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Forward Thinking on the recipe for Asia’s success story with Justin Yifu Lin

In this episode of the McKinsey Global Institute’s Forward Thinking podcast, co-host Janet Bush talks with Justin Yifu Lin. Lin is dean of the Institute of New Structural Economics, dean of the Institute of South-South Cooperation and Development, and professor and honorary dean of the National School of Development at Peking University. He served as chief economist at the World Bank from 2008 to 2012, and he actually took up his World Bank position after serving for 15 years as professor and founding director of the China Center for Economic Research at Peking University. In this podcast, he covers topics including the following:

  • What is new structural economics?
  • How can emerging economies catch up?
  • Is globalization going into reverse?
  • Will the economies of China and Asia maintain momentum?

Janet Bush (co-host): Michael, have you heard about the flying geese syndrome in economics?

Michael Chui (co-host): Yes, I believe it refers to an economy leading the way in economic development, and allowing others to follow.

Janet Bush: Yes, I confess I had not heard of this concept before. The notion comes from a Japanese economist. But our guest today coined his own follow-up concept—the flying dragon—for China—simply because China is so much bigger than a goose.

Michael Chui: Love it, I am looking forward to hearing more.

Janet Bush: Welcome to our podcast, Professor Lin.

Justin Yifu Lin: Thank you very much for the invitation, Janet.

Janet Bush: We like to ask our guests about their journey into their specialism, in your case economics. Were you always interested in economics from when you were at school? Or how did your interest in your subject start to develop?

Justin Yifu Lin: I always wanted to make a contribution to the industrialization, modernization of China. And certainly, when I was young, I was searching for what I can do. At the beginning, I thought I should be a historian to understand the past better so I can make a contribution to the current situation. But there was an unexpected opportunity.

When I studied at Peking University, I met Theodore Schultz. He was a 1979 Nobel laureate. And when he visited Peking University, I was assigned to be his interpreter for his lecture. And he saw that I did a very good job. So after he returned to Chicago, he gave me an offer to say, “Young man, if you’d like to study economics, I can offer you a scholarship.” And who can refuse such a good offer?

So I went to Chicago, and after I got my PhD and I graduated from the University of Chicago, I continued my academic work. And so I became an economist. But I have no regrets. I think being an economist I will be able to make a much better contribution than being a historian.

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Janet Bush: Yes, I used to be an economics journalist, and some people in my paper used to think that economics was very boring. And I used to say to them, “But economics is about everything in life.” But when you were being an interpreter, what did you do that was so impressive to lead to this offer?

Justin Yifu Lin: Well, I think I smiled a lot, and when I translated his lecture, there were some parts I did not fully understand. I smiled and I talked to the audience as a joke. And then they smiled. Then Professor Schultz thought I must have done a very good job. Otherwise, the audience would not smile in response to his lecture.

Janet Bush: I think in American, that’s called chutzpah.

Justin Yifu Lin: Yeah.

Janet Bush: I want to ask you about new structural economics, which is something that you’re a proponent of. Could you describe to our listeners what this subdiscipline of economics is all about for you?

Justin Yifu Lin: To be short, I tried to bring the structural perspective into modern economics. But I have to say the modern economics is a structure. In general, if you study modern economics, for example, macroeconomics or growth economics, they use one sector model to describe developed countries and developing countries.

And in that kind of theoretical model, the difference between the developed country and developing country has only a quantitative difference. But we know there are qualitative differences between the developed country and developing country. As someone who lived and grew up in a developing country, I can see the structural difference.

It’s very important for us to bring this kind of structural perspective into mainstream economics. And I want to understand what causes the structure to be different. And what causes the structure to evolve from a lower-stage structure to a higher-stage structure. And I also like to understand: what are the impacts of the structural difference?

In mainstream economics, there was a new subdiscipline called development economics. And the first generation of development economics is structuralism. They see the structural difference between the developed country and the developing country, but they did not have a good understanding of the reason for the structural differences.

And so they recommend that developing countries should adopt or should develop similar types of industries, the advanced industries, as the developed countries. And I think the intention was good, but the result was disappointing. And I will try to distinguish my type of research from structuralism, so I refer to my type of research as “new structural economics.”

Janet Bush: Give us an example of why a different structure in a developing economy matters so much for, say, what policies should be pursued.

Justin Yifu Lin: Well, to understand the structural differences and the way to change the structure will be very important. Because certainly, if developing countries want to catch up to developed countries, at the end result, their income level should be the same.

And if they want to have the same income level, they should have the same level of productivity. And the reason why the advanced country has a high income is because they have those kind of technological-intensive, capital-intensive industries, which have high labor productivity. So they have high income.

In a developing country, currently the income level is low, only because their industries are either in traditional agriculture or in small-scale, labor-intense industries. And in those kinds of industries, their productivity level is low. And that’s the reason why their income level is low.

If you want to narrow the income gap, you need to move up your industrial ladders to the same type of industries as the industries in the high-income countries.

But the reason why the high-income countries develop capital-intensive industry is because the advanced countries, they started to accumulate capital since the Industrial Revolution. So relatively, they have abundant supply of capital. But in a developing country, their productivity level has been low, and the accumulation of capital is small. And they have a scarcity in capital.

In this kind of situation, capital-intensive industry is not the developing country’s comparative advantage. And you need to understand the cause, why you stay in these kinds of industries, which are either land-intensive agriculture or labor-intensive, small-scale industries.

It’s because capital in your country is scarce. You need to understand this kind of reason, and so once you understand this kind of reason, then you start to find a way to accelerate the accumulation of capital. If you can accumulate your capital faster than the advanced country, then gradually you can narrow the availability of capital to your workers—the gap of the availability of capital, and then you can close the income gap. And so it’s very important for us to be able to understand the causes, and then we can prescribe the policy.

Janet Bush: I read somewhere that you said that new structural economics draws on a growth report by Mike Spence and others. And that report argued that fast, sustained growth is possible with five traits. So 1) open economies; 2) macroeconomic stability; 3) high rates of saving and investment; 4) they let markets allocate resources; and 5) they have committed, credible, and capable governments. Do you agree with those five traits?

Justin Yifu Lin: It’s from the facts, so certainly I do not dispute the facts. But when Michael Spence—he’s a good friend of mine, I respect him a lot—after he released his growth commission report and identified those five stylized facts for success, certainly all the government leaders in the developing world were very excited.

They invited him to give advice on how to make the country from the poverty trap become a dynamic growing country and to catch up with the advanced country. But at that time, Michael responded and said that these five traits are “ingredients, but they are not a recipe.” However, if you only have ingredients and you don’t have a recipe, you cannot cook good dishes, right? You need to have recipe.

But from the new structural economics, actually, there is a recipe. Because the recipe for the success from the new structural economics is to develop your industries, your technologies according to the comparative advantages based on your factor endowments: how much capital you have, how many labor forces you have, how many natural resources you have.

And according to your factor endowments, you can now identify the sectors for which you have comparative advantages. And in those kind of sectors, you can produce at the lowest possible cost, and that is the foundation of competitiveness. Comparative advantage is a concept understandable for economists. But how can you translate that into a spontaneous choice of the entrepreneur?

Then you need to have, you know, a price system, which can reflect your relative abundance of your factor endowments. And the only way to get those kind of factor prices, which can reflect your relative abundance of factor endowments, is to have a well-functioning competitive market. So that market institution is very important. But having only a market institution is insufficient, because the competition in a market is a competition of total cost, including the production cost determined by your factor inputs. But it also depends on how high the transaction cost. If the transaction cost is too high, even your production cost is low, your total cost will be too high. Then you cannot be competitive in a market. And the transaction cost depends on how good your infrastructure is and how good your institution.

The improvement of infrastructure and institution could reduce the transaction cost. Entrepreneurs cannot do that by themselves. So the government needs to apply a proactive approach to improve infrastructure and institution.

So my recipe for success from the new structural economics, that first principle is to follow your competitive advantages in the process of economic development. But you need to have two institutions to make that possible.

If you look at the five stylized facts, the number four, the market economy, the number five, to have a credible, competent, committed government, those are two institutional preconditions for a country to follow their comparative advantages determined by their factor endowments.

Then if you follow your comparative advantages, certainly you will be an open economy. You will produce goods for which you have comparative advantages. You export them. And then for goods where you do not have comparative advantages, you will import them. So then you will be an open economy.

And secondly, if you follow your comparative advantages in a market economy, you will be competitive. And under that kind of situation certainly you are not going to have homegrown crisis. At the same time, if you were hit by a crisis from outside, global crisis, the country will be prepared to adopt mitigation measures. Because they will accumulate more capital. Government will be in a good position. And they will accumulate more foreign reserves, so they have a larger room for maneuvering.

And third, if you follow your comparative advantages, on the one hand, you will be competitive. You’ll be profitable, and also you have more to save, to invest. At the same time, if you make investment according to your comparative advantages, the return will be high. And so the incentive for saving will be high.

So from what I see, those five ingredients actually imply a recipe. The recipe is to follow your comparative advantage as advocated by the new structural economics. But to do that, you need to have two institutional preconditions, a market economy with a facilitating state. Then the result will be open, stable, and high saving and high investment.

Janet Bush: Looking at all of that, the five traits and the recipe and how they work together, does China have the recipe? Does the rest of Asia have the recipe?

Justin Yifu Lin: I think yes, China has that—after 1978, the transition from a planned economy to a market economy, because you can see after transition China grew so dynamically in trade. And now China is the largest trading country in the world. Certainly China is an open economy.

And secondly, China in the past 40 years is the only economy which did not have an internal crisis. So it’s stable.

And third one, certainly China with a saving rate of 40 to 50 percent of GDP, certainly China has high savings and high investment, as described.

And China certainly has a credible, committed government, and China, on the way from a planned economy to a market economy, certainly China has all those five traits.

But certainly, China is a transition economy. And in this process, China adopts some kind of dual-track gradual approach, on the one hand continuing to provide some necessary subsidies and protection to the old sectors. But the old sectors are inconsistent with China’s comparative advantages, which were built up during the planning economy. China needed to provide transitory protection and subsidies to them in order to maintain stability. But China liberalized the entry to the new sectors, which are consistent with China’s comparative advantages.

In those new sectors, all the five traits are demonstrated in this process of transition. And if you look into other East Asian successful economies, from Korea, Taiwan, Hong Kong, Singapore, and so on, certainly they all have those five traits.

Janet Bush: And the fact that that approach has been so successful in China and Korea and other parts of Asia, does that give a model for the rest of Asia to follow? And are they following that model?

Justin Yifu Lin: I think other Asian economies—for example, Thailand, Indonesia, and so on, and Cambodia, certainly—learn from the lessons and follow very closely. That’s the reason why they also grow relatively dynamically compared to other regions in the world, especially if you look into the middle-income trap in Latin America, poverty trap in Africa. And you can see all the East Asian countries, they are performing much better, because they learn from each other.

Janet Bush: You talk about a syndrome called the “leading dragon syndrome.” Way back when, my own country, Britain, underwent its Industrial Revolution, and in those days was the leading dragon. And those industrial processes and ways of doing things went to Europe and then America. And then, in the case of Asia, China is a leading dragon. Could you tell our listeners what the usefulness is of having that leading dragon, in terms of everybody’s development?

Justin Yifu Lin: First let me say, “leading dragon” is a term coined by me. The other, similar term called the “flying geese” is coined by Japanese economist [Kaname] Akamatsu. And in the flying geese model, he studied the economic development process in Japan and certainly other countries. More traditional, labor-intensive industries gradually moved up the industrial ladder to more capital-intensive industries. And in this process, for you to move up to the new industries, you will open your old industries for other, following countries to enter. So in this, it is like flying geese.

And China follows a similar pattern. However, the economic size of China is much larger, because as you know, the population size in Japan is about 120 million people. But China is 1.4 billion people. It’s more than ten times larger.

And so under this situation, although China follows a similar pattern, when China moves up the industrial ladder, China will open the space for other foreign countries to enter. But the countries that can enter will be much larger. For example, in the 1950s, Japan moved up to more capital-intensive industries when their raised their income. At that time, Japan’s population size of workers in manufacturing sectors was 9.7 million. And so Korea, Taiwan, Hong Kong, Singapore entered into the labor-intensive industries.

And certainly, they were also successful. And in the 1980s, Korea, Taiwan, Hong Kong, Singapore moved up the industrial ladder, because they became newly industrialized economies and reached the stage of higher income. They opened up the labor-intense industries for other countries to enter. At that time, Korea employed one and a half million [in manufacturing sectors], Taiwan about five million. I don’t have the exact figures in my mind right now. And Hong Kong one million and Singapore half a million.

Okay, but this time in 2010, China moved up the industrial ladder. China employed 140 million workers in manufacturing sectors. And within this 140 million, 85 million were in labor-intensive sectors. And with rising wages, China would lose comparative advantages in those labor-intensive sectors. And China will open up the space for other low-income countries to enter into the labor-intensive industries.

And so that’s the reason why I describe this as “leading dragon.” So it’s just a [scaled up] version of the flying geese.

Janet Bush: I want to move on to what might happen next. The McKinsey Global Institute has got this research stream that we’re asking the question, “Are we on the cusp of a new era?” So we’ve had a number of disruptive events. We’ve had the pandemic. We’ve had, in Europe, the invasion of Ukraine. We’ve got geopolitical tension.

Similar clusters of events have happened before, and they’ve tended to change the rules of the game or the landscape in which we operate. Do you think that these disruptions that we’ve seen over the last two or three years are leading to something different in the world? It could be economic, it could be political, it could be demographic.

Justin Yifu Lin: I think certainly we are going to enter into a world different from before, because in the past 30 years, especially after the collapse of the Soviet Union, we entered into a unipolar world, right? And I think that with the rise of China, now the economic size of China is about the size of the US.

If we measure by purchasing power parity, China is bigger than the US. If we measure by market exchange rate, certainly the US is still the biggest country in the world. And now only the economic size of China and the US are roughly the same. We are seeing the rise of India as well, and with a 1.4 billion population, I think sooner or later their economic size will be about the same as the US again.

We know that the economy is the foundation of political influence, cultural influence and so on. So with that, I think we are going to enter into a multipolar world. We are going to have pluralism in the culture, in the influence.

When I was young, I was always educated that we need to respect that pluralism is a good thing, because it will cause certainly certain competition. But competition will stimulate innovation. So I think that we are going to change from a unipolar world to a multipolar world. And I think that will be a much better scenario for the world than having only one power and only one model.

Janet Bush: In the past era, in our research, we talked about the era of markets. And there were two characteristics that stood out. One was many, many more economies opened up their markets. They adopted the market model. They opened up to trading around the world, and alongside that, there was this amazing spread of digital technologies. And Asia during that period, the Asian economies thrived enormously.

Looking at participation in global supply chains and technology, could we look at global supply chains first? Do you think that the opening up of the world and the integrating of the world through global supply chains, are we going to see more of that in the next era or not? And is it going to change?

Justin Yifu Lin: I think that first, we need to understand trade is win-win for everyone. And so globalization certainly should be good for every country in the world in principle. During the era of globalization, we see the dynamic economic growth in the world.

And now we do see deglobalization, I think for two reasons. One reason is that in many advanced countries, they have domestic problems. And actually, the roots of the domestic problem are not globalization, but politicians use globalization as a scapegoat. That’s one thing. And secondly, there is rivalry between the great powers, to be specific, between China and the US.

But I think this is just a temporary phenomenon. Fundamentally, we have a philosophy—and I agree with that, from the new structural economics—certainly we are going to encounter many problems at any time in any country.

But the best way to address the problem is development. And the best opportunity for development is for each country to follow the comparative advantages of their economy to develop. You need to have market economy, an enabling government, and you also need to have open globalization.

So I think globalization should be part of the formula for us to address poverty, for us to create jobs, and to generate social political stability in every country. And I’m sure people will learn that lesson.

Janet Bush: You’ve talked about technology transfer and how important that is. Do you think that Asia will move from being a huge consumer of technology to a leading innovator of technology?

Justin Yifu Lin: I think certainly, Asian people are as innovative as any people in the world. And actually, all people are innovative. But to be a technological leader, you need to have some conditions. The first one, if you want to be a technology leader, you need to invest a lot for the innovation of new technologies.

And only if you reach high-income stages, you will have those kind of resources to invest in new technology. So you need to be high income, the first one. And for the new technology, to be competitive, if you have a large domestic economy, you have some advantages.

In the 1980s, up to about 2000, the most innovative firms in terms of patent applications, the majority, the top ten, were Japanese companies. So Japan was quite innovative, right?

But the size of the domestic economy of Japan is not as large as the US. So it appeared that the US should be more competitive, only because the US has a large domestic size, okay. Now I mentioned, we are going to move into a multilateral world. Certainly, you find the income level in China rising, then China will have more resources to invest in new technologies. And China also has a large domestic economy, so China will be innovative.

And also, India is rising, and when they reach high-income stages, I’m sure they will be as equally innovative as any other country. Because individually, we are all the same, but some countries appear to have advantages indeed in technology, only because they reached high-income stages earlier and happened to have a large domestic economy.

Janet Bush: Overall, do you see the momentum that Asia has had over the past 30 years continuing with the same strength and speed?

Justin Yifu Lin: I think that it will continue, because when we know the secret, we are not going to give up that enlightenment. So we will make an effort to maintain a peaceful global environment. And we will continue to advocate globalization, because that’s good not only for Asia but good for every country in the world.

Janet Bush: So listen, we like to finish these podcasts with a few little quick questions. My first question to you, because we’ve been talking about recipes, is what is your favorite food?

Justin Yifu Lin: Well, I’m quite globalized. Certainly, I like Chinese food, I like Western food, I like Korean food. I like Japanese food also.

Janet Bush: Same with me. But I was thinking, is there a particular dish that you dream about when you’re hungry?

Justin Yifu Lin: Oh, certainly cooking from my mother.

Janet Bush: Good answer. What would you have done if you hadn’t become an economist, do you think? Do you have other things that you would have liked to have done?

Justin Yifu Lin: As I stated, if I did not have the opportunity to study at Chicago, likely I’d be a historian. But if I’m not a historian, if I did not stay in academia, I think I would be a practitioner of development. Because I always want to contribute to the understanding of the success of a country and make a contribution to the success.

Janet Bush: What makes you optimistic about the world at the moment?

Justin Yifu Lin: I still believe in people’s rationality. I think that everyone has incentives to work hard, so they can do better, not only for themselves but also for their younger generations. And with that, I think once we have a better understanding about the nature and the causes of development, I think people will follow the kind of understanding just like Adam Smith; he demystified the wealth of the nations and he influenced the world, so once we have a better understanding, a developing country can catch up.

So far, 85 percent of the population in the world is in the developing part of the world. But once we understand, for a developing country, the path to catch up, I think sooner or later we will benefit from that understanding. And we can one day let all the people in the world get out of poverty. All the people in the world can be on the same level of affluence.

Janet Bush: And what makes you pessimistic, if anything? What worries you?

Justin Yifu Lin: What worries me is some people due to their personal, political intentions manipulate the message to their constituencies, causing the policy to deviate from the policy which will benefit their own people and would also benefit people in the world.

Janet Bush: What one piece of advice would you offer to our listeners?

Justin Yifu Lin: I think the one piece of advice that I’d like to offer to both the developed countries and developing countries is that we always have to start from what we have. Look at what you have now, instead of what other people have. And look at what you can do your best with what you have now, instead of looking at what other people could do well and that you cannot do well.

If all the people in the world, all the governments, can follow this advice, we can all enjoy very sustainable, dynamic, economic growth anytime, anywhere. And we are going to have a much better world.

Janet Bush: Thank you so much. Now, listen, I have to say to my listeners that Professor Lin is smiling a lot, and that’s how he got his great break in Chicago. So that’s very welcome.

Justin Yifu Lin: Thank you very much, Janet.

Janet Bush: Thank you so much.

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