How Asian economies can compete and grow

In this environment, sustaining Asia's past growth rates will require broadening the sources of that growth. Asian governments can learn from international experience as they find ways of exiting their fiscal and monetary stimulus programs.

The global recession raised some fundamental questions about the sustainability of export-led growth

The Asian economies have performed relatively well during the first global recession since World War II. This performance was partially a result of Asian governments' fiscal and monetary stimulus packages that offset the falloff in Asian exports to markets such as North America and Europe. But the crisis has raised some fundamental questions about the sustainability of the export-led approach to growth, given debt and unemployment levels in Asia's traditional export markets, and the increased likelihood of Asian currency appreciation reducing the competitiveness of the region's exports.

In this environment, sustaining Asia's past growth rates will require broadening the sources of that growth. Asian governments can learn from international experience as they find ways of exiting their fiscal and monetary stimulus programs. New research by the McKinsey Global Institute (MGI) highlights which kinds of competitiveness and growth policies have been successful—or have failed—in the past and suggests four lessons for policy makers to keep in mind.

First, don't expect emerging innovative sectors to solve the job creation challenge. Generating jobs is the number one priority on the minds of many policy makers globally—and much hope is pinned on innovative sectors such as cleantech or biotech. But recent patterns in job creation suggest that these expectations are unlikely to be met. Such innovative new sectors are simply too small. The successful South Korean semiconductor industry accounts for less than 0.5 percent of overall. The quest for new jobs is much more likely to bear fruit in large local business and household-services sectors. That is not to say it is a waste of time to try to promote such innovative sectors. New technologies can have a transformational impact on broader productivity and offer significant consumer benefits—as the IT sector has shown. But it is low-tech green jobs in local services, such as improving building insulation and replacing obsolete heating and cooling equipment, that have the greater potential to create jobs in the near term.

Second, ensure that services contribute their share to overall growth. In middle-income countries, the service sectors contributed more than half of overall GDP growth and 85 percent of net new jobs between 1995 and 2005. And as incomes rise, services become even more central: in high-income economies, 87 percent of GDP growth and all net job growth came from services. Ensuring that the region creates dynamic, productive, and competitive domestic service markets will be key to sustaining growth—particularly as competition in export markets increases. South Korea, for instance, has a phenomenal record of manufacturing sector success but could boost overall growth by improving service sector growth and productivity from their relatively low level today. Services are the next frontier not only for South Korea but also for China, where the 11th Five Year Plan in 2005 targeted a three percentage point increase in the services share of the economy every five years after 2010.

Third, bring in private sector talent—and mind-set—to shape competitiveness and growth policies. Asia has generated many of the most impressive industrial policy successes—South Korea's POSCO company and Taiwan’'s semiconductor giant TSMC are just two examples. Both companies enjoyed significant public support in their early days based on an in-depth understanding of the underlying economics of the steel and semiconductor industries, and in both cases the governments drew on business expertise to execute policy. For the successful growth of services, it is vital that regulation unleashes the market and allows more productive companies to gain share or replace less productive ones. Government's critical role is to ensure that regulation creates competitive pressure for entrepreneurs to innovate and adopt better practices.

Fourth, governments need to take a cool-headed view on what are realistic expectations of jobs and growth in sectors and not jump on the latest hot fad. Take cleantech, where so many governments aspire to being major players that global subsidies for the sector already top $500 billion. Competition is fierce, and not every country will emerge as a winner, as lessons from the semiconductor sector show. In semiconductors, the three leading clusters today in the United States, South Korea, and Taiwan all benefited from sustained public support during early stages of the industry's development. However, large public subsidies among these and many other regions aspiring to become high-tech regions have led to intense competition in the sector and low returns to capital for the sector as a whole. The rapid innovation and declining user costs have been significant benefits to semiconductor-using companies and households globally but have had limited impact on almost all of the regions receiving support from their respective governments.

Designing and implementing policies to improve growth and competitiveness are not easy. Even if the agenda and the tools are right, poor execution can sink even the best efforts. The hope must be that, despite today's challenging market conditions, governments will learn from the industrial policy missteps of the past.

This article originally ran in Forbes.

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