are essential.

However, firms also face many challenges and risks in taking part in GVCs. Under many GVC arrangements, the latecomer partner is often subordinated to the decisions of the buyer in the initial stages of the relationship, and often depends on the MNC for technology and components as well as market access. The MNC sometimes imposes restrictions on the activities of the latecomer firm by, for instance, preventing it from selling in other markets or to other customers. Profits tend to be severely squeezed and, without its own distribution outlets, the latecomer is limited in its post-manufacturing valued added. The heavy dependence on assembly can prevent firms from spreading the risks of production to other parts of the GVC. Also, the arrangement makes it difficult for latecomers to build up the international brand image needed to sell high-quality goods directly. This situation is often overcome, though, when the latecomer firm grows, finds new customers, and builds its capacity.

G.  Catch-Up Competitiveness: Some Lessons

For a developing nation, long-run growth depends on the combined capabilities of all of the main economic actors (e.g., firms, government bodies, educational suppliers, and providers of infrastructure) to implement effectively strategies for sustainable growth and development. To catch up, rather than merely keep up with (at a certain distance behind) the leaders, this combined capability must be sufficient to assimilate and improve on technologies created in the leading nations over sustained periods of time. The absorption of foreign technology is essential to create internationally tradable products that are competitive in terms of cost and quality. This points to an important difference between leadership and catch-up competitiveness. The former is centered on the creation of new markets through R&D and marketing investments. By contrast, catch-up competitiveness is based on "behind-the-frontier" innovation, involving constant improvements to process and products (and their interfaces), supported by various kinds of technical and engineering capabilities. Selective R&D may also be required to support these capabilities. Catch-up competitiveness depends on entrepreneurship and educational provision, as well as market-friendly institutions and sound macroeconomic management.

Therefore, catch-up competitiveness is a dynamic concept. Catch up cannot occur if a country does not create new resources or restructure its industries toward more productive, higher value-added products. This is achieved by the country absorbing, adapting, and improving on the technologies that underpin new products, services and processes. Dynamic competitiveness also relies on the infrastructure needed for sustained industrial development. Countries may be compared with their performance in each of these areas, as these will feed into the aggregate "transformational" performance of the economy.


Indeed, it is unlikely that any developing country ever has achieved, or could achieve, long-run competitiveness, i.e., a well-functioning economy, without a substantial degree of innovation in the policy, institutional, and technological arenas. On this basis, no single set of policies can be prescribed for achieving sustained competitiveness. On the contrary, each country must generate its own distinctive policies based on its individual circumstances. The value of lessons from other countries is for "receptor" countries to consider, then accept, reject, or adapt policy advice to its own particular circumstances.

IV.  Insights for Other Countries

Each country must develop its own policies, based on its own resources and given its particular level of development. The stages of development are endogenously determined and not simply and automatically passed through. This qualification applies both to early developers who followed existing new paths and to latecomers. The latter respond, adapt, and act on the new conditions facing them as a result of new technology and market conditions created by earlier developers. Countries wishing to improve competitiveness need to focus on and develop their own distinctive capabilities and resources.

At a general level, experience in the NIEs suggests that innovation is at the heart of the process of economic development and catch-up competitiveness. Attempts to imitate earlier developers and follow established development paths and policies are not, and in most cases probably cannot be, sufficient to produce catch-up development. The NIEs revealed a wide variety of development paths, not only in terms of government policy and industry structure, but also in patterns of industrial ownership, firm size, and the mechanisms for acquiring technology. The evidence shows that the NIEs undertook a great deal of experimentation and innovation in the technological, institutional, and policy arenas.

Achieving long-run competitiveness depends on the combined capabilities and resources of all of the main economic actors (firms, government, and institutions) in their efforts to generate and execute strategies for sustainable economic development. To catch up, rather than merely keep up with the leaders (and to prevent falling behind), this "dynamic" capability must be sufficient both to assimilate and to improve on technologies created by the leading nations over a long period of time.

Technological innovation is an essential part of catching up because it is crucial to the creation of internationally tradable products that are competitive in terms of cost and quality with those of more advanced nations. As has been noted, this kind of behind-the-frontier innovation, widely demonstrated in the NIEs, is not necessarily based on R&D but instead is concerned with continuous incremental improvements to existing production processes and products. Although these activities may lead eventually on to specific types of indigenous R&D-based innovations (e.g., for new product designs) that result from indigenous R&D expenditure, catch-up competitiveness is very different from the leadership competitiveness carried out by firms in industrial countries. The latter depends on substantial long-term R&D with respect to new materials, processes, and products that these firms undertake over long periods of time. The evidence also reveals considerable innovation in institutions and policies in the NIEs as they developed. This occurred because each NIE had to ensure that its industry was sufficiently dynamic and outward looking. The experience of the NIEs strongly suggests that the mere imitation of the paths followed by the leading countries would have been unsuccessful because the latter group constantly move the competitive frontier forward by generating new technologies and new markets.

Conclusions

Competitiveness is defined as the ability of firms to remain profitable by delivering to the market the products and services that consumers desire and demand. Firms become more competitive by competing with other firms and by slowly and patiently learning how to do business better. Consequently, it is unavoidable that many firms will fail and go out of business, yet others will emerge.

Governments and policy makers are particularly interested in the issue. This has given rise to the notion of "national competitiveness" and to the discussion of the topic as if it were the elixir for growth and development. However, competitiveness is not a panacea for development for the developing countries in Asia. Rather, a proper discussion of competitiveness can provide a framework of analysis for entrepreneurs and policy makers to analyze the best ways to achieve sustained growth.

For example, a consideration of competitiveness can help focus on ways to improve the climate for investment. Competitiveness should be best understood as a course of action, and not as a one-time event. It is a continuing process, a way of seeking a better future for individual firms, industries and, ultimately, national economies. The consideration of the East Asian experience, in particular, provides useful insights for firms and policy makers in less advanced countries in the Asia-Pacific region as they devise new strategies and approaches to promote higher rates of sustainable growth.

Globalization, technological progress, and competition are the main drivers of change in today's world, where knowledge is the most important resource. These three factors have raised a whole spectrum of new challenges and opportunities of which firms and policy makers in developing Asia should be aware. The discussion has shown that this environment offers substantial opportunities for the firms and countries in the region to achieve sustained growth. The key to success in the coming years is that governments and firms across Asia devise strategies so as to take full advantage of the potential benefits that globalization, technology, and competition offer. It will be necessary for them to understand what competitiveness means and how it fits in the development puzzle.

Competitiveness is a firm-level issue and hence its analysis requires a firm-level approach. It is, therefore, essential to provide a grounded explanation of the microeconomic foundations of competitiveness. An important implication is that the term national competitiveness, especially if used in the context of nations competing for market shares in exports, as some scholars and governments have taken it, is elusive and even misleading. While nations are concerned about status and power, they do not compete for market shares in the same manner that individual firms do. Indices of national competitiveness have little theoretical foundation and thus must be treated with caution. Misconceptions of the nature and role of competitiveness in national economic development can be counterproductive.

Competition and the quest for profits are the driving forces of firms in a market economy. Competition among firms forces the adoption of the cheapest methods of production and the improvement in the quality of products. In the process of introducing better technologies, new lower-cost methods become available, which allows for increases in labor productivity. Increasing productivity is critical for firms because this is how the profit motive that drives them is put into practice. Labor productivity grows through the interplay of two complementary mechanisms—increases in efficiency and the rate of technical progress. The latter is the result of both investment and the development of entrepreneurial and technological capabilities. These capabilities are defined as the ability to use, generate, change, and add to the pool of the industrial arts. In other words: firms become more competitive not only by reducing costs but also by improving existing products and developing new technologically intensive products. This involves firms moving into new areas, such as services, as well as taking risks and engaging in trial and error.


A well-functioning market economy is the result of a partnership between the state and firms. Although national competitiveness may be an elusive concept, as a shorthand for well-functioning market economy, it has a place in the policy debate. The ultimate objective of this partnership is for developing countries to increase living standards and to catch up with the countries at the income and technological frontier. Increases in labor productivity are the key to achieving sustained long-run growth in living standards. The other component of a well-functioning market economy is the development of institutions, which are determined by historical and cultural factors as well as by government actions that are necessary for growth. Institutions are an immobile factor of production and consequently each country has to experiment and set up the institutions that work in its particular context.

The role of firms in this partnership is to try to be as competitive as possible. Governments have a very important role to play with a view to building a well-functioning market economy, and toward enhancing firms' competitiveness. They have to provide the institutional infrastructure and make available myriad services to facilitate competition among firms by providing a level playing field. Specifically, governments' main functions are to: (i) provide macroeconomic stability; (ii) set up the necessary legal system, including competition and entry and exit laws; and (iii) address market failures. Likewise, there are three major areas where there is room for state and markets to share responsibilities: (i) education, (ii) technology and innovation, and (iii) physical infrastructure.

Certain aspects of government intervention that aim to enhance competitiveness are more controversial when they are used as competitiveness policies and, in particular, if they cloak what is in effect industrial policy and an exercise in picking the winners. These are: (i) the provision of financial incentives to attract FDI; (ii) the creation of EPZs; and (iii) the creation of clusters and industrial parks. The empirical evidence to date indicates that government intervention in these areas might not yield significant benefits. Moreover, the evidence regarding technology transfer mandates, specific local content requirements, or mandatory joint ventures indicates that they do not yield benefits as large as expected to the host country. The problem with the creation of clusters and EPZs is that they often appear packaged as "new competitiveness policies" when, in many cases, they are no more than discredited industrial policies that attempt to pick the winners.

Among the variety of possibilities for firms to enhance their entrepreneurial and technological capabilities, global value chains (GVCs) offer significant opportunities to many Asian firms to take advantage of the potential benefits of globalization. There are many ways for a firm to enter a GVC and these largely depend on the firm's level of development. The NIE firms successfully entered GVCs three decades ago and it was in this way that they climbed the development ladder. Their experience can be very useful to the firms in less developed countries of the region.

The availability of skilled labor is another dynamic competitive force that is making developing Asia a formidable producer and exporter of technology-intensive goods. Education is an area of shared responsibility between government and market, especially at the tertiary level. The East and Southeast Asian economies now provide basic education for all those who are eligible. However, in recent years they have realized that their educational systems need important reforms, in particular regarding the mismatch between the type of education supplied by universities and the skills demanded by the firms. There is no unique solution to this problem and countries in the region will have to experiment.

Finally, firms in less developed countries in the region can learn a great deal from the experience of the firms in the NIEs, which reduced substantially the technological gap with firms at the frontier during the last two decades. They did this not by undertaking R&D, but through behind-the-frontier innovation, which involved constant improvements to process and products. This has been referred to as catch-up competitiveness, which depends on entrepreneurship, provision of education as well as market-friendly institutions, and sound macroeconomic management. The discussion has argued that exactly replicating their experience will be impossible mainly because the global economic environment has changed, and that the specific resources and capabilities of today's developing economies differ from those of the NIEs. Thus, although the successful experience of many NIE firms has many important lessons, catch-up by the firms in less developed countries in the region will be impossible without a substantial degree of indigenous innovativeness at the entrepreneurial and technological levels, as well as at the policy and institutional levels.

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