They showed that in agriculture, unlike in manufacturing, when you have a lot of poor people, so wage rates are very low, that you can actually turn agriculture very efficiently into a kind of form of gardening. You can make it incredibly labor intensive, and you can have higher yields than you’re actually able to achieve on a large farm. East Asia pioneered it. So, they’ve never been done before. 

Then on top of that, they over-emphasized the role of manufacturing because this was the best way to take people out of the agricultural economy. When you’ve got low skilled people coming out of farming, it’s a lot easier to train them to work in factories than it is to train them for service jobs because so much of what needs to be done is embedded within machinery. 

Then, the final thing that they did was that they used finance to support small-scale household farming and manufacturing. 

When they did those three things, they were able to move on from what the US and Germany had achieved in growing at 5% to 6% a year, and move to growing an average 10%. As you know, China, the latest example, has grown up 10% average, 10% a year for the last 30 years. So, that’s a rather long answer.

Stig Brodersen  5:23  

That might be a long answer, but a really great answer, Joe.

Just to sum up here. So, the first of the three steps: that’s land reforms. The second step is manufacturing. Finally, the third step is all about how the financial industry can support the agriculture and manufacturing industries. So as we move on, we’ll talk about each of these three segments.

Preston Pysh  5:47  

Stig, you’re exactly right. My first question that I have here for you, Joe, is relating to the farming and the agricultural piece. I would like to talk more about the key role that it played into this development over in Asia. 

One of the many reasons why this is the first step is because developing countries have this abundance of farm labor and a shortage of capital. Why is it that countries like Korea and Japan managed to get high yields out of their lands and their laborers whereas other Asian countries have struggled to do the same?

Joe Studwell  6:15  

Well, fundamentally, the land reform and because that’s politically very difficult to do. The end of the Second World War, the US had a big problem because the communists were winning in China, and socialist parties were also strong in Japan and in Korea. 

Of course, the US occupied Japan until 1952. So we could tell the Japanese to do whatever it wanted them to do. In the winter of 1945-1946, the US government instructed the Japanese Emperor to instruct his government to pursue a very comprehensive land reform program. Interestingly, the Japanese actually in the 1870s have done a land reform program themselves. But it has not had limitations on people’s ability to buy and sell the land. 

A lot of landlords have managed to reaggregate large farms or larger farms than they would have with equal distribution. That had kind of unwound the impact of that in the course of the Great Depression, which hit Japan very hard. 

One of the reasons that Japan was going ahead of any other East Asian country was they had a land reform in the 1870s. So the Americans made a much more comprehensive one after the Second World War, and the US military opposed doing the same thing. 

In Korea, the US military was occupying South Korea. It was opposed to doing the same thing. However, when the Korean War started with the invasion by the North Koreans and involvement of the Chinese, and at the end of that, the US government decided we’ve got to do the same thing in Korea to stabilize support for our allies in South Korea. At the same time, they said, “Well, if we’re doing it in South Korea, we might as well do it in Taiwan as well.”

These land reforms occurred in all of these places, and the communists in China won the Civil War telling everybody that they were doing the same thing that the land reform, which occurred in China, which was actually much more violent, because Mao saw it as a class struggle as well as a simple economic solution. The Chinese did that, but from the mid 50s, they started to collectivise because Mao’s view was that private ownership of land was the root of capitalism. 

So, it didn’t produce the positive results in China until Deng Xiaoping came in in 1978, and the Communist Party accepted the return to household farming, the same kind of high yield household farming.

But in all of these places, it worked for the reason that I pointed to earlier that agriculture, when you have a lot of poor people, is not like manufacturing. In manufacturing, you always get returns to scale. So bigger factory, lower unit costs. It’s pretty much always the case. 

In agriculture, when you have a lot of poor people and you turn agriculture into a kind of vegetable gardening operation, it becomes very responsive to labor intensity because you apply water just to the plant. Fertilizer, just the plants. Use vertical trellising. I mean, you guys lived in Korea. You must have seen, when they were using the plastic and the vertical trellising. I mean, there’s no room to drive a tractor through those fields, because the land is being used so intensively. 

This is what they realized in these countries is that actually if you’ve got the labor available, then rather than having these people sitting around doing nothing, being an economic deadweight, you want to get them out on the land and just produce more and more food. Then, producing more food, they then got this fantastic income distribution, which was very evenly spread in society. So, everybody was creating demand for basic things, household goods, and producer goods: a bit of cement, a bit of glass improved my home. These are all manufactured products that you could make domestically with quite low levels of technology. 

It was just a sort of usable kind of demand story as well. Oddly enough, it should be very intelligible to Americans because in the United States, of course, the US was split between a household farming story in the northern states were under the Homestead Act, you could go and get your 20 acres or whatever it was, and farm it. 

I mean, [in the] US [there] are just much more land, abundant or people have more. But it was still labor, intense family farming in the 19th century. The southern US was plantation agriculture, which was much lower yields, but were very much favored by the people who owned the plantations because it just had large profits for small numbers of people. 

Well, of course, the Civil War meant that the northern states won out, and it was the agricultural economy of the northern states that was much more conducive to the industrialization of the US. So yeah, it’s a story that’s not unconnected but what we’ve seen elsewhere in the world, but it was just applied in a much more rigorous and aggressive way in East Asia. It meant that these countries could grow at 10% a year.

Stig Brodersen  11:11  

Really interesting point here, Joe. I would really like to stress how we have seen the policies in effect before, but not to the same magnitude because they haven’t been implemented with the same conviction. Now, I would like to talk about Japan specifically, because even though Korea and Taiwan have done really well since the Second World War, Japan has done better. Why is that the case?

Joe Studwell  11:35  

I mean, you’ve got to go back to the world in the 1860s. Of course, the American Navy turned up in Japan in the 1860s with great big battleships. The Japanese didn’t react in the way that the Chinese did to the arrival of the Europeans by just saying, “Look, we’ve got 5000 years of history. You’re a very inferior bunch of people. Go away.”

The Japanese looked at this and said, “Geez, this is actually quite scary. What are we going to do? We need to figure out how to get ourselves the same kind of military capabilities that these people have.”

So the Japanese did what the Chinese later did, and the Koreans later did, and the Taiwanese did, which is to say, “Well, this is a solvable problem. We really need to catch up with them. And so, all we’ve got to understand really is what they did, and how we can apply it to our society here.”

So in the Meiji era, a small group of political leaders, I mean, they traveled to Europe. They traveled to the United States. They visited huge numbers of factories, talked with anyone in government who would talk with them *inaudible*. 

For instance, in Germany, they visited, and they put together this plan, which involved the first comprehensive land reform program, I guess, that had been initiated by a developing country government. 

Unless you don’t include the US Homestead Act, which you could say was a form of land reform as well instituted by Americans, the coffee laws and regulations, wholesale, and they figured out what they needed to do. So they were the breakout states in East Asia because they saw development as a solvable problem.

Preston Pysh  13:21  

Joe, in the West, we might sometimes underestimate the importance of manufacturing because the economy here is predominantly service based. However, for developing countries, this is a crucial step that you talk about in the book. 

The manufacturing in Korea took off from the early 60s to the mid 70s, and went from as little as 9% to 27% of the GDP. So an important reason that you explained in your book is that the government conducted reforms for export oriented growth. Could you explain to us how credit could drive exports and also how the credit expansion backfired decades later?

Joe Studwell  13:57  

In Korea, *inaudible* aggressively made interest rates offered by banks significantly low when they were given to firms that were exporting. Okay, so how did he know that they were exporting or how can he prove that they exported? Well, the loans were given against the letters of credit. So exporting firms use letters of credit to finance, working capital needs. 

So, you can actually prove that there’s actually a paper trail that shows that these firms are exporting when you provide the credit to them. The credit was so cheap in Korea because of a relatively high inflation rate, that it was negative in real terms for a very long time. 

Effectively, so long as you could raise your prices and you wouldn’t be able to do this if your quality was good enough because your prices were determined by international prices, you were being paid more money in effect in Korea. This was very, very effective at increasing foreign exchange earnings and then the foreign exchange earnings were taken, and they were used to buy equipment in more complex and more demanding industrial sectors.

In other countries that succeeded. There were variations on this theme but they really were just variations on the theme. The Japanese used a private banking system, but they used the central bank, which did a lot of what is called in banking rediscounting. So that means that if you’re a commercial bank, if you make a certain type of loan that conforms with government’s objectives, as stipulated by the Central Bank, you take that loan to the central bank, and they will rediscount it. That means that they will give you additional credit, up to 100% of the value of the loan against that.

Now, of course, it increases the money supply. So there’s some inflationary pressure, and so long as you keep this targeted on particular objectives, and they would both obviously do it for exports. Then the inflationary implications didn’t prove to be too serious.

In the longer run, of course, this tends whereas at the beginning all these countries had wrong current account deficit, trade deficit. There’s a tendency in the long run for countries that follow this type of strategy to get stuck in perennial trade surpluses. 

In China, you’ve noticed, I’m sure, the huge trade surpluses. Japan still has [a] big trade surplus. They tend to kind of lock that in. The problem is that when that strategy is served, as far as we know, there’s a lot of path dependency in lieu. And so, countries tend to get sort of stuck on forms of behavior.

Preston Pysh  16:35  

So when you say that they’re getting stuck on that behavior of this trade surplus, is that through the manipulation at the Central Bank, or how would you describe that? How would you say that that’s happening?

Joe Studwell  16:45  

Well, it’s different in different countries. Germany does not provide the same level of banking support with manufacturers, as it did in the past, but the structure of the German banking system is nonetheless highly supportive to US manufacturing economy, far more so than the banking system. 

For instance, in the UK. So it’s a number of things. It doesn’t remain as egregious as it is that this part of the development period, but these policies, they create institutional arrangements that last for a long time.

Stig Brodersen  17:21  

Now we’re talking about financial policies and how even though they sparked growth and are good for a number of reasons, it also has a few drawbacks. Now, next, I’ll actually talk about the Philippines because as much as it’s been interesting talking about the North East Asian countries that [have] done really well over the past 60 or 70 years, it’s also really interesting to look at what we can learn from the countries that haven’t performed. 

I think the Philippines might be the best example because in just less than half a century, the Philippines went from being twice as rich as Korea to 11 times as poor. What went wrong?

Joe Studwell  18:03  

Well, everything went wrong. I mean, the Philippines had everything going for it. You’re absolutely right. They had the best educated workforce in East Asia as well. So of course, agriculture went wrong. They never implemented any of their land reform programs. They retained a kind of semi-feudal plantation type agriculture at low yield. They failed to implement any kind of domestic manufacturing strategy. 

In terms of the financial sector, the political elite just looted the financial system for its own benefit for the last 50 years to the point where the Philippines ended up as East Asia’s number one IMF junkie. You know, more IMF programs than anyone else in the region. 

So, the Philippines is really a lesson about [the fact that] it’s entirely a human matter development. It’s within human hands. You can have all the advantages of the Philippines. The Philippines has had more agricultural land per person, more fertile agricultural land, better educated labor force, more developed education system, thanks to the US, and [a] much more sophisticated financial system. It took all of those advantages and free them all away.

Preston Pysh  19:22  

Alright, Joe, so in the US and in the UK, they’ve been supporting economic reforms in Taiwan and Korea and Japan, but not in Southeast Asia. Do you think this is a coincidence? Also, how much of the progress that you’re seeing in Asia do you attribute to Western influence and why?

Joe Studwell  19:37  

Well, all of the success or a lot of success in Japan, Taiwan, South Korea here really does have to be credited to the Truman administration, in terms of the Truman administration support the land reform and the Truman administration support or aid in developing manufacturing capabilities of a very different types. 

As the US has supplied since the 50s, in the late 40s, the US was willing to provide machinery and information without the money to pay for it without always compelling countries to buy American goods. 

The objective was simply to make these economies work and become more successful, and taking a looser view that as long as countries become rich, the US will always be successful at trading around the world. So it’s in our interest to have a more wealthy, stable economy. 

The US deserves enormous credit for the success of the Japanese, South Koreans, and Taiwanese economies. In Southeast Asia, things were very different and why they were different is those political changes in the United States in the 1950s. That meant the group of people who had supported change in Japan, Taiwan, and Korea were pushed out of government, political jobs, and university jobs in the fifth. They were regarded as left wing. There was a loss of political appetite. 

There was also a stabilization of the Cold War frontier, which meant that there was less existential pressure on the US to do radical things than there was at the end of the Second World War, when Washington was really worried that it could actually lose a large part of East Asia to communist control. 

Then again, of course, in Southeast Asia where there had been colonies, and although the US was not a major colonial power, with the exception of the Philippines, all around Southeast Asia, the US had much more vested corporate interests than it had in Japan and Korea. Of course, when you have your own best commercial interests at stake, your capacity to make open minded political decisions about how to help other countries is perhaps not as great.

Stig Brodersen  21:55  

Now, I think it’s really inspiring to study the economic history of Asia, partly because the speed of development, but also because today it seems that we have much better data to study what has a beneficial effect on the economy and what has not, at least compared to the first and second waves of industrialization in the West. So, Joe, I couldn’t help but think, how can we apply a three step formula in developing countries today?

Joe Studwell  22:27  

I think one of the stories of development is that once you grow too far in the wrong direction, it is very hard to roll back. This is the problem in Latin America. So we’ve seen in the last decade, the rise of left wing governments in Latin America that have said they’re committed to radical change. 

However, actually, I mean, if you look at a government like Lula’s in Brazil, they weren’t able to fundamentally change the approach to agriculture. It’s very, very hard at this point to make a fundamental change in that way in Brazil, though they couldn’t do a lot to support small farmers. But they didn’t do that. They didn’t really get an industrial policy in place. 

What they did was to implement essentially a welfare program to support the poor. We’ve seen similar things in Venezuela. But the problem is that you put a welfare program in place, just giving money to poor people, once you hit a macroeconomic shock, as has happened in Venezuela, with the oil price and in Brazil with a broader commodity correction, you don’t have the money to pay the welfare any longer.

Durable economic development, durable change is about giving people the capacity to look after themselves, but I just don’t know how there’s going to be any fundamental change in South America or indeed in Southeast Asia. 

Now, I just think that those are going to be parts of the world where countries are going to develop much, much slower and instead of taking 50 years, it’s going to take 200 or 300 years of change. 

In Africa, there is greater potential, I think. One possibly is Ghana, which has been very badly run in the past, but now seems to have a more focused developmental government. The other is Rwanda, which following the genocide in the 90s, has had a leadership which is very, very focused on trying to emulate East Asian development. 

Although, they’re very engaged with the Singaporean government. They want to… I mean, it’s a small country in the middle of a lot of other countries, and they see that more as a sort of potential way forward for them. However, the most important one is Ethiopia, which is a country of 100 million people. It’s the second most populous country in Africa. 

Ethiopia now has been growing at about 11% a year for over a decade. They’re very engaged at an economic commercial level with China because China is able to offer them credit for various things that they need and machinery at a better price than other countries. They’re very engaged at an intellectual level with the Japanese and the Koreans. They’re doing all of the right stuff. They are bending their financial system to support their objectives. As I say, they’ve been doing over 10% for over a decade already. So, I think within the next few years, they will very much come on to the radar. 

They’re not there yet, mainly because as with China, when I first went to China, the GDP per cap was $300 in 1991. It’s now 9000. So Ethiopia has been growing 10% a year, but it was so poor that it’s still only I think about 700 or 800 *inaudible*. 

So, that’s happening. As I say, I’m not excited about anything in Southeast Asia. I was in Myanmar last year. I don’t think Myanmar is going to surprise us on the upside, I’m afraid. I think that Latin America is just going to be a slow burn development story. But I think we’re going to see things in Africa that will surprise people. However, it’s going to be a very *inaudible* story.

Preston Pysh  26:04  

Joe, I got the last question here and having gone through your book, there is so much research that was done. I can’t even imagine the number of books that you had to read and individuals that you had to connect with in order to write this book. But that’s why we’ve got this question for you. So if you could pick one book to recommend to our audience about economic history, what book would you recommend that they read?

Joe Studwell  26:29  

My favorite book about economic history? Well, I think the normal one, the normal one that people recommend is perhaps the Robert Heilbroner book, which is called “The Worldly Philosophers,” which is about the history of economics.

But I like a book that came out in, I think, 1982. It was by a guy called A.K. Dasgupta, who actually is the father of the guy who’s the head of the economics department at Cambridge at the moment. The book is called “Epochs of Economic History.” I really like it because it shows better than any other book how economic theory has evolved over the last 200 or 300 years. I have always been utterly rooted in the time in which it’s been made. That’s a kind of a counterintuitive thing, because everybody is led to believe that economics is a science in the way that the natural sciences are assigned. 

Economics is an effort to use some of the positive things in a scientific approach in understanding human life, which cannot be subjected to laboratory analysis and the way, the manner in which chemicals interact.

Preston Pysh  27:42  

Joe, we cannot thank you enough for coming on the show today. For everybody out there listening, the name of Joe’s book is “How Asia Works.” This is all about the success and failure in the world’s most dynamic region. I mean, you talk about some heavy hitters endorsing this book you got billionaires like Bill Gates. 

In fact, Bill had his staff at his foundation read this book, so that this was a forced reading that he put out to all of his employees that they were to read this book, so that they understood how important the message is inside.

Stig and I can absolutely attest to how incredible this book is and how eye opening it is to help developing countries to emerge into success and into a wealthier being for their citizens. So, Joe, we thank you so much for coming on the show, and we appreciate your time.

Joe Studwell  28:30  

All right. Thank you for having me.

Stig Brodersen  28:32  

That was all that Preston and I had for this week’s episode of The Investor’s Podcast. We will see each other again next week.

Outro  28:38  

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