FRBSF Economic Letter
1997-22 | August 8, 1997
Pacific Basin Notes. This series appears on an occasional basis. It is prepared under the auspices of the Center for Pacific Basin Monetary and Economic Studies within the FRBSF’s Economic Research Department.
Over the past 30 years, Hong Kong, Korea, Singapore, and Taiwan have had remarkably rapid and sustained economic growth, earning the nickname the four tigers. Because of the new investment opportunities they provide and because their experiences may offer lessons for less developed economies, they have attracted considerable attention from the financial and policy communities, as well as from economists who have renewed interest in research in theories of economic growth.
Despite their physical proximity and shared economic vigor, there are some notable differences among the tigers. For instance, Hong Kong and Singapore are cities with limited resources, whereas Korea and Taiwan are economies with relatively large populations and more diverse industrial structures. This Economic Letter focuses mainly on the differences in the way the private financial sectors were used to pursue industrialization and export growth in these economies, with special attention paid to the banking sector.
Of the four tigers, Korea is the most populous, with about 45 million people, and it is the largest economy; its GDP was $378 billion in 1994 (by comparison, U.S. GDP was $6.6 trillion). Taiwan’s GDP is about two-thirds the size of Korea’s, with about half the population. Hong Kong and Singapore are by far the smallest tigers.
All four economies started out poor in all areas except potential labor supply before they began to grow in the 1960s. Though the exact timing of the beginning of rapid growth differs from economy to economy, the track records for the previous three decades have been spectacular. For all four, average income per capita grew 6 to 7% a year since 1965, resulting in about fivefold increases by 1994, which ranged from $8,260 for Korea to $22,500 for Singapore. While they account for roughly 1% of the world’s population, the four economies produced about 3% of global goods and services in 1994. This share of world output might not appear significant compared to economies like Japan (18% with about 2.3% of world population) and the U.S. (26% with about 4.6% of world population), but the relative share of the four economies in the global trade is more impressive. Exports from the four economies together made up over 10% of the world’s total exports, only slightly less than the U.S. in 1994, compared to only about 2.5% in 1971 (Glick and Moreno 1997). The relative shares of imports were about the same.
These numbers make it clear that external trade has been an important element in the development of these economies. The external sector (imports plus exports), measured relative to total GDP, represented 52% in Korea, 73% in Taiwan, 240% in Hong Kong, and 280% in Singapore in 1994 (for the U.S., by comparison, it was 17%).
As the four economies have matured, the composition of exports has evolved; inparticular, they have started to export more sophisticated manufactured products, such as machinery and equipment (Rose 1997). This shift in the composition of exports reflected a major shift in the industrial landscape of these economies. Such transformations required financial resources. The need was particularly acute since all of these economies had only very small rudimentary financial systems in 1970.
With the exception of Hong Kong, the governments of these economies took very active roles in mobilizing savings and financing industrialization efforts. Savings were encouraged through various incentives as well as by government mandate. The most prominent example is Singapore, where the government encouraged high private savings through mandatory provident fund contributions by both employers and employees. (A member of the provident fund could use savings for housing, education, medical care, or retirement.) Though less formal and limited in scope, the governments of Korea and Taiwan also operated various specialized saving vehicles. Using these resources, all three governments established government-owned development banks and various special funds for the purposes of channeling credit to targeted areas of industrialization. Heavy emphasis was put on promoting export-oriented manufacturing sectors, as well as investing in large infrastructure projects.
Commercial banks also played a critical role, because they were the major source of private savings. In Korea and Taiwan, the governments required commercial banks to extend credit towards industries targeted in the governments development plans. Furthermore, due to regulated loan rates, which were below market-determined interest rates, and the lack of loanable funds, these loans were offered at very favorable lending rates.
In Korea, about 54% of total bank loans went to the manufacturing sector, the crown jewel of the economy in 1980. By 1990, this share had fallen to a still substantial 44%. At the same time, the manufacturing sector’s contribution to GDP was about 30% in both years (Nam 1995). This general emphasis on the manufacturing sector has persisted, even though in the early 1980s the Korean government discontinued an ambitious policy to create large heavy and chemical industries and had to address related banking sector problems with a massive credit infusion. In Taiwan, the pattern was similar: in 1980 more than 70% of loans went to the manufacturing sector, and in 1990 it fell to 57%, while manufacturing output contributed 48 and 44% to the GDP in the same two years (Shea 1995).
In Singapore, the government directed credit to the targeted industrial sectors via state- owned institutions but did not use regulation of the banking sector to do so. In 1990, lending to manufacturing, which accounted for about 30% of GDP, made up only 13% of commercial bank loans and advances. This figure has been typical since the early 1970s. Singapore decided early on to promote itself as a key regional financial center, taking advantage of its location as a major transshipment port and hence a potential hub of commerce. Accordingly, controls on interest rates, foreign capital, and entry barriers in banking were abolished in the 1970s. (In comparison, removal of these controls is still being carried out piecemeal in Korea and Taiwan.) Although Singapore still strictly limits offshore transactions on its currency, it has allowed liberal international financing operations for both domestic and foreign financial institutions. Perhaps policymakers realized the necessity of guaranteeing transparent and unencumbered operations of commercial banks for fostering a vibrant financial sector.
Hong Kong’s case differs dramatically from the other three because the government did not direct funding of the industrial sector and stayed out of decisions on the relationship between the two sectors. Basically, the Hong Kong government adhered to maintaining the rule of law and did not intervene in most facets of economic activity.
Despite such disparate arrangements between the industrial and financial sectors, the four tigers collectively achieved remarkable growth, raising the question of whether the structure of the financial sector really matters much for growth. However, the very recent experiences of the four economies offers a hint that financial repression might adversely affect the health of an economy.
The pace of growth of the four economies slowed in the second half of 1996 when they were hit by a common adverse terms-of-trade shock. The price of computer memory chips–the new holy grail for these and other east Asian economies–fell precipitously.
The resulting cyclical slowdown was largest in Korea. Starting early this year, several large businesses, many of which had expanded rapidly into many different areas of specialization, either went bankrupt or experienced financial difficulties. As it turns out, many were so heavily leveraged that GDP growth of 5 to 6% in real terms was not enough to generate sufficient cash flow to service their debt.
These financial problems were transmitted directly to the Korean banking sector, since commercial as well as state-run banks have been the main source of funds for these businesses. Indeed, many of these loans were made on the basis of whether a company was in a strategic industry rather than whether the loan made sense from a business perspective. For example, a former executive of a bank was called to a special hearing after a steel company had gone bankrupt; when asked why his bank had extended so much credit to the firm, he said he approved the loans because steel is an important national strategic industry. Recent experiences show that promoting shareholders interests and lending money based on profitability have not yet taken a firm hold in the Korean banking sector, even though ten years have passed since the government completed de jure privatization of all major commercial banks by selling off the majority shares it had held.
As a result, the borrowing costs of many Korean financial institutions have risen noticeably in international capital markets since the beginning of this year. This has been an unwelcome development for most banks, since they already had experienced some deterioration last year in their performance, as measured by the rate of return on assets.
In Taiwan, efforts to modernize the financial sector appear to have made slow progress. Although a substantial number of private banks have started up since 1991, most banks are still owned by central or local governments. Government ownership, however, does not seem to be a guarantee of a good credit standing. Moody’s lowered its financial strength rating of a couple of major commercial banks in Taiwan early this spring, citing their high bad loan ratios. The plan to privatize them has been postponed on several occasions. In addition, the lack of standard accounting practices has not helped: commercial banks had only partial control in the lending decisions, so reliable accounting information, which is needed to gauge a project’s profitability, had not been important in the past (Shea 1995).
Under such circumstances, it may be understandable that banks impose very stringent collateral requirements for the loans they make. This practice, in turn, drives many firms with inadequate collateral to informal financial markets where they face added borrowing costs, close to 10% above bank rates (Shea 1995).
In 1994, the manufacturing sector accounted for about 31% and 27% of GDP in Taiwan and Korea, respectively, whereas banking and financial services accounted for 18% and 17%. In contrast, the relative shares of the manufacturing and financial sectors were 28% and 27% for Singapore and 9% and 27% for Hong Kong. These figures seem to reflect the emphases of the past development policies. The financial system was rather the accommodator of this real economic performance than its instigator, wrote one economist after examining the role of the financial sector in economic development experiences of these economies (Patrick, 1994). Recent banking sector developments in Korea and, to a lesser extent, Taiwan point to the negative side-effects that government direction of credit to preferred industries can have in the long run. Singapore’s experience seems to suggest that a government could implement industrial development policies without directing the credit decisions of the commercial banking sector. Finally, Hong Kong’s case seems to illustrate that an active industrial policy may not be essential for rapid economic development.
Glick, R., and R. Moreno. 1997. “Government Intervention and the East Asian Miracle.” FRBSF Economic Letter 97-20 (July 11).
Nam, S. 1995. “Korean Financial Markets and Policies.” In Financial Sector Development in Asia. Asian Development Bank.
Patrick, H. 1994. “Comparison, Contrasts and Implications.” In The Financial Development of Japan, Korea, and Taiwan, H. Patrick and Y.C. Park, eds. New York: Oxford University Press.
Rose, A. 1997. “Dynamic Measures of Competitiveness: Are the Geese Flying in Formation?” FRBSF Economic Letter 97-17 (May 30).
Shea, J. 1995. “Financial Sector Development and Policies in Taipei, China.” In Financial Sector Development in Asia. Asian Development Bank.
Opinions expressed in FRBSF Economic Letter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System. This publication is edited by Sam Zuckerman and Anita Todd. Permission to reprint must be obtained in writing.
Please send editorial comments and requests for reprint permission to
Attn: Research publications, MS 1140
Federal Reserve Bank of San Francisco
P.O. Box 7702
San Francisco, CA 94120