How Asia Became the World's Manufacturing Hub
Why is everything "Made in China" (or Vietnam, etc.)?
Economic development needs to pass through stages. Agriculture builds up the capital needed for investments in manufacturing, which if executed tactically can lead to a country's transition to services.
This process isn't simple, though.
Roads and ports (infrastructure), central banks (institutions) and education (human capital) are all important inputs into economic growth, and they need to be developed over time, sequentially.
At One Road Research, we specialize in analyzing how Asian governments have encouraged their economies to quickly move through these three stages. We call this process Asian Capital Development (or ACD).
A robust agricultural sector is the first step on this road to development. However, transitioning from an agricultural economy to a manufacturing economy is not always a given.
Developing A Rural Industrial Sector
In undeveloped economies, most people are farmers. So developing rural industries like food processing plants or textile factories are the first building blocks toward a more sophisticated manufacturing industry.
Infant industries don’t have the infrastructure, capital or ‘know how’ to compete against foreign firms. This is why economies across Northeast Asia favored protectionist policies for industries they deemed ‘strategic.’
But protectionism isn’t enough. Infant industries require access to credit, technology and skilled employees. In other words, they need to go to an after-school math club to get ahead.
The Road to the Factory
Northeast Asian governments nurtured infant manufacturing industries in ‘strategic sectors’ through a set of innovative ‘carrot and stick’ policies. Successful businesses grew and ‘losers’ were ‘culled’.
Governments also helped domestic manufacturers get foreign technology through collective bargaining. For example, foreign firms were allowed market access if they shared their advanced technical know-how.
Until these infant industries matured, government policies kept foreign competition at bay, but did force domestic firms to compete against each other.
Through export quotas and preferential treatment, governments encouraged these firms to be ‘export-oriented’. And as a result of these policies, Northeast Asian countries became world-class manufacturing hubs.
One Small Step (at a time) For Man
Human capital can only be built up gradually.
A farmer can get hired at a textile factory sewing Nike logos onto sport shoes, but could not work as a technician at a solar panel manufacturing plant because that kind of job requires a higher level of vocational training – something that didn’t yet exist in the early stages of economic development.
Investing And Supporting the Manufacturing Machine
To grow, Northeast Asian governments subsidized strategic industries, that is, essential building blocks of an economy like telecommunications, infrastructure and heavy industries. They also imported foreign talent and technology to push the manufacturing sector to new heights.
From 1965 to 1985, Japan’s GDP rocketed from US$90 billion to US$1 trillion on the back of government investments in infrastructure and telecommunications.
Following the Korean War, South Korea needed foreign exchange desperately since its geography limited productivity in agriculture. Following the Japanese model, the South Korean government created a textile cartel furnishing it with cheap loans, tax exemptions and tariff exemptions on its raw materials.
Overseas sales increased and foreign exchange started to flow in.
The Chinese government, too, invested heavily in strategic sectors with similar results.
But how good (efficient) are these coddled companies?
To make sure their State Owned Enterprises (SOEs) didn’t languish in inefficiency, Northeast Asian governments forced manufacturing companies to compete by dangling juicy carrots (subsidies and government contracts) that were attached to big sticks (limiting credit access for underperformers).
In the 1990s, the South Korean government used subsidies to attract half a dozen entrepreneurs into the automobile manufacturing industry.
Through stiff domestic competition and a mandate to export, the inefficient failed and the innovative grew. Today, the top-class automaker reigns: Hyundai-Kia.
During the 1990s, inefficient SOEs in China were ‘culled’ and successful companies received generous loans in a strategy known as ‘Grasp the Big, Let Go the Small.’
The ‘culling’ of unproductive state firms was combined with a highly effective program that increased levels of competition amongst the biggest state firms. And as a result, many companies controlled by state policies delivered annual profits equivalent to 3-4% of China’s GDP through the 2000s.
But being domestically competitive isn’t enough. In today’s globalized economy, firms must be able to compete on international playing fields, if they want to stay in the game.
How This Impacts Your Investments
We are constantly on the lookout for clues on who and what are going to be the next manufacturing failures and successes of Asia, as well as what areas of the service industry are evolving through the addition of new competitors. Stay tuned with us to know who to watch in this highly lucrative sector.