The Dragon and the Flying Geese: The Effects of the Emergence of China on Patterns of Growth and Development in Asia

Outline

1. Introduction

2. The Complementarities of Asian Economic Dynamics

3. China’s Awakening

4. The Effect of China on Asian Trade and FDI

5. China and the Future of Asian Economic Dynamics

1. Introduction

For the past 30 years, Asian economies have been the world’s envy as they have surpassed practically every other region in terms exports and economic growth. The remarkable development of various Asian countries has drawn millions of people out of poverty and created some of the wealthiest and most competitive economies in the world. Much of this success has been attributed to a distinctly Asian development model that combines high work ethics with an exceptional emphasis on savings and high rates of investment in both infrastructure and human capital. Moreover, it is clear that the Asian Miracle was also facilitated by the extraordinary complementarily of resources, stages of development and policies of Asian countries. This complementarily made possible a pattern of development known as the Flying Geese model, in which capital, technologies and know-how trickled down, first from Japan to the Tiger economies (Taiwan, Korea, Singapore and Hong Kong) and then to the Aspirant Tigers of Southeast Asia (Thailand, Malaysia, Indonesia and the Philippines), fostering economic development throughout the region.

During the 1990s, however, this picture changed abruptly. First, fuelled by excessive liquidity combined with a policy of financial repression, a real estate and equity bubble developed in Japan, the bursting of which dragged Japan into a decade long economic crisis. Consequently, Japanese FDI flows to the region, which had played an instrumental role in the Flying Geese Pattern, were reduced significantly. Second, China emerged as a major player in the world economy as her strategy of opening up to FDI and redirecting economic activity towards exports began to pay off. While the drastic reduction of

Japanese FDI definitely hit Asian economies hard, it has been the rise of China that has created the biggest worries in South and Southeast Asian countries. The addition of hundreds of millions of Chinese workers to the world supply of labor clearly has increased competitive pressures, especially in the labor intensive industries in which many Asian economies have specialized. This nurtured fears and a sense of helplessness in light of a seemingly all encompassing absolute advantage of China in so many industries and, similarly, fears that Chinese attractiveness to FDI would be to the detriment of ASEAN countries.

In the following paper, I analyze how the spectacular rise of China has affected the patterns of Asian economic dynamics since the early 1990s. In particular, I focus on the question weather the win-win situation of economic complementarily of the past has given way to a zero sum competitive game in which the Asian economies fiercely compete for the same FDI inflows and the same export markets. Part 1 of this paper will give an overview of how the complementarities of Asian economics have contributed to the remarkable growth in the region, emphasizing the Flying Geese pattern of Asian Development and the importance of production networks. Part 2 introduces China as an Asian player and describes along general lines how her policy of opening up and integrating into the global economy contributed to her exceptional rise. Part 3 constitutes the core of this paper and analyses in depth how trade and FDI flows have evolved in Asia since the early 1990s. In particular, the effect of rising Chinese exports and FDI inflows on selected Asian economies will be discussed. Part 4 builds upon this analysis and describes how the rise of China is likely to affect Asian dynamics in the future and to what effect the complementarities of the past will continue to remain relevant.

2. The Complementarities of Asian Economic Dynamics

During the second part of the 20 ^th Century, several Asian countries have been among the most successful economies in the world, exhibiting spectacular growth rates over a sustained period of time and lifting out of poverty millions of people. On the one hand, this performance has rightly been attributed to the comparatively inclusive domestic policies and institutions that focused on high investments in infrastructure and human capital and that were largely founded on market-based incentives (see Campos and Root 1996). These policies and institutions have often been analyzed in conjunction to distinctly idiosyncratic Asian cultural traits such as discipline, hard work ethics and a particularly high valuation of education. On the other hand, and more importantly in the context of this paper, the Asian Miracle has also been explained through the exceptional complementarily of Asian economies in terms of their endowments with natural resources, human resources and levels of development. The various Asian countries are very differently endowed with factors of production, indeed. Japan and the Tigers are extremely short on natural resources and particularly on energy of which, conversely, ASEAN and South Asian countries are typically well endowed with. It is remarkable how first Japan and then the Tiger economies were able to exploit this complementarily by rapidly developing their own dynamic comparative advantages in increasingly valueadded industries by accumulating physical and human capital while employing the natural resources from ASEAN countries. In order to secure and extract the necessary resources, massive amounts of foreign direct investment flowed from the resource consuming to the resource producing countries of South East Asia, thereby in turn

contributing to the economic development of these countries. This pattern of investment and knowledge flows was termed the Flying Geese pattern of Asian development, as it fostered a catch-up development of the lower Tier countries through providing them with access to markets, management know-how, technology and capital (Kojima 2000).

Production Networks and Economic Integration

Economic integration through FDI and the resulting production networks gained further importance when the East Asian economies switched to more export led growth strategies after they increasingly experienced the limits of their import substitution growth strategies. The East Asian countries followed the export-oriented development model of Japan and consequently, from 1985-1986 in Malaysia and Thailand and 1991 or 1992 in the Philippines and Indonesia, the governments began to switch their FDI policy from a very selective approach to a policy of actively seeking to attract FDI across sectors (Ando and Kimura 2003). Incidentally, this development coincided with a massive surge in costpush FDI from Japan as it moved its marginalized industries to the Tiger and ASEAN economies after the Plaza Agreement of 1985, in which Japan agreed to drastically revalue the Yen against the US Dollar to correct the massive US trade deficit with Japan (Harvie 2002). Thus, FDI inflows into the South East Asian economies surged right at a time when these countries began to actively engage in FDI attracting policies.

Table 1 – Japanese FDI in Asia (US$ millions)

Source: Japanese Ministry of Finance 1990.

What is interesting about Asian FDI is that investments abroad were usually more integrated into the production chain of the parent companies than similar investments elsewhere in the world. Thus, extensive and complex international production and distribution networks emerged, exploiting the complementarities of Asian countries in terms of their respective comparative advantage, different factor prices and economies of scale and fostering countries to specialize in specific steps of production. Vertical production chains extended across the countries in the region and were connected to distribution networks throughout the world (Chanatasawat 2004a).

The effects of the development of production networks on Asian economic dynamics were twofold. First, they strengthened the Flying Geese pattern of development by contributing to the catch-up process of the less developed Asian countries. In fact, typical flows of FDI followed a pattern, in which – according to the product cycle – goods were first manufactured in the most advanced countries such as Japan and the NIEs while they were luxury goods and then, through FDI, their production was moved to the less developed neighboring countries as the goods became commodity consumer goods. During this process, the FDI receiving countries had the opportunity to accumulate physical and human capital and know-how and to move upward in the production of higher value added products. Such repeated rounds of FDI upgrading helped Southeast Asian countries to follow the regional technological leaders, increased their exports and moved their economies towards higher stages on the value added chain (Kojima 2000).