The Role of Government in Economic

Development:
Some Experiences from China, Hong
Kong, and Taiwan

Krisha Suasin & Modinne Buenafe

Three sources of growth of an economy:
1. Increase in tangible inputs such as capital, labor, and human capital.
2. Increase in efficiency, both technical and allocative.
3. Increase in intangible inputs such as R & D.
AUGMENTING THE INPUTS
How do the governments of the three economies attempt to augment
their inputs of products, such as capital, labor, and human capital?
CAPITAL
• In order for the fixed capital stock to increase, there must be fixed
investment.
• Fixed investment is financed from saving, both domestic and foreign.
Increasing Savings
• All 3 economies achieved very high saving rates, of between 35 and
40 per cent.
• 1979 this high saving rate was partially achieved by China through a
restriction of consumption opportunities.

• Saving ( and investment) is encouraged by the macroeconomic

stability maintained by the different gov’ts in their respective
economies.
Monetary Policy in Taiwan is targeted on a positive real rate of interest.

Real wages in all three economies are somewhat repressed- the labor
unions have been, until recently, kept weak.
Increasing Investments
• Aggregate Saving is not necessarily equal to aggregate invenstment
Labor
• The rates of growth of the labor force in China, Hong Kong, and Taiwan
have been quite rapid.
• Both HK and Taiwan have experienced labor shortages and rising wages
since the 1980s.
• The use of foreign contract labor has become common in HK and
Taiwan.
• In the year 2020, the proportion of the Chinese labor force employed in
the agricultural sector will still be 33 per cent.
• The female labor force participation rates in all the 3 economies are
high.
Human Capital
• Universal compulsory primary education, financed by the
government, was achieved in Taiwan sometime in the early 1960s.
• Universal Secondary Education was mostly achieved in Hong Kong.
• There is a potential deficiency in the supply of human capital in China.
• Illiteracy is still a serious and increasingly important problem in the
poorer rural areas of China.
• Tertiary education are still relatively scarce in China.
• HK and Taiwan’s public educational system is supplemented by private
institutions.
ALLOCATING RESOURCES
EFFICIENTLY
• Allocation of resources is said to be efficient if not additional output
can be produced without increasing at least one input, and no input
can be decreased w/o decreasing at least one output.
• Welfare Theorem breaks down if there are increasing returns to scale,
other nonconvexities, informational asymmetry, or other
externalities, and/or significant market power on either the supply
side or the demand side of the economy.
• The role of the government is to help achieve an efficient allocation of
resources.
• There is a distinction between a permanent (one-time) allocation of
ret and a repeated allocation of rent.
• Under repeated allocation, some care has to be taken to assure that
there will be actual competition in the market.
The Structure of Ownership
• Hong Kong and Taiwan’s predominant mode of ownership of
enterprises is private (family owned).
• In China, it is the nonstate sector that has been the most dynamic and
successful over the past 15 years.
• Hong Kong has always operated as a private-enterprise economy: its
public utilities- electricity, gas, and transportation.
• Taiwan’s reliance on the private sector was by no means inevitable-
the share of the public sector in terms of the value of industrial assets
in the early 1950s was almost 90 per cent.
• The choice of private over public ownership for enterprises other than
public utilities turned out to have enormous economic significant.

• First, the effectively family-owned nature of these private enterprises

implies that they are owner managed.
• The transition of Chinese agriculture from a collective system to an
essentially private individual household system resulted in large gains
in efficiency of the order of between 30 and 40 per cent from 1979 to
1985.
The Market Environment
• Hong Kong has always been a private-enterprise and a free market
economy.
• Taiwan’s government has been more activist or interventionist.
• China is the least marketized of the three.
• The government must also assure that there is the transportation and
communication infrastructure to make the one market a reality.
• The government must also assure that there is sufficient meaningful
competition.
• The government also needs to provide services for standardization,
inspection, and certification.
• In Hong Kong, a free port, the market works the best of the three
economies.
• The market in Taiwan is becoming more open.
• China is still far from being a competitive market, both because of
infrastructural bottlenecks and because of significant monopolistic
elements in the economy.
• In the three economies, commercial banks are not relied upon as a
primary source of equity capital.
• Hong Kong’s financial market is one of the most competitive in the
world.
• In Taiwan, financial repression is practically absent.
• China is the only economy with bank lending rates significantly below
the market.
• Financial repression and credit rationing may be viewed as a
reallocation of rents between lenders and borrowers, savers, and
investors.
Coordination Externalities
• Multiple economic equilibria can arise from “nonconvexities,”
complementarity, information asymmetry, or the lack of credible
commitments.
• One useful role of the government is to create conditions that are
conductive to the achievement of the efficient economic outcome
that otherwise is not achievement and to guarantee its
implementation through its powers of enforcement.
• Coordination means using or sharing the same information among
economic agents, so that the adverse effects of information
asymmetry can be overcome.
• Coordination is much more important for investment decisions than
for current production decisions.
• Nonmarket coordination does not necessarily need to involved the
government.
• Coordination, whether public or private, can lead to either private or
social benefit, or both.
• Another role is to reduce transaction costs.
Achieving Technical Efficiency
• Red tape is a relic of the days when the government had to provide
employment to a large number of people and carve up to make work
for them.
• China and Taiwan have made special provisions to expedite foreign
investment applications.
• Also relevant is whether the style of the government is discretion based
or rule based.
Discretion based system is open to “rent-seeking” and corruption
Hong Kong has already put in place a rule-based system.

Transition from a discretion-based system to rule-based system, kinship

and long-term friendship rooted in shared cultural norms can provide the
bases for the implicit contracts necessary to support economic
transactions in the absence of explicit rules and regulations or
established customs.
Creating New Institutions and Drafting New
Laws
• The government can make new laws and create new institutions that
facilitate and support economic development. These can be laws with
regard to property rights.
Social Safety Net, Income Distribution, and
Social Welfare Programs
• It is the responsibility of the government to provide a social safety
net.
• Social Safety Net reduces risks to workers and the population in
general.
• The government should also pay attention to the distribution of
income to make sure that the gap between the rich and the poor does
not become so excessive that it may breed social and political
instability, and to the equality of access to opportunities to make sure
that sufficient social mobility, and hence hope, exists in society.
Social Welfare Programs
Traditionally provided only for very low-income households in HK and
Taiwan.
Social welfare programs must be carefully designed.
• One important aspect of these programs is that in order for them to
work, they must be compulsory to everyone.
Infrastructural Investment
• The social overheard capital such as electric utilities, transportation
and communication facilities, and industrial parks all require a huge
amount of investment, which cannot be afforded by individual private
enterprises, especially in the early stage of economic development.
• Infrastructural projects are usually undertaken by the government
rather than by private investors because of factors such as
nonappropriability, lack of sufficient capital position.
• Infrastructure should be an area of primary focus of government
investment.
Examples of successful infrastructural
projects :
• Hsinchu Science-Based Industrial Park in Taiwan- modeled after the
Stanford Industrial Park
• China is trying to do the same thing in an area located adjacent to the
Chinese Academy of Science in Zhongguaneun, a suburb of Beijing.
• Export processing zone in Kaohsiung
• Special Economic Zones of Chuna
• Suzhou project run by Singapore
• Infrastructural Investment projects also act as signals for coordinated
expansion in an industry, a cluster of industries, or a geographical
area as well as a tangible demonstration of a government
commitment.
• The existence of complementarities is a major reason for
coordination.
Consumer and Environmental Protection
• The area of consumer and environmental protection is one where the
government must take a leading role.
• China still lags fat behind in both consumer and environmental
protection.
• New measures of real GDP or GNP are required in order to reflect the
benefits of a cleaner, healthier, and safer environment.
Efficient Allocation across Industries
• A necessary condition for overall efficiency of the economy is an
efficient allocation of resources, including fixed investment and
capital, across industries.
• The selection, or targeting, of industries for favored treatment in
order to promote investment in them by the government is often
referred to as an industrial policy.
• In China, prior to 1984, the entire industrial sector was state owned.
• Industrial policy in Hong Kong is rather limited.
• In Taiwan, credit rationing is definitely used to support industries that
the government wants to start- these are referred to a pioneering
industries.
• Protection in the form of tariffs, quotas, and import permits is used to
favor certain industries.
• One notable failure of industrial policy in Taiwan is an attempt to
promote Taiwanese large trading firms along the lines of the Japanese
firms of Marubeni, Mitsubishi, and Mitsui.
• Direct Investment by the government, or by government development
banks, in favored industries in the form of a state-owned or controlled
enterprise, is also done.
• Example:
China Steel Corporation , established in the mid 1970s was majority
owned by the government of Taiwan.
The export industries and enterprises have been favored in the early
phase of Taiwan’s industrialization and China’s economic reform.
In Taiwan, it is done through preferential interest rates for the finance of
production for exports.
• Miscellaneous advantages: rebating of import duties on inputs used in
production for exports and reduction of port fees.
• There is no explicit government support for exports in Hong Kong.
Efficient Allocation across Enterprises
• The government has to take into account the existence of increasing
returns to scale which render the usual market allocation inefficient.
• The government must be able to identify and enlist promising
entrepreneurs/ enterprises to undertake selected industrial projects
in the early stage of its industrial development.
• The government has the ability to create, as well as allocate rents,
through taxation and subsidies, franchising, preferential loans, and
land grants.
Performance based rents: investment tax credits, accelerated
depreciation, and tax holidays for new enterprises.
Transition-facilitating rent: used to compensate vested interests so as to
obtain their support for reforms that enhance the overall efficiency of
the economy.

Two-track price system with one price market determined and the
other one fixed, is a major factor in the relatively smooth transition of
the Chinese economy from a centrally planned one to a mostly market
one.
• Under this system, efficiency is immediately achieved because, on the
margin, everything is bought and sold at the free-market price.
Efficient Allocation through Government
Coordination
• One important role of the government is to enforce contracts and
commitments that are not “self-enforcing.”
• Governments of Hong Kong and Taiwan tend to be less interventionist
than those of Japan and South Korea.
• The key to successful government coordination lies in the credibility
of its commitments, including the commitments to enforce explicit
and implicit agreements among independent contracting parties.
• The government must therefore use its credibility wisely and in
particular should avoid engaging in predatory behavior that
undermines its future credibility.
Shifting the Production Possibility Frontier
To the extent that technical progress is embodied, any policy that
increase the quantity of gross domestic fixed investment shifts the
production possibility frontier upward. Other measures that shift the
production possibility frontier include R & D investments and
reorganizations.
R & D Technology

In the 1970s, Taiwan avoided an industrial policy and set up a number

of national research institutes and dramatically increased its funding of
large-scale industrial R & D projects.
Hong Kong is relatively late to this game although it recently set up a
new Hong Kong University of Science and Technology which has a R & D
arm that works closely with industry.
China has a strong scientific and technological capabilities in the
Chinese Academy of Sciences.
• Industrial policy is not infrequently linked to R & D and science and
technology policies.
• The personal computer industry in Taiwan provides a successful example of
government-financed R & D and industrial policy.

• Appropriability has long been recognized that the basic issue in the financing
of R & D.
• Government investment in R & D: through government laboratories or
indirectly by financially supporting R & D projects at universities and in private
industry, can also be viewed as an attempt to create comparative advantage.
Technology Transfer
• Foreign Direct investment can also bring in new technology, and in
principle can shift the production possibility frontier.
• While foreign direct investment and the use of imported new capital
equipment and technology increase gross output, they do not
necessarily increase added value above a normal return to the capital,
and thus there is no ‘’excess” returns to be measure.
Strategic R & D
• R &D can be used strategically.
• The standard practice in the technology transfer world to cross-license.
In order to cross-license, an enterprise must have an invention, a
patent, something to cross-license to another enterprise.
• Indigenous R & D
• -often has the effect of coaxing a reluctant technology to transfer the
technology.
• As long as a country does R&D itself and is in the business of cross-
licensing, it will have the incentive to enforce intellectual property
rights.
Reorganization
• Reorganization and the introduction of new modes of production are also
measures that can shift the production possibility frontier.
• HK and Taiwan- whatever changes there have been are more evolutionary.
• China- the changes have been more radical.
• Contract responsibility system was the foundation of decentralization
effort.
• Contract responsibility system- coupled with the agricultural price and
market reforms, was immediately and immensely successful, generating
huge increases in productivity in agriculture of the order of 30-40 per cent
within a few years.
CONCLUSION
• The role of government in the economic development of China, Hong Kong, and
Taiwan has been diverse and multifaceted.
• Many similar policies and measure have been adopted in different economies,
albeit at different times, reflecting the differences in their relative stages of
economic development.
• Major differences across three economies:
The relative lack of support for tertiary education and for R & D by the government
in HK has resulted in the superiority that Taiwan has in high technology industries.
Freedom Capital Movement, low tax rate, and the adherence of the law, with a
relaxed regulatory system have contributed to HK’s success as leading financial
center in East Asia.
• The free trade policy in HK has resulted to more development than the
economies of China and Taiwan which are characterized by dualism.
• Taiwan is producing and exporting what Japan was producing and exporting a
decade ago.
• China is producing what Taiwan was producing a decade ago.
• Shanghai will be looking to replace or at least supplant HK’s role as a financial
center serving the Chinese economy within the next couple of decades.
• What distinguishes China, Taiwan, and Hong Kong on the other is the role of
ideology and the East Asian tradition of a high degree of personalization of
government.