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THE POLITICAL ECONOMY
OF EAST ASIA
2

THE POLITICAL ECONOMY
OF EAST ASIA
STRIVING FOR WEALTH AND POWER
Ming Wan
George Mason University

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Library of Congress Cataloging-in-Publication Data
Wan, Ming
The Political economy of East Asia : striving for wealth and power / by Ming Wan.
p. cm.
Includes bibliographical references and index.
ISBN 978-1-933116-91-4 (alk. paper)
1. East Asia—Economic policy. 2. East Asia—Commercial policy. 3. East Asia—Foreign economic
relations. I. Title.
HC460.5.W3476 2008
330.95—dc22 2007033250
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For Maggie
5

CONTENTS

Tables, Figures, and Maps
Preface
PART I: INTRODUCTION
1. Introduction
What Is East Asia?
The Political Economy Approach
Defining Political Economy
Institutions
Comparative Political Economy and International Political Economy
The State and the Market
Economic Growth Versus Political Regime
Power of Ideas
Design of the Book
Suggested Readings
Notes
2. The East Asian National Systems of Political Economy
The Political Economy Systems of East Asia: An Overview
The Japanese System of Political Economy
The Embedded Mercantilism
Structural Reform
The Political Economy Systems of the Asian Tigers
South Korea
Taiwan
Singapore
The Political Economy Systems of Southeast Asia
Malaysia
Thailand
Indonesia
The Philippines
Burma/Myanmar
The Transitional Political Economies
China
Vietnam
North Korea
Cambodia
Conclusion
Suggested Readings
Notes
PART II: THE RISE AND FALL OF EAST ASIA
6

3. The Chinese World Order
World Orders
International Order
The Chinese World Order
Political Economy of East Asian Trade
Comparative Political Economy
China
Korea
Japan
Southeast Asia
Beyond European Models of World History
Eurocentric Models of World History
New Scholarship on World History
Why Did the West Rise?
Conclusion
Suggested Readings
Notes
4. Modern Imperialism
Western Imperialism
Imperialism
History of Western Domination in East Asia
East Asian Responses to Western Domination
Legacies of Western Colonialism
Japanese Imperialism
Japanese Response to Western Imperialism
History of Japanese Imperialism
Legacies of Japanese Imperialism
Conclusion
Suggested Readings
Notes
5. The East Asian Miracle
Postwar Transformation of East Asian Political Economy
Rapid Economic Growth with Equity
Was There a Miracle?
Structural Change
March to Capitalism
Explaining the East Asian Miracle
Neoclassical Economics
The Developmental State Approach
The East Asian Challenge
What Exactly Explains the East Asian Miracle?
A Regional Perspective of East Asian Political Economy
Flying Geese Formation
Regional Integration and Learning
The United States and East Asian Political Economy
The U.S. Hegemony
Managing Rivals
The United States and East Asian Regionalism
7

The Political Economy of Growth
Conclusion
Suggested Readings
Notes
6. The Asian Financial Crisis
Tracing the Crisis
Explaining the Crisis
Speculative Capital
Unsustainable Economic Policies
Crony Capitalism
Managing the Crisis
The Consequences of the Crisis
The Political Economy of the Crisis
Conclusion
Suggested Readings
Notes
PART III: ISSUES OF EAST ASIAN POLITICAL ECONOMY
7. The Political Economy of East Asian Production
The “Factory” of the World
East Asian Industrialization
Foreign Direct Investment in East Asia
The Investors of the World
Regionalization of Production
The East Asian State and Production
Picking the Winners
Foreign Direct Investment Policies
East Asian Companies
Domestic Political Economy of Production
Conclusion
Suggested Readings
Notes
8. The Political Economy of East Asian Trade
Trade Patterns in East Asia
Rapid Expansion in Trade
Structural Change in Trade
Surplus with the World
Greater Regional Trade Interdependence
East Asian Trade Strategies
Import Substitution
Export Promotion
Trade Liberalization
Facing the World
Managing Trade Disputes
Global Rules, Asian Plays
East Asian Trade Regionalism
Domestic Political Economy of Trade
Conclusion
8

Suggested Readings
Notes
9. The Political Economy of East Asian Finance
East Asian Finance
East Asian Capital Accumulation
East Asian Banking
Shallow Financial Markets
East Asian Financial Policies
Mobilizing Domestic Capital
Financial Liberalization
East Asia in Global Finance
Cross-Border Capital Flows
Global Saving Glut
East Asian Financial Regionalism
East Asian Political Economy of Finance
Conclusion
Suggested Readings
Notes
10. The Political Economy of East Asian Monetary Relations
East Asian Exchange Rate Policy
Exchange Rate Policies
East Asian Exchange Rate Policies Through the Early 1970s
From the Early 1970s to the 1997 Financial Crisis
Postcrisis East Asian Exchange Rate Regimes
East Asia in the Global Monetary System
International Monetary Regime
East Asia and the Bretton Woods System
The Dollar Standard
East Asian Regional Monetary System
Monetary Union
A Yen Bloc
The Yuan’s Arrival
East Asian Political Economy of Money
Conclusion
Suggested Readings
Notes
11. The Political Economy of East Asian Regionalism
Defining Regionalization and Regionalism
East Asian Regionalization
East Asian Regionalism
Open Regionalism
The New East Asian Regionalism
“East Asia Plus” Versus “East Asia Minus” Regionalism
Theories of Regionalism
Economic Theories of Regionalism
Political Economy Theories of Regionalism
Political Economy of Regionalism
Conclusion
9

SUGGESTED READINGS

Borthwick, Mark. Pacific Century: The Emergence of Modern Pacific Asia, 3rd ed. (Boulder:
Westview, 2007).
Caporaso, James A. “Across the Great Divide: Integrating Comparative and International
Politics.” International Studies Quarterly 41, no. 4 (December 1997): 563–592.
Gilpin, Robert. Global Political Economy: Understanding the International Economic Order
(Princeton: Princeton University Press, 2001).
Hall, Peter A., and Rosemary C. R. Taylor. “Political Science and the Three
Institutionalisms.” Political Studies 44, no. 4 (December 1996): 936–957.
Islam, Iyanatul, and Anis Chowdhury. The Political Economy of East Asia: Post-Crisis
Debates (New York: Oxford University Press, 2000).
Keefer, Philip. “What Does Political Economy Tell Us About Economic Development and
Vice Versa?” Annual Review of Political Science 7 (May 2004): 247–272.
Kim, Samuel S., ed. East Asia and Globalization (Lanham, Md.: Rowman and Littlefield,
2000).
Krugman, Paul. Pop Internationalism (Cambridge: MIT Press, 1996).
Lipset, Seymour Martin. “Some Social Requisites of Democracy: Economic Development
and Political Legitimacy.” American Political Science Review 53, no. 1 (1959): 69–105.
Milner, Helen V. “Rationalizing Politics: The Emerging Synthesis of International,
American, and Comparative Politics.” International Organization 52, no. 4 (Autumn
1998): 759–786.
Moe, Terry M. “Power and Political Institutions.” Perspectives on Politics 3, no. 2 (June
2005): 215–233.
North, Douglass C. Institutions, Institutional Change, and Economic Performance (New
York: Cambridge University Press, 1990).
Olson, Mancur. Power and Prosperity: Outgrowing Communist and Capitalist Dictatorships
(New York: Basic Books, 2000).
Pierson, Paul. Politics in Time: History, Institutions, and Social Analysis (Princeton:
Princeton University Press, 2004).
Przeworski, Adam. States and Markets: A Primer in Political Economy (New York:
Cambridge University Press, 2003).
Rondinelli, Dennis A., and John M. Heffron, eds. Globalization and Change in Asia
(Boulder: Lynne Rienner, 2007).
Simone, Vera. The Asian Pacific: Political and Economic Development in a Global Context,
2nd ed. (New York: Longman, 2001).
Wolf, Charles, Jr. Markets or Governments: Choosing Between Imperfect Alternatives
(Cambridge: MIT Press, 1990).
26

NOTES

1. East Asia, including China, Japan, South Korea, Taiwan, Hong Kong, and the ten-member
Association of Southeast Asia Nations (ASEAN), had a total merchandise trade volume of
$4,753 billion in 2005. The trade statistics for Hong Kong includes only domestic exports
and retained imports. By contrast, NAFTA had $3,745 billion and EU had $8,136 billion.
World Trade Organization, International Trade Statistics 2006, Table 1.6 and Table 1.10
(www.wto.org/english/res_e/statis_e/its2006_e/its06_overview_e ). The trade statistics
for all three regions include intraregion trade. EU now has 27 members, with Bulgaria and
Romania admitted on January 1, 2007.
2. William R. Thompson, “The Regional Subsystem: A Conceptual Explication and a
Propositional Inventory,” International Studies Quarterly 17, no. 1 (March 1973): 89–117.
3. Giovanni Arrighi, Takeshi Hamashita, and Mark Selden, “Introduction,” in The
Resurgence of East Asia: 500, 150, and 50 Year Perspectives, ed. Giovanni Arrighi,
Takeshi Hamashita, and Mark Selden (New York: RoutledgeCurzon, 2003), 4–7.
4. James A. Caporaso and David P. Levine, Theories of Political Economy (New York:
Cambridge University Press, 1992); Colin Wright, “Competing Conceptions of Political
Economy,” in From Political Economy to Economics—And Back? ed. James H. Nichols Jr.
and Colin Wright (San Francisco: Institute for Contemporary Studies, 1990), 57–77.
5. Robert Gilpin, Global Political Economy: Understanding the International Economic
Order (Princeton: Princeton University Press, 2001), 25–31.
6. Helen V. Milner, “Rationalizing Politics: The Emerging Synthesis of International,
American, and Comparative Politics,” International Organization 52, no. 4 (Autumn
1998): 759–786; Barry R. Weingast, “Rational Choice Institutionalism,” in Political
Science: The State of the Discipline, ed. Ira Katznelson and Helen Milner (New York:
Norton, 2002), 660–692.
7. Barry Clark, Political Economy: A Comparative Approach, 2nd ed. (Westport, Conn.:
Praeger, 1998), 3–19. Also see David P. Levine, Wealth and Freedom: An Introduction to
Political Economy (New York: Cambridge University Press, 1995); Charles Wolf Jr.,
Markets or Governments: Choosing Between Imperfect Alternatives (Cambridge: MIT
Press, 1990).
8. Peter A. Hall and Rosemary C. R. Taylor, “Political Science and the Three
Institutionalisms,” Political Studies 44, no. 4 (December 1996): 936–957.
9. James E. Alt, “Comparative Political Economy: Credibility, Accountability, and
Institutions,” in Political Science: The State of the Discipline, ed. Ira Katznelson and Helen
Milner (New York: Norton, 2002), 149.
10. Hall and Taylor, “Political Science and the Three Institutionalisms,” 938.
11. For a representative work in the approach, see James G. March and Johan P. Olsen,
Rediscovering Institutions: The Organizational Basis of Politics (New York: Free Press,
1989).
12. For useful works on the importance of cultures and traditions in East Asian development,
see Ronald Dore, Taking Japan Seriously: A Confucian Perspective on Leading
Economic Issues (Stanford: Stanford University Press, 1987); Tu Wei-Ming, ed.,
Confucian Traditions in East Asian Modernity: Moral Education and Economic Culture
in Japan and the Four Mini-Dragons (Cambridge: Harvard University Press, 1996);
Gilbert Rozman, The East Asian Region: Confucian Heritage and Its Modern Adaptation
(Princeton: Princeton University Press, 1991); Francis Fukuyama, Trust: The Social
Virtues and the Creation of Prosperity (New York: Free Press, 1995); Lawrence E.
27

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Harrison and Samuel P. Huntington, eds., Culture Matters: How Values Shape Human
Progress (New York: Basic Books, 2000).
13. Weingast, “Rational Choice Institutionalism.”
14. Paul Pierson, Politics in Time: History, Institutions, and Social Analysis (Princeton:
Princeton University Press, 2004); James Mahoney and Dietrich Rueschemeyer, eds.,
Comparative Historical Analysis in the Social Sciences (New York: Cambridge
University Press, 2003).
15. Paul A. David, “Clio and the Economics of QWERTY,” American Economic Review 75,
no. 2 (May 1985): 332–337; W. Brian Arthur, “Competing Technologies, Increasing
Returns, and Lock-In by Historical Events,” Economic Journal 99, no. 394 (March 1989):
116–131.
16. James Mahoney, The Legacies of Liberalism: Path Dependence and Political Regimes in
Central America (Baltimore: Johns Hopkins University Press, 2001), 6. See also Ruth B.
Collier and David Collier, Shaping the Political Arena: Critical Junctures, the Labor
Movement, and Regime Dynamics in Latin America (Princeton: Princeton University
Press, 1991); Douglass C. North, Institutions, Institutional Change, and Economic
Performance (New York: Cambridge University Press, 1990); Kathleen Thelen,
“Historical Institutionalism in Comparative Politics,” The Annual Review of Political
Science 2 (June 1999): 369–404.
17. Wolfgang Streeck and Kozo Yamamura, eds., The Origins of Nonliberal Capitalism:
Germany and Japan in Comparison (Ithaca, N.Y.: Cornell University Press, 2001);
Michel Albert, Capitalism Versus Capitalism (New York: Four Walls Eight Windows,
1993).
18. Kathleen Thelen, How Institutions Evolve: The Political Economy of Skills in Germany,
Britain, the United States, and Japan (New York: Cambridge University Press, 2004).
19. Terry M. Moe, “Power and Political Institutions,” Perspectives on Politics 3, no. 2 (June
2005): 215–233.
20. For some important IPE works that do emphasize power, see Margaret Levi, Of Rule and
Revenue (Berkeley: University of California Press, 1988); Margaret Levi, “A Logic of
Institutional Change,” in The Limits of Rationality, ed. Karen Schweers Cook and
Margaret Levi (Chicago: University of Chicago Press, 1990), 402–418; Jack Knight,
Institutions and Social Conflict (New York: Cambridge University Press, 1992); Mancur
Olson, Power and Prosperity: Outgrowing Communist and Capitalist Dictatorships (New
York: Basic Books, 2000).
21. Hall and Taylor, “Political Science and the Three Institutionalisms,” 940–941.
22. Thomas Ertman, Birth of the Leviathan: Building States and Regimes in Medieval and
Early Modern Europe (Cambridge: Cambridge University Press, 1997).
23. James A. Caporaso, “Across the Great Divide: Integrating Comparative and International
Politics,” International Studies Quarterly 41, no. 4 (December 1997): 563–592.
24. For a discussion of how IPE and CPE courses are taught in the United States, see Darel E.
Paul, “Teaching Political Economy in Political Science: A Review of International and
Comparative Political Economy Syllabi,” Perspectives on Politics 4, no. 4 (December
2006): 729–734.
25. Adam Przeworski, States and Markets: A Primer in Political Economy (New York:
Cambridge University Press, 2003), 11–12.
26. Margaret Levi, “The State of the Study of the State,” in Political Science: The State of the
Discipline, ed. Ira Katznelson and Helen Milner (New York: Norton, 2002), 40.
27. Mancur Olson, “Dictatorship, Democracy and Development,” American Political Science
Review 87, no. 3 (September 1993): 567–576.
28. Philip Keefer, “What Does Political Economy Tell Us About Economic Development and
28

Vice Versa?” Annual Review of Political Science 7 (May 2004): 247–272.
29. Seymour Martin Lipset, “Some Social Requisites of Democracy: Economic Development
and Political Legitimacy,” American Political Science Review 53, no. 1 (1959): 69–105.
30. Samuel P. Huntington, Political Order in Changing Societies (New Haven: Yale
University Press, 1968).
31. Erika Weinthal and Pauline Jones Luong, “Combating the Resource Curse: An
Alternative Solution to Managing Mineral Wealth,” Perspectives on Politics 4, no. 1
(March 2006): 35–53.
32. Douglass C. North and Robert Paul Thomas, The Rise of the Western World: A New
Economic History (London: Cambridge University Press, 1973).
33. Olson, Power and Prosperity. For a detailed empirical inquiry, see Adam Przeworski,
Michael Alvarez, Jose Antonio Cheibub, and Frederick Limogi, Democracy and
Development: Political Institutions and Well-Being in the World, 1950–1990 (Cambridge:
Cambridge University Press, 2000).
29

T
CHAPTER 2
The East Asian National Systems of Political
Economy

his chapter examines East Asian political economy from a comparative perspective,
focusing on the different national systems of political economy in East Asia. One
country’s national system may differ from another in terms of national purpose, the role of
the state in economy, and corporate governance and business practices.1 This chapter
discusses mainly national purpose and state versus economy for East Asian economies to
simplify the discussion of the diverse and rich experiences of East Asian political economy.
East Asian political economy is characterized by a high degree of diversity, with regional
economies ranging from advanced to the poorest in the world and with the economies often
having greater similarities with nonregional countries than with each other. At the same time,
East Asian economies are converging in that virtually all of them treat economic growth as a
high priority and are making concerted efforts to advance that all-important goal. Viewing
economic performance as a basis of political legitimacy, East Asian economies exhibit a
strong tendency of “developmental state,” which is reinforced by mutual learning. From a
dynamic perspective, the stage of economic development corresponds roughly with that of
political development in East Asia, exhibiting a tiered pattern of more advanced economy
having better governance. Such a regional trend is reflected in the analysis of specific East
Asian economies. The country-specific materials discussed in this chapter are also designed
to prepare students for the following chapters that are organized chronologically and
thematically.
THE POLITICAL ECONOMY SYSTEMS OF EAST ASIA: AN
OVERVIEW
This section addresses the following two questions. First, are East Asian political economies
converging, in other words, are they becoming more alike among themselves or with other
regions? Second, is one particular national model of political economy superior to others?
Convergence versus divergence has been an important question for students who adopt a
comparative-historical perspective.2 National differences allow scholars to explain varying
economic performance and public policy. At the same time, globalizing forces have affected
all countries. Thus, whether countries are converging or not conditions our basic
understanding of international political economy as well as East Asian political economy.
One school of thought assumes convergence among advanced industrial democracies in the
context of a homogenizing globalization.3 Modernization theorists argue that developing
nations should converge with developed nations if they want to achieve development.
30

Neoclassical economists also believe that national economies will eventually converge as a
result of market forces or harmonization through political negotiations. An opposing school
sees a persistent divergence among nations.4
Are East Asian economies converging with each other or with the advanced nations in the
world? When we look at contemporary East Asian political economy, one feature that stands
out is a great diversity among regional economies, with advanced capitalist economies, major
transitional countries, and small developing nations. Japan is comparable with Germany as
advanced capitalist countries. China and Vietnam share some similarities with Russia as
transitional economies. With large land-owning families that have had a strong hold on the
state, the Philippines is more like some Latin American countries. North Korea should be
compared with Cuba as laggards in market reform. Small but oil-rich Brunei is similar to a
Persian Gulf state. Whereas economies such as Singapore, Taiwan, and South Korea have
joined the high-income club, other states such as Myanmar, Laos, Cambodia, and North
Korea have failed.5 Last but not least, a deliberate harmonization process does not exist in
East Asia, unlike in Europe.
It would be wrong to dismiss all this obvious diversity in East Asia, but we should take a
more nuanced and dynamic perspective in examining East Asia. Judging by the criteria of
national purpose and state versus economy, there is a certain degree of convergence among
East Asian economies. To begin with, virtually all East Asian economies now desire
economic growth. One should not take this collective desire for granted. Pursuit of economic
development is a modern phenomenon in East Asia as well as elsewhere in the world.
Economic activities have always been important because a society needs to provide for itself,
but achieving sustained economic growth has only been around for several decades. Also,
East Asian economies did not share this paramount goal of economic growth after the Second
World War. The People’s Republic of China (PRC) leadership under Mao Zedong was
focused on revolutionizing Chinese society and supporting revolutionary movements
worldwide, and the country did not shift to economic modernization as an overarching
national objective until the late 1970s. The Kuomintang government in Taiwan was initially
preoccupied with retaking the mainland and shifted to economic development of the island
only in the early 1960s. The Republic of Korea government similarly aimed at reunification
with the north initially and only launched a state-led industrialization plan in the early 1960s.
The national purpose of rapid economic growth has not been just convenient rhetoric.
Rather, it has driven national policymaking throughout the region and has been implemented
and monitored by both the state and society. Whether a government is really committed to or
just gives lip service to the goal of development explains much about the difference in
economic performance between East Asian economies and between East Asia and other
developing regions.
We also observe an interventionist state in East Asia to the extent that we often lump East
Asian economies together as practicing a “developmental state” capitalism, which is
divergent from the West. Scholars of advanced democracies have generally differentiated the
liberal market economies represented by the United States and Britain from the socially
embedded systems of political economy found in Germany and Japan. The East Asian model
should therefore not be viewed as too different from the continental European model. At the
same time, much of the study from the Anglo-Saxon perspective views East Asia as
significantly different from the West.
As will be discussed extensively in Chapter 5, the mainstream neoclassical view shared
by the U.S. Treasury, the International Monetary Fund, and the World Bank, the so-called
“Washington consensus,” is that the best way to achieve economic growth is to “set the price
right” and let the market work its magic. Some neoclassical thinkers have argued that East
Asia’s postwar economic success has resulted from market-friendly policies adopted by the
31

successful governments. By contrast, developmental state theorists argue that the state in East
Asia has only intervened in the market by “picking the winners” and that it possesses a high
capacity to formulate and implement long-term economic development strategies because of
its insulation from society.6
Not surprisingly, the developmental state model reveals flaws under scrutiny.7 First, a
strong state may lead to both economic successes and failures in East Asia as well as
elsewhere.8 To address that issue, Peter Evans proposed a notion of “embedded autonomy”
that emphasizes a positive link between the state and society.9 Second, some scholars have
taken the state apart and have shown a large variation of state capacity between government
agencies and between the national and local levels. The state in East Asia has been
transformed by both modernizing forces and conflicts within a disaggregated state
apparatus.10 The developmental state model has also been criticized as implying a compliant
society, which is often not the case in East Asia. Even in South Korea, often recognized as
having the strongest developmental state in East Asia, society has often been militant against
the state.11 In fact, protest movements have taken place in all high-performing economies in
East Asia.
However, few models remain intact under scrutiny. East Asian economies share a strong
economic nationalism. For better or for worse, the state intervention has yielded good
economic performance for these economies in the past few decades. A strong state argument
also does not have to assume a weak society.
Developments in East Asian political economy are not random events. My discussion so
far shows that a highly diverse East Asia looks more orderly from the perspective of political
economy systems. We can see things even more clearly from a dynamic perspective. If we
factor in stages of development, there is a greater degree of convergence, which may be
described as a “tiered convergence.”
As will be discussed in the following chapters, East Asian economies have followed
similar production-oriented, export-led, state-directed credit policies, albeit not necessarily at
the same time. This development is mainly due to emulation of successful national models.
There was much interest in East Asia as well as elsewhere in learning the Japanese model
before the early 1990s. There are also other examples, such as Taiwan’s export zones and
Singapore’s Central Providence Fund. The Chinese government was interested in emulating
the South Korean chaebol system before the Asian financial crisis and is now trying to learn
from South Korea about building a “new countryside.” All this learning helps to create a
hybrid of different national models in East Asia.12
More broadly, a tiered convergence in political development can be observed. In an
edited volume published in 1999, James Morley, Harold Crouch, and others have shown a
rough correlation between levels of economic development and political regimes in the Asia
Pacific region, with low levels correlating with autocratic regimes and high levels with
democracies.13 To follow up on that important research, I have created Table 2.1, which
shows that one can indeed observe some large patterned economic and political developments
in East Asia.
First of all, a rough correlation between level of economic development and level of
political development exists. Japan led the way with the highest per capita gross national
income (GNI) and the strongest democracy in East Asia. Taiwan and South Korea followed
in Japan’s footstep, consistent with their high-income status.14 Hong Kong is a Special
Administrative Region of the PRC. Given its strong civil society, vibrant party politics, and
experience with limited elections, Hong Kong should be a functional democracy but for
Beijing’s opposition. Singapore also fails to have a true democracy despite its first-world
level economic development. Arguably, Singapore’s small urban population makes it
possible for a paternalistic government to operate as long as it continues to deliver economic
32

and social benefits and boast one of the cleanest governments in the world. Similar to
Singapore, Malaysia also has an authoritarian democracy in which one party continues to
dominate even though elections are held. Moving down the ladder, only China is an
authoritarian country among the four East Asian lower-middle-income countries. Thailand,
the Philippines, and Indonesia all have a formal democracy in which elections are held and
political parties operate, although these countries face constant threats of military coup and
street demonstrations. When it comes to low-income categories, three of the four East Asian
countries in the table—Vietnam, Laos, and Myanmar—are authoritarian, while Cambodia
allows elections but maintains single-party domination.
TABLE 2.1
Economic Change and Political Change in East Asia
Source: World Bank, World Development Indicators 2006,
http://mutex.gmu.edu:2416/wdi2006/contents/Usersguide.htm. Data for per capita GDP annual growth rate
are calculated from World Bank, World Development Indicators Database. Data for Taiwan are from the
Asian Development Bank, Key Indicators 2006. It is per capita GNP rather than GNI for Taiwan.
Note: The criteria for income categories are from World Development Indicators 2006. GNI = gross national
income; na = not available.
* Taiwan’s per capita information in current US$ is available but that is not comparable with constant $
statistics used in the table.
** Official information about Myanmar is exaggerated. The country is estimated to be low-income.
There is not a neat correlation between stages of industrialization and economic policies
or political regimes. Political change is not predetermined in its direction and is uneven
33

http://mutex.gmu.edu:2416/wdi2006/contents/Usersguide.htm

among regional economies. Facing opportunities or crises, different governments react
differently, creating entrenched interests in the process. Facing the same opportunities of
globalization, China and Vietnam have bravely moved forward whereas North Korea lags
behind. Facing the Asian financial crisis, Thailand and South Korea chose greater
liberalization whereas Malaysia opted for capital controls.
A combination of liberal democracy and market economy has proved to be the best
system available, particularly when one has to compete in a world where most powerful
countries are market economy democracies. At the same time, countries face tremendous
challenges during the transition period, and backlash is common. It is ultimately difficult to
judge the superiority of a particular system unless one adopts a teleological view of history.
The purposes countries pursue can be very different. How do we determine the proper
balance of economic efficiency and social harmony? Empirically, which national model is
considered superior to others tends to depend on the economic performance of the country at
the time. The German model was praised in the 1970s, the Japanese model in the 1980s, and
the American model in the 1990s. Thus, we should not be preoccupied with which national
model is “winning.”
THE JAPANESE SYSTEM OF POLITICAL ECONOMY
The Japanese system of political economy has gone through two stages since the early 1950s.
After World War II, Japan created a growth-oriented political system with a reinforcing
dynamic of rapid economic growth, conservative politics, and social participation that
became the envy of the world. By the end of the 1970s Ezra Vogel called Japan “the Number
One” country in the world.15 The catch-up, export-led Japanese model experienced severe
strains with a matured economy and backlash from the West in the 1980s. But instead of
introducing structural reform, Japan adapted by turning to an investment-led strategy,
allowing the yen to appreciate sharply after the 1985 Plaza Accord, and adopting a loose
monetary policy to limit the extent of appreciation. Such a strategy, combined with a lack of
investment opportunities at home, led to a bubble in the real estate and stock markets. The
burst of the bubble in 1991 ushered in the second stage of structural reforms. Much has
changed, particularly on the economic front, but much remains the same. While Japan
remains one of the most advanced economic and technological powers in the world, the
Japanese model has lost its luster, and the country’s struggles in recent years serve as a
cautionary tale for many.
The Embedded Mercantilism
T. J. Pempel has used the term “embedded mercantilism” to characterize the Japanese
political economy system through the 1980s.16 One may also use the term “the 1955 system”
or “the developmental state.”17 The 1955 system, which refers to the continuous rule of
Japan’s Liberal Democratic Party (LDP) since 1955, is more commonly used, but the
embedded mercantilism and the developmental state have the advantage of highlighting the
crucial economic dimension of the Japanese political system.
Japan regained sovereignty in 1952. The American Occupation authorities had created a
democratic political system in the country. Through the 1980s, the primary purposes of the
Japanese state were catching up with the West and ensuring social harmony. Japanese politics
was divided between conservatives and progressives. In response to the unification of the
Japan Socialist Party (JSP), different conservative political forces founded the LDP in 1955.
Whereas the LDP shared the neo-mercantilist view that Japan should become a competitive
economic power in the world, the party had to reconcile at least two different agendas. On the
34

one hand, big business, elite bureaucrats, and bureaucrat-turned-politicians wanted to create
internationally competitive large firms with industrial policy and fiscal responsibilities. On
the other hand, small business and agricultural bases of the party preferred local protection
and subsidies. The LDP managed to reconcile the two competing agendas by adopting an
industrial policy to upgrade technologies and penetrate foreign markets while protecting the
home turf from foreign competition. Japanese firms enjoyed a comparative advantage over
foreign competitors because of a secure domestic base. A dual economic structure thus
resulted. The Japanese state also sought to redistribute economic gains to ensure social
harmony. But unlike most Western European welfare states that aim at disadvantaged
individuals, the Japanese state focused on disadvantaged locations and sectors.18
The Japanese political system was often characterized as an “iron triangle” of
conservative LDP politicians, big business, and elite bureaucrats. The LDP politicians
ensured a stable business environment and adopted policies that promote the interests of big
business. Big business provided financial support for the LDP. Elite bureaucrats influenced
Japanese business behavior through state regulations.
The state was powerful because of heavy regulations of the economy. At the same time,
the capacity or the willingness of the Japanese state to direct economy should not be
exaggerated. Scholars have shown how the Japanese state adopted a market-friendly
approach and the rapid Japanese economic growth was driven by market forces. Put simply,
the market can be viewed as embedded in the Japanese state.19
The 1955 system was durable. Despite constant internal and external challenges, the LDP
has ruled continuously since 1955. The reasons often cited include the advantage of
incumbents, the party’s ability to adapt and co-opt ideas from the opposition, and the cold
war international environment that called for a conservative party trusted by the United
States. The fact that the Japanese state sought societal participation and supported various
social groups was an important reason for the durability of the system.20 Put simply, since the
1955 system served Japan so well, why rock the boat?
The embedded mercantilist system came under strains in the mid-1980s. Japan’s large
firms had become too competitive for other developed nations, which in turn pressured Japan
to open its market, which would necessarily hurt Japan’s protected domestic political
economy, at least in the short run. Instead of conducting structural reforms, Japan shifted to
an investment-led strategy, which planted the seeds for the lost decade of the 1990s. The
1985 Plaza Accord led to a sharp appreciation of the yen meant to reduce Japan’s mounting
trade surpluses with the world. To prevent too much pressure on Japanese exporters and to
expand the economy, the Japanese government chose a loose monetary policy, which led to a
huge bubble in real estate and stock values due to limited investment opportunities.21
Structural Reform
The burst of the bubble in 1991 began a prolonged period of economic stagnation and made it
necessary for Japan to conduct reforms.22 Much has been said about the progress and nature
of Japanese reform efforts and little has been agreed upon. Most observers do not view
Japanese reforms as significant or successful, while some see substantial incremental change
that may lead to a fundamental break from the past.23 Whichever is the case, what is clear is
that a stable new Japanese model of political economy is yet to emerge.24
Because of globalization and internal dynamic, the Japanese economic structure has
changed. The Japanese government has liberalized financial flows, relaxed labor regulations,
privatized special public corporations, and revised the pension system, among other
measures. The government has also conducted reorganization of itself. The private sector has
responded with reforms of its own.25
As a case in point, incremental change for the past decade has added up, making Japanese
35

corporations different from before. The lifelong employment system has been eroded.
Japanese companies have reduced new hires, hiring less than half as many new graduates in
2003 as in 1997, and now prefer to hire cheaper part-timers or temporary-contract employees.
The percentage of “nonregular” workers that accounted for 18.8 percent of the labor force in
1990 reached 30 percent by early 2005.26 Put more broadly, Japan’s social protection system
is unraveling.27 Moreover, shareholders now have greater influence than before. Although 46
percent of the company stocks were held as cross-shareholdings and only 6 percent by
foreign investors in 1992, foreign investors’ share increased to 22 percent while cross-
shareholdings accounted for 24 percent in 2004. Now institutional investors challenge the
management of companies. A few high-profile hostile takeover attempts, although
unsuccessful, have forced company management to pay more attention to profitability and
dividends to shareholders than previously.28
At the same time, it is easy to understand why many Japan watchers do not see much
progress in the Japanese reform. With the burst of the bubble, there was much discussion in
the Japanese policy community to shift to a liberal market economy. They criticized the old
system and wanted to break the iron triangle.29 They argued that Japan can only compete
better in a globalizing world by liberalizing its economy.30 But Japan clearly is not yet a
liberal market economy. It is more puzzling if we consider the fact that the Japanese public
actually wants reform, as indicated in Junichiro Koizumi’s astonishing victory at the
September 11, 2005, snap election.
Why is it so difficult to reform, and why has there not been a significant voter revolt in
Japan despite a decade of economic stagnation? As T. J. Pempel has argued, this is the central
puzzle about contemporary Japanese political economy. His explanation is that the advantage
of the incumbents in Japan has not been significantly weakened by the 1994 electoral system
reform, particularly in the rural areas. Besides, based on the new electoral system,
incumbents who lose in their swing-seat districts may still be elected on the proportional
party ticket. Also, Japan’s fiscal centralization means that it is difficult for opposition parties
to try out new ideas and develop local power bases. Moreover, the beneficiaries of the
existing system resist fiercely any structural reform efforts.31
Taking a middle ground between macrolevel analysis of the state and a microlevel study
of the private sector, Steven Vogel has offered an institutionalist explanation of the extent
and nature of Japanese reform. Structural reform is not a simple task of giving the market
greater room. Because market systems are embedded in state institutions of laws, customs,
and norms, reforming them requires revisions of these institutions as well. It follows then that
Japan’s existing institutions are transforming themselves, which explains both why there have
been drastic institutional changes and why the emerging Japanese model does not look like a
liberal market economy.32 Vogel’s insight will also be helpful for understanding reform
efforts conducted by other East Asian economies.
THE POLITICAL ECONOMY SYSTEMS OF THE ASIAN
TIGERS
The second tier of East Asian economies includes Singapore, Hong Kong, Taiwan, and South
Korea, as shown in Table 2.1. These “four tigers” focused on catching up with developed
countries quickly. Because they started later than Japan, they had to move up at a faster pace,
which could explain why South Korea, Taiwan, and Singapore had interventionist
governments. At the same time, Hong Kong has followed a free-market policy, even more so
than Great Britain and the United States. Thus, the East Asian experience does not endorse
state intervention in the economy as a necessary condition for rapid economic development.
36

The four tigers are different politically. Being Japanese colonies before 1945, Taiwan and
South Korea share more similarities with Japan. By contrast, Singapore and Hong Kong had
similar experiences as British colonies. Ironically, even though the British colonial
governments practiced a higher degree of democracy than the Japanese counterparts and
sought to leave behind a parliamentary democracy, it is Taiwan and South Korea that have
become consolidated democracies. Unlike Japan, which consolidated the democratic system
created by the American Occupation authorities, South Korea began with an autocratic
government, experimented with democracy in 1960–1961, made an authoritarian turn in the
1960s, increased repression in the 1970s, and began democratization in the late 1980s. The
Nationalist Party or the Kuomintang (KMT) government, which was authoritarian, moved to
Taiwan after losing the civil war in China and began with high repression. But the KMT
government began gradual reform in the 1970s and moved toward democracy around the
same time as South Korea. Singapore had a stable one-party dominant system like Japan.
Singapore has become one of the most affluent and well-governed countries in the world but
remains largely non-democratic. I will not discuss Hong Kong here because the island was a
British colony until 1997 and has been a Special Administrative Region of the PRC since
then. Hong Kong has a limited democratic system under the arrangement of “one country,
two systems.” Hong Kong is scheduled for full electoral democracy down the line, but it
remains a question whether Beijing will allow that to happen and how a democracy may
operate within the constitutional framework of the PRC.
South Korea
The Republic of Korea was founded in 1948. After the Korean War ended in 1953, the South
Korean government under Rhee Syngman was initially interested mainly in unification with
the North. General Park Chung Hee’s coup in 1961 began almost three decades of
authoritarian rule in the country. Park’s declared purposes were to bring about economic and
social transformations of the country and to strengthen national security.
South Korea took the Japanese model to another level. The state was more interventionist
than the Japanese state and any other nonsocialist East Asian economies. It has been argued
that as a later industrializer than Japan, South Korea needed a stronger government to
deliberately distort relative prices to target investment for long-term economic growth.33
The purpose of fast industrialization and the effort to support large business were
mutually reinforcing. The state tried to limit the expansion of large businesses to some extent
without much success. The authoritarian state needed an alliance with big business.34 In fact,
President Park said explicitly that the country needed large modern enterprises to compete
internationally, although he also saw the need for the state to control these very enterprises.
With the state’s power over licensing and its control of the commercial banks, the
government indeed forced some large enterprises out of existence for economic or political
reasons.35 Such a cozy state-business relationship may logically lead to corruption and did in
South Korea, which would come to be called crony capitalism.36 However, until the Asian
financial crisis, analysts tended to praise the South Korean model because the big South
Korean companies that the government supported did become internationally competitive.
While recognizing the presence of a strong state in South Korea, South Korean society
was politically active and was difficult for the state to co-opt, indicated by often militant
student demonstrations and labor movements.37 Kim Dae Jung, an opposition candidate
against President Park, received 46 percent of the votes in the 1971 presidential election. In
response, the Park regime increased its political repression of the opposition. However, the
state could not truly subdue its opponents. The country’s eventual turn to democracy had
much to do with bottom-up social protests.
South Korea turned to democracy in 1987 because of societal pressure and the
37

anticipation of the 1988 Seoul Olympics. President Chun Doo Hwan’s presidential candidate
Roh Tae Woo made a surprising proposal to accept the opposition demands for amending the
constitution and holding direct presidential elections. With a new constitution adopted in
October, the voters elected the next president by direct popular vote. With the opposition split
between Kim Young Sam and Kim Dae Jung, Roh won with a plurality of 36.6 percent of the
vote against the two Kims. South Korean democracy was consolidated in 1992 with the
second presidential election under the new democratic constitution. Kim Young Sam defeated
Kim Dae Jung for the presidency.38
Kim Dae Jung got his chance in the December 1997 presidential election, in the middle of
the Asian financial crisis. Unlike Japan, a voter revolt put Kim Dae Jung in the seat of
president. Responding to public demands, the new government under Kim Dae Jung
introduced more serious reforms as the majority of voters had wanted and achieved some
good results. Consequently, South Korea sustained democracy through a serious economic
crisis.39 South Korea has risen from the ashes of the crisis. Because of its young democracy,
the South Korean government has also expanded social safety nets since the crisis. A similar
trend is found in Taiwan.40
Taiwan
Similar to South Korea, Taiwan was a “frontline” economy feeling threatened by
communism. Taiwan had an authoritarian regime until the late 1980s. However, unlike South
Korea, which took a more authoritarian turn in the early 1970s, the KMT government began
gradual reform around the same time. Also unlike South Korea, the KMT government faced a
major communal divide between the minority mainlander ruling party and the Taiwanese
majority society, an all-important fault line that helped shape the KMT’s economic policies
and the nature and progress of Taiwan’s democratization.
The KMT government moved to Taiwan after losing the civil war to the Chinese
Communist Party. Ironically, the KMT acquired far greater unity in Taiwan than in the
mainland because Chiang Kai-shek took mainly the loyal and competent with him to the
island. The KMT also imposed martial law in Taiwan from May 1949 to July 1987, with
severe security measures to repress the opposition. Thus, the KMT had a strong state to
implement its policies.41 While the KMT initially hoped to retake the mainland, it
increasingly accepted the fact that it should focus on Taiwan, which was particularly the case
for Chiang Ching-kuo, the son of Chiang Kaishek and the heir apparent. The KMT’s survival
came to depend on economic performance and inclusion of Taiwanese into the party.
Concerned about the mainland, the government saw economic growth as a matter of life and
death.
To accomplish the central mission of economic growth, the state largely allowed
technocrats rather than politicians to handle economic decision making. Since the Taiwanese
natives controlled the private sector, the state turned to state-owned enterprises for heavy
industrialization.42 It was also easier for an outsider government without local ties to conduct
land reform, which would benefit the economy by turning the land to the Taiwanese tillers
and benefit the KMT politically by weakening local power bases that might pose a challenge
to the party. At the same time, the KMT allowed the Taiwanese businesses to prosper with
few restrictions, and the government limited the scope of the state enterprises. There was thus
plenty of room for social mobility and economic advancement.43
Although the KMT as a Leninist party is different from Japan’s LDP, Taiwan was similar
to Japan in that it had a one-party dominant system. Taiwan allowed limited elections as a
way to mobilize political support from the Taiwanese majority and to improve its
international image, particularly in the eyes of the United States whose support was crucial
for an increasingly isolated Taiwan.44 Similar to Japan, Taiwan had a multiseat, single, and
38

nontransferable vote electoral system that favored the incumbents. The KMT mastered
electioneering.45 Nevertheless, the one-party dominant system in Taiwan did end despite the
tremendous advantage of incumbents in forging corporatist links. One main reason is that the
Taiwanese majority viewed the KMT as an outsider, a handicap that proved difficult for the
party to overcome even though the party adopted a “Taiwanization” strategy.
Chiang Ching-kuo began a slow process of reform after 1972, which made a dramatic
turn to democratization in 1986 when the formation of the opposition party, the Democratic
Progressive Party (DPP), was tolerated. Chiang subsequently announced his intention to lift
martial law, which would make it much more difficult to repress freedom of speech and
freedom of association. Lee Tenghui of the KMT won the first direct presidential election in
March 1996. However, in a dramatic shift of the balance of power, Chen Shui-bian of the
DPP won the March 2000 presidential election by a small margin in a three-way election
against the KMT candidate and a candidate leading a splinter party from the KMT.46
Singapore
Similar to South Korea and Taiwan, Singapore had a strong sense of vulnerability. After
being granted autonomy in 1959, the conservative People’s Action Party (PAP) government
led by Lee Kuan Yew faced a strong leftist challenge at home and in neighboring Malaysia.
Like South Korea and Taiwan, Singapore experienced a separation trauma with its expulsion
from Malaysia in 1965 after two years of merger. The split was a result of the Singaporean
government’s demand that Malaysia should belong to Malaysians as defined by citizenship
rather than to Malays as defined by ethnicity.47 Moreover, with a population of less than four
million, Singapore is a small, Chinese-majority city state in the middle of a Muslim Malay
world and is situated in a competitive global market. The PAP has used all these perceived
vulnerabilities to justify its tough, disciplined rule in a country that has become one of the
most affluent in the world.48
Many small countries are democratic, but economically successful small democracies are
mainly found in Europe. Small countries that participate in the global economy are more
exposed by definition and are therefore more vulnerable. That basic reality has political
consequences for the type of political system likely to be adopted. Some small European
countries use a corporatist system to manage the challenge.49 Some small states are simply
failing. Singapore offers an alternative approach.
The Singaporean government sought to control the strategic domestic markets and
institutions to advance its main purpose of job creation and economic growth. The state
followed a philosophy of nurturing the private enterprises to serve as an instrument of
economic growth. Unlike South Korea, Singapore has actively sought foreign direct
investment. The Singaporean government does not just formulate plans. Rather, it issues and
enforces government directives. Utilizing the Economic Development Board offices
overseas, the Singaporean government monitors closely the developments in the global
market to select potential winning sectors.50
Similar to Taiwan and Japan, Singapore had a dominant one-party system. By 2006, the
PAP had won ten straight elections since independence. As conservative as the KMT and the
LDP, the PAP fought the leftists in Singapore to the extent that Lee sought integration with
Malaysia to check on the power of the leftists as well as to gain access to a larger market.51
Unlike the KMT, the PAP remains the dominant party despite new challenges. The early
1990s saw the PAP’s declining electoral support and a new generation of leadership.52 Lee
Kuan Yew retired in 1990, replaced by Goh Chok Tong. But the PAP increased its electoral
support in the 1997 election. Lee Kuan Yew’s son, Lee Hsien Loong, became prime minister
in 2004.
The PAP maintains political rule because of Lee Kuan Yew’s political skills, Singapore’s
39

rapid economic growth, the party’s clean image, the party’s ability to field new candidates,
and tough measures against opposition parties. Lee skillfully manipulated his communist and
communalist opponents to his advantage.53 Singapore’s rapid growth since its independence
gave the PAP an instant boost. Moreover, the PAP government introduced policy measures to
improve the living standards of Singaporean citizens in addition to letting the rising tide lift
all boats. In particular, the government implemented a public housing program that was the
key to its continuous electoral success. Singapore has a clean government, as indicated by
Transparency International’s highly publicized corruption perceptions index survey. The
2006 survey ranks Singapore as the fifth cleanest government in the world, trailing only
Finland, Iceland, New Zealand, and Denmark among 163 countries rated in the survey.54
With the advantage of the incumbents, the PAP has been able to recruit competent candidates
for elections. Last but not least, the PAP has employed coercive measures such as the Internal
Security Act to intimidate opponents and adopted a strategy of suing opponents to bankruptcy
in recent years.
THE POLITICAL ECONOMY SYSTEMS OF SOUTHEAST
ASIA
Southeast Asia has ten countries, namely Singapore, Malaysia, Thailand, Indonesia, the
Philippines, Brunei, Vietnam, Cambodia, Laos, and Burma/Myanmar. Singapore has been
discussed in the previous section. Vietnam, North Korea, and Cambodia will be discussed in
the next section. This section will not discuss Brunei, a rich, absolutist monarchy that became
independent in 1983.
Analysts often lump Malaysia, Thailand, Indonesia, and the Philippines together as “the
ASEAN Four.” They are all third-tier countries in terms of economic development. They are
not as advanced economically as the four tigers, but they have made substantial economic
progress, particularly Malaysia and Thailand. Different from the second-tier tigers, the
ASEAN Four are rich in resources and are major agricultural exporters. They were also
largely market-oriented early on. The state in the ASEAN Four is less interventionist and
developmentalist than Northeast Asian governments.55 By contrast, Burma/Myanmar, which
shares similar geographical and social features with the ASEAN Four, has chosen a
semisocialist economic autarky and harsh political repression under a military junta, a lethal
combination that has led to a failed state in a region that has seen much economic and
political progress for the past decades.
Malaysia
Communalism defines the Malaysian system of political economy. The native Malays
accounted for 50 percent of the population at the time of national independence in 1957, the
Chinese community 37 percent, and the Indian community 11 percent.56 The Malay-
dominated government categorized the Malays and other indigenous people as bumiputra or
“the son of the soil” as opposed to non-bumiputra like the Chinese and Indians.
The main story of Malaysia has been the interplay between Malay political power and
Chinese economic power. During the British colonial period, the Malays were mainly
subsistence farmers, whereas the Chinese and the Indians engaged in more lucrative rubber,
mining, retail, and financial sectors. Based on their numerical advantage and traditional rule
in the land, the Malays possessed political power, which they used to advance their political
and economic interests.
The Malays and the Chinese struck a bargain at the time of independence: The Malays
would enjoy political dominance with special rights while the Chinese could continue their
40

dominant role in business activities. Moreover, the Chinese should help the Malays gain
economically—closing the income and educational gap—while the Malays should help the
Chinese gain politically—gaining more access to the public sector and greater rights such as
Chinese language education. The bargain was embodied in the political structure, which was
modeled after the British parliamentary system. The ruling Alliance included the dominant
United Malays National Organization (UMNO), the Malaysian Chinese Association (MCA),
and the Malaysian Indian Congress (MIC), and there was much deal making and compromise
among them.57 The political regime in 1957–1969 has been described as “consociational
democracy” in which the elites from different ethnic groups accommodate each other to
allow democracy to operate.58
The violent ethnic riots on May 13, 1969, undid that initial bargain. Three days earlier,
the Alliance had lost seats to the opposition parties in the election. The root causes for the
riots were the Chinese resentment for the special rights for the Malays and the Malay
resentment that the economic gap with the Chinese had not narrowed.
After the riots, a national state of emergency was declared. The Malay political elites then
created a more authoritarian regime to explicitly encourage nation-building and communal
harmony on their terms, which meant less political influence for the non-Malays. UMNO
created a new ruling coalition, the Barisan Nasional (National Front), that incorporated more
parties. UMNO adopted the New Economic Policy (NEP) in 1971, which was essentially an
affirmative action for the politically powerful Malay majority to enhance their economic
power over the non-Malays. The NEP aimed at making employment at all occupation levels
reflect the racial composition of the country and increasing the ownership of the productive
wealth to 30 percent for the bumiputra by 1990. The NEP precipitated Malaysia’s shift from
limited state intervention in the economy to a heavily interventionist approach.
The Malaysian state became strong and developmentalist. It did not face an entrenched
landowning class like in the Philippines. The dominant Chinese business community was
politically vulnerable. The Malay business class grew strong but remained beholden to the
state for favors and protection. Malaysia also had a strong leader in Mahathir Mohamad, who
became prime minister in 1981 and ruled until October 2003.
The NEP achieved some of its objectives by 1990. The interethnic income gap narrowed,
and the Chinese no longer monopolized the national economy. The fact that Malaysia has
performed better in racial harmony than most other countries in similar situations means that
all communities have benefited from stability. Large income gaps between ethnic
communities are likely to lead to tensions and make it impossible for anybody to achieve
their economic goals. Moreover, as Harold Crouch has pointed out, the Malaysian state has
become more repressive and responsive at the same time.59
However, the goal of 30 percent Malay ownership was not achieved, and the income gap
within the Malay community widened. Not surprisingly, directives from bureaucrats and
politicians created economic distortions. Successful Malay businessmen owed their affluence
to their connections to UMNO politicians, and few indigenous entrepreneurs had emerged.
To ensure sustainable economic development, Malay politicians also tried to accommodate
the non-Malays, although not as much as the Malays. Chinese businessmen basically adopted
the strategy of co-opting native politicians or bumiputra business people with political
connections. In short, the state used rents, which are the returns from government protection
or favor, to achieve desired political and economic consequences, namely UMNO’s
dominance and a redistribution of wealth in favor of the Malays.60
When the NEP reached its twenty-year target in 1991, Mahathir announced new
development strategies of Vision 2020 and the National Development Policy (NDP) to turn
Malaysia into a developed nation by the year 2020. The new plans focused more on faster
economic growth and liberalization than interethnic redistribution and state intervention.61
41

However, interethnic considerations still drive Malaysian politics, which in turn influences its
economic policy. The Asian financial crisis provided an opportunity for the society to push
for greater democracy, but Mahathir survived with harsh measures against the opposition.
Thailand
Thailand has a constitutional monarchy. The absolute monarchy ended in 1932 after a
military coup. King Bhumibol Adulyadel, who has reigned since 1946, enjoys high respect
from the Thais and has occasionally intervened in Thai politics as a steady hand. In May
1992, the King criticized the prime minister and the opposition leader on national television
for the military suppression of prodemocracy demonstrations, an action that led to the
country’s return to civilian rule. More recently, the King appeared to have tolerated the
military coup that ousted Prime Minister Thaksin Shinawatra in September 2006.
Similar to Malaysia, Thailand also has a large ethnic Chinese community, but unlike
other Southeast Asian countries, the ethnic Chinese have largely assimilated into the Thai
society. This was due to the compulsory Thai language education in the Thai schools rather
than a European language starting in the 1920s. Also, the Chinese immigrants found it
culturally easier to accept Theravada Buddhism than Islam. Equally important, unlike most
other Southeast Asian governments that adopted legislation or policy to restrict the rights of
the Chinese, the Thai government removed restrictions after the Second World War.62
Unlike Malaysia but similar to most East Asian economies, Thai military officers were
dominant in the Thai government since 1932. The military government introduced the first
economic development plan in 1958, but the state had limited intervention in the
marketplace. Similar to some other developing nations, the military relied on technocrats to
formulate development strategies. Thai generals also became involved in business ventures,
legal or illegal, for personal wealth. The military and business leaders accommodated each
other. However, with the mounting social protest and insurgency and with the weakening of
the military-business alliance in the early 1970s, a student movement provided the catalyst
for the downfall of the military government.63 A short period of democracy was ended by a
military coup in October 1976, but the military leaders had to appear accommodating to the
public.
The economic growth in the 1980s led to greater societal demands for liberalization and
political participation. In particular, the business community became more powerful since the
early 1970s, and they helped found political parties and supported parliamentary
democracy.64 A general election in 1988 selected Chatichai Choonhaven as prime minister,
but corruption charges eroded the public support for the Chatichai government. The military
launched a coup in February 1991. After the May 1992 uprising, a formal democracy was
established.65
In the 1990s, the Democrat Party headed by Chuan Leekpai formed the ruling coalition
most of the time. The party at first represented the provincial interests but became a party for
the Bangkok business community and the urban middle class. The party was blamed for the
country’s fall during the 1997 Asian financial crisis.66 In its place rose the Thai Rak Thai
(Thai Love Thai) party led by Thaksin Shinawatra, who became prime minister in February
2001. Being one of the richest businessmen in Thailand, Thaksin’s rise symbolized the rise of
domestic capital. Tapping into postcrisis sentiment, Thaksin followed a populist policy to
support the businesses hurt by the crisis and to make promises to the rural poor, which were
largely delivered. Thai Rak Thai enjoyed a clear electoral majority, rare in Thai electoral
politics.67 However, Thaksin came to be viewed as corrupt. In February 2006, large street
protests took place, which forced a snap election in April, which he won. The election
revealed a clear class division: Thaksin was popular among the urban poor and rural
population for his generous programs for them but he angered the urban middle class.
42

The military, which had experienced a notable decline in the 1990s, staged a bloodless
coup on September 19, 2006, the first military coup since 1991. Even though Thaksin had
gradually undermined the democratic institutions and created a political impasse with the
opposition, the military coup was a setback for democracy.
Indonesia
After independence in 1949, the Indonesian government practiced constitutional democracy
in 1950–1957. In response to regional rebellions in 1957–1958, President Sukarno created a
presidential-style strong government in 1959 and ruled under the so-called “Guided
Democracy” in 1958–1965. With high inflation, the economy began to decline sharply by the
mid-1960s. More seriously, the Indonesian Communist Party (Partai Komunis Indonesia—
PKI) and the army were competing for the state power, which came to a head in 1965. In a
massive bloodbath, hundreds of thousands of Communists and suspected supporters were
massacred throughout the country. Sukarno was forced to resign. General Suharto came to
dominate in the next two years and became president in 1968. Suharto created “the New
Order” in which the military that had already become part of the ruling elite came to
dominate.68
From 1968 to 1998, the country’s rapid economic growth led to more authoritarianism
than democratization.69 The Suharto government created Golkar, a type of state party in 1971,
which weakened old political parties. In terms of the relationship between the state and
business, the state had a clear upper hand because the dominant Chinese business community
was politically vulnerable owing to their outsider status in the eyes of the largely Muslim
indigenous population and was dependent on the political patronage of the government.70
Foreign aid from 1968 onward helped to stabilize Indonesia’s economic situation.
Indonesia’s revenues from oil exports increased sharply in the early 1970s, which facilitated
the country’s political stability. Whereas the oil exports provided 29 percent of the central
government’s revenues in 1970, they accounted for 70 percent in 1981.71 Windfalls often
distorted the economic and political structure with long-term negative consequences.72 The
Indonesian government used the oil revenues for domestic investment rather than domestic
consumption, but increased domestic investment led to higher prices of nontradable relative
to tradable goods and those of imports relative to exports. The appreciation of the Indonesia
currency, rupiah, due to current account surpluses reduced the competitiveness of Indonesia’s
exports. The oil windfalls also led to more corruption.73
With declining oil prices in 1982, the Indonesian government had to reduce its ambitious
industrialization programs. In response, the government turned to deregulation and export-led
industrialization in the mid-1980s. The Suharto government focused reforms in the areas
where the politico-bureaucrats and business conglomerates could benefit or at least would not
suffer.74
The Asian financial crisis hit Indonesia the hardest, exacting high political prices. Suharto
resigned in May 1998, ending his thirty-two-year rule. The postcrisis reforms were more
thorough than the liberalization measures adopted between the mid-1980s and the mid-1990s.
More important, Indonesia, the world’s largest Muslim country, now has a formal democracy
defined as having regular and competitive elections participated in by freely associated
political parties. The slowest to recover from the crisis, Indonesian economy has improved,
particularly under current president Susilo Bambang Yudhoyono.
The Philippines
The Philippines became independent in July 1946, with a constitutional democracy modeled
after the American system. At the same time, the country is known as the “antidevelopment
state,” with weaker economic performances than most of its high-flying neighbors. Thus,
43

those skeptical of democracy often use the Philippines as an example of why American-style
democracy is inappropriate for a developing nation.
President Ferdinand Marcos introduced martial law in 1972 with the declared aim of
creating a strong developmental state like South Korea. Nevertheless, the Philippine economy
worsened. As Alasdair Bowie and Danny Unger observed, “whether under democratic or
authoritarian regime, particular characteristics of Philippine economy and society persisted in
producing poor economic results after the 1950s.” The reason they gave, similar to many
other analysts, is the dominance of oligarchic, landowning families that have captured the
state to advance their own interests.75 Put simply, oligarchy defines the Philippine political
economy system. By contrast, the central government is weak because civil servants are
beholden to their political patrons outside the bureaucracy.
The Philippines actually enjoyed healthy economic growth in the 1950s and the early
1960s, better than most Southeast Asian countries. Having a constitutional democracy with
checks and balances, the country boasted one of the strongest legislatures in East Asia, which
encouraged interelite competition and greater response to mass demands. At the same time,
the executive branch remained strong and the state did not adopt any policies against the
interests of the oligarchs. By the early 1970s, the country faced a mounting political crisis
with street demonstrations and a communist insurgency. Marcos declared martial law in
1972, ushering in authoritarianism.76
Political scientist Samuel Huntington offered an explanation of why some democracies in
the developing world had turned authoritarian in a seminal book in the late 1960s. He argued
that a developing nation often experiences political disorder when it achieves rapid economic
growth, which unleashes social forces and increases expectations that strain fragile political
institutions.77 His theory fit in the Philippine case. A democratic system and progress led to
mass expectation that strained the political system. The ruling elite faced a choice between
expanding participation in policy process, which was perceived to be against their own
interest, and restricting participation. Filipino elite chose the latter.78 The country would pay
dearly for that choice.
When Marcos was elected president in 1965, he was a symbol of hope. He sought advice
from technocrats for economic policy making. But his policy initiatives lost steam quickly.
He won reelection in 1969 partly based on public works.79 In 1972, while in his second term
as president, Marcos declared martial law was necessary to combat civil disorder, but the real
reason was to maintain his power since the constitution did not allow a third term. With
martial law, the state capacity strengthened. Marcos initially talked about reform, but his
regime quickly became a model of crony capitalism. Marcos used state power to enrich his
family and his cronies, which led to increased social opposition.80
The Philippines faced a debt crisis in the early 1980s. The Marcos regime could not
ensure sufficient financial resources for the central government because of the resistance of
the powerful families. Marcos incurred foreign loans to finance his projects, which were
largely unproductive. It was easy to borrow money from Western banks in the 1970s. The
first oil shock led to a massive flow of “petrodollar” from oil exporting countries to Western
banks and simultaneously decreased investment opportunities in the developed countries. As
a result, Western bankers eagerly pushed large loans on governments and public enterprises
in large developing countries in Latin America and elsewhere. With the second oil crisis in
1979 and rising interest rates, a major debt crisis occurred. The Latin American debt crisis
that took place in the early 1980s also hit a few non-Latin American countries such as the
Philippines.
The assassination of Benigno Aquino, the main opposition leader, in Manila in August
1983 led to stronger societal opposition and U.S. criticism. Aquino had just returned from
political exile in the United States. In response to U.S. pressure, Marcos called an early
44

presidential election for February 1986, in which Corazon Aquino, the widow of Benigno
Aquino, claimed victory, supported by hundreds of thousands of demonstrators in the streets.
Although the Filipino military had been less inclined to intervene in domestic politics than
other Southeast Asian militaries, the martial law politicized the Filipino military. But the
military switched side, and the Marcos family was forced to flee the country.
The Aquino “People Power” revolution did not fundamentally reform the country as
triumphant street demonstrators had hoped for. Aquino’s victory was not a true revolution as
many had thought but a return to the dominance of the powerful provincial families.81 Being
from one of the wealthiest land-owning families herself, Aquino did not push the land reform
hard. It did not help that Aquino exempted her 6,000-hectare family estate.82 The election of
Fidel Ramos as president in 1992 led to reform and modest economic growth in the early
1990s. That strategy came to be viewed as faulty when the Asian financial crisis hit. Lower-
class voters put a populist former movie star Joseph Estrada into the seat of presidency.
However, Estrada created his own cronies. The old elite and the middle class replaced
Estrada with Gloria Macapagal Arroyo, who has focused more on supporting the United
States’ war on terror rather than on reforms.
Burma/Myanmar
Burma became independent from Great Britain in 1948, one of the earliest independent
countries in East Asia. The current military government changed the country’s name to
Myanmar in 1989, a name recognized by the United Nations. I will refer to the country as
Burma before 1989 and Myanmar thereafter.
Similar to other Southeast Asian countries, Burma faced a daunting task of nation-
building from the beginning. The prospect for the country was promising. In fact, a
contemporary observer might well have predicted that Burma would end up performing better
than Thailand and South Korea, the two countries with a similar population size and
comparable living standards. The reasons for such optimism came from the fact that the
country was the world’s largest exporter of rice before World War II, it was a producer of oil,
and it had untapped natural resources, easy waterways, and a high level of literacy.83 But as
we know now, Myanmar is a failed state and one of the least developed nations in the world,
sharply different from Thailand and South Korea. The best way to think about Burma’s
ultimate failure is to see the government making one blunder after another, leading to a
vicious cycle of economic and political developments.
After independence, Burma followed parliamentary democracy in 1948–1962. Various
groups contended for control of the state, resulting in a civil war and a weak government with
weak financial capacity. These contestants for the state included the Anti-Fascist People’s
Freedom League, the Burmese Communist Party, the Karen National Union, and some other
groups.84 The civilian government allowed General Ne Win to run a caretaker government for
eighteen months in 1958–1960 to avoid a possible civil war.
With a taste of political power and foreseeing continuous political chaos, Ne Win seized
the state power in a military coup in March 1962 with a declared aim to restore order and to
prevent a possible breakup of the country. Ne Win sought to create what he called the
“Burmese Way to Socialism,” which mixed elements of Buddhism, humanism, and Marxism.
The government launched a nationalization campaign in 1963 and adopted economic autarky
in its foreign economic policy, the opposite of the more open orientation of the ASEAN Four
even though Indonesia and Thailand also had military governments. Ne Win’s development
strategy had a devastating effect on Burmese political economy. More seriously, since the
government had little control over the border regions, illicit trade boomed. It was estimated
that the black market operation accounted for 40 percent of the nation’s GDP by 1987, which
explained why some insurgent groups ended up better financed and better armed than
45

government troops.85 Ironically, the strengthened quasi-states and insurgent groups in the
border regions were also used to justify a military government in Rangoon.86
With mounting social unrest, Ne Win was forced to resign in 1988. A military junta, the
State Peace and Development Council, has ruled in the country since 1988. In 1988, the
military government announced a shift of development strategy to a market-oriented
economy and to attract foreign investment, including in its prized oil and natural gas sector.
However, with the crackdown after the electoral victory by the National League for
Democracy led by Aung San Suu Kyi in May 1990, the West imposed sanctions on
Myanmar. With political repression and mismanagement by the military government, the
prospect for the country remains bleak.
THE TRANSITIONAL POLITICAL ECONOMIES
East Asia has had a number of socialist countries, namely China, North Korea, Vietnam,
Cambodia, and Laos. Myanmar, discussed above, also follows a unique socialist path by the
military. I discuss China, North Korea, Vietnam, and Cambodia in this section. North Korea
was more industrialized and urbanized than China and Vietnam. The Chinese Communist
Party and the Vietnamese Communist Party won the state power even though they both
received substantial external assistance. The communist victory in North Korea had much to
do with the Soviet occupation, which made the country similar to Eastern Europe. Similarly,
the Cambodian People’s Party (CPP), the current ruling party in Cambodia, traced its origin
to the Vietnamese invasion in 1978. But the CPP did not have as much time to consolidate its
power as its counterpart in North Korea. Unlike China and North Korea, Vietnam
experienced a prolonged period of war after the Second World War, which affected its
economic system.
The socialist system includes political rule by a communist party and a command
economy, in which the government dictates economic activities. The socialist countries all
sought to achieve rapid economic development through multiple-year plans based on high
accumulation. The national purpose of rapid economic growth is embedded in the communist
ideology. The communist system is supposed to represent the highest level of material
production. The socialist countries also competed with advanced capitalist countries. So for
both security and propaganda purposes, they needed to catch up with the West or their
capitalist rivals in their regions.
China
The People’s Republic of China (PRC) was founded in 1949. The Chinese Communist Party
(CCP) government transformed the Chinese economic system into a Soviet-style command
economy by 1957. Beijing introduced the first five-year plan in 1953.87 Mao Zedong decided
to develop China’s own unique path to socialism and launched the “Great Leap Forward”
campaign in 1958, which essentially involved mass mobilization to achieve rapid
industrialization and collectivization of the agriculture. The ensuing three-year Great Famine
was the worst man-made disaster in postwar East Asian history. Mao retreated to some extent
and allowed Liu Shaoqi and Deng Xiaoping to restore economic order by implementing
moderate policy. China’s economic recovery in the early 1960s served as the backdrop for a
rivalry between two lines within the party leadership. For Mao, China’s main purpose should
be to create a revolutionary society and to engage in a continuous revolution to educate the
young. Liu and his supporters did not oppose that objective, but they did not endorse Mao’s
radical positions. Mao launched the Cultural Revolution in 1966 to purge Liu and his
supporters, resulting in ten years of political chaos and economic stagnation.
46

Deng launched reform in 1978, leading to a major shift in China’s national purposes. The
Chinese government and society now share the same goal of making the country stronger and
its people richer. At the same time, there were early challenges from hardliners who argued
that Deng’s reform was leading China astray. There were also social protests and intellectual
demands for political reform. The Deng line has held after several rounds of ideological and
policy debates within the government.
We can ask three major questions about the contemporary Chinese political economy.
First, why did the Chinese leadership decide to adopt economic reform and opening policy in
the late 1970s? Second, why did China succeed in economic reform compared with economic
reforms in some other transition economies? Third, why did the Chinese leadership adopt
economic reform without political reform, and will economic reform lead to political opening
in the foreseeable future?
Why did the CCP decide on reform? One simple explanation is that they had little choice
since the country was on the brink of bankruptcy. However, when a country is facing crises,
it is possible to imagine other policy choices such as retrenchment or muddling-through. An
analysis of the Chinese institutions offers a good explanation. It is both the strengths and the
weaknesses of the state that explained the choice of the CCP. The fact that China was not as
institutionalized in the communist political economy system as the Soviet Union meant that it
was easier for the CCP to try something new.88 China’s administrative decentralization also
meant that local officials could experiment with new policies that might become models for
other localities.
The Chinese state could sustain the reform because the Chinese reform was done in such
a way that it turned party officials into entrepreneurs who benefit from the new political
economy system emerging in the country. Take China’s countryside, for instance. Fiscal
decentralization and decollectivization have allowed local officials to become winners in the
reform era.89
The CCP wants to maintain its dominance, which it believes is important for social
stability. To some extent, it is easy to understand why a ruling party does not want to let go of
political power. However, in the late 1980s, the Soviet Union and Eastern Europe did have
political reform, which led to the demise of communism in Europe. Why not China? A
simple way to look at this is that Mikhail Gorbachev wanted to reform the Soviet Union
rather than ending the communist rule, but his choice to start with political reform unleashed
forces that led to the demise of the communist system. By choosing to start with economic
reform and doing so very gradually, the CCP had a greater capacity to manage the change,
and China managed to grow out of its planned economy.90
Over time, the Chinese economic reform has transformed China. As far as the political
economy system is concerned, the direct state role in economy has diminished. By the 2000s,
the percentage of national economy directly controlled by the state sector declined to about
one-third. It is inevitable that China’s rapid economic development and transformation for the
past three decades should impact its political system, but the CCP continues to adapt. For one
thing, the party is co-opting the new and powerful private business interests by absorbing
them into the party system. Private entrepreneurs are the products of economic reform and
will naturally support economic reform, but they are unlikely to become agents of political
change in China because of their behavior and beliefs and their close ties with the state.91 In
fact, Minxin Pei argued that China’s economic reform has stalled and a gradualist approach
has led to a trapped transition, in which an emerging predatory state prevents
democratization. The reasons he cited include weak institutions, lack of government
accountability, and corruption.92 Similarly, Mary Gallagher suggested that Chinese reform
has so far strengthened the Chinese state, which will delay democratization.93 Conversely,
Bruce Gilley maintained that economic reform has transformed the Chinese elite, who will
47

lead China down the path of democracy.94
It has often been noted that if Taiwan could democratize, China could too. The KMT is a
Leninist party, just like the CCP. However, despite considerable similarities between the two
parties, they are different in important ways, particularly leadership’s willingness to listen to
the society and the parties’ adaptation to the changed domestic and external environments.
Thus, the KMT’s evolution may not be a good indicator of what’s to come for the CCP.95 The
KMT also allowed limited elections, which gave a valuable training experience to the
opposition and allowed better feedback from society to the ruling party.
A combination of political and economic power is emerging in China that share interest in
repressing the societal discontent from the “losers.” Government officials can easily gain
personal wealth based on their political power and policy influence, which is of course the
essence of crony capitalism. There has been much discussion about social justice in China. In
a populist appeal, the government now talks about creating a “harmonious society.”
However, without a genuine political reform that leads to competitive elections, an
independent judiciary, and freedom of press, there is little hope that the CCP party state will
be able to discipline itself.
Vietnam
Under the 1954 Geneva Accord, Vietnam was divided into the communist north and capitalist
south. The Democratic Republic of Vietnam in the north adopted the Soviet model in 1955
and nationalized most of its industrial and transportation enterprises by the end of 1960. The
communist government also collectivized agriculture. Hanoi introduced the first five-year
plan for 1961–1965 at the end of the 1950s. Once North Vietnam unified the country in 1975
and established the Socialist Republic of Vietnam in 1976, it introduced the socialist planned
economy in the south as well.96
The Soviet approach of planned economy led to economic crises in 1978–1979. In 1981,
the Vietnamese government adopted reform measures within the central planning framework.
Vietnam could not adopt more drastic reform until Le Duan, the head of the wartime
leadership, died in 1986.97 Political leadership at a crucial junction is important. The Sixth
Party Congress held in December 1986, under new leadership, adopted a policy of economic
reform, or doi moi. Vietnam’s reform shares similarities with China’s. Both reforms were
gradual and cautious, ending with more drastic transformation of economy. Both countries
have experienced a virtuous cycle of early successes encouraging later reform initiatives.98
Vietnam also adjusted its foreign policy. Vietnam invaded Cambodia in 1978 and did not
withdraw until 1989. Because of the invasion, Vietnam isolated itself from everyone in
Southeast Asia except Laos, as well as from China, Japan, and the United States. A few years
after the launch of doi moi, Vietnam withdrew from Cambodia and eventually joined ASEAN
in 1995.
Significantly, the Tenth National Congress of the Vietnamese Communist Party held in
April 2006 demonstrated greater political openness than the Chinese Communist Party.
Before the congress, the Vietnamese citizens were encouraged to submit comments, which
were discussed in the media. At the congress, delegates were allowed for the first time to
recommend candidates for the position of general secretary. An intriguing political economy
question is whether Vietnam’s greater political openness, assuming that it will continue and
deepen, will give the country a comparative advantage in democratization over China in
attracting foreign investment given the presence of a more transparent government or gaining
easier access to the Western markets given the partial removal of human rights as a reason for
protectionism.
North Korea
48

The Democratic People’s Republic of Korea (DPRK) has diverged from Vietnam drastically.
Whereas Vietnam has enjoyed strong economic growth thanks to economic reforms, North
Korea has become a failed state. North Korea began with hesitant reform measures in July
2002, but the country remains repressive, unreformed, and confrontational. By the end of
2006, the difference between the two countries could not be greater. North Korea tested a
nuclear bomb on October 9, 2006, which was condemned by the international community,
and a UN Security Council resolution authorized economic sanctions on Pyongyang. By
contrast, Vietnam joined the World Trade Organization on November 7, 2006, and hosted the
Asia-Pacific Economic Cooperation summit on November 12–19.
The DPRK nationalized most industrial enterprises in 1946 and introduced economic
planning in 1947. The state launched land reform after the Korean War and collectivized
agriculture by 1958. Pyongyang introduced the first five-year plan in 1957. North Korea
focused on heavy industrialization, but the collapse of the Soviet Union deprived North
Korea of aid, cheap fuel, and export markets, triggering a serious economic crisis.99
Kim Il Sung, the founder of the DPRK, died in July 1994. His son Kim Jong Il has been
ruling the country since then. Kim Jong Il wanted to modernize the country and sought to
normalize diplomatic relations with the United States and Japan. Upon formally assuming the
official title after mourning the death of his father for over three years, Kim decided to have a
new development strategy of “building kangsong taeguk” (strong and prosperous great state),
which essentially means “enrich the nation and strengthen the army,” similar to the Japanese
objective before the Second World War and the declared objectives of South Korea leader
Park Chung-hee in the 1970s. But Kim resorted mainly to nuclear weapon blackmail, which
led to increased economic pressure on his country. In 1994–1998, two or three million people
reportedly starved to death and the country increasingly turned to the international
community for aid. Instead of reforms, however, Kim chose a “military-first” strategy in the
late 1990s.100
Kim’s confrontational foreign policy creates a serious problem for North Korean reform.
By contrast, China improved relations with the United States and Japan before its reform.
Vietnam began relaxing economic policy in the late 1970s and then conducted a more drastic
reform in the mid-1980s while it was still isolated internationally. Vietnam’s invasion of
Cambodia is similar to North Korea’s current situation with its nuclear program. But Hanoi
adjusted its foreign policy shortly after doi moi began, as discussed above, which helped to
create a favorable international environment for its economic reform and development.
Cambodia
The Cambodian case is highly unusual in that the country adopted a formal democracy in the
early 1990s, which made it part of the democratization wave sweeping the world at the time.
It is unusual also in that Cambodia is one of the poorest countries in East Asia but now has a
multiparty electoral system that more advanced economic powers like China have failed to
embrace.
Cambodia suffered from an extreme collectivization campaign under the Pol Pot regime
in the late 1970s. Vietnam invaded in 1978, overthrew the Pol Pot regime, and created a
puppet regime in the People’s Republic of Kampuchea, which was later named the State of
Cambodia (SOC). The new regime allowed private plots for farmers in the early 1980s and
conducted market reform in the late 1980s. Simultaneously, Cambodia went through two
other transformations, namely from war to peace and from authoritarianism to democracy.
The two transformations were closely related. With the end of the cold war and the
withdrawal of the Vietnamese troops, the United Nations brokered a peace agreement among
the warring parties in 1991 and created a democratic system that began with an UN-
sponsored election in 1993.101
49

Prime Minister Hun Sen’s Cambodian People’s Party (CPP) lost the election but
maneuvered into a joint government with the winning royalist United National Front for an
Independent, Neutral, Peaceful, and Cooperative Cambodia (Front Uni National pour un
Cambodge Independent, Neutre, Pacifique et Cooperatif—FUNCINPEC). The CPP then
forced FUNCINPEC leaders to flee after a gun battle near Phnom Penh in July 1997. A fair
election was held in 1998 and the CPP formed a coalition party with FUNCINPEC, which
was now a junior partner. Hun Sen has won reelections based on personal patronage and
power. The prospect of a true democratic Cambodia thus remains questionable. International
democracy promotion has its limitations as the CPP continues to hold sway over the rural
villages by controlling the flow of resources to them.102
CONCLUSION
The discussion of the East Asian economies in the chapter shows a rich diversity of the
national systems of political economy in the region. This diversity is an important reason why
East Asia has experienced far greater difficulties in achieving regional integration than
Europe, which has far less divergence than Asia. At the same time, East Asian postwar
developments have exhibited a rough pattern of a higher stage of economic development
corresponding to better governance and ultimately to democracy. To be sure, economic
development is not a sufficient condition for political development. As the country-specific
discussions in the chapter show, how a government chooses to respond to internal and
external challenges explains much about different public policy, economic performance, and
social well-being for its citizens. From a regional perspective, the countries that have made
better choices have outdone the countries that have adopted terrible policies. Economic
development does not necessarily have a linear relationship with political development.
Those countries that are catching up and that are experiencing fast socioeconomic
transformations and rising social expectations can and have often experienced more heavy-
handed political rule. One should note, however, that some of those early authoritarian
governments have turned democratic in recent years.
My discussion of the East Asian economies in this chapter is focused on postwar
developments. To have a better understanding of contemporary East Asian political economy,
we need to look at it first from a historical lens from ancient time to the present, a task for the
next four chapters.

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NOTES

1. Robert Gilpin, Global Political Economy: Understanding the International Economic
Order (Princeton: Princeton University Press, 2001), 149.
2. Colin Crouch and Wolfgang Streeck, eds., Political Economy of Modern Capitalism:
Mapping Convergence and Divergence (London: Sage, 1997).
3. Ethan B. Kapstein, “Workers and the World Economy,” Foreign Affairs 75, no. 3
(May/June 1996): 16–37; Paulette Kurzer, Business and Banking: Political Change and
Economic Integration in Western Europe (Ithaca, N.Y.: Cornell University Press, 1993).
4. Suzanne Berger and Ronald Dore, eds., National Diversity and Global Capitalism (Ithaca,
N.Y.: Cornell University Press, 1996); Eisuke Sakakibara, Beyond Capitalism: The
Japanese Model of Market Economics (Lanham, Md.: University Press of America, 1993);
Peter A. Hall and David Soskice, eds., Varieties of Capitalism: The Institutional
Foundations of Comparative Advantages (New York: Oxford University Press, 2001);
Torben Iversen, Jonas Pontusson, and David Soskice, eds., Unions, Employers, and
Central Banks: Macroeconomic Coordination and Institutional Change in Social Market
Economies (New York: Cambridge University Press, 2000); Michel Albert, Capitalism
Versus Capitalism (New York: Four Walls Eight Windows, 1993); Herbert Kitschelt, Peter
Lange, Gary Marks, and John D. Stephens, eds., Continuity and Change in Contemporary
Capitalism (New York: Cambridge University Press, 1999).
5. The World Bank created a list of seventeen failing nations in 2003, which included
Myanmar and Laos. An updated list of twenty-six issued in September 2006 includes also
Cambodia and East Timor. Karen DeYoung, “World Bank Lists Failing Nations that Can
Breed Global Terrorism,” The Washington Post, September 15, 2006, A13.
6. Chalmers Johnson, MITI and the Japanese Economic Miracle: The Growth of Industrial
Policy, 1925–1975 (Stanford: Stanford University Press, 1982); Robert Wade, Governing
the Market: Economic Theory and the Role of Government in East Asian Industrialization
(Princeton: Princeton University Press, 1990).
7. Kjeld Erik Brødsgaard and Susan Young, “Introduction: State Capacity in East Asia,” in
State Capacity in East Asia: China, Taiwan, Vietnam, and Japan, ed. Kjeld Erik
Brødsgaard and Susan Young (New York: Oxford University Press, 2000), 1–16.
8. After the Asian financial crisis, the strong state was associated with crony capitalism in
many people’s minds. David C. Kang, Crony Capitalism: Corruption and Development in
South Korea and the Philippines (New York: Cambridge University Press, 2002).
9. Peter Evans, Embedded Autonomy: States and Industrial Transformation (Princeton:
Princeton University Press, 1995).
10. Thomas B. Gold, “The Waning of the Kuomintang State on Taiwan,” in State Capacity in
East Asia (see note 7), 84–113; Jürgen Domes, “State Capacity in an Asian Democracy:
The Example of Taiwan,” in State Capacity in East Asia (see note 7), 114–130.
11. Hagen Koo, ed., State and Society in Contemporary Korea (Ithaca, N.Y.: Cornell
University Press, 1993).
12. Peter J. Katzenstein, “East Asia—Beyond Japan,” in Beyond Japan: The Dynamics of
East Asian Regionalism, ed. Peter J. Katzenstein (Ithaca, N.Y.: Cornell University Press,
2006), 4–14.
13. James M. Morley, ed., Driven by Growth: Political Change in the Asia-Pacific Region,
52

rev. ed. (Armonk, N.Y.: M. E. Sharpe, 1999).
14. According to studies by the Economist Intelligence Unit of The Economist, of 165
countries and 2 territories, only Japan belongs to the 28 “full democracies” (20); South
Korea (31) and Taiwan (32) are termed “flawed democracies,” but they have a higher
ranking than Italy and India. Economist Intelligence Unit,
www.economist.com/theworldin/international/display Story.cfm?
story_id=8166790&d=2007. Also see Laza Kekic, “A Pause in Democracy’s March,” The
Economist: The World in 2007: 59–60.
15. Ezra F. Vogel, Japan as Number One: Lessons for America (Cambridge: Harvard
University Press, 1979).
16. T. J. Pempel, “A Decade of Political Torpor: When Political Logic Trumps Economic
Rationality,” in Beyond Japan (see note 12), 37–62.
17. Johnson, MITI and the Japanese Economic Miracle.
18. Pempel, “Decade of Political Torpor,” 41–45.
19. Ikuo Kume, “Institutionalizing Post-War Japanese Political Economy: Industrial Policy
Revisited,” in State Capacity in East Asia (see note 7), 61–83.
20. Ikuo Kabashima and Terry MacDoughall, “Japan: Democracy with Growth and Equity,”
in Driven by Growth (see note 13), 307–309.
21. T. J. Pempel, Regime Shift: Comparative Dynamics of the Japanese Political Economy
(Ithaca, N.Y.: Cornell University Press, 1998), 200–201.
22. Richard Katz, Japan: The System that Soured—The Rise and Fall of the Japanese
Economic Miracle (Armonk, N.Y.: M. E. Sharpe, 1998).
23. Richard Katz, Japanese Phoenix: The Long Road to Economic Revival (Armonk, N.Y.:
M. E. Sharpe, 2002).
24. As a case in point, Japan has yet to create a new social protection system to provide both
production and protection. Leonard J. Schoppa, Race for the Exits: The Unraveling of
Japan’s System of Social Protection (Ithaca, N.Y.: Cornell University Press, 2006).
25. Steven K. Vogel, Japan Remodeled: How Government and Industry Are Reforming
Japanese Capitalism (Ithaca, N.Y.: Cornell University Press, 2006).
26. “The Sun Also Rises,” The Economist, October 8, 2005, 4.
27. Schoppa, Race for the Exits.
28. “Capitalism with Japanese Characteristics,” The Economist, October 8, 2005, 6–7.
29. See for example Eisuke Sakakibara, Structural Reform in Japan: Breaking the Iron
Triangle (Washington, D.C.: Brookings Institution Press, 2003).
30. Derek Hall, “Japanese Spirit, Western Economics: The Continuing Salience of Economic
Nationalism in Japan,” in Economic Nationalism in a Globalizing World, ed. Eric
Helleiner and Andreas Pickel (Ithaca, N.Y.: Cornell University Press, 2005), 91–138.
31. Pempel, “Decade of Political Torpor.” See also Ethan Scheiner, Democracy Without
Competition in Japan: Opposition Failure in a One-Party Dominant State (New York:
Cambridge University Press, 2006).
32. Vogel, Japan Remodeled, 3–4.
33. Alice H. Amsden, Asia’s New Giant: South Korea and Late Industrialization (Oxford:
Oxford University Press, 1989), 8–11; Meredith Jung-En Woo (Cummings), Race to the
Swift: State and Finance in Korean Industrialization (New York: Columbia University
Press, 1991).
34. Jong-Chan Rhee, The State and Industry in South Korea: The Limits of the Authoritarian
State (London: Routledge, 1994).
35. Amsden, Asia’s New Giant, 11–18.
36. Kang, Crony Capitalism.
37. Koo, State and Society in Contemporary Korea.
53

http://www.economist.com/theworldin/international/display Story.cfm?story_id=8166790&d=2007

38. Sung-Joo Han and Oknim Chung, “South Korea: Economic Management and
Democratization,” in Driven by Growth (see note 13), 210–223.
39. Young Whan Kihl, Transforming Korean Politics: Democracy, Reform, and Culture
(Armonk, N.Y.: M. E. Sharpe, 2005), 149–182.
40. Joseph Wong, Healthy Democracies: Welfare Politics in Taiwan and South Korea
(Ithaca, N.Y.: Cornell University Press, 2004).
41. Thomas B. Gold, State and Society in the Taiwan Miracle (Armonk, N.Y.: M. E. Sharpe,
1986), 123.
42. Li-Min Hsueh, Chen-kuo Hsu, and Dwight H. Perkins, Industrialization and the State:
The Changing Role of the Taiwan Government in the Economy, 1945–1998 (Cambridge:
Harvard University Press, 2001), 4–6.
43. Gold, State and Society in the Taiwan Miracle, 125–126.
44. Shelley Rigger, Politics in Taiwan: Voting for Democracy (New York: Routledge, 1999).
45. Rigger, Politics in Taiwan, 39–54.
46. Shelley Rigger, From Opposition to Power: Taiwan’s Democratic Progressive Party
(Boulder: Lynne Rienner, 2001).
47. For Lee Kuan Yew’s own account of the early years of Singapore, see Lee Kuan Yew,
The Singapore Story: Memoirs of Lee Kuan Yew (Singapore: Prentice Hall, 1998).
48. Lam Peng Er, “Singapore: Rich State, Illiberal Regime,” in Driven by Growth (see note
13), 260–261.
49. Peter J. Katzenstein, Small States in World Markets: Industrial Policy in Europe (Ithaca,
N.Y.: Cornell University Press, 1985).
50. W. G. Huff, Economic Growth of Singapore: Trade and Development in the Twentieth
Century (Cambridge: Cambridge University Press, 1994).
51. Lam, “Singapore,” 265.
52. Garry Rodan, ed., Singapore Changes Guard: Social, Political, and Economic Directions
in the 1990s (New York: St. Martin’s, 1993).
53. Lee, The Singapore Story.
54. Transparency International, “Transparency International Corruption Perceptions Index
2006,” www.transparency.org. Hong Kong ranked 15th, Japan 17th, Taiwan 34th, South
Korea 42nd, Malaysia 44th, Thailand 63rd, China 70th, Laos and Vietnam 111st, the
Philippines 121st, Indonesia 130th, Cambodia 151st, and Myanmar 160th.
55. Alasdair Bowie and Danny Unger, The Politics of Open Economies: Indonesia, Malaysia,
the Philippines, and Thailand (New York: Cambridge University Press, 1997), 14–15.
56. James P. Ongkili, Nation-Building in Malaysia 1946–1974 (Singapore: Oxford University
Press, 1985), 153.
57. Ongkili, Nation-Building in Malaysia 1946–1974, 126–131.
58. Zakaria Haji Ahmad and Sharifah Munirah Alatas, “Malaysia: In an Uncertain Mode,” in
Driven by Growth (see note 13), 180–183.
59. Harold Crouch, Government and Society in Malaysia (Ithaca, N.Y.: Cornell University
Press, 1996).
60. Edmund Terence Gomez and K. S. Jomo, Malaysia’s Political Economy: Politics,
Patronage, and Profits, 2nd ed. (Cambridge: Cambridge University Press, 1999).
61. Gomez and Jomo, Malaysia’s Political Economy, 166–176.
62. Charles F. Keyes, Thailand: Buddhist Kingdom as a Modern Nation-State (Boulder:
Westview Press, 1987), 133–134.
63. Pasuk Phongpaichit and Chris Baker, Thailand: Economy and Politics, 2nd ed. (New
York: Oxford University Press, 2002), 296–317.
64. Bowie and Unger, Politics of Open Economies, 133–134; Phongpaichit and Baker,
Thailand, 341.
54

http://www.transparency.org

65. Suchit Bunbongkarn, “Thailand: Democracy Under Siege,” in Driven by Growth (see
note 13), 161–175.
66. Phongpaichit and Baker, Thailand, 447.
67. Chris Baker, “Pluto-Populism: Thaksin and Popular Politics,” in Thailand Beyond the
Crisis, ed. Peter Warr (New York: RoutledgeCurzon, 2005), 107–137.
68. Harold Crouch, The Army and Politics in Indonesia, rev. ed. (Ithaca, N.Y.: Cornell
University Press, 1978).
69. Jamie Mackie, “Indonesia: Economic Growth and Depoliticization,” in Driven by Growth
(see note 13), 123–141.
70. Bowie and Unger, Politics of Open Economies, 47–48.
71. Radius Prawiro, Indonesia’s Struggle for Economic Development: Pragmatism in Action
(Kuala Lumpur: Oxford University Press, 1998), 101.
72. See Erika Weinthal and Pauline Jones Luong, “Combating the Resource Curse: An
Alternative Solution to Managing Mineral Wealth,” Perspectives on Politics 4, no. 1
(March 2006): 35–53.
73. Bowie and Unger, Politics of Open Economies, 51–52.
74. Andrew Rosser, The Politics of Economic Liberalization in Indonesia: State, Market, and
Power (Richmond, Surrey: Curzon Press, 2002).
75. Bowie and Unger, Politics of Open Economies, 99–100.
76. David Wurfel, Filipino Politics: Development and Decay (Ithaca, N.Y.: Cornell
University Press, 1988), 325–329.
77. Samuel P. Huntington, Political Order in Changing Societies (New Haven: Yale
University Press, 1968).
78. Wurfel, Filipino Politics, 328–329.
79. Lela Garner Noble, “Politics in the Marcos Era,” in Crisis in the Philippines: The Marcos
Era and Beyond, ed. John Bresnan (Princeton: Princeton University Press, 1986), 72–84.
80. Wurfel, Filipino Politics, 329–338.
81. David Joel Steinberg, The Philippines: A Singular and a Plural Place, 2nd ed. (Boulder:
Westview Press, 1990), 147–148.
82. Walden F. Bello, Herbert Docena, Marissa de Guzman, and Mary Lou Malig, The Anti-
Development State: The Political Economy of Permanent Crisis in the Philippines (New
York: Palgrave, 2005), 33.
83. David I. Steinberg, “Burma/Myanmar: Under the Military,” in Driven by Growth (see
note 13), 35–36.
84. Robert H. Taylor, ed., Burma: Political Economy Under Military Rule (New York:
Palgrave, 2000), 229–290.
85. Martin Smith, “The Paradox of Burma: Conflict and Illegality as a Way of Life,” IIAS
Newsletter 42 (Autumn 2006): 20–21.
86. Mary P. Callahan, Making Enemies: War and State Building in Burma (Ithaca, N.Y.:
Cornell University Press, 2003), 2–20.
87. A. Doak Barnett, Cadres, Bureaucracy, and Political Power in Communist China (New
York: Columbia University Press, 1967); Kenneth Lieberthal, Governing China: From
Revolution Through Reform (New York: Norton, 1995).
88. Susan L. Shirk, The Political Logic of Economic Reform in China (Berkeley: University
of California Press, 1993) and How China Opened Its Door: The Political Success of the
PRC’s Foreign Trade and Investment Reforms (Washington, D.C.: Brookings Institute,
1994).
89. Jean C. Oi, Rural China Takes Off: Institutional Foundations of Economic Reform
(Berkeley: University of California Press, 1999).
90. Minxin Pei, From Reform to Revolution: The Demise of Communism in China and the
55

Soviet Union (Cambridge: Harvard University Press, 1994); Barry Naughton, Growing
Out of the Plan: Chinese Economic Reform, 1978–1993 (New York: Cambridge
University Press, 1995); Justin Yifu Lin, Fang Cai, and Zhou Li, The China Miracle:
Development Strategy and Economic Reform (Hong Kong: Chinese University Press,
1996).
91. Bruce J. Dickson, Red Capitalists in China: The Party, Private Entrepreneurs, and
Prospects for Political Change (New York: Cambridge University Press, 2003); Margaret
M. Pearson, China’s New Business Elite: The Political Consequences of Economic
Reform (Berkeley: University of California Press, 1997).
92. Minxin Pei, China’s Trapped Transition: The Limits of Developmental Autocracy
(Cambridge: Harvard University Press, 2006).
93. Mary Elizabeth Gallagher, Contagious Capitalism: Globalization and the Politics of
Labor in China (Princeton: Princeton University Press, 2005), 10.
94. Bruce Gilley, China’s Democratic Future: How It Will Happen and Where It Will Lead
(New York: Columbia University Press, 2004).
95. Bruce J. Dickson, Democratization in China and Taiwan: The Adaptability of Leninist
Parties (New York: Oxford University Press, 1997).
96. Thaveeporn Vasavakul, “Vietnam; Sectors, Classes, and the Transformation of a Leninist
State,” in Driven by Growth (see note 13), 60–68.
97. Adam Fforde and Stefan de Vylder, From Plan to Market: The Economic Transition in
Vietnam (Boulder: Westview Press, 1996).
98. Barry Naughton, “Distinctive Features of Economic Reform in China and Vietnam,” in
Reforming Asian Socialism, ed. John McMillan and Barry Naughton (Ann Arbor:
University of Michigan Press, 1996), 273–296.
99. Dick K. Nanto, “North Korea’s Economic Crisis, Reforms, and Policy Implications,” in
North Korea: The Politics of Regime Survival, ed. Young Whan Kihl and Hong Nack
Kim (Armonk, N.Y.: M. E. Sharpe, 2006), 118–142.
100. Young Whan Kihl, “Staying Power of the Socialist ‘Hermit Kingdom,’” in North Korea:
The Politics of Regime Survival (see note 99), 3–33.
101. Caroline Hughes, The Political Economy of Cambodia’s Transition, 1991–2001
(London: RoutledgeCurzon, 2003), 1–3.
102. Hughes, The Political Economy, 3–17 and 214–221.
56

T
CHAPTER 3
The Chinese World Order

his chapter examines the traditional East Asian international political economy (IPE). It
addresses two questions. First, what was the state of East Asian IPE before the European
arrival in the early sixteenth century? I answer this question by first focusing on the regional
structure of political economy. Discussing the Chinese world order in the context of world
orders, I show that East Asia had a system of political economy distinct from the modern
Westphalian international system. The Westphalian system is composed of sovereign states
equal legally if not in power. By contrast, the Chinese world order was constructed as a
hierarchical, moral, international arrangement, which was in reality incomplete, sometimes in
name only, often challenged, and involving frequent use of violence. An extensive regional
trade network existed in East Asia, responding to both political and market forces. East Asian
nations did not evolve in isolation. The political economy approach helps us understand a
regional economic impact on politics, a process we are only beginning to comprehend.
Next, I compare the political economy of key East Asian countries, focusing on the
origins and evolution of their political and economic institutions, thus connecting to the
previous chapter. The institutions created in these countries reflected their goals and
circumstances, which partly explained the variations among them. Power was a principal
driving force for East Asian political economy. Interplay between the ideas of power and
wealth were particularly important in guiding choices. Locations and timing also mattered.
The second question addressed in the chapter is why Western Europe rather than East
Asia achieved the Industrial Revolution and subsequently surged ahead of the rest of the
world. I first compare East Asia and Western Europe prior to the latter’s rise. East Asia
shared much in common with Western Europe in agriculture, commerce, level of wealth, and
population control as late as the mid-eighteenth century. The next section explains that
Western Europe achieved an industrial breakthrough largely because of a highly competitive
interstate system that encouraged innovation and its forcible possession of rich resources in
the Americas. Power based on the modern state and the market economy allowed the West to
dominate the world and triggered a process of adaptation and reform in East Asia and other
developing regions.
WORLD ORDERS
International Order
The notion of order helps us understand how states in a region are organized. Order in
international relations is often viewed as a normative goal for those who seek stability in
relations between nations. Order is preferable to disorder, which means chaos, violence, and
insecurity. By international order, I mean a predictable international arrangement in which
57

states act in accordance with the purposes embedded in the system. Although international
order is often associated with stability, I stress predictability in my definition. What makes
order different from disorder is that members in the system are aware of the norms and rules
and expect rewards and sanctions from certain behavior. In other words, order is associated
with a set of institutions, although these institutions may not necessarily lead to peace. It is
important to keep this caveat in mind when we discuss the East Asian international system in
the context of the Chinese world order. No international order is complete, unchallenged, or
necessarily just for all. Rome in the ancient times and Pax Americana, an international
political authority created and maintained by the United States, in the contemporary world are
cases in point.
International order is a systemic variable. It includes not only distribution of power,
which is the structure of the international order, but also purposes, which are crucial elements
of the normative basis of the order.1 Although order is an actual state of affairs, it is not
divorced from goals embedded in the order. Hedley Bull defined order in social life as “not
any pattern or regularity in the relations of human individuals or groups, but a pattern that
leads to a particular result, an arrangement of social life such that it promotes certain goals or
values.”2 International order is therefore broader than international system or structure.3 Two
similar situations of power balance between states may create different international orders if
their dominant purposes are different. Unless we know the accepted purposes embedded in
the international order, the balance of power cannot fully indicate how states will act.
The argument above that power alone does not explain the exact nature of an international
order does not negate its centrality in international affairs. Violence or threat of violence
occupies a central place in creating and reproducing institutions. Shifting power balance
explains partly why the international orders by the Chinese, Westerners, and Japanese in East
Asia were created, expanded, maintained, ignored, challenged, or destroyed.
The Chinese World Order
For two thousand years until the mid-nineteenth century, the East Asian international system
could be best described as the Chinese world order.4 Labels are often loaded ideologically
and emotionally. Using the term Chinese world order does not imply that China was always
at the center of East Asian international relations or should be. Rather, the term is a useful
way to summarize the nature of the ancient East Asian international system in contrast to the
contemporary international system. The term has more substance than alternatives such as
“the East Asian international relations of the past two millenniums.” Equally important, the
Chinese world order draws attention to an analytical framework based on both power and
legitimacy, consistent with the theory of international order, for studying traditional East
Asian international relations in contrast to later projects to create order in East Asia, namely
Western and Japanese imperialism, and regionalism.
China was not at the center of the world. Even if we view the world narrowly as the
Eurasian continent, the steppe peoples were the true world players who treated East Asia as
an important but not the only sedentary region to trade with or to raid; there were rich and
developed states in South Asia, West Asia, and Europe.5 China was not always at the center
of East Asian international relations either. Frequent and often successful incursions of non-
Chinese into what is called China today created a dynamic process in which the definition of
who is Chinese has been highly contingent historically. Although early China historians
tended to emphasize the theme of Sinicization, a process for non-Chinese to assimilate into
Chinese culture, more recent studies often point at hybrid origins of the Chinese civilization.6
At the same time, however, we define who Chinese really were at a given moment; China
was at the center of East Asia more consistently than any other powers in the past
millenniums. Moreover, the Chinese articulated a universal system and sought to practice it
58

in the political and economic arenas. Once the Chinese system was formulated, non-Chinese
rulers often emulated it to create their own “Chinese” world orders. Although the term
Middle Kingdom might glorify China unnecessarily, the country was indeed located
geographically and strategically in one of the most developed regions of the time.
Furthermore, China accounted for 26.1 percent of world gross domestic product (GDP) in
AD 1 and 32.9 percent in 1820. Only India was in the same league.7
The Chinese world order did not overlap neatly with what we call East Asia today. It was
composed of a complex set of concentric circles centered on China. The Chinese culture zone
included China, Korea, Japan, Annam (Vietnam), and Ryukyu (Okinawa), which shared the
Chinese writing system, the Confucian ideology, and certain lifestyles such as use of
chopsticks. Emperors in China conducted military campaigns against Korea, Vietnam, and
Japan and at times had direct administrative control over Vietnam (111 BC–AD 938, 1407–
1428) and Korea (108 BC–AD 313, 668–676). Vietnam regained independence in 938 after a
millennium of Chinese rule. The country fought hard to maintain its independence while
accepting a tributary state status for much of its history until the nineteenth century. After
Koguryo ended the Chinese administration in the Korean peninsula in the early fourth
century, the Korean states were active participants in East Asian international relations. Silla,
which unified the Korean peninsula in 671, was modeled after the Chinese Tang Dynasty
political system. For much of the following centuries, Korea remained largely an independent
state but also a tributary to the Chinese court.
Japan was in a unique position in the Chinese world order. Japan borrowed heavily from
China but was never ruled by China. In fact, Japan challenged China politically. Japan had an
emperor, a title forbidden in the hierarchical Chinese world order. Geography facilitated
Japan’s independence from China. The main Japanese islands are separate from Korea by
more than 100 miles and from China by about 450 miles. Thus, Japan was close enough to
borrow culturally from the continental civilization but too distant to be invaded easily.
Japanese shogun Ashikaga Yoshimitsu accepted the tributary state status to engage in
trade with China. Japan sent eleven tribute missions to China from 1433 to 1549 but stopped
the practice after the mid-sixteenth century. Japan did not resume official relations with
China after the Qing Dynasty was established. Tokugawa Japan engaged in active foreign
relations in Asia and sought to structure a new East Asian international order around Japan
based on the divinity of the Japanese emperor and the notion that Japan was on par with or
superior to China given its high virtue and China’s conquests by barbarians.8 In fact, Japan’s
General Hideyoshi tried to conquer Korea and China in the late sixteenth century, but a joint
force of Ming China and Korea stopped the Japanese invasion.
The Chinese world order went beyond the Chinese culture zone. It included an Inner
Asian Zone of nomadic peoples culturally different from the Chinese. More than any other
external players, continuous interaction with steppe peoples profoundly shaped Chinese
history in terms of culture, territoriality, and ethnic stock. The Chinese emperors were
sometimes forced to take an equal or even inferior position vis-à-vis steppe peoples during
periods of military weakness. Various nomadic peoples became rulers in China although they
largely adopted the Chinese way to rule the settled Chinese territories, sometimes out of
admiration and sometimes out of political pragmatism. Nomadic empires typically adopted
“dual administration” to rule the nomads and sedentary states. In particular, the Mongols
conquered China and established the Yuan Dynasty (1206–1368) and the Manchus founded
the Qing Dynasty (1644–1911).
Extending further out still, the Chinese world order included Southeast Asian states that
sent tributes to China. In mainland Southeast Asia, Chinese troops destroyed Champa’s (now
South Vietnam) political center at Hue in 446. The Mongols tried unsuccessfully to conquer
Champa in the 1280s. The Qing army conducted inconclusive military campaigns against
59

Burma in the 1760s. By contrast, Chinese power rarely reached maritime Southeast Asia. As
exceptions, Chinese military power was projected in the region in the Yuan period (1206–
1368) when Kubilai Khan waged unsuccessful military campaigns against Java in 1293, and
Ming Admiral Zheng He’s seven expeditions in the early fifteenth century (1405–1433)
increased Chinese influence in the region and brought more states into the Chinese tributary
system.9
The Chinese saw their world order in universal terms, though they themselves did not use
the term world order. From as early as two millenniums ago, they used the word tianxia or
“all under heaven” to characterize a zone of high culture, and they saw what was beyond as
“barbarian.” At the core of the Chinese world order was a strong sense of universal kinship.
The emperor, the Son of Heaven, possessed universal authority on a religious and cosmic
basis. Such universal Chinese claims were similar to other great civilizations of the ancient
times. What made the Chinese worldview unique was the association of Confucianism with
high civilization after the Han Dynasty (206 BC–AD 220).10 In the Chinese mind, Chinese
superiority was proven with a powerful, enduring empire.
The Chinese world order was hierarchical. The emperor was at the apex of the universe.
Smaller countries paid tributes to the rulers of China, known as the Middle Kingdom. This
view was consistent with status-conscious Chinese society, in which a desirable sociopolitical
order was based on obedience of son to father, wife to husband, and official to emperor. By
contrast, the contemporary world order based on the Westphalian principles considers all
countries equal legally despite inequities in power.
The Chinese world order was also supposed to be moral, explicitly based on Confucian
criteria of moral leaders and moral behavior. The Confucian ideal stipulates that a leader
should be benevolent and exemplary in moral conduct. Based on correct ceremonies and
principles, virtuous conduct by rulers would influence subjects through attraction and awe.
Order is maintained if the ruler remains benevolent and subordinates play their roles
accordingly. With a virtuous emperor, non-Chinese would come from all corners of the world
to pay their respects (weide). Thus, Chinese emperors treated proper ceremonies as central to
relations with other peoples and considered studies of Chinese classics to be an indication of
degree of civilization.
A gap existed between myth and reality, however. It was not always moral examples
based on Confucianism that guided China’s foreign policy. There was a strong school of
militant thinking based on Legalism that emphasized discipline and punishment.11 The
Chinese emperors mainly used military force rather than moral persuasion to expand the
Chinese empire. In fact, war and coercion shaped the formation of state in ancient China,
similar to early modern Europe.12 Chinese territorial expansion often provoked hostile
reactions. The Xiongnu empire, the first serious threat from steppe peoples to the Chinese
empire, was formed as the first known Inner Asian empire in reaction to Qin Emperor
Shihuangdi’s decision to send a large army to conquer the territory in the great bend of the
Yellow River, which had been the best grazing land for the Xiongnu.13
At the same time, Confucianism still mattered in that it limited the Chinese expansion.
Confucianist criticism of the expansionist policy of Han Emperor Wudi (140–87 BC) played
an important role in reversing that policy after his death. Like any political ideals such as
democracy and human rights, Confucianist ideals for virtuous leaders and social stability
mattered because they helped frame policy choices for a government and because choices
made out of political necessities inconsistent with the ideals were recognized as such by
proponents of those ideals, who sought to return to “the way” when circumstances permitted.
The Chinese world order was operationalized in the tribute system, which was the sum of
the ceremonies that guided relations with non-Chinese peoples. In the tribute system, the
emperor provided an official title to a non-Chinese ruler and an official seal for
60

communications. Tributary states had to use the Chinese reign titles as the calendar to date
correspondence, present a symbolic tribute (gong) of local products, and perform the kowtow
(prostrating and touching the head on the ground) in front of the emperor. In return, the
emperor offered imperial gifts and allowed the tribute missions to exchange goods in the
capital and at the border.
Chinese rulers began to record all foreign missions as tribute missions in the Later Han
Dynasty (25–220), viewing tribute relations as the norm in their dealings with non-Chinese.14
The Ming (1368–1644) and the Qing dynasties (1644–1911) institutionalized the tribute
system, with detailed regulations for all parties involved. The Qing court decreed as of 1818
that Korea could send tributes four times a year, Ryukyu once in two years, Annam
(Vietnam) two tributes combined into one for every four years, Laos once every ten years,
Siam (Thailand) once every three years, Sulu (now southern part of the Philippines) once
every five years, and Burma once every ten years.15
Mutual deception often existed in tribute relations. What the Chinese recorded as tributes
was often not intended as such. Chinese officials did so to maintain the appearance of
Chinese superiority and to avoid the emperor’s wrath. Symbolic submission was often the
chief objective of the Chinese court in any case. Sometimes, foreign rulers did not know that
their missions to China were recorded as tributes in Chinese archives. Other times, they
knowingly played along to engage in lucrative trade with China.16 Inner Asia, which was
culturally distinct from China, simply did not accept China’s supremacy, but that did not
prevent principalities and merchants from playing the game just to preserve court-subsidized
goods exchanges; the leadership of a tribute mission could be purchased for a price.17
While China dominated in East Asia, smaller tribute systems evolved around other states.
Ryukyu paid tributes to both the Chinese emperor and Satsuma daimyo (feudal lord) of
Japan. After invading Ryukyu in 1609, Satsuma effectively controlled the kingdom while
concealing the fact from Chinese envoys in order to maintain lucrative tribute trade with
China.18 Laos was a tributary state to Vietnam. Korea maintained its own version of tribute
system when dealing with Japanese and Ryukyuans who did not represent their
governments.19
POLITICAL ECONOMY OF EAST ASIAN TRADE
The Chinese tribute system was essentially a managed trade system. As such, the system
reflected China’s political calculations. Tributes from “all corners of the earth” confirmed the
emperor’s central place in the world. That was why the Chinese court was often willing to
offer expensive gifts for symbolic submission. Chinese imperial gifts for the tributary
Hsiung-nu increased from 6,000 catties (a traditional Chinese measurement of weight; 1 catty
= 244 grams) of silk floss and 8,000 pieces of silk fabric in 51 BC to 30,000 catties and
30,000 pieces in 1 BC.20 Politics dominated in Chinese official thinking because the Chinese
government was convinced that domestic order should be based on agriculture. Confucianists
had little trust in merchants. Equally important, the Chinese government did not encourage
trade with steppe peoples in part because they did not want frontier people to gravitate toward
“the barbarians,” a process that might destabilize the border area and even the core areas of
the country. By contrast, foreign dynasties, particularly the Mongol empire, valued trade as
an important source of revenues and protected traveling caravans.21
Considering trade to be a favor to foreigners, the Chinese government often intended to
use permission for tribute missions as a control mechanism over non-Chinese peoples by
making them dependent on China, which was of course difficult to accomplish in practice
then as now. Conversely, the Han Dynasty rulers often bribed nomadic peoples with luxury
61

goods to maintain frontier stability because it was far more costly, dangerous, and often futile
to seek out highly mobile enemies deep in the steppe. Trade was thus seen as an unpleasant
but necessary cost for security, which would become a dominant frontier strategy for native
Chinese dynasties.22
China could see itself running a tributary system not only because of its cultural sense of
self-importance. Chinese agriculture and manufacturing were highly developed. Grains such
as millet and rice and iron tools were desired by the steppe peoples. There was a major silk
textile industry in Han China, particularly in what is now Shandong Province and Sichuan
Province. Lacquer work and bronze mirrors were also important for export in the Han
Dynasty. China remained a major economic center until the mid-nineteenth century. The
Chinese court generally considered China to be self-sufficient and trade with non-Chinese to
be a favor. In a famous letter to King George III of Great Britain dated October 3, 1793,
Emperor Qianlong announced, “We have never valued ingenious articles nor do we have the
slightest need of your country’s manufactures.”23
At the same time, economic interests mattered to China. The Chinese government was not
always restrictive on the merchant class. Ying-shih Yu termed the commercial policy of the
Later Han Dynasty (25–220) “laissez-faire.”24 The Chinese government was interested in
trading for horses and products such as jade from nomads. As another example, China had a
sustained high demand for foreign silver and was the world’s largest silver importer from
Japan and Spanish Mexico for over a century (1550–1650). Also, “foreign” dynasties in
China were less controlling regarding trade. Given their cultural roots and familiarity with the
steppe, these dynasties were more successful in keeping steppe peoples divided and weak.
The importance of trade for China was reflected in widespread legal or contraband trade
by Chinese merchants. Chinese history recorded as early as the third century AD that China
imported a variety of valuable forest products from the Malay kingdoms (Java, Sumatra, the
Malay Peninsula, and Borneo).25 Chinese traders traveled to Southeast Asia in the Song and
Yuan dynasties for various local products. Ming/Qing China periodically forbade private
overseas trade, which led to a problem of “pirates,” who were really armed traders with bases
overseas. The tighter the government control on private trade, the more serious the piracy
problem was. When the Ming government lifted the sea ban in 1567, 50 junks were licensed
to travel to Southeast Asia each year. That number increased to 117 by 1597.26
The flag followed the trade. The activities of Chinese merchants along the border led to
China’s imperial expansion. In the Han Dynasty, Chinese merchants from Sichuan often
illegally entered the territories of non-Chinese peoples, and their trading activities drew in
Chinese political and military expansion, resulting in the creation of several new Chinese
provinces.27
Politics played a role in the calculations of non-Chinese nations as well. Nomadic peoples
needed to trade with sedentary states like China for grain, iron tools, and other commodities.
But starting from the Xiongnu, nomadic empires often needed to exhort tributes or subsidies
from the Chinese court to ensure their political power. They did this by sharing luxury goods
such as silk with political elites whose political loyalty was fluid in their imperial
confederacies and then demanding open border markets to allow commoners to benefit in
trade.28 Steppe empires arose when China was unified because they depended on subsidies
and tributes from the country. A close economic interaction with the Chinese empire put a
steppe leader in an advantageous position vis-à-vis his competitors. In the case of Korea,
Hae-jong Chun suggested that Korea, the model tributary state, received less than it gave in
its regular tributary relationship with China; nevertheless, Korean rulers found it politically
advantageous to maintain a tribute relationship with China to boost their legitimacy.29
At the same time, economic considerations mattered for tribute states. Many states sent
tribute missions for commercial rather than for political reasons. Some foreign merchants
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were allowed to accompany tributary missions and to sell a certain quantity of goods in the
Chinese capital. Because of profits to be made, some foreign merchants would pretend to be
tribute missions to carry out trade. As the largest economy in the region, China was an
attractive market, and the Chinese court had to regulate the frequency of such missions. The
market principle was at work here, with the amount and composition of tributes determined
by supply and demand and price differential within and outside China. In fact, Takashi
Hamashita maintained that the Chinese tribute system ended not just because of Western
pressure but because it became less profitable for tributary states in the nineteenth century as
a result of Qing currency inflation, a situation that encouraged private trade at the expense of
official relationships.30 With currency inflation in China, the Chinese currency became
cheaper, which meant that foreigners would receive less for their goods when the official
price remained the same. Foreigners then naturally had incentives to engage in often “illegal”
private trade based on the true market value of their goods.
East Asian regional trade was broader than China-centered tribute trade. East Asian trade
patterns reflected complex economic conditions and domestic order of political economy in
different countries. For example, the Ryukyu sent missions to Southeast Asia to purchase
pepper and sappanwood to present to Beijing as part of its tribute trade.31 Tokugawa Japan,
which did not have official relations with China, traded with Chinese merchants who came to
Nagasaki.
There was long-distance trade involving many states. As shown in Map 3.1, the Silk Road
was one of the most important trade networks in the world at the time, linking markets in East
Asia, Central Asia, the Middle East, and Europe, starting around the late second century
BC.32 The Silk Road started in the city of Xian in China, to Samarkand and Bukhara in
Central Asia, around the Caspian Sea to Turkey, and finally to Europe. There were also other
routes through Mongolia, Kazakhstan, Russia, and to Europe. Other routes and branches
reached Afghanistan, India, Iran, and the Middle East. Because silk was a major product,
there was a good reason that people called the East-West trade route the Silk Road. But other
products were also traded, such as porcelain, tea, and lacquer ware from East Asia; furs from
Siberia; horses from Central Asia; dyes, glassware, and incense from the Middle East;
pepper, cotton, and sandalwood from India; and ambers, silver, and gold from Europe. The
Silk Road also allowed new technologies, ideas, and religions to spread between East and
West. The wealth generated from the access to the Silk Road helped shape international
politics of the time. The Silk Road decayed when the Ming court decided to close the Chinese
border in 1426.
MAP 3.1
Eurasia and the Silk Road, 100 BC
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An equally important Spice Route operated for two millenniums, originating from the
Spice Islands (now part of Indonesia) in Southeast Asia and linking East Asia, India, the
Middle East, and Europe. The trade in spices that were light in weight but high in value was
highly lucrative, which provided an important motivation for Columbus to cross the Atlantic
Ocean seeking a new route to the source of spices. When the over-land Silk Road declined,
the ocean-going ships along the Spice Route also carried Chinese silk and porcelain to the
extent that the Spice Route came to be known as the Maritime Silk Road.33
Japanese traders and pirates traveled throughout Northeast and Southeast Asia and set up
trade outposts in the Philippines, Vietnam, and Thailand. When the Ming court lifted the ban
on trade with Nanyang (the Chinese expression for Southeast Asia) but not with Japan in
1567, Chinese and Japanese traders used Southeast Asian ports as entrepôts, with Japanese
exporting silver for Chinese silk and Southeast Asian sugar, spices, and deer hides. In the
period of 1604–1635, 355 Japanese ships went to Southeast Asia.34 Even though the
Tokugawa government forbade Japanese from traveling overseas in 1635, that ban did not
stop Japanese trade with the outside world. It is commonly assumed that the Tokugawa
government “closed the country” (sakoku) after 1640. The Dutch were the only Europeans
allowed to trade in a small island in Nagasaki. However, from an East Asian regional
perspective, Japan maintained significant trade with Korea and China, and its trade volume
did not decrease significantly.35 Thus, Hamashita Takeshi called the Tokugawa policy
“selective opening.”36 In fact, some Japanese scholars have pointed out that the word sakoku
did not appear until 1801 when a Japanese scholar coined the word when translating a
German book.37
Southeast Asians always depended on commerce. The region is accessible to waterways,
and most political centers are right on the water. Native traders as well as those from India,
the Arab world, China, and Japan were active players before the arrival of Europeans.
Southeast Asia, which entered the age of commerce in 1450, was part of a global trade
expansion. Chinese imported most pepper and spices from Southeast Asia until 1500. In the
next century, exports of pepper and spices to Europe and the Middle East grew rapidly,
amounting to half of the region’s exports by 1600. In fact, the export of spices was one
reason Westerners came to East Asia in the first place.38 The Westerners did not create but
participated in the formation of the modern Asian market that had already been regionally
linked when they arrived in the region.39 East Asian trade networks developed because of
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technology in production, transportation, and financial institutions.
Trade links in ancient East Asia also had an impact on exchange rates and finance, which
would affect domestic political economy in a way not well understood by the contemporaries.
China developed a paper currency system as early as the eleventh century. The Ming
government’s financing of military expeditions and the move of the capital to Beijing from
the south with paper money led to hyperinflation and the collapse of the paper money system
by the mid-fifteenth century. In response, Chinese merchants turned to silver as their
preferred currency, followed first by local governments and then the central government.
China now had a silver standard, which meant that merchants used silver as the medium of
transaction and governments accepted only silver for taxes and for tributes. As the world’s
largest economy at the time, China’s turn to silver shaped the global economy. China’s
tremendous demand for silver was met by Spanish America and Japan, the world’s two
largest silver producers at the time. Spanish America produced 150,000 tons of silver
between 1500 and 1800, accounting for about 80 percent of global production. Japan was the
major supplier of silver to China in the late sixteenth and early seventeenth century, exporting
about 200 tons a year mainly through European and Chinese middlemen. Spaniards and
Japanese exported silver to China in exchange for gold for high profit. China’s gold-to-silver
price was 1:6 when Spanish silver arrived, compared to 1:11 or 1:12 in Europe. It took one
century to level the relative price of silver in China with the rest of the world. But even after
arbitrage profits diminished, China continued to attract silver inflows because the country had
more buyers at the same price. China’s silverization, with imports of silver, essentially
created a silver zone in East Asia because the Chinese court demanded silver from tribute
states as the medium of exchange.40 This inflow of silver led to inflation of prices, which put
a tremendous financial strain on local governments. Corruption became worse when local
officials sought to compensate losses through levies.
COMPARATIVE POLITICAL ECONOMY
Comparative political economy studies state formation and the interplay of the state and the
market. The conception and practice of the nation state emerged in Europe and became the
norm for contemporary international relations. Thus, whatever political form a non-Western
nation possessed prior to its entry into the West-dominated international system came to be
called a state even if it did not meet all the essential requirements of a modern state. The
universal, hierarchical Chinese world order would disqualify East Asian countries as modern
states, which are supposed to be sovereign and equal in a legal sense. At the same time, East
Asian political entities met the key domestic requirement for a nation state, namely monopoly
of violence over a population within a territory. Scholars of the European state formation
emphasized war making and domestic political authority in defining the modern state.41 East
Asia nations had highly developed political and social institutions to ensure what they
considered to be valuable goals, namely stability and moral life. Most Northeast Asian and
mainland Southeast Asian political entities that exist today were formed centuries or
millenniums ago. The way the state interacted with the market varied from country to country
in East Asia. Although I spent considerable time earlier discussing the interaction between
nomadic empires and China, I will not discuss nomadic political systems in this comparative
political economy section.42
China
The first state in East Asia emerged in northern China in the Shang Dynasty (1450–1122
BC), although some scholars date it as early as the Xia Dynasty (2000–1450 BC). The
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Chinese civilization took shape in the Xia, Shang, and Zhou (1122–221 BC) dynasties. The
Chinese nation expanded in all directions, conquering and absorbing other peoples in the
process. The main Chinese traditions such as Confucianism, Legalism, and Taoism as well as
the notion of the Middle Kingdom were fully articulated in the Zhou period. Confucianism
refers to a system of teachings by Confucius (551–479 BC) and his followers that emphasize
the practice and cultivation of virtues of benevolence, righteousness, filial piety, and loyalty
as the basis of personal ethic and politics. Legalism refers to a system of teachings that
originated around the same time as Confucianism that emphasize rewards and punishment for
an orderly society. Taoism refers to a system of teachings by Laozi (believed to be
Confucius’s elder) that emphasize inactivity, search for immortality, and retreat from the
world.
A centralized Chinese empire was established in 221 BC. Judging by duration, China had
the most successful empire in human history, lasting for two millennia (from 221 BC to
1911) despite periodic breakdowns. What stands out about China’s political history is that the
Chinese empire endured while the Roman Empire (27 BC–AD 312) and the Byzantine
Empire (330–1453) disintegrated. The Chinese empire, established in the Qin Dynasty in 221
BC and degenerating into warring entities after AD 311, was reconstituted with the
establishment of the Sui Dynasty in 589. While China and Europe evolved similarly for a
thousand years, China began to diverge from Europe with the establishment of the Song
Dynasty in 960. While semifeudal landed aristocracies had considerable strength, the central
government prevailed eventually after the Ming Dynasty (1368–1643) was established. The
Chinese empire used civil service examinations to select officials, a practice firmly
established in the Song Dynasty. By contrast, feudal lords in Europe controlled their fiefdoms
in return for military service, and the Roman Catholic Church and cities were centers of
power that challenged the monarch for resources and influence.43
The Chinese political tradition that emphasized autocratic rule is a well-known story. The
Chinese emperor was the absolute, omnipotent ruler as well as a religious leader. The only
check on the emperor was the Confucian obligation to be a benevolent leader and the danger
that an emperor’s misbehavior might lead to loss of the Mandate of Heaven, that is, the
collapse of the dynasty.
At the same time, the Chinese state was weak, as measured by its limited ability to raise
revenues for state projects.44 China’s principal source of government revenue was land tax.
The Ming government (1368–1643) collected around 10 percent of the nation’s total grain
output, and the Qing government (1644–1911) collected roughly 5–6 percent of the total in
the mid-eighteenth century. Other sources of revenues, namely salt tax and native customs,
accounted for one quarter of the land tax prior to the mid-nineteenth century. In fact, the
economic power of the central government declined during the six centuries of the Ming and
Qing dynasties.45
Chinese rulers chose to limit revenue collections from peasants, motivated by their
overarching concern to maintain political control over a vast empire and ensure social
stability. With an agrarian empire, the emperor’s major concern was to prevent emergence of
power centers from challenging central authority and to maintain social order. Facing no
corporate challengers, the Chinese court learned that the secret of a stable political rule lies in
a low tax burden on peasants. The court was prudent fiscally. During the Qianlong reign
(1736–1795), government revenues amounted to 43–44 million taels (Chinese ounce = 1.208
English ounces of pure silver) a year, mostly from land tax, while its annual expenditure was
around 35 million taels.46 By 1500, the Chinese state promoted agricultural production as the
foundation of the state economy, complemented by commerce and crafts production. The
Chinese state saw the market as useful but distrusted concentration of wealth through
commerce, although in practice the government was often more sophisticated than official
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rhetoric suggested.47 Moreover, the court was concerned that people might leave the land to
engage in commerce, a situation considered detrimental to social stability.
By contrast, European states emerged after centuries of fighting by the monarchy to
mobilize resources to expand their political power over nobility and towns and to compete
with other states. As corporate entities, the nobility, towns, and the church were
accommodated politically in measures such as representation in exchange for tax and an
impartial legal system. Thus, a successful European state could raise revenues. Beginning
around 1500, the European monarch, who was constantly at war and broke financially,
actively sought tax revenues from all sources, including foreign commerce.
The Chinese institutions created to advance the objectives of maintaining social order and
preventing domestic challengers came with costs. The central government’s inability to raise
revenues as the economy expanded was one reason for its difficulty in achieving
modernization compared with Japan.48 After the An Lushan Rebellion in the Tang Dynasty,
the Chinese rulers carefully avoided creating strong military commanders and often diverted
revenues from defense to other purposes, which led to military weakness vis-à-vis nomads.
Chinese military weakness became a serious problem in the nineteenth century when the
Chinese government needed resources to fend off pressure, first from Western nations and
then from Japan.
The high premium China placed on stability also prevented institutional and technological
innovations. In fact, the Ming financial administration was inferior to the previous dynasties,
which had learned to formulate tax policy based on an expanding economy. Ming practice
retarded the growth of public services and government-owned industries and led to
insufficient investment in infrastructure such as transportation. The Manchu conquerors
essentially adopted the Ming financial administration.49 By contrast, security necessities
forced European monarchs to adopt costly new military technologies, which led to the urgent
need to raise revenues, which in turn led to creation of new institutions such as standing
armies, tax-collecting bureaucracies, and mints to raise money and to fight wars—two
purposes at the core of the modern nation states.50
The fact that China struggled to achieve a modern economy led to arguments that the
state in the Qing period blocked China’s economic advance with ineffective management,
exploitation of the private sector, and structural corruption. Recent research shows, however,
that the Qing government was rational in that its administrative institutions and practices
were consistent with what it wanted to achieve: social stability, security, and control of its
vast empire by emphasizing the empire’s agricultural base, and economic stability. The
government cooperated with the private sector, promoted agricultural development by
encouraging farms and experimenting with new seeds, and combined ritual, custom, and law
to promote family-based agriculture and craft production to ensure self-sufficiency and
stability.51 The main problem for China, however, was that the government’s limited financial
resources did not allow it to promote new technologies or capital formation. As Dwight
Perkins noted, “China’s retarded industrialization was more a result of sins of omission than
of commission.”52
Moreover, a fiscally sound Chinese government did not need overseas trade expansion as
a source of income. Ming rulers initially forbade foreign trade. Although private traders
remained active, China’s overseas trade could have developed much further but for
government restrictions. Without government support, Chinese private traders were at a
distinct disadvantage against Western armed traders fully supported by their home
governments. In fact, both Ming and Qing courts saw armed Chinese traders as a threat to
their authority and sought to destroy them.53
Korea
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Korean nationalists believe that Dangun, the god-king, founded the Korean nation in 2333
BC, but there was no written history at the time. The Koreans came under strong Chinese
cultural influence in the third century BC. Chinese emigrants founded the state of Choson in
Korea in the third century BC. The Chinese Han Dynasty troops conquered Korea by 109 BC
and set up an administrative structure, part of which lasted until AD 313. The kingdom of
Koguryo rose in the early fourth century and destroyed the Chinese commanderies in
northwest Korea. In 313–668, Koguryo, the state of Paekche, and the state of Silla
participated actively in the East Asian international system. The Tang army defeated
Koguryo in 668, which allowed Silla to unite Korea in 671 for the first time in Korean
history.
After the Silla unification, Korea modeled its political system after China. Silla sent
thousands of students to China to learn Confucianism, Buddhism, bureaucratic organization,
and science. Korea followed Confucianist principles faithfully and accepted the basic notion
of the Chinese world order. Still, Koreans saw themselves as occupying a high place in the
civilized world and came to view their country as the last fortress of civilization when
“barbarian” Manchus conquered China and established the Qing Dynasty.54
Underneath the appearance of similarities, Korea’s political system differed from China’s
in that the Korean government’s main purpose was to protect the interests of the yangban, the
aristocracy who inherited status and land. While Korea had a civil service examination
system to select bureaucrats, mainly aristocrats could apply.55 The yangban also rigidly
maintained the purity of their bloodlines. The Korean society was divided into three classes:
commoners, serfs or slaves, and the yangban class. During the Yi Dynasty (1392–1910), the
size of the slave class declined and most of the land in the country was privately owned and
could be bought and sold. The disappearance of slaves resulted in part from the country’s
growing population density: Labor abundance made slaves less necessary. Korea experienced
centuries of relative peace during the Yi Dynasty, which led to population growth and an
extremely limited per capita land endowment (0.12 hectares of arable land per capita in
1918). Similar to China and Japan, Korean cities emerged as political centers where elites and
their servants resided. The growth of cities in Korea, though not as large as in China and
Japan, led to more developed commerce in the eighteenth and the nineteenth centuries.56
Unlike more self-reliant villagers, urban residents require supplies of food and goods from
other regions.
Similar to China but different from Japan, the Korean state was financially weak, taking
in about the same percentage (2 percent) of GDP for government use as China. Much of the
wealth was in the hands of the ruling yangban class.57 The Korean king and his aristocrats
needed each other to maintain a stable hierarchical political and social structure, but the
landlords who had the power to tax peasants provided an insufficient share of revenues to the
court.58 This of course meant limited government capacity to deal with external challenges.
Koreans participated culturally in the Chinese world order. Economically, Korea
participated in Northeast Asian trade networks with China, Japan, and the nomadic peoples to
the north. During the Silla Dynasty, Koreans founded trading settlements in China’s
Shandong and Jiangsu provinces. They also traded with Arab merchants who came to the
region.59
Japan
The state of Yamato unified Japan in the second half of the third century. After the Taika
Reform in 645, the Japanese rulers made systemwide efforts to introduce the Chinese
political and legal system, ideology, and language. Japan sent study emissaries to China. This
process lasted for almost two centuries. Japanese called this period their country’s “first
opening.” However, the Japanese political system diverged from the Chinese model. By the
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twelfth century, Japan had developed a feudalist system, which was drastically different from
China but similar to the feudalist experiences in Western Europe. Unlike China where
Confucian scholars were eminent, the warrior class (samurai) was dominant in Japan.
Diverging from European feudalism, Japan achieved political unification by the end of the
sixteenth century and formed a centralized feudal political system.60
In the Tokugawa shogunate (1603–1868), the Japanese emperor was a figure-head while
the shogun (general) ruled over subordinate daimyo (feudal lords) who had their own armies,
administrative system, and tax collection systems in their autonomous fiefs. The shogun
controlled about a quarter of the land while assigning the rest to allegiant daimyos. The
shogun controlled daimyos by assigning loyal ones nearby and potential rivals far from the
political centers. He also controlled them by threat of force, by keeping hostages, and by
requiring an annual residence in Edo (now Tokyo), the seat of the bakufu (shogun’s office),
for each daimyo. The Tokugawa administration in Edo developed a large bureaucracy to run
the country, but unlike China, which depended on civil service examinations to staff the
government, the Japanese government turned to hereditary daimyos and the shogun’s
retainers. The dominant warrior class during the Tokugawa period was different from the
European aristocracy in two important ways: Japanese warriors did not own land and they
were largely bureaucrats.61 Also, samurai culture was heavily influenced by Zen, a meditative
form of Buddhism introduced from China. In a major difference from China, the Tokugawa
government had greater financial resources as measured by percentage of the country’s
national income, estimated at 25–27 percent in the 1860s.62
Peace and stability in the Tokugawa period led to an improved economy. Population
control mechanisms helped to slow the population growth, thus leading to higher per capita
wealth. Also, the political control mechanism for feudal lords to reside alternatively in Edo
helped to promote urban commerce. The shogun and daimyo became heavily indebted to
urban merchants. The Japanese society was divided by class and status with samurai,
merchants, and artisans living in cities and peasants living in villages. At the same time,
Tokugawa merchants participated actively in conceptualizing politics from an economic
perspective and in advising the government on economic affairs.63
Since the 1970s, scholars came to view the economy of Tokugawa Japan as highly
sophisticated. Japanese scholars argue that Japan became an “economic society” in the
Tokugawa period in that the market guided economic activities and people behaved
rationally. In fact, it is argued that Japan had an “industrious revolution,” in which peasants
worked hard and acquired a good work ethic.64 It is also suggested that Japan entered a proto-
industrialization—growing domestic industry that aims at nonlocal markets—during the
Tokugawa period.65 The Tokugawa government experimented successfully with an import-
substitution strategy to produce domestically imported goods such as raw silk and sugar after
silver and copper mines were exhausted. Tokugawa’s success with import substitution was
one reason that some Japanese scholars saw Japan diverging from the rest of Asia even in the
preindustrial period to stand alone among non-Western nations as having a rational national
economy similar to that in Western Europe.66 However, studies of China’s economic history
have shown similar developments in China.67 (Table 3.3, to be found later in the chapter,
shows that Japan and China had a similar level of GDP per capita.)
With political unification, the Tokugawa government proceeded to eliminate all possible
sources of challenge. Continuing a campaign by General Hideyoshi to root out Christian
influence, the Tokugawa prohibited Japanese who left the country from returning to Japan
after 1636 and forbade construction of boats suitable for ocean voyages. Japan still engaged
in foreign trade, particularly with its Asian neighbors, but Japan ceased to venture out to
engage directly in East Asian trade.
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Southeast Asia
The history of Southeast Asia is not as well documented as Northeast Asia’s.68 The dominant
features of Southeast Asia are easily accessible waterways and dense forests, which allowed
the people in the region to interact closely with each other and to maintain distinctiveness
from outsiders such as China and India that projected cultural influence in the region.
Surrounded by the Pacific and the Indian oceans, Southeast Asia was accessible mainly by
sea for travelers from China, India, or elsewhere. On the northern border of Southeast Asia,
Vietnam blocked any possible Chinese expansion into Southeast Asia by land routes. Unique
among Southeast Asian nations, Vietnam was politically and intellectually modeled after
China.69 Ironically, Vietnam’s success in copying Chinese military and bureaucratic practices
helped the nation to maintain independence from China.
The dominant religious and political forms in Southeast Asia prior to colonial times were
Hindu, Buddhist, and Islamic. With the exception of northern Vietnam, Southeast Asia was
thus drastically different from Confucianist Northeast Asia.
Buddhism and Hinduism spread along trade routes from India to Southeast Asia. Unlike
Confucian rulers in Northeast Asia, Southeast Asian rulers were god-kings. In precolonial
times, a dominant form of state formation was modeled after India, in which an exemplary
monarch resided at the center of a state whose authority radiates outward from a central core.
Political power is centralized through personal connections and patronages. Southeast Asian
rulers were supposed to have absolute power, but their actual influence was compromised by
weak legal and bureaucratic structures.70 The states in Southeast Asia tended not to have a
clear sense of frontiers. With a sparse population, the Southeast Asian states cared more
about whom (allegiance) rather than what (territories) they controlled.71 Thailand and Burma
(now Myanmar) remain Buddhist states and Hinduism has survived in Bali, Indonesia, to the
present day.
Muslims came to the archipelago via trade between India and the Arab world on the one
end and China on the other end as early as the eighth century. With the expansion of Islam in
the twelfth and thirteenth centuries, Islam spread through trading ports in the region from the
thirteenth to the seventeenth century.72 Islam is now the dominant religion in Indonesia,
Malaysia, and southern regions of the Philippines and Thailand.
On mainland Southeast Asia, Vietnam, Cambodia, Thailand, and Burma existed as
recognizable political entities long before Western colonialism, although their modern
boundaries were mostly colonial artifacts. By contrast, the archipelago states of Indonesia,
Malaysia, Singapore, and the Philippines were largely colonial creations, although coherent
polities influenced by Indian culture began to develop in the seventh century, and the Melaka
sultanate that converted to Islam became the dominant political center in the Malay Peninsula
in the fourteenth century.
The states in precolonial Southeast Asia were highly dependent on maritime trade. They
were essentially urban centers around seaports. They imported rice and other essentials from
the international market and paid with profits from reexporting goods and from producing
goods in the cities.73 Unlike Northeast Asia, the Southeast Asian states depended on
commerce as their principal source of government revenue. Wealth derived from control of
trade routes and markets as well as technical innovations explained the rise and fall of the
states in the region.74 As a case in point, the Burmese state received increased taxes from
trade as a result of its increased participation in the Indian Ocean trade from the late sixteenth
century. The state’s decreased dependence on agricultural taxes enhanced its consolidation.75
Southeast Asian commerce expanded after 1400 and included intense intraregional
commerce. Anthony Reid called the period of the fifteenth to the seventeenth century “the
age of commerce” for the region.76 Increased trade enlarged cosmopolitan coastal cities,
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which became political, economic, and cultural centers, and the state evolved around them.
Buddhism, Islam, and Christianity all entered the region via cities. In addition, China’s trade
policy, whether to send expeditions to the region or to ban trade, had a major impact on the
development of Southeast Asia. The rise of port states in Southeast Asia beginning in 1400
had much to do with the Ming Dynasty’s heightened interest in the region. Trade with China
brought wealth to some states.
Unlike China and Japan, which severely restricted foreign traders’ freedom of action
inside their countries, Southeast Asia was open to foreign people, goods, and religions. In
Southeast Asian states, foreign merchants from within or outside the region played an active
role in the city life and even served as court officials. In fact, foreigners had considerable
bargaining leverage vis-à-vis local governments because they could always move to another
port city.77
BEYOND EUROPEAN MODELS OF WORLD HISTORY
Why Western Europe grew rich and consequently surpassed the rest of the world by the mid-
nineteenth century is an intriguing question for students of world history. Attempts to answer
this question have also shaped the views of the contemporary international political economy
of East Asia. Here I will discuss two related questions. First, what was the level of
development in East Asia compared with Western Europe? Second, why did the West end up
outranking the rest of the world? This section discusses the first question and the next section
the second.
We compare East Asia with Western Europe because of the dominance of the West in
modern times. If we look at world history millenniums ago, it would be more appropriate to
compare East Asia with Egypt, Mesopotamia, and India, the three other ancient civilizations
that preceded China by 500–1,500 years. As Jared Diamond showed, with easy access to
domesticated high-yield plants and large animals, these four civilizations enjoyed a head start
in global competition for wealth and power.78 However, this book focuses on contemporary
East Asian political economy, which has experienced an overwhelming impact from the
West. In fact, all four ancient civilizations faced similar challenges to adapt to the modern
world.
Eurocentric Models of World History
Early research maintains that Western Europe possessed unique features that explain its
success in the Industrial Revolution. First, some suggest that Europeans became wealthier
than Asians, which allowed a more capital-intensive path of development. Europeans had
more livestock compared with Asians, which translated into greater transportation capacity
and healthier people. More important, Europeans became wealthier than East Asians because
they managed to lower their fertility rate from the sixteenth to eighteenth century owing to a
high rate of celibacy and late marriages. Such family planning behavior allowed Europe to
escape the trap of population growth keeping down per capita growth.79
Second, other scholars see economic institutions such as property rights as the secret of
Europe’s dramatic rise. Douglass North and Robert Thomas argued that “the development of
an efficient economic organization in Western Europe accounts for the rise of the West”
because “the establishment of institutional arrangements and property rights … creates an
incentive to channel individual economic effort into activities that bring the private rate of
return close to the social rate of return.”80 More broadly, Fernand Braudel viewed the profits
of the wealthy as laying the foundation for capitalism.81
A third school of thought emphasizes unique European cultural factors. Max Weber
71

famously talked about the “Protestant ethic” and “worldly ascetic” capitalism, which
motivates efforts to create wealth in this world.82 Others talked about the attitudes of the
European elite and then middle class toward luxury consumption, which led to a unique
European materialism that turned aristocratic luxuries such as sugar into modern daily
necessities and stimulated the market economy. Consumers had to work harder to obtain
these luxury goods, which were available principally from the market.83
For Eurocentric scholars, the modern world political economy based on the state and the
market economy originated from Western Europe and spread to the rest of the world. It
follows then that what matters is how successfully or unsuccessfully East Asians have
adapted to the dominant Western political economy. By contrast, the East Asian version of
political economy before the West matters little since it was at best a tributary to the Western
mainstream or was simply a dead end for historical development.
New Scholarship on World History
Some recent studies show that East Asia was similar to Western Europe in living standards,
agriculture, commerce, and proto-industrialization (handicraft manufacturing for the market)
as late as 1750.84 While Europe had more livestock per capita than East Asia, East Asia had
sufficient farm animals to sustain a living standard similar to Western Europe.85 In addition,
East Asia had a high level of transportation capacity. China transported 30 million shi (a shi
is about 160 pounds) of grain over long distances to feed about 14 million people in the
eighteenth century, about five times Europe’s long-distance grain transportation in the same
period.86 The fact that Asia had more large cities than Europe (22 percent urban in Japan and
15 percent in the Malay Archipelago compared with 10–15 percent in Western Europe) in the
eighteenth century also indicated East Asia’s ability to transport bulk goods.87 Chinese and
Japanese arguably had similar if not higher life expectancy than West Europeans.88 Life
expectancy for Southeast Asians is harder to measure, but as an indication of nutrition level,
Southeast Asians appeared to have similar heights as Europeans in the sixteenth and
seventeenth centuries.89 East Asians also had their mechanisms to keep population growth
under control in order to improve living standards, using practices such as long breast-feeding
periods, infanticide, and abortion.90 Japan’s population, for instance, increased less than
Europe’s population from 1730 to 1870.91
Recent studies also show that Chinese agriculture was more market-driven than European
agriculture. The majority of land in China could be legally sold or rented.92 By contrast, it
was far more difficult to buy or rent land in Western Europe because of hereditary tenures.
Thus, Western Europe’s property land rights were not as efficient as in China. The labor
market situation in China was similar to that in Western Europe. The practice of labor being
bound to the landlords became unimportant in the Yangzi Valley by the eighteenth century,
and agricultural laborers had become unbound to the land in North China even earlier.93
China also experienced far greater long-distance labor migrations than Western Europe did.
Ten million Chinese made long-distance migrations from the Middle Yangzi region to the
Upper Yangzi in the late seventeenth and eighteenth centuries. Most migrants were free
farmers while the rest were mostly free tenants.94 By contrast, European migration to the
Americas did not reach 1.5 million before 1800, and two-thirds of English emigrants were
indentured servants.95 Chinese peasants could sell their farm products to more buyers in the
marketplace and had an easier time engaging in commercial handicraft production than their
English and French counterparts.96
In terms of culture and values, China and Japan had a comparable level of consumption of
durable luxury goods in furniture and clothing to Europe. China also enjoyed higher per
capita consumption of daily luxury goods such as sugar and tobacco as late as 1800.97
Merchants in Osaka, Japan, elevated their position in the Confucian order. In fact, scholars
72

began to argue in the 1980s based on East Asia’s economic success that Confucianism, which
emphasizes education and organizational identity, was conducive to modernization.98 Some
even suggest that neo-Confucian cultures are better at supporting industrialization or
modernization than Western cultures.99
East Asia was a shaping force for global political economy. Europe did not evolve in
isolation but in a dynamic relationship with the rest of the world. Silver trade, discussed
earlier, was often cited as the primary example of how East Asia helped to expand Europe’s
success. Ming China’s need for silver helped to maintain the Spanish Empire until around
1640, and declining profits from the silver trade led to a financial crisis for the Spaniards.100
More directly, Europe benefited from the transfer of technology such as guns, printing,
textiles, and metallurgy from China at the outset of the Industrial Revolution.101
The best available estimates of international comparisons of wealth show East Asia ahead
of Europe as late as 1820. Tables 3.1 and 3.2 show that China (32.9 percent of the global
total) alone had a GDP 32 percent larger than the combined GDP of Western Europe and
Western offshoots (25.0 percent) in 1820. Moreover, as Table 3.3 shows, China and Japan
were not far behind Europe in per capita GDP as late as 1820.
TABLE 3.1
Economic Development, Asia and the West, 1–2001 (1990 international Geary-Khamis
dollars, in millions)
Source: Angus Maddison, The World Economy: Historical Statistics (Paris: Development Center, OECD,
2003), 259.
Note: The twelve Western nations include Austria, Belgium, Denmark, Finland, France, Germany, Italy, the
Netherlands, Norway, Sweden, Switzerland, and the United Kingdom. The Geary-Khamis method: R. S.
73

Geary and S. H. Khamis developed the method, based on purchasing power parity and international average
prices of commodities to allow international comparisons.
TABLE 3.2
Shares of World GDP, 1–2001
Source: Angus Maddison, The World Economy: Historical Statistics (Paris: Development Center, OECD,
2003), 261.
While recognizing East Asian economic progress, one still needs to explain the basic fact
that the Industrial Revolution took place in Western Europe rather than in East Asia. The
three tables in the chapter show a dramatic rise of the West beginning in the early nineteenth
century. If level of wealth, economic institutions, and cultures did not explain Western
Europe’s rise sufficiently, what would be the reason then? A related question, as shown in the
three tables, is why Japan, unlike China, never trailed far behind the West. A principal reason
for the rise of the West and Japan’s catching up lies in the international system and domestic
political economy of East Asia versus Europe.
WHY DID THE WEST RISE?
The Industrial Revolution resulted from technological progress. It took place in Great Britain
because the country succeeded in developing a capital- and technology-intensive modern
sector of the economy, which grew at the expense of the traditional sector and eventually
penetrated the traditional sector as well. A modern scientific revolution preceded the
74

Industrial Revolution. While East Asia made great achievements in applied science, modern
science developed mainly in Western Europe.102 Modern market economy grew from
extended application of science to production.103 Without a technological breakthrough,
China was caught in a “high-level equilibrium trap” in which once a country reaches the limit
of resources due to expanding population it reverses to stagnation and decline.104 Technology
and science did not just happen, however. Technological advance required a suitable
environment.
Politics made a major difference. On the domestic level, the nature of the relationship
between the state and merchants was different between China and Western Europe. The
Chinese government did not interfere with commerce as much as the European governments
did, but it also provided fewer opportunities for merchants.105 The European state had to
compete with aristocracies, church clergy, and urban residents. By contrast, the Chinese
emperor ran a centralized bureaucracy and faced few institutionalized power centers outside
the state.106 Political pluralism and diversity in organizations and technology allowed
Europeans to experiment with new ways of doing business and politics.107 Different political
experiences in Europe and China provided different scenarios for future leaders.
However, the difference between political systems is not a sufficient condition to explain
Europe’s rise and Asia’s decline. For one thing, Japan, which had a feudal aristocracy,
resembled Western Europe more than China in terms of political structure. Nevertheless,
whether Japan’s structure allowed the country to be better prepared to emulate the West than
China, it did not result in the Industrial Revolution. It was also not clear that political
pluralization in Europe by itself would naturally lead to modernity.
TABLE 3.3
International Comparison of GDP per Capita, 1–2001 (1990 international Geary-Khamis
dollars)
75

Source: Angus Maddison, The World Economy: Historical Statistics (Paris: Development Center, OECD,
2003), 262.
To understand how domestic political economy affected the performance gap between
Western Europe and East Asia, one has to move up to the international level for better
explanations. Some scholars have argued that the West rose by exploiting the periphery in a
process of “primitive accumulation,” which was central to the Industrial Revolution.108 James
Blaut argued that Europe was not superior to the rest of the world prior to 1492, but European
colonialism led to the rise of the West and underdevelopment of the rest of the world.109
Similarly, Immanuel Wallerstein saw a world system in which Western Europe prospered by
exploiting the periphery.110 Critics have challenged this line of argument based on empirical
evidence showing that non-European trade was small compared with domestic capital
accumulation.111 At the same time, the opening of the new world was important for the West.
As Pomeranz argued, trade with the Americas was an important if not sufficient reason for
Europe’s great divergence from the rest of the world after 1750; metal ore found overseas and
coal in Europe allowed Europe to avoid a labor-intensive path found in East Asia.112
Moreover, an intensely competitive interstate system in Western Europe was more
conducive to technological and organizational innovation than the hierarchical Chinese world
order in East Asia. The West prevailed over the East largely by using military force. The
West had superior military weapons and organizations because of intense competition among
equals in Europe, a system that emerged after 1500. Sustained warfare had a profound impact
on state building in Europe.113 War called on the state to figure out ways to collect
revenues.114 A related development is that the European state considered profit from trade as
central to its ability to compete with other states. Thus, a competitive international system
76

contributed to the emergence of capitalism and militarism.115 By contrast, firearms, which
had been developed and widely used previously in China, enjoyed little progress once Ming
rulers (1368–1644) stabilized the country. In Japan, Tokugawa Ieyasu, who ended the civil
war and established a stable shogunate government in 1603, forbade feudal lords to own
firearms and banned information about guns.116
It is historically incorrect to picture a stark contrast between a progressive, competitive,
balance-of-power system in Europe and a repressive, coercive, unified China. Both Europe
and China had periods of empires and of balance-of-power systems.117 And both regions have
experienced progress and decay. The point here is simply that a truly competitive
international system in Europe at a critical juncture accelerated the pace of technological,
economic, social, and political transformations, which gave Europeans significant advantages
over non-European peoples.
CONCLUSION
East Asia had a sophisticated and regionally connected economy prior to the European arrival
in the region. East Asia was on par economically with Western Europe in many areas by the
mid-eighteenth century. East Asia’s post–World War II economic growth is thus a resurgence
to its ancient status as a vibrant economic center.
East Asia had readily identifiable political entities, with sustained and extensive
experience in organizing political, military, economic, and cultural affairs. Thus, the
developmental state, to be discussed in Chapter 5, emerged naturally from this political
tradition. Unlike some other developing regions, it was relatively easy for East Asian states to
devote themselves to development based on their strong nation state traditions. One needs to
have a nation to begin with in order to have national development.
East Asia failed and the West succeeded in making the industrial breakthrough because of
the different nature of the regional orders that had evolved on opposite ends of the Eurasian
continent. The Chinese world order was highly successful judging by its duration. It was
different from the European international order because of different purposes and related
practices, which resulted from different circumstances. The Chinese emperor, who did not
face corporate power centers at home, rationally sought to perpetuate imperial rule through
fiscally responsible policy of limiting the tax burden on peasants and of keeping government
expenditure under control. By contrast, Western monarchs needed to generate new resources
to compete in an anarchical regional system. Necessity was the mother of institutional and
technological innovations. Armed trade and monopoly played an important role in explaining
Europe’s success.
The history of East Asian international political economy matters because East Asians
bring their historical experience into analysis of current affairs and into their policy
prescriptions. The cultural and economic connections among East Asians for centuries in the
past make it possible for them to imagine an Asian community.
The Chinese world order provides China with both a longing to revive its past glory and a
sense of confidence in being a natural leader in East Asia. The memory of the ancient
Chinese world order is a source of fear and respect for other East Asian nations. Having had
to deal with strong outside powers from a weak position in the past, Southeast Asia can live
with a strong China while seeking also to form strong relations with other greater powers as a
check on the Middle Kingdom. By contrast, Japan, which was mostly outside China’s
political order historically, does not accept Chinese regional leadership and views China’s
alleged Middle Kingdom mentality with grave concern.

SUGGESTED READINGS

Arrighi, Giovanni, Takeshi Hamashita, and Mark Selden, eds. The Resurgence of East Asia:
500, 150, and 50 Year Perspectives (New York: RoutledgeCurzon, 2003).
Barfield, Thomas. The Perilous Frontier: Nomadic Empires and China (Cambridge:
Blackwell, 1989).
Cohen, Warren I. East Asia at the Center: Four Thousand Years of Engagement with the
World (New York: Columbia University Press, 2000).
Elvin, Mark. The Pattern of the Chinese Past (Stanford: Stanford University Press, 1973).
Fairbank, John King, ed. The Chinese World Order: Traditional China’s Foreign Relations
(Cambridge: Harvard University Press, 1968).
Flynn, Dennis O., and Arturo Giraldez. “China and the Spanish Empire.” Revista de Historia
Economica 14, no. 2 (Spring 1996): 309–338.
Goldman, Merle, and Andrew Gordon, eds. Historical Perspectives on Contemporary East
Asia (Cambridge: Harvard University Press, 2000).
Hamashita, Takashi. “The Intra-Regional System in East Asia in Modern Times,” in Network
Power: Japan and Asia, ed. Peter J. Katzenstein and Takashi Shiraishi (Ithaca, N.Y.:
Cornell University Press, 1997), 113–135.
Ho, Ping-Ti. “In Defense of Sinicization: A Rebuttal of Evelyn Rawski’s ‘Reenvisioning the
Qing.’” The Journal of Asian Studies 57, no. 1 (February 1998): 123–155.
Huang, Philip C. C. The Peasant Economy and Social Change in North China (Stanford:
Stanford University Press, 1985).
Hui, Victoria Tin-Bor. War and State Formation in Ancient China and Early Modern Europe
(New York: Cambridge University Press, 2005).
Kazui, Tashiro. “Foreign Relations During the Edo Period: Sakoku Reexamined.” Journal of
Japanese Studies 8, no. 2 (Summer 1982): 283–306.
Lawton, John. Silk, Scents, and Spice: Retracing the World’s Great Trade Routes (Paris:
UNESCO, 2004).
Lee, John. “Trade and Economy in Preindustrial East Asia, c. 1500–c. 1800: East Asia in the
Age of Global Integration.” The Journal of Asian Studies 58, no. 1 (February 1999): 2–
26.
Leonard, Jane Kate, and John R. Watt, eds. To Achieve Security and Wealth: The Qing State
and the Economy, 1644–1911 (Ithaca, N.Y.: Cornell University Press, 1992).
Maddison, Angus. The World Economy: Historical Statistics (Paris: Development Center,
OECD, 2003).
Palais, James B. Politics and Policy in Traditional Korea (Cambridge: Harvard University
Press, 1975).
Perkins, Dwight H. “Government as an Obstacle to Industrialization: The Case of Nineteenth-
Century China.” The Journal of Economic History 27, no. 4 (December 1967): 478–492.
Pomeranz, Kenneth. The Great Divergence: China, Europe, and the Making of Modern
World Economy (Princeton: Princeton University Press, 2000).
Rawski, Evelyn S. “Reenvisioning the Qing: The Significance of the Qing Period in Chinese
History.” The Journal of Asian Studies 55, no. 4 (November 1996): 829–850.
Reid, Anthony. Southeast Asia in the Age of Commerce 1450–1680. Vol. 1, The Lands Below
the Winds (New Haven: Yale University Press, 1988).
Reid, Anthony. Southeast Asia in the Age of Commerce 1450–1680. Vol. 2, Expansion and
Crisis (New Haven: Yale University Press, 1993).
Reischauer, Edwin O., and Marius B. Jansen. The Japanese Today: Change and Continuity,
enlarged ed. (Cambridge: Harvard University Press, 1995).
Rosenberg, Nathan, and L. E. Birdzell Jr. How the West Grew Rich: The Economic
78

Transformation of the Industrial World (New York: Basic Books, 1986).
Rowe, William T. Hankow: Commerce and Society in a Chinese City, 1796–1889 (Stanford:
Stanford University Press, 1984).
Rozman, Gilbert, ed. The East Asian Region: Confucian Heritage and Its Modern Adaptation
(Princeton: Princeton University Press, 1991).
Smith, Thomas C. Native Sources of Japanese Industrialization, 1750–1920 (Berkeley:
University of California Press, 1988).
Tarling, Nicholas. Nations and States in Southeast Asia (Cambridge: Cambridge University
Press, 1998).
Toby, Ronald P. State and Diplomacy in Early Modern Japan: Asia in the Development of
the Tokugawa Bakufu (Stanford: Stanford University Press, 1984).
Wang, Gungwu. The Nanhai Trade: The Early History of Chinese Trade in the Southeast
China Sea (Singapore: Times Academic Press, 1998).
Wong, R. Bin. China Transformed: Historical Change and the Limits of European
Experience (Ithaca, N.Y.: Cornell University Press, 1997).
Woodside, Alexander Barton. Vietnam and the Chinese Model (Cambridge: Harvard
University Press, 1988).
Yu, Ying-shih. Trade and Expansion in Han China: A Study in the Structure of Sino-
Barbarian Economic Relations (Berkeley: University of California Press, 1967).

NOTES

1. See Hedley Bull, The Anarchical Society: A Study of Order in World Politics (New York:
Columbia University Press, 1977); John G. Ruggie, “International Regimes, Transactions,
and Change: Embedded Liberalism in the Postwar Economic Order,” in International
Regimes, ed. Stephen D. Krasner (Ithaca, N.Y.: Cornell University Press, 1983), 195–231;
Judith Goldstein and Robert O. Keohane, “Ideas and Foreign Policy: An Analytical
Framework,” in Ideas and Beliefs, Institutions, and Political Change, ed. Judith Goldstein
and Robert O. Keohane (Ithaca, N.Y.: Cornell University Press, 1993), 3–30.
2. Bull, Anarchical Society, 4.
3. For literature on international system and structure, see Morton A. Kaplan, System and
Process in International Politics (New York: Wiley, 1957); Stanley Hoffmann, The State
of War (New York: Praeger, 1965); Kenneth Waltz, Theory of International Politics
(Reading, Mass.: Addison-Wesley, 1979).
4. For a classic on the topic, see John King Fairbank, ed., The Chinese World Order:
Traditional China’s Foreign Relations (Cambridge: Harvard University Press, 1968).
5. Thomas Barfield, The Perilous Frontier: Nomadic Empires and China (Cambridge:
Blackwell, 1989); Carter Vaughn Findley, The Turks in World History (Oxford: Oxford
University Press, 2005); Anatoly M. Khazanov and André Wink, eds., Nomads in the
Sedentary World (Richmond, Surrey: Curzon Press, 2001).
6. Evelyn S. Rawski, “Reenvisioning the Qing: The Significance of the Qing Period in
Chinese History,” The Journal of Asian Studies 55, no. 4 (November 1996): 842. For a
rebuttal, see Ping-Ti Ho, “In Defense of Sinicization: A Rebuttal of Evelyn Rawski’s
‘Reenvisioning the Qing,’” The Journal of Asian Studies 57, no. 1 (February 1998): 123–
155.
7. Angus Maddison, The World Economy: Historical Statistics (Paris: Development Center,
OECD, 2003), 261.
8. Ronald P. Toby, State and Diplomacy in Early Modern Japan: Asia in the Development of
the Tokugawa Bakufu (Stanford: Stanford University Press, 1984).
79

9. Wang Gungwu, “Without Southeast Asia: A Background Essay,” in The Chinese World
Order (see note 4), 52–60. Also see Louise Levathes, When China Ruled the Sea: The
Treasure Fleet of the Dragon Throne 1403–1433 (New York: Simon and Schuster, 1994).
10. Benjamin I. Schwartz, “The Chinese Perception of World Order, Past and Present,” in
The Chinese World Order (see note 4), 277. See also Charles Patrick Fitzgerald, The
Chinese View of Their Place in the World (New York: Oxford University Press, 1964).
11. Alastair I. Johnston, Cultural Realism: Strategic Culture and Grand Strategy in Chinese
History (Princeton: Princeton University Press, 1995).
12. Victoria Tin-Bor Hui, War and State Formation in Ancient China and Early Modern
Europe (New York: Cambridge University Press, 2005).
13. Findley, Turks in World History, 28–29.
14. Wang, “Without Southeast Asia,” 41.
15. John King Fairbank, “Framework,” in The Chinese World Order (see note 4), 11.
16. For examples, see Sarasin Viraphol, Tribute and Profit: Sino-Siamese Trade, 1652–1853
(Cambridge: Harvard University Press, 1977).
17. Joseph F. Fletcher, “China and Central Asia,” in The Chinese World Order (see note 4),
206–224.
18. Robert K. Sakai, “(Liu-Chiu) Islands as a Fief of Satsuma,” in The Chinese World Order
(see note 4), 112–134; Ta-tuan Chen, “Chiu Kings in the Ching Period,” in The Chinese
World Order (see note 4), 135–164.
19. Kenneth R. Robinson, “Centering the King of Choson: Aspects of Korean Maritime
Diplomacy, 1392–1592,” The Journal of Asian Studies 59, no. 1 (February 2000): 109–
125.
20. Ying-shih Yu, Trade and Expansion in Han China: A Study in the Structure of Sino-
Barbarian Economic Relations (Berkeley: University of California Press, 1967), 47.
21. Barfield, Perilous Frontier.
22. Yu, Trade and Expansion in Han China, 36–64.
23. Cited in Jonathan D. Spence, The Search for Modern China, 2nd ed. (New York: Norton,
1999), 122.
24. Yu, Trade and Expansion in Han China, 18–19.
25. Wang Gungwu, The Nanhai Trade: The Early History of Chinese Trade in the Southeast
China Sea (Singapore: Times Academic Press, 1998), 29–35.
26. Anthony Reid, “An ‘Age of Commerce’ in Southeast Asia,” Modern Asian Studies 24,
no. 1 (1990): 9.
27. Yu, Trade and Expansion in Han China, 93.
28. Barfield, Perilous Frontier.
29. Hae-jong Chun, “Relations in the Ch’ing Period,” in The Chinese World Order (see note
4), 90–111.
30. Takashi Hamashita, “The Intra-Regional System in East Asia in Modern Times,” in Peter
J. Katzenstein and Takashi Shiraishi, eds., Network Power: Japan and Asia (Ithaca, N.Y.:
Cornell University Press, 1997), 117.
31. Takeshi Hamashita, “Tribute and Treaties: Maritime Asia and Treaty Port Networks in
the Era of Negotiation, 1800–1900,” in The Resurgence of East Asia: 500, 150, and 50
Year Perspectives, ed. Giovanni Arrighi, Takeshi Hamashita, and Mark Selden (New
York: RoutledgeCurzon, 2003), 21–22.
32. John Lawton, Silk, Scents, and Spice: Retracing the World’s Great Trade Routes (Paris:
UNESCO, 2004), 11–73.
33. Lawton, Silk, Scents, and Spice, 75–113.
34. Reid, “An ‘Age of Commerce’ in Southeast Asia,” 9–10.
35. Toby, State and Diplomacy in Early Modern Japan; Tessa Morrison-Suzuki, The
80

Technological Transformation of Japan: From the Seventeenth to the Twenty-First
Century (Cambridge: Cambridge University Press, 1994); Tashiro Kazui, “Foreign
Relations During the Edo Period: Sakoku Reexamined,” Journal of Japanese Studies 8,
no. 2 (Summer 1982): 283–306.
36. Hamashita Takeshi, Kindai chūgoku no kokusaiteki keiki: chōko boeki shisutemu to kindai
ajia [Modern China’s international opportunity: The tributary trade system and modern
Asia] (Tokyo: Tokyo daigaku shuppankai, 1990), 44.
37. Tashiro, “Foreign Relations During the Edo Period,” 283–284.
38. Anthony Reid, Southeast Asia in the Age of Commerce, 1450–1680, vol. 1, The Lands
Below the Winds (New Haven: Yale University Press, 1988) and Southeast Asia in the
Age of Commerce, 1450–1680, vol. 2, Expansion and Crisis (New Haven: Yale
University Press, 1993).
39. John Lee, “Trade and Economy in Preindustrial East Asia, c. 1500–c. 1800: East Asia in
the Age of Global Integration,” The Journal of Asian Studies 58, no. 1 (February 1999):
2–26.
40. Dennis O. Flynn and Arturo Giraldez, “China and the Spanish Empire,” Revista de
historia economica 14, no. 2 (Spring 1996): 309–338; “China and the Manila Galleons,”
in Japanese Industrialization and the Asian Economy, ed. A. J. H. Latham and Heita
Kawakatsu (London: Routledge, 1994), 71–90.
41. Charles Tilly, Coercion, Capital, and European States, A.D. 990–1990 (Cambridge:
Blackwell, 1990).
42. For useful readings of pastoral nomadic political organizations, see Anatoly Khazanov,
Nomads and the Outside World, 2nd ed., trans. Julia Crookenden (Madison: University of
Wisconsin Press, 1994); Barfield, Perilous Frontier.
43. Mark Elvin, The Pattern of the Chinese Past (Stanford: Stanford University Press, 1973),
69–83.
44. For a general study of rule and revenue, see Margaret Levi, Of Rule and Revenue
(Berkeley: University of California Press, 1988). She argued that rulers maximize
revenues to the state, which relates to their ability to rule, but they are constrained by their
bargaining power and transaction costs, including the cost of inviting revolts.
45. Dwight H. Perkins, Agricultural Development in China, 1368–1968 (Chicago: Aldine,
1969), 176–182; Ray Huang, Taxation and Government Finance in 16th Century Ming
China (Cambridge: Cambridge University Press, 1974); Yeh-chien Wang, Land Taxation
in Imperial China, 1750–1911 (Cambridge: Harvard University Press, 1973).
46. Immanuel C. Y. Hsu, The Rise of Modern China (New York: Oxford University Press,
1970), 75–82.
47. See, for example, William T. Rowe, Hankow: Commerce and Society in a Chinese City,
1796–1889 (Stanford: Stanford University Press, 1984).
48. Gilbert Rozman, ed., The Modernization of China (New York: Free Press, 1981), 75–77.
49. Huang, Taxation and Government Finance in 16th Century Ming China, 316–323.
50. Charles Tilly, Big Structures, Large Processes, Huge Comparisons (New York: Russell
Sage Foundation, 1984), 142.
51. Jane Kate Leonard and John R. Watt, eds., To Achieve Security and Wealth: The Qing
State and the Economy, 1644–1911 (Ithaca, N.Y.: Cornell University Press, 1992).
52. Dwight H. Perkins, “Government as an Obstacle to Industrialization: The Case of
Nineteenth-Century China,” The Journal of Economic History 27, no. 4 (December
1967): 478.
53. Wang Gungwu, Anglo-Chinese Encounters Since 1800: War, Trade, Science, and
Governance (New York: Cambridge University Press, 2003), 55.
54. JaHyun Kim Haboush, “The Confucianization of Korean Society,” in The East Asian
81

Region: Confucian Heritage and Its Modern Adaptation, ed. Gilbert Rozman (Princeton:
Princeton University Press, 1991), 85–86; Carter J. Eckert, “Korea’s Transition to
Modernity: A Will to Greatness,” in Historical Perspectives on Contemporary East Asia,
ed. Merle Goldman and Andrew Gordon (Cambridge: Harvard University Press, 2000),
122–126; Chai-Sik Chung, A Korean Confucian Encounter with the Modern World: Yi
Hang-no and the West (Berkeley: Institute of East Asian Studies, University of
California, 1995), 13–16.
55. Takashi Hatada, A History of Korea, trans. and ed. Warren W. Smith Jr. and Benjamin H.
Hazard (Santa Barbara, Calif.: ABC-Clio, 1969).
56. Dwight H. Perkins, “The Historical Foundations of Modern Economic Growth,” in The
Economic and Social Modernization of the Republic of Korea, ed. Edward S. Mason et al.
(Cambridge: Harvard University Press, 1980), 62–70.
57. Perkins, “Historical Foundations of Modern Economic Growth,” 66.
58. James B. Palais, Politics and Policy in Traditional Korea (Cambridge: Harvard
University Press, 1975), 12–18, 61–67.
59. Warren I. Cohen, East Asia at the Center: Four Thousand Years of Engagement with the
World (New York: Columbia University Press, 2000), 98.
60. Edwin O. Reischauer and Marius B. Jansen, The Japanese Today: Change and
Continuity, enlarged ed. (Cambridge: Harvard University Press, 1995), 52–77.
61. Thomas C. Smith, Native Sources of Japanese Industrialization, 1750–1920 (Berkeley:
University of California Press, 1988), 133–147. This explains why some samurais were
willing to destroy the aristocracy after the Meiji Restoration.
62. E. Sydney Crawcour, “The Tokugawa Heritage,” in The State and Economic Enterprise
in Japan, ed. William Wirt Lockwood (Princeton: Princeton University Press, 1965), 31.
63. Tetsuo Najita, Visions of Virtue in Tokugawa Japan: The Kaitokudo Merchant Academy
of Osaka (Chicago: University of Chicago Press, 1987), 8–10.
64. Hayami Akira and Miyamoto Matao, eds., Nihon keizai shi, ichi; keizai shakai no seiritsu,
jushichi juhachi seiki [A history of Japanese economy, vol. 1, The coming of economic
society, the seventeenth and the eighteenth centuries] (Tokyo: Iwanami shoten, 1988).
65. David L. Howell, Capitalism from Within: Economy, Society, and the State in a Japanese
Fishery (Berkeley: University of California Press, 1995); Kären Wigen, “The Geographic
Imagination in Early Modern Japanese History: Retrospect and Prospect,” The Journal of
Asian Studies 51, no. 1 (February 1992): 3–29.
66. Lee, “Trade and Economy in Preindustrial East Asia.”
67. Eric Jones considered Tokugawa Japan, Song China, and Western Europe the only three
areas where intensive economic growth, which refers to increased per capita income, took
place before industrialization. Eric Jones, Growth Recurring: Economic Change in World
History (Oxford: Clarendon Press, 1988).
68. Few written documents survived after 1500 and the Europeans kept more detailed records
of Southeast Asia than Chinese and Arabs before them. Reid, “An ‘Age of Commerce’ in
Southeast Asia,” 1–30.
69. Vietnam was also part of Southeast Asia culturally. This is particularly the case for the
“Indianized” southern peoples such as Cambodians and Malayo-Polynesian Chams,
whom the northern Vietnamese conquered relatively late. Alexander Barton Woodside,
Vietnam and the Chinese Model (Cambridge: Harvard University Press, 1988), 22–25.
70. O. W. Wolters, History, Culture, and Region in Southeast Asian Perspectives (Singapore:
Institute of Southeast Asian Studies, 1982); George M. Kahin, ed., Government and
Politics in Southeast Asia, 2nd ed. (Ithaca, N.Y.: Cornell University Press, 1964).
71. Nicholas Tarling, Nations and States in Southeast Asia (Cambridge: Cambridge
University Press, 1998), 47–48.
82

72. Robert W. Hefner, Civil Islam: Muslims and Democratization in Indonesia (Princeton:
Princeton University Press, 2000), 26–31.
73. Anthony Reid, “The Organization of Production in Southeast Asian Port Cities,” in
Brides of the Sea: Port Cities of Asia from the 16th to 20th Centuries, ed. Frank Broeze
(Honolulu: University of Hawaii Press, 1989), 55–74.
74. Reid, Southeast Asia in the Age of Commerce, 1450–1680, vol. 2, 203–266.
75. Robert H. Taylor, The State in Burma (Honolulu: University of Hawaii Press, 1987), 45.
76. Reid, Southeast Asia in the Age of Commerce, 1450–1680, vol. 1.
77. Reid, “An ‘Age of Commerce’ in Southeast Asia,” 4.
78. Jared Diamond, Guns, Germs, and Steel: The Fates of Human Societies (New York:
Norton, 1999).
79. David Landes, The Unbound Prometheus: Technological Change and Industrial
Development in Western Europe from 1750 to the Present (Cambridge: Cambridge
University Press, 1969); Eric L. Jones, The European Miracle: Environments, Economies,
and Geopolitics in the History of Europe and Asia (Cambridge: Cambridge University
Press, 1981); John Hajnal, “Two Kinds of Preindustrial Household Formation Systems,”
Population and Development Review 8, no. 3 (September 1982): 449–494; Jan DeVries,
The Economy of Europe in an Age of Crisis, 1600–1750 (New York: Cambridge
University Press, 1976), 9–12.
80. Douglass C. North and Robert Paul Thomas, The Rise of the Western World: A New
Economic History (Cambridge: Cambridge University Press, 1973), 1.
81. Fernand Braudel, Afterthoughts on Material Civilization and Capitalism, trans. Patricia
M. Ranum (Baltimore: Johns Hopkins University Press, 1977).
82. Max Weber, The Protestant Ethic and the Spirit of Capitalism, trans. Talcott Parsons
(New York: Scribner’s, 1958).
83. Chandra Mukerji, From Graven Images: Patterns of Modern Materialism (New York:
Columbia University Press, 1983); Sidney W. Mintz, Sweetness and Power: The Place of
Sugar in Modern History (New York: Penguin, 1985).
84. R. Bin Wong, China Transformed: Historical Change and the Limits of European
Experience (Ithaca, N.Y.: Cornell University Press, 1997); Kenneth Pomeranz, The Great
Divergence: China, Europe, and the Making of Modern World Economy (Princeton:
Princeton University Press, 2000).
85. Philip C. C. Huang, The Peasant Economy and Social Change in North China (Stanford:
Stanford University Press, 1985), 145–151.
86. Wu Chengming, Zhongguo zibenzhuyi yu guonei shichang [Chinese capitalism and the
national market] (Beijing: Zhongguo shehui kexue chubanshe, 1985), 254–258; Perkins,
Agricultural Development in China, 297–307; Pomeranz, Great Divergence, 34.
87. Thomas C. Smith, The Agrarian Origins of Modern Japan (Stanford: Stanford University
Press, 1958), 67–68; Reid, “Organization of Production in Southeast Asian Port Cities,”
57; Gilbert Rozman, Urban Networks in Ching China and Tokugawa Japan (Princeton:
Princeton University Press, 1973).
88. Susan B. Hanley and Kozo Yamamura, Economic and Demographic Change in
Preindustrial Japan, 1600–1868 (Princeton: Princeton University Press, 1977), 221–222;
William Lavely and R. Bin Wong, “Revising the Malthusian Narrative: The Comparative
Study of Population Dynamics in Late Imperial China,” The Journal of Asian Studies 57,
no. 3 (August 1998): 714–748.
89. Reid, Southeast Asia in the Age of Commerce, 1450–1680, vol. 1, 45–50.
90. George Barclay, Ansley J. Coale, Michael A. Stoto, and T. James Trussell, “A
Reassessment of the Demography of Traditional China,” Population Index 42, no. 4
(October 1976): 606–635; James Z. Lee and Wang Feng, One Quarter of Humanity:
83

Malthusian Mythology and Chinese Realities, 1700–2000 (Cambridge: Harvard
University Press, 1999).
91. Laurel L. Cornell, “Infanticide in Early Modern Japan? Demography, Culture, and
Population Growth,” The Journal of Asian Studies 55, no. 1 (February 1996): 22–50.
92. Huang, Taxation and Government Finance in 16th Century Ming China; Huang, Peasant
Economy and Social Change in North China; Kenneth Pomeranz, The Making of a
Hinterland: State, Society, and Economy in Inland North China, 1853–1937 (Berkeley:
University of California Press, 1993).
93. Elvin, Pattern of the Chinese Past, 235–267; Luo Lun and Jing Su, Qingdai shandong
jingying dizhu jingji yanjiu [Economic research on managerial landlords in Shandong
during the Qing Dynasty] (Jinan: Qilu shushe, 1984).
94. James Lee and Bin Wong, “Population Movements in Qing China and Their Linguistic
Legacy,” in Languages and Dialects of China, ed. William S.-Y. Wang (Berkeley:
Journal of Chinese Linguistics Monograph Series, 1991), 52–77. In addition, 3 million
migrants moved from the Middle Yangzi and the Upper Yangzi to southwest China in the
late eighteenth and the early nineteenth century. Twelve million people moved from north
China to settle in northeast China in the late nineteenth century and the early twentieth
century.
95. Pomeranz, Great Divergence, 83.
96. Ming-Te Pan, “Rural Credit in Ming-Qing Jiangnan and the Concept of Peasant Petty
Commodity Production,” The Journal of Asian Studies 55, no. 1 (February 1996): 94–
117; Hanchao Lu, “Arrested Development: Cotton and Cotton Markets in Shanghai,
1350–1843,” Modern China 18, no. 4 (October 1992): 468–499.
97. Pomeranz, Great Divergence, 114–165.
98. Yu Ying-shih, Zhongguo jinshi zongjiao lunli yu shangren jingshen [Modern Chinese
religious ethics and merchant spirit] (Taipei: Lianjing chubanshe, 1987); Najita, Visions
of Virtue in Tokugawa Japan; Michio Morishima, Why Has Japan Succeeded?: Western
Technology and the Japanese Ethos (New York: Cambridge University Press, 1982);
Peter L. Berger and Hsin-Huang Michael Hsiao, eds., In Search of an East Asian
Development Model (New Brunswick, N.J.: Transaction Books, 1988).
99. Herman Kahn, World Economic Development: 1979 and Beyond (Boulder: West-view
Press, 1979), 117–126. For a study of neo-Confucianism, see William Theodore de Bary
and Irene Bloom, eds., Principle and Practicality: Essays in Neo-Confucianism and
Practical Learning (New York: Columbia University Press, 1979).
100. Flynn and Giraldez, “China and the Spanish Empire”; Richard Von Glahn, Fountain of
Fortune: Money and Monetary Policy in China, 1000–1700 (Berkeley: University of
California Press, 1996); Ward Barrett, “World Bullion Flows, 1450–1800,” in The Rise
of Merchant Empires, ed. James Tracy (New York: Cambridge University Press, 1990),
224–254; Andre Gunder Frank, Reorient: Global Economy in the Asian Age (Berkeley:
University of California Press, 1998).
101. Frank, Reorient, 185–204.
102. Joseph Needham, Science in Traditional China: A Comparative Perspective
(Cambridge: Harvard University Press, 1981); Joseph Needham, The Great Titration:
Science and Society in East and West (London: Allen and Unwin, 1969).
103. Karl Polanyi, The Great Transformation: The Political and Economic Origins of Our
Time (Boston: Beacon Press, 1957); Simon Kuznets, Modern Economic Growth Rate,
Structure, and Spread (New Haven: Yale University Press, 1966), 8–16.
104. Mark Elvin, “The High-Level Equilibrium Trap: The Causes of the Decline of Invention
in the Traditional Chinese Textile Industries,” in Economic Organization in Chinese
Society, ed. William E. Willmott (Stanford: Stanford University Press, 1972), 137–172.
84

105. Pomeranz, Great Divergence, 173.
106. Wong, China Transformed, 101–102.
107. Nathan Rosenberg and L. E. Birdzell Jr., How the West Grew Rich: The Economic
Transformation of the Industrial World (New York: Basic Books, 1986).
108. Andre Gunder Frank, Capitalism and Underdevelopment in Latin America: Historical
Studies of Chile and Brazil (New York: Monthly Review Press, 1969); Eric Williams,
Capitalism and Slavery (London: Andre Deutsch, 1964); Samir Amin, Accumulation on
a World Scale: A Critique of the Theory of Underdevelopment, trans. Brian Pearce (New
York: Monthly Press, 1974).
109. James M. Blaut, The Colonizer’s Model of the World: Geographical Diffusionism and
Eurocentric History (New York: Guilford Press, 1993).
110. Immanuel Wallerstein, Capitalist Agriculture and the Origins of the European World
System (New York: Academic Press, 1974) and The Modern World-System III: 1730–
1840s (New York: Academic Press, 1989).
111. Jan DeVries, The Economy of Europe in an Age of Crisis, 1600–1750 (New York:
Cambridge University Press, 1976), 139–146. See also Patrick O’Brien, “European
Economic Development: The Contribution of the Periphery,” Economic History Review
35, no. 1 (February 1982): 1–18.
112. Pomeranz, Great Divergence.
113. Thomas Ertman, Birth of the Leviathan: Building States and Regimes in Medieval and
Early Modern Europe (Cambridge: Cambridge University Press, 1997).
114. Tilly, Coercion, Capital, and European States.
115. Giovanni Arrighi, Po-Keung Hui, Ho-Fung Hung, and Mark Selden, “Historical
Capitalism, East and West,” in The Resurgence of East Asia (see note 31), 317–318.
116. Elvin, Pattern of the Chinese Past, 89–97.
117. Hui, War and State Formation in Ancient China and Early Modern Europe.
85

T
CHAPTER 4
Modern Imperialism

his chapter examines the modern transformation of East Asian international political
economy (IPE) with the European arrival in East Asia. It answers two major questions.
First, how did the European arrival in Asia influence the evolution of East Asian IPE? What
was the nature of the Western impact, and how did East Asians respond? The chapter shows
that East Asia’s modern transformation, partly defined by Western pressure and Asian
response, presents a complex picture of Westerners also adapting to the preexisting
commercial networks and political realities in East Asia. As East Asia and Europe interacted
in a global market, studies of East Asian IPE shed light on what was unique and universal in
both regions. The strategies and purposes pursued by various East Asian nations, including
Japanese imperialism, nationalism, and communism, helped to shape the region’s modern
international political economy.
The Western imperialist order in Asia went through two stages. The first stage lasted
from the early sixteenth century to the mid-nineteenth century. Europeans gained a strategic
position in maritime Southeast Asia. Around the same period, China and several other Asian
states were also expanding dramatically. Europeans came to dominate in East Asia after the
mid-nineteenth century and maintained that dominance for only a century, a short period in
the long history of East Asia. However, the impact of the West was profound. To begin with,
Europeans forged new states in maritime Southeast Asia, such as Indonesia, Malaysia, and
the Philippines. They also helped to define the current borders of continental Southeast Asia
and Northeast Asia. The European impact was also reflected in the profound transformation
of the state, economy, and culture throughout East Asia.
The second question the chapter addresses is how Japanese imperialism influenced East
Asian IPE. Japan’s expansion constituted an Asian comeback at the expense not only of the
West but also of the rest of East Asia. Japanese elites saw building a modern economy as
essential for building a strong army to defend against encroaching Western powers. The
Japanese expansion was initially driven by a desire to control the “lines of advantage” but
came to incorporate an economic rationale for strategic materials and markets as its
industrialization progressed and as the Great Depression led to protectionist blocs controlled
by Western powers. Japanese imperialism left statist legacies in places like Korea and Taiwan
that it had administered for a lengthy period of time. Japan helped destroy the Western
imperialist order in the early years of the Pacific War, which could not be restored easily
afterward. Japan’s loss of the war facilitated the emergence of a cold war structure in East
Asia, with Japan itself becoming a market democracy while creating conditions for the
eventual triumph of communism in China, Vietnam, and North Korea.
WESTERN IMPERIALISM
86

Imperialism
Much has been studied about imperialism. For some scholars, imperialism and empires
describe the same political situation in which one nation imposes its political control on
others.1 Imperialism is a type of international order.
East Asia was not unfamiliar with empires and subjugation of one people by another. But
Western imperialism was different from the Asian empires in that it was based on the nation
state and market economy.2 Thus, some scholars see modern imperialism as distinct from
empires. Imperialism refers to the expansion of the sovereignty of the European state beyond
its border; by contrast, empires do not have fixed boundaries.3 The notion of sovereignty
introduced by the West would reshape East Asian international relations.
Students of political economy should know economics-based studies of imperialism. To
scholars using this approach, capitalist overproduction drives imperialism, and bankers and
financiers support imperialism.4 Critics argue that capitalism is unrelated to imperialism.5
Financial investments did not always go to the new colonies; capital-poor Russia and Italy
also engaged in imperialist expansion.6 Nevertheless, economic motives were clearly
important for imperialist powers, certainly when it came to East Asia.
History of Western Domination in East Asia
Westerners arrived in East Asia in the early sixteenth century and succeeded by the late
nineteenth century in creating a new imperialist order in East Asia driven by economic
interests but based on military power and military organization, which reflected and
contributed to the emergence of the modern state and to the Industrial Revolution in Europe.7
Although individual Europeans had reached East Asia centuries before the sixteenth century,
they were not state-sanctioned operations.
The Europeans first acquired a strong strategic position in archipelago Southeast Asia for
the wealth of the region and for access to the markets in China and Japan. The Portuguese
were the first Europeans to arrive in East Asia. Vasco da Gama reached India in 1498
following a voyage around Africa’s Cape of Good Hope. Alfonso d’Albuquerque captured
Melaka (Malacca) in 1511. The Portuguese monarch sent the first European mission to China
in 1517. The Portuguese bribed Chinese officials to allow them access to dry goods in Macau
in 1535 and appointed officials to the territory in 1557. The Portuguese based in Macau
monopolized the China trade and excluded other Europeans. From Macau, the Portuguese
also served as middlemen between Chinese and Japanese merchants since the Chinese Ming
court banned trade with Japan for not paying tribute.
The Spaniards were next in line. A Spanish fleet led by Ferdinand Magellan arrived in
Luzon (the Philippines) in 1521 from South America. The Spanish king ordered that the
Philippines be colonized in 1532. The Spaniards established the first permanent settlement in
the Philippines in 1565 and took control of Manila in 1571. Two Spanish delegates visited
China’s Fujian Province in 1575, the first official China-Spain contact. Trade, particularly in
silver, flourished between Spanish Mexico and China via Manila.
Dutch merchants made the first trip to Sumatra and Java in 1596. With state support,
Dutch merchants formed the Dutch East India Company (VOC) in 1602. The Dutch
government authorized the company to possess troops, colonize territories, declare war, and
enter into treaties with Asian nations. The VOC sought to establish trade with China in
Canton (now Guangzhou) but was blocked by the Portuguese in Macau. However, the
company seized Sumatra, Java, and the Moluccas from the Portuguese and obtained trading
rights from Japan’s Tokugawa government. The Dutch founded the city of Batavia in Java in
1618 and the Batavian government the following year. The VOC established a trading post in
Taiwan in 1624 after driving out the Spaniards there. They defeated the rulers in Aceh and
Mataram in 1629. By 1639, the Dutch monopolized the European access to Japan. They
87

secured Melaka from the Portuguese in 1641 and conquered part of Maluku, which was rich
in clove and nutmeg. Successfully exploiting divisions among indigenous rulers, the Dutch
now controlled the supply of pepper. The Dutch sent the first mission to China in 1656.
The Europeans, particularly the Dutch, used force rather than competitive pricing or
better services to turn Southeast Asian commerce to their advantages. As Reid argued, the
only advantages Europeans had at the time were military weapons and organizations, which
Europeans did not hesitate to use.8 One wonders what would have happened if China and
Japan had adopted a proactive and expansionist foreign policy in Southeast Asia and used
military force to back up their commercial operations in the region.
It was fortunate for early European adventurers in East Asia that China and Japan were
turning inward. The Chinese state did not support its citizens’ activities overseas and actually
punished them. Emperor Jiaqing of the Ming Dynasty (1522–1566) forbade foreign traders to
land in China and Chinese citizens to take ocean voyages. The market forces were such that
private Chinese citizens settled in Japan and Southeast Asia to smuggle and trade. Many
turned into pirates, who were often really armed traders. Fujianese were particularly engaged,
which explained why it was the Fujianese governor who persuaded the court to end the trade
ban in 1567. Without state support, Chinese residents in Southeast Asia were often victims of
Europeans.
As shown in Hideyoshi’s attempts to conquer Korea and China in 1592 and 1597, Japan
was a country to contend with in East Asia. Tokugawa Ieyasu chose to concentrate on
internal affairs. The Tokugawa government banned Portuguese shipping in Japan. Only the
Dutch were allowed in 1640 to reside in Nagasaki. As discussed in the previous chapter, the
Japanese government did not close the country in the early seventeenth century since it
maintained active trade with the Chinese and the Koreans. However, Japan did not allow its
citizens to travel overseas, let alone engage in state-supported adventures in East Asia.
Other Westerners followed the Portuguese, Spanish, and Dutch pioneers. English explorer
Francis Drake crossed the Pacific in 1579. In 1600, the English monarch granted a charter to
some London merchants to conduct business in the Far East, which led to the creation of the
British East India Company. The company quickly established posts in India and East Asia.
In the early seventeenth century, however, the English could not compete with the Dutch in
East Asia in terms of naval power and the marketability of commodities. The English wanted
to sell English cloth, which was not as attractive as Indian cloth and Chinese silk. The French
began their move to East Asia in 1604 but remained a minor player through the eighteenth
century. The Russians expanded to Asia by land in the north, beginning aggressively in the
mid-sixteenth century and reaching the Bering Strait in 1648. The first Russians arrived in
Beijing in 1567. The Americans were latecomers. The Empress of China, the first American
ship to China, arrived in 1784.
Western powers dominated in East Asia after the mid-nineteenth century. As Table 3.2 in
the previous chapter shows, East Asia and the West traded places in economic power around
the mid-nineteenth century; the share of the Western nations in the global gross domestic
product increased from 24.9 percent in 1820 to 43.0 percent in 1870 while the share of the
Asian nations decreased from 59.4 percent to 38.4 percent. Western domination was also
based on superior military power and organization that originated from modern nationalism
and the industrial and technological revolution in Europe.
The power struggle in Europe spread to the rest of the world. Like other non-Western
regions, East Asia became an arena for Western power competition. Britain defeated China in
the Opium War and imposed an unequal treaty on China, opening five Chinese ports for trade
and seizing the island of Hong Kong. Britain thus introduced China into a treaty port system.
In a separate commercial agreement signed in October 1843, Britain fixed the import and
export duties at 5 percent, won the right to establish consular courts to try civil and criminal
88

cases involving British citizens (extraterritoriality), and included a most-favored-nation
(MFN) clause that would automatically give Britain any privileges given to other nations.
These agreements were unequal because China did not enjoy the same rights in Britain.
France and the United States followed the British lead with treaties signed in 1844. Russia
(1858), Prussia (1861), Portugal (1862), Denmark and Holland (1863), Spain (1864),
Belgium (1865), and Italy (1866) joined the group. They also cooperated to pressure China
for more privileges.
Commodore Matthew C. Perry of the United States forced Japan to open for trade in
1853. Britain signed a treaty with Japan in October 1854 and Russia in February 1855. Under
pressure from the Western business community for terms similar to the China arrangement,
the U.S. government signed an unequal treaty with Japan in July 1858, which imposed a 5
percent tariff and extraterritoriality on Japan. Similar to the case of China, other Western
nations followed the American lead with similar unequal treaties imposed on Japan. Holland
and Russia signed their treaties in August. Britain signed a treaty shortly afterward, with the
MFN clause. France took its turn in October.
Around the same time, Europeans shifted from control of strategic ports and trade routes
based on indirect rule and protection of native states to direct colonial administration in
Southeast Asia. After indirect rule for almost two centuries, the Dutch began to construct a
state called Netherlands India in the early nineteenth century and succeeded in depriving
most Indonesian states of their independence by 1848. Great Britain secured a settlement in
Singapore in 1819. Britain extended influence over the Malay kingdoms on the Malay
Peninsula and created the Federated Malay States in 1895. In the meantime, the Spaniards
engaged in state-building in the Philippines. The Philippines was passed from Spain to the
United States as a result of the Spanish-American War of 1898. Britain and France managed
to sever the Chinese suzerainty in mainland Southeast Asia. Siam King Chulalongkorn ended
his kingdom’s recognition of China’s suzerainty and accepted the Western system of
international relations in 1882.9 France forced Vietnam into a protectorate in 1883 and fought
a war with China to maintain that claim and ended the special relationship between China and
Vietnam. After three wars, Britain destroyed the Burmese kingdom in 1886 and then
negotiated with China over the border of British Burma.
By the late nineteenth century, the Western powers had destroyed the Chinese world
order and forced most East Asia countries open for Western goods and ideas in an imperialist
order. In contrast to the tribute system, the treaty system was an operational feature of the
Western-dominated imperialist order in which a series of unequal treaties were forced upon
East Asian nations. In most cases, unequal treaties led to direct administrative control. While
Europeans viewed each other as equal sovereign states, they treated non-Western peoples
differently. East Asian nations also began to conclude treaties among themselves, including
the 1876 Japan-Korea Treaty of Kangwha, the 1882 Regulations for Maritime and Overland
Trade between Chinese and Korean subjects, and the 1885 China-Japan Tianjin Treaty.
MAP 4.1
Western Imperialism in East Asia to 1910
89

East Asia was incorporated into the global capitalist system by force, ending up as a
peripheral region exporting primary products while importing manufactured goods from the
West. East Asian nations could not resist because they lost the control of tariffs and
foreigners effectively administered treaty ports through which foreign goods and ideas
poured into East Asia. The situation began to change toward the end of the nineteenth century
when national capitalists in Japan and China began to compete more effectively with Western
countries.
By the outbreak of the First World War, as shown in Map 4.1, East Asia was divided
among Western nations: the East Indies (what is now Indonesia) by Netherlands, the
Philippines by the United States, Malaya and Burma by Britain, and Indochina (what is now
Vietnam, Laos, and Cambodia) by France. The only independent countries were Japan,
Thailand, and China, although the Chinese considered their country to be semicolonized
given Western extraterritorial rights. Japan became an imperialist power and colonized
Korea.
East Asian Responses to Western Domination
To say that the dynamic between the Western impact and the Asian responses defined
modern East Asia is overly simplistic. We need to examine the internal dynamic for
transformation within the region. Westerners in the early stage of the East-West interaction
also participated in the existing regional trading networks.10 Although the Europeans had
controlled important Southeast Asian ports and commodities by 1650, they did not yet have
enough strength to impose direct rule on the native peoples.11 Before the mid-nineteenth
century, Westerners engaged East Asia essentially on East Asian governments’ terms,
particularly in Northeast Asia.12 The Dutch East India Company, for example, was frustrated
in their effort to establish trade with China in the late seventeenth century but did not take
any actions to change the terms of the contact with the Chinese. In 1661 Zheng Cheng-gong
(known as Koxinga to Westerners), who was a Ming rebel against the Qing court, destroyed
the Dutch rule in Taiwan. In fact, the Dutch envoys to Beijing in 1656 accepted the role of
tributary envoys and performed kowtow to the Chinese emperor.13 The Qing government
severely restricted the Westerners’ access to the China market. In 1757 Beijing designated
Canton (now Guangzhou) as the only port open to foreign commerce. The Qing government
authorized only thirteen Chinese commercial firms to handle foreign trade and imposed strict
90

regulations on foreign traders, restricting foreigners’ contact with the Chinese and imposing
arbitrary fees. The system collapsed only after the Opium War of 1839–1842.14 Japan’s
Tokugawa government allowed only the Dutch to trade in Japan, and they could reside only
in a restricted area in Nagasaki. Korea went even further and allowed only an indirect foreign
contact via China and “emerged” only in the 1870s.
Furthermore, some East Asian countries were expanding their own empires during this
period.15 China paid far more attention to its northern border, as it had done for most of the
past two millenniums. The Ming court engaged in major military campaigns against the
Mongols, who were perceived to be the principal threat to China. At the same time, Nurhaci
(1559–1626) and Hongtaiji (1592–1643) in Manchuria built a strong state and conquered
Ming China. As shown in Map 4.2, the Manchus built an empire twice as large as Ming
China. It was largely the Qing territories that modern China lays claim to. While Chinese
nationalists can refer to earlier times in the Han and Tang dynasties when the emperor had
large territories as well, Qing China’s expansion was on the same scale as America’s move to
the west and Russia’s move to the east. Qing scholars generally consider the Qing the most
successful conquest dynasty in Chinese history.16 Japan’s Hideyoshi Toyotomi tried in vain
to conquer Korea and then China in the late sixteenth century. Japanese territories expanded
in the seventeenth and eighteenth centuries with the conquest of the Ainu lands, which are
now Hokkaido, Sakhalin, and the Kuriles.17 Burma expanded in all directions in the 1750s.
From the early sixteenth century, Vietnamese were moving south and incorporated central
Vietnam and southern Vietnam. In short, the East Asians were as willing and capable of
building empires as the Europeans.
MAP 4.2
China in the Qing Dynasty, 1644–1911
With Northeast Asia forced into free trade by Western powers after the mid-nineteenth
century, East Asians could also penetrate neighboring markets. Chinese merchants took
advantage of the free trade environment maintained by the Western powers and built an
extensive and competitive network in East Asia through intra-Asian trade, migration, and
capital flows. Indian and Japanese merchants were also active. Thus, East Asians had to
91

respond to East Asian commercial challenges as well as to the Western challenge. As some
Japanese scholars have argued, the Japanese industrialization had much to do with a desire to
end the Chinese commercial domination.18
The European military domination after the mid-nineteenth century forced East Asian
states to respond. If East Asians had been blind to the power of the West in the early stage of
the East-West contact, contemporary officials and thinkers throughout East Asia had come to
recognize the severity of the Western challenge by now. After all, resistance to Western
conquest in East Asia in the nineteenth century was fierce and largely futile. Throughout East
Asia, elites talked about reform. There were two main schools of reformist thought about how
best to respond to the West: one was to revitalize traditional values and the other was to
borrow from Western powers. To some extent, the two schools of thought continue to this
day.
East Asian governments mixed revitalization and borrowing differently. When assessing
the different responses, it is easy to adopt a post hoc explanation and conclude that those
countries that avoided Western domination such as Japan must have adopted better strategies
and those that failed to do so such as China must have adopted faulty ones. This was true to
some extent. At the same time, there are two inherent dangers in post hoc reasoning. First,
whether a country was successful or not was not always contingent on its strategies. We need
to examine the internal and external conditions to determine what was possible and what was
not possible for East Asian nations. It was conceivable for Northeast Asia and mainland
Southeast Asia to survive or thrive in the new international system. They had a long history
of political unity prior to the Western arrival and possessed considerable institutional
capacities. This explains why Western powers penetrated and controlled archipelago
Southeast Asia relatively easily while accepting the terms of Northeast Asian and mainland
Southeast Asian governments until they built up sufficient power to break down the
resistance. Second, when a state failed in responding to the West, it did not necessarily mean
that all elements of its response failed and a radical alternative would always be preferable.
In Northeast Asia, Japan successfully adapted to the new Western imperialist order and
joined the Western powers on an equal footing by the end of the nineteenth century. Japan
will be discussed in detail in the next section. By contrast, China and Korea could not reform
themselves thoroughly and fast enough to avoid becoming victims of imperialism. China
ended up as a so-called semicolony with foreign powers creating spheres of influence in the
country. Korea became Japan’s colony.
As the center of the Chinese world order, China the Middle Kingdom was resistant to
fundamental change. The Opium War shattered China’s position in East Asia but did not
immediately change China’s conduct of foreign policy and domestic policy. Rather, it took
another twenty years for China to use treaties as a basis for dealing with the West and another
twenty years for China to join the Westphalian system diplomatically. During the forty years
of adjustment, the Manchu court used treaties to manage Westerners in terms of Chinese
traditions.19 It took more military defeats for the Chinese government to introduce more
drastic reforms to strengthen its dynasty, first after the British and French troops seized
Beijing and burned the Summer Palace in 1860 and then after a humiliating loss to Japan in
the Sino-Japanese War of 1894–1895. In the 1890s Chinese reformist thinkers such as Yan
Fu, Liang Qichao, and Kang Youwei broke from the Confucianist world order and endorsed
the Western international system by seeking to transform China from a universal empire to a
strong state. The Qing reform movement afterward essentially accepted China’s position as a
state in a multistate system.20 The Chinese court’s reform failed to save it. The dynasty
collapsed in 1911, and China sank into a chaotic period of warlords.
China did not fail on all fronts, however. China was being transformed on the societal
level. Native Chinese capital grew competitive. Chinese traders came to defeat foreign rivals
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in controlling China’s domestic market and foreign trade.21 After the 1895 Shimonoseki
Treaty allowed foreign firms to invest in industrial operations in China, native Chinese
industrial firms proved competitive vis-à-vis foreign firms.22 With the collapse of the Qing
dynasty, Chinese capitalism entered a “golden age” with Chinese enterprises and banks
emerging, particularly in 1910–1920.23 Chinese merchants were actually dominant in an
intra-Asia trade network, beating both Western and Asian competitors in the second half of
the nineteenth century.
Ultimately, China failed because the Chinese state failed. As discussed in the previous
chapter, the Chinese empire operated on a political system suitable for an agrarian society
facing no competing civilizations. Seeing limited tax burden on peasants as central to social
order and political stability, the Chinese empire traditionally did not have sufficient
resources. The Qing court continued to follow the traditional logic of political and social
stability even after the Opium War. Put simply, the Chinese government did not have enough
resources to build a modern military force and modern infrastructures. Rampant corruption,
typical of the end of the Chinese dynasty, further diverted resources away from
modernization. On top of that, unlike in Japan where the elite and society could rally behind
the emperor as a direct descendent of the sun god, it was difficult for the majority Han
Chinese to place hope on Manchu emperors they still considered to be foreigners. In such an
environment, reform measures by local governments created local power centers that came to
challenge the central government.
The removal of the oppressive Chinese state helped the Chinese bourgeoisie to grow in
1915–1927, but the weak Chinese state, specifically weak policy initiatives and public
investment, explained why China could not sustain this development. In a stage of late
development and weak power position in the world, China needed a strong state to achieve
sustainable economic development: Society could substitute for state initiatives to some
extent but not replace them completely.24
Korea came into contact with the West later than China and Japan. Korea was even more
resistant to borrowing from the West.25 After opening China and Japan for trade, Westerners
also pressured Korea for the rights to trade, to conduct missionary activities, and to establish
diplomatic relations. The Koreans saw their country as occupying a high place in the
Confucianist Chinese world order. Korea’s sense of cultural superiority affected its attitudes
toward the West and Japan. Considering Westerners and reforming Japanese as inferior
barbarians, the dominant conservative forces in the Korean government refused to take any
reform measures in a changing time. In fact, Korean elites also viewed China’s decision to
open to the West with disdain.26 At the same time, there were disgruntled elements within the
ruling yangban elite and second-tier elite who wanted to change the status quo. Based on
their historical experience, Korean reformers saw the Western order as a hierarchical one
based on culture and in which Korea could learn to excel. But their emphasis was on culture
and education in an imperialist age based on military and economic power.27 Smaller than
China and adopting reforms later than China, Korea’s fate was sealed in an imperialist age.
Japan established control over Korea after its victories against China in the 1894–1895 War.
Japan became a protector of Korea after defeating Russia in the 1904–1905 War and annexed
Korea in 1910.
In Southeast Asia, there were also revitalizers and borrowers. Revitalizers called on
people to resist the West in a just and righteous cause. They blamed the failure of their states
on deviation from traditional values and wanted to resist the West by going back to their
traditions. By contrast, borrowers viewed the technical superiority of the West as the key to
Western power and therefore saw the solution in borrowing Western technologies to beat the
West. Southeast Asian monarchs tried to obtain steamships, the symbol of Western power.
Vietnam had steamships and built a factory to reproduce steam engines in the 1830s. Siam
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and Burma acquired steamships in the 1850s. However, borrowers came to realize that they
needed to copy more than just steamships and gradually expanded borrowing to include
government and education.28 Ultimately, reforms did not succeed in most cases. Southeast
Asia, except Thailand, was colonized.
The Jesuits arrived in Vietnam in 1615. Vietnam adopted an approach similar to those of
China and Korea. Once a civil war ended and Nguyen Anh became the emperor in 1802, the
Vietnamese government reasserted Confucian principles and sought to stamp out Western
influence, particularly the French missionaries. The French who had become involved in the
civil war seized the opportunity and established colonial control in Vietnam. The French
naval ships attacked Vietnamese ports in the 1840s to demand release of imprisoned
missionaries. A joint French-Spanish force sacked Saigon in 1859 and created a colony of
Cochin-China in the south. The 1862 treaty between France and Vietnam gave France an
indemnity of $4 million, trading rights, rights to spread Christianity, and direct control of
three provinces in the south. In 1883, the French established a protectorate over Annam and
Tonkin after attacking the north and fighting a war with China.
Burma asserted itself against the British with a tragic ending. Burma’s expansion came
into conflict with Britain, which jealously guarded its interests in India. The British and
Burmese fought a two-year war. Britain scored military victories, and the Treaty of Yandabo
was signed in 1826. The Burmese court did not reform its military or adjust its foreign policy
toward Britain after that war. When British troops fought another war in Burma in 1852 and
seized lower Burma, Burma tried to reform and to accommodate British interests. However,
the French arrival in Southeast Asia in the 1870s and 1880s prompted Britain to seize full
control of Burma. In 1885 Britain waged the third war against Burma and annexed the
remainder of Burma in January 1886.
Thailand succeeded in defending its independence. The Thai kingdom was at its peak of
power when Western pressures began, which allowed the Thais to make concessions to
Western powers in Laos, Cambodia, and the south while keeping the core Thai territories.
The Thai government avoided confrontation and signed unequal treaties with the West. In
1826 the Thai Kingdom concluded the Burney Treaty with the British East India Company.
In 1855 Thailand and Britain agreed to allow extraterritoriality and limits to Thai tariffs on
British products. Thailand also began reforms. Thailand’s flexible diplomacy clearly
contributed to its survival, but the country also benefited from its position as a buffer zone
between British Burma and French Indochina. After all, Burma had tried to reform and to
accommodate Britain after the 1852 War, to no avail. Thailand secured an equal status by
joining the British and French during the First World War and participating in the Paris Peace
Conference.
Legacies of Western Colonialism
East Asia had traditional empires and states with distinct identities lasting for hundreds or
thousands of years and had a vibrant economy linked regionally. At the same time, Western
imperialism had a profound impact on East Asian IPE. The interaction with the West served
as an external catalyst for domestic transformation in East Asia.
East Asian international political economy. The Western arrival had a profound, direct
impact on East Asian IPE. First, Western imperialism destroyed the Chinese world order,
created an imperialist order, and colonized virtually all East Asian states. Thus, most East
Asian peoples fought to win independence as an equal sovereign state in the West-dominated
international system. Sovereignty, once achieved, is a jealously guarded national treasure.
East Asians are fully embracing the Westphalian system, particularly the notion of
noninterference in domestic affairs, while Europe is moving away from that conception. As
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will be discussed in Chapter 11, East Asia’s emphasis on sovereignty and Europe’s
abandonment of nation state sovereignty is one reason why Europe has been far more
successful than East Asia in institutionalizing regional integration.
A specific legacy from the colonial days is a widely held belief that a strong and
supportive state is needed to ensure national security and national capacity to compete
internationally, thus the root of economic nationalism. The Chinese businessmen, for
instance, found trading conditions worsened by the 1880s and felt strongly that without a
strong state they could not compete against Western firms that enjoyed advantages in the
treaty ports and strong backing from home governments.29
Second, Western powers created some states in East Asia. Indonesia, Malaysia, the
Philippines, and Singapore were colonial creations. While Burma, Thailand, Cambodia, and
Vietnam had had political identities before the Western arrival, Western powers determined
their current borders. Western colonialism had a varied impact on the domestic political
institutions and practices of East Asian nations. The United States, for example, decentralized
the Philippines’ political system based on the assumption that the Philippines was historically
overly centralized.30
Third, Western imperialism integrated East Asia more closely into the global market.
While controlling footholds in Melaka, Macao, Nagasaki, and Manila, Europeans facilitated
trade expansion between East Asia and the rest of the world. Manila, for instance, was a
center for the galleon trade in which Chinese traded silks, ceramics, and cottons for silver
shipped from the new world.
Fourth, European and American treaties with East Asians allowed the treaty ports to be
connected, forming an intra-Asia network for East Asians as well as Westerners.31 Western
powers also left a legacy of institutions, education, technologies, and cultures. Colonial
legacies were part of the reason for the later successes of Hong Kong and Singapore. A
familiarity with Western culture and practice and with the English language gave the two
cities advantages over the rest of East Asia in international commerce.32 As a testament to
colonial legacies, the most vibrant commercial cities such as Singapore, Hong Kong, Manila,
and Shanghai traced their origins to the Western imperial period. It is no coincidence China’s
economic reform began with coastal cities.
Fifth, a mass migration in the Western imperialist period explains why Chinese networks
strengthened in Southeast Asia, which would become a major shaping force for East Asian
IPE in later years. Chinese had been moving southward for centuries, but large migrations did
not take place until Western powers came to control Southeast Asia.33 Because of the Ming
court’s ban on Chinese returning home, Chinese settlers married local women and became
assimilated in the sixteenth century. The Western colonial rule in Southeast Asia meant
greater commercial opportunities for the Chinese. Chinese population in Thailand, Malaya,
Singapore, and Indonesia increased from about 700,000 in 1860 to 3.8 million in 1931.34 One
estimate put the influx of Chinese to Southeast Asia at over 16 million between 1891 and
1939. While most returned to China after a short stay, around 6.2 million Chinese resided in
the region in the 1930s. The Chinese migration networks greatly facilitated an intra-Asia
network.35
Nationalism and communism. Western imperialism also had a profound impact on East Asian
nations’ underlying ideologies. East Asians had to make sense of the drastic changes they
were observing and to create a new system to view the world and to act accordingly. Two of
the ideologies in response to colonialism were nationalism and communism.36 Both
nationalism and communism had a profound impact on East Asian political economy then
and now, shaping the basic geography of political economy in East Asia after 1945. One
camp comprised firmly nationalist, capitalist countries and the other communist countries.
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Nationalism as a modern ideology originated in Europe. It refers to an emotional
attachment to one’s nation and the idea that members of a nation should be able to determine
their own destiny and create a state of their own.37 The rise of East Asian nationalism was in
part a direct response to Western imperialism. Unequal treaties were an immediate reason for
resistance. Japanese, Chinese, and other East Asians were eager to restore rights such as tariff
autonomy. The nationalist ideology borrowed from Europe by East Asians would later be
used against colonial powers. Europeans trained some local elites but did not offer them
opportunities. These elites were resentful and came to realize that there was equality in the
colonial powers’ home countries.38 In fact, the nationalists from the Dutch East Indies who
were studying in Netherlands began to use the term Indonesia in the 1920s. Nationalism arose
in the Philippines in the late nineteenth century. Similar to what happened in Latin America,
the Creoles (island-born Spaniards) and Mestizos (mixed race) tried to forge a separate
identity because the Spanish colonial government excluded them from decision making.39
Although nationalism as a modern ideology came from Europe, nationalism evolved
naturally from a strong sense of nationhood and communities that already existed in East
Asia. For Korean nationalists, for example, Korea “regained” political independence from
Japan in 1945 because Korea had been independent practically for centuries already.40 A
similar sense of nationhood existed in Vietnam.41 The challenge of nationalism in archipelago
Southeast Asia was to forge new nations within the boundaries artificially created by colonial
governments.
One school of nationalism came early. The early modernization drive in East Asia had a
clear nationalist basis. Chinese, Japanese, and Koreans recognized the technological
superiority of the West, and all sought to borrow Western technologies while maintaining
traditional values. The Chinese differentiated ti, which is essence or Confucian values, from
yong, which is the practical or the Western technologies. Japan’s nationalism after
encountering the West in the nineteenth century traced its origin to the Japanese spirit. The
myth of the land of gods and the emperor descended from Gods created a religious,
nationalist fervor about Japan’s superiority over other peoples. Japanese talked about wakon
yōsai, which means Japanese spirit, Western technology. The early version of East Asian
nationalism was reflected in the slogan “enrich the nation, strengthen the army” (fukoku
kyohei in Japanese and fuguoqiangbing in Chinese). Such a nationalist origin of
modernization effort explains the state’s active support and paternalist attitudes toward the
private sector.42 With Western thoughts largely filtered through Japan and China, Korean
intellectuals also sought to understand the secret of Western power and wealth.43 The
tradition of economic nationalism runs deep in East Asia. Economic nationalism remains
potent in an era of globalization, particularly in Northeast Asia.44
Although response to the West was a principal reason for East Asian nationalism, it was
not the only one. For some nations, anti-Chinese sentiment was a major source of
nationalism. Vietnamese defined their national identity partly by their millennium struggle to
maintain independence from China.45 Indigenous Indonesian nationalists targeted the Chinese
who enjoyed economic success and influence under the Dutch rule.46 In Malaya, ethnic
Malays were more interested in working with the British to maintain their privileges as sons
of the soil (bumiputras), so the Malay nationalism was aimed at the immigrant communities,
particularly the Chinese. By contrast, ethnic Chinese were more willing to challenge the
British colonial governments. For China and Korea, nationalism was heavily anti-Japanese as
well as anti-Western. Burma faced a problem of competing nationalisms by ethnic minorities
such as the Karens.
Communism refers to the Marxist ideology, which sees a structural exploitation in the
capitalist systems and advocates creation of a political system in which properties are
commonly owned. Though a European creation, communism resonated with some East
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Asians. Communism promised a universal system with universal kinship, which was similar
to Confucianism in that regard. It also promised an alternative to what they viewed as a
predatory Western capitalist system. The Bolshevik Revolution in Russia inspired many
Asian revolutionaries, and the Soviet government explicitly appealed to East Asians in a
common struggle against imperialism.
Communism was a potent political force in East Asia, prevailing in China, North Korea,
and Indochina. Communist parties were also active in other countries including Japan. In
particular, the Indonesian Communist Party was the largest communist party in the
noncommunist world until it was crushed in a bloody massacre in 1965.
In East Asia, nationalism and communism were related. Communists were also
nationalists, the only difference being that they wanted a more drastic approach toward
political and societal change. Nationalists and communists often came from similar educated
backgrounds. Communists often cooperated with nationalists in coalitions while maintaining
their own organizational identity in China, Vietnam, Indonesia, Korea, and elsewhere in East
Asia. Communist states tried to sever economic ties with the West while connecting to the
socialist camp. As soon as communism faded in countries like China and Vietnam,
nationalism seamlessly stepped into the void.
JAPANESE IMPERIALISM
Japanese Response to Western Imperialism
Japan’s contact with Westerners began in the sixteenth century. The Portuguese came to
Japan in 1542 and converted half a million Japanese, more than the percentage of Christians
in Japan today. They also introduced firearms to Japan. In 1603 Tokugawa Ieyasu established
the Tokugawa shogunate in Edo, now called Tokyo. The Tokugawa shogunate stamped out
Catholicism by 1638. As a result of this anti-Christian sentiment, Japan banned trade with
Western nations except Holland. The Tokugawa government dictated the terms by which it
would engage the outside world.
Like China, Japan became a victim of Western imperialism after the mid-nineteenth
century. In 1853, Commodore Matthew Perry forced the Japanese to allow port access to
American ships. The United States signed a treaty in 1854, with limited success, and then a
full treaty in 1858. Other European powers followed suit. These treaties were unequal, similar
to those imposed on China. They allowed Western powers to provide military protection of
foreign merchants at open ports and to enjoy extraterritorial privileges, and they ended
Japan’s autonomy in determining tariffs.
Unlike China, Japan responded quickly to the new challenge. The unequal treaties
imposed on Japan led to a fundamental shift in Japan’s worldview, which in turn led to
fundamental transformations of Japanese politics, economy, and society.47 A coalition of
outer daimyos seized Kyoto and restored direct imperial rule on January 3, 1868. The
imperial forces then occupied Edo and ended the Tokugawa rule. The 1868 Meiji Restoration
started with a slogan of “honor the emperor and expel the barbarians.” But Japanese elites
came to realize that while the slogan was convenient for overthrowing the shogunate, a
confrontation with the West would be disastrous. Japan’s strategic goal was seen as building
up national strength by learning the advanced military and economic technologies from the
West.
Some Japanese strategic thinkers had proposed such a program before the Meiji
Restoration. Hotta Masayoshi wrote in a memorandum in 1857 that “military power always
springs from national wealth” and that wealth is “principally to be found in trade and
commerce.” A related school of thought was that the best defense was offense. Yoshida
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Shōin (1830–1859) reasoned that Japan should seize Manchuria, Korea, and the islands to the
south to keep watch on Russia and China. An opposing view represented by Aizawa Seishisai
(1782–1863), who was guarded against “corrupt” foreign ways, urged preservation of
traditions.48
Japan now followed the slogan of wakon yōsai (Japanese spirit, Western ability), namely
to acquire modern institutions and technologies while sticking to Japanese traditions. Japan
conducted more thorough reforms than did China, introducing a whole range of institutions,
ideologies, and technologies from the West. The Japanese reformers centralized military and
political power and mobilized limited resources to build a strong military and improve
infrastructure to fend off Western pressure. The Meiji Restoration was an impressive
accomplishment. Few nations have been able to transform their societies in such a short
period.
Japan also emphasized the Japanese spirit to an extent unmatched in China. A reinforced
Japanese spirit based on the myth of the “land of gods” and of the Japanese emperor as a
direct descendant of the sun god justified Japanese superiority to other peoples. Later
Japanese leaders used such a myth to become a grave threat to other nations. Moreover,
Japanese elites at the time felt that Japan should emulate the West in an imperialist age,
namely to create its own colonial empire for security from the West and an equal status with
Western powers.49 An emulation of the West meant that Japan should behave like Western
powers in dealing with other Asian nations.50
A key purpose of Japan’s Meiji reformers was to modernize Japanese economy to provide
the base for a strong military. Japan also responded to both the opportunities and competition
from other Asian countries, particularly China. Japanese merchants utilized the Chinese
commercial network in Asia to promote exports. The presence of Chinese competition also
spurred Japanese efforts to upgrade technologies and organizations. Put simply, Japan’s
industrialization also resulted from an intra-Asia dynamic.51
From the Meiji Restoration to 1914, Japan’s economy went through three stages. In the
first stage from 1868 to 1880, the Japanese government sought to protect Japan’s domestic
market and use government investment in strategic sectors such as munitions, shipyards,
transport, and communications and to support import-substituting industries such as textile,
cement, and glass. In the next stage from 1880 to 1894, Japan achieved progress in silk and
cotton industries. In the third stage from 1894 to 1914, an industrial sector emerged in Japan,
and the Japanese government began to facilitate heavy industrial development in
shipbuilding, iron and steel, and electric power.52 Japan achieved impressive economic
growth. While not yet an economic power on a par with Western nations by 1914, Japan was
on its way to becoming an industrial power.
History of Japanese Imperialism
Japan first sought to reestablish relations with Asia on Western terms. In 1870 the Meiji
government sought to establish official relations with China by concluding a formal treaty.
The Manchu court concluded a treaty with Japan despite opposition from conservative
officials who treated Japan as a former tributary state. Some Japanese leaders wanted to
attack other Asian nations immediately after the Meiji Restoration, partly to divert the
aggressiveness of the samurai class that had been deprived of privileges and fringe benefits.
The government rejected an appeal to attack Korea but approved an expedition to Taiwan in
1874. The Meiji government also contacted the Korean government to adjust the traditional
relationship between Korea and the Japanese feudal lord of the Tsushima Islands. The Korean
government refused to acknowledge the Japanese emperor on the ground that only the
Chinese emperor could use such a title. As a tributary state to China, Japan that becomes an
equal of China would necessarily be higher in status than Korea. Japan sent gunboats to
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Korea in 1875 and forced Korea to conclude the Treaty of Kangwha in 1876. Korea opened
three ports for Japan, exchanged diplomatic envoys, and allowed Japanese consular
jurisdiction in the three ports.
As shown in Map 4.3, Japan began expansion toward the end of the nineteenth century.53
Japan seized Bonin Islands in 1876 and annexed Ryukyu Islands in 1879. In 1894–1895,
Japan defeated China, acquired its first colony, Taiwan, and increased its influence in Korea.
After defeating Russia in the Russo-Japanese War of 1904–1905, Japan received a long-term
lease on China’s Liaodong Peninsula, renaming it as the Kwantung Leased Territory, and
Southern Sakhalin from Russia, renaming it Karafuto. Japan also turned Korea into a
protectorate in 1905 and annexed the country in 1910.54 Japan joined the First World War on
the side of Great Britain and the United States and was awarded mandatory control over the
German islands in Micronesia, namely the Marshalls, the Carolines, and the Marianas (not
including Guam), which Japan renamed Nanyō guntō. Thus Japan established its formal
colonial empire by 1922, including Taiwan, Korea, the Kwantung Leased Territory, Karafuto,
and Nanyō guntō. Japan also formed an informal empire in China after 1895, based on trade,
investment, treaty port settlements, and cultural activities.55
While Japan’s slogan was “enrich the nation, strengthen the army,” it did not wait to
strengthen the army until after enriching the nation. The two goals went hand in hand.
Japan’s early success against China and Korea showed that power can also enhance wealth.
In the Sino-Japanese War of 1894–1895, Japan did not have a stronger economy than China
or better weapons than China. Rather, the strength and the effort of the Japanese state made
the difference. Japan mobilized resources for national defense. The war cost the Japanese
government about ¥200 million, but Japan received an indemnity of ¥366 million, which was
4.6 times Japan’s annual public expenditure or 4.3 times its annual ordinary revenues before
the war, and Japan expanded territories by seizing Taiwan.56 By contrast, the war cost China
dearly and weakened the state further.
MAP 4.3
Japanese Expansion in Asia, 1895–1941
The Meiji government was basically bankrupt by 1880 owing to expenditures to buy off
the samurai class, to pay for the expedition to Taiwan and a civil war, and to repress several
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peasant uprisings. To fight off high inflation, the Meiji government sold off state enterprises
at low prices to “political merchants” with close ties with the government or former high
government officials. The zaibatsu who traced their origin to this period would cooperate
closely with the government. The old zaibatsu came to have political influence on the
government by financing political parties. The military, which distrusted the old zaibatsu and
politicians, promoted new zaibatsu to meet the needs of the military. Both old and new
zaibatsu kept Japan’s perceived national interest in mind. The Japanese state and the military
used state capitalism to finance and support frequent foreign wars and acquisition of colonies.
The government favored certain enterprises deemed capable of competing with Western
firms. A dual economic structure of large competitive firms versus small enterprises emerged.
The Japanese enterprises were forced to adapt to a war economy in the 1930s. From that
experience, the Japanese government, companies, and workers learned how to adapt to
achieve industrial change, which would be useful for Japan’s postwar development.57
Japan’s initial push in Korea, Taiwan, and Manchuria was driven mainly by strategic
interests and prestige. Economic reasoning was present but not dominant. After all, the
concern was mainly economic costs rather than economic necessities. This would change
when Japan became a more industrialized country by the end of the First World War. Japan
was now more concerned about securing supplies of raw materials and markets overseas.
Japan’s greater economic ability also meant that Japan used economic power, backed by
military power, vis-à-vis its Asian neighbors the same way as Western powers. This is
particularly the case in China. Japan invested heavily in strategic sectors such as railways and
mining. The Japanese government also participated in consortium loans to the Chinese
government to support pro-Japanese Chinese leaders and secure more advantages. In the case
of China, Japan participated with Western powers to lend to the Chinese government within
the treaty port system in 1895–1930. This form of “cooperative imperialism” did not last long
because of Japan’s continuous rise and its far greater needs for raw materials from China than
the Western powers. By the 1920s, Japan increasingly relied on imports of coal for its heavy
industry. Once the Great Depression took place, Japan turned unilateralist.
In the late 1920s, Japan faced difficulties abroad because of the protectionist policies
adopted by major powers in the aftermath of the Great Depression. The Japanese armed
forces increasingly agitated against party politicians and businessmen, whom some young
officers considered to have been corrupted by Western capitalism. The pressure on Japan to
expand its trade and send its people to other regions was a driver for a more aggressive
foreign policy since Japan was a late-comer in the imperialist game.
Japan turned to China as a target for expansion. The Japanese army took action in
Manchuria in anticipation of a weaker Japanese position due to China’s rising nationalism.
On September 18, 1931, the Japanese army seized China’s three northeastern provinces.
Japan’s aggression threatened the status quo in East Asia and started a second round of
imperial expansion. On July 7, 1937, war broke out between China and Japan. After Germany
occupied France in June 1940, Japanese troops seized North Vietnam in the summer of 1940
and South Vietnam the next summer. The United States resorted to embargo of oil supplies to
Japan after Japan occupied South Vietnam. On December 7, 1941, Japan attacked Pearl
Harbor. Simultaneously, Japan conquered Southeast Asia. By the end of 1942, Japan came to
control 340–350 million people in East Asia, with a territory larger than that indicated in Map
4.3.
Japanese imperialism had a clear economic dimension. A strong economic basis was seen
as the source of national wealth, and industry and trade were viewed as central elements of
acquiring wealth. Military force would provide protection and create commercial
opportunities. This does not mean that economic rationale drove every single Japanese move.
In the early days, security concerns about Japan in a competitive international environment
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were dominant, but Japan’s military expansion created opportunities for Japanese trade and
industry. Economic weaknesses sometimes also served as a check on Japan’s ambition in
policy debates. The Great Depression decreased Japan’s trade with China and Manchuria
while Japan’s trade with Taiwan and Korea increased, which made Japan believe that it
would be more advantageous for Japanese commercial interests where it enjoys direct
administrative control.58 Japan became more integrated with Korea, Taiwan, Manchuria, and
China proper. However, Japan became increasingly dependent on Southeast Asia for strategic
materials such as oil, iron, rubber, and tin. Economic self-sufficiency now required a much
larger formal or informal colony than before.
In short, Japan was creating an imperialist order in East Asia. Similar to other imperialist
powers, there was hesitancy and pullback at times. Japan’s expansion was based on brute
force, but Japan also wanted to legitimize its empire by creating a rationale behind it. In the
early days, Japan justified its empire-building based on security (line of advantages) and
international prestige (an advanced country has to have colonies). This line of argument
would make Japan a major player in the existing imperialist order dominated by the West. In
later years when Japan wanted to dominate the region and engaged in direct competition with
the West, Japan increasingly espoused a race-based co-prosperity notion to sugarcoat its
imperialist order. The notion had been discussed in the early days of Meiji but was now
pushed with greater urgency. By the end of 1937 Prime Minister Konoe Fumimaro talked
about creating a new order in Northeast Asia. Some intellectuals working for Konoe argued
that unlike individualistic Western imperialism, Japan was seeking to lead a true partnership
with Asia, based on an Asian conception of justice and Japanese ethic.59 Foreign Minister
Matsuoka Yosuke announced the goal of the Greater East Asia Co-Prosperity Sphere in a
press conference in August 1940, using the slogan of freeing fellow Asians from Western
powers.60 In practice, the Japanese colonial empire shares much in common with all empires
in that the colonizers use brute force to subdue the colonized.
Ultimately, Japan’s imperialist agenda failed. Japan could not match the United States in
material wealth. The pattern of trade between Japan and the United States shows a high
percentage of silk in exports to the United States while cotton, oil, machinery, and
automobiles came from the United States. Japan had become an exporter of manufactured
products to Asia but was still a backward supplier of raw materials to the United States.
Equally important, rising nationalism in Asia made Japan’s project impossible to implement.
Legacies of Japanese Imperialism
What is striking about Japanese imperialism is the speed by which Japan built a massive
colonial empire within a mere fifty years (1895–1945). By contrast, it took European colonial
powers more than three centuries to exercise direct colonial administrations in East Asia.
Japanese colonialism also had a varied impact on East Asia, fifty years in Taiwan, thirty-five
years in Korea, and three or four years in Southeast Asia. Short though it was, Japanese
imperialism as a historical force had a strong impact on the future developments of East
Asian IPE. To say that Western imperialism or Japanese imperialism left some positive
legacies in no way justifies imperialism in the first place.
East Asian international political economy. First, similar to what Western imperialism did to
the Chinese world order, Japanese imperialism helped to destroy the Western imperialist
order in East Asia. Despite a pan-Asian rhetoric, Japan invaded Southeast Asia for its own
strategic interests and to replace Western powers as the master in the region. But its short stay
in the region contributed to the end of Western colonialism in Southeast Asia. The Japanese
destroyed the prestige of Westerners in Southeast Asia by defeating them soundly in the early
stage of the war. They also elevated local people into the colonial administration, which
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would make return of former colonial rulers difficult. The Japanese created puppet states in
Burma and the Philippines in 1943 and proposed a future independent Indonesia in 1944. In
Indonesia, Japanese trained and equipped local troops, which gave Indonesians modern
military experience. By 1945, the Java auxiliary army had 35,000 men.61 This armed group
would fight the returning Dutch troops. The Japanese military government in Java granted
independence to the East Indies four days before Japan surrendered. Japan also granted
nominal independence to Burma on August 1, 1943. Aung San, the father of Burmese
independence, led the Burmese Independence Army trained by the Japanese.
Second, Japan’s colonialism had a long-term impact on East Asia’s later developments in
political economy.62 Japan introduced a highly centralized political system and heavy state
intervention in the economy. While Japan’s colonial policy was meant to benefit itself and
was brutal in implementation, it improved the infrastructure and public education. The
Japanese reinvested much of the surplus in the economic development of Korea and Taiwan.
Unlike Western powers, Japan created heavy industry in the colonies.63 Thus, Japanese
colonial rule laid the foundations for Taiwan and Korea to enjoy a head start against the rest
of East Asia in postwar economic development.
East Asian nationalism and communism. Nationalism and communism predated Japan’s
attempt to create its international order in East Asia, but Japan’s imperialist expansion had an
unintended consequence of strengthening the nationalist and communist movements
throughout East Asia.
Japan served as a model for many reformers throughout East Asia. In Korea, some young
progressive reformers sought reform modeled after Meiji Japan. Japan’s defeat of Russia in
1904–1905 left a deep impression on East Asians. A major wave of Chinese students went to
Japan to learn the secret of modernization. Similar admiration for Japan’s accomplishments
developed in other parts of East Asia. Vietnamese anticolonialists, for example, sent a
delegation to Japan in 1905 to seek Japanese intervention in Southeast Asia and Japanese
help to liberate Vietnam.64
Japan’s rapid military victory in Southeast Asia encouraged nationalists in the region by
destroying the mystique of European superiority, but Southeast Asian nationalists would later
turn against Japanese invaders.65 Japan’s surrender in August 1945 also created a temporary
power vacuum in countries like Indonesia and Vietnam where nationalists seized the
opportunity to establish governments, which would make it difficult for the Dutch and French
to reestablish their respective colonial rule in these countries.66 The Japanese occupation of
Indochina also provided opportunities for Lao nationalism and Lao independence.67
The Japanese occupation also helped explain the communist success in China and North
Korea. Japan’s invasion weakened the Chinese Nationalist government’s control over large
parts of the country, particularly in the north, and gave the Chinese Communist Party a
golden opportunity to mobilize peasants by appealing to their nationalism and establishing
political dominance in the countryside.68 Mao Zedong himself famously thanked the Japanese
for invading much of China, which made it possible for the Chinese people to unite and for
the Chinese Communist Party to seize power.69 Korean nationalists and communists were
motivated by their resistance to Japan’s colonial rule.70 Ironically, the Korean students who
studied in Japanese universities and colleges, often under liberal-minded Japanese
intellectuals, became critics of Japanese colonial policy in Korea with enhanced nationalist
awareness.71
Japan’s imperialist past on Japan. Japan’s imperialist endeavor has also profoundly affected
Japan itself.72 Its failure discredited that strategy, which channeled Japan to a drastically
different path after World War II. Also Japan possessed a rich pool of economic
102

professionals, businessmen, and officials with intimate knowledge of using the state to
achieve economic growth and of East Asia. Their expertise acquired during the war in the
1940s would be important for postwar Japanese economic development and for Japanese
thinking toward development in Asia in general.
CONCLUSION
Imperialism, Western or Japanese, was a powerful shaping force for East Asian IPE. Western
imperialism ended the Chinese world order and ushered in a new era of a modern
international system. The West prevailed over East Asia not because of commercial
superiority. Rather, use of force and violence was central to the European success in seizing
the market in Asia. Equally important, it was not merely Western merchants or Western
companies but the Western states that served as the agents of Western expansion in East Asia.
This experience taught East Asian nations a major lesson about the reality of modern
international relations: Nation states compete with each other for wealth and power. That
recognition explains why the slogan of “enrich the nation, strengthen the army” has been a
common theme for key nations such as Japan and China. Having an effective state or not
partly explained Japan’s subsequent successes and China’s continuous decline and
disintegration.
A new international order triggers responses. States that imitate the successful ones tend
to survive and thrive. Emulating the West and drawing from its own traditions, Japan
established a formal colonial empire by 1922 and sought to monopolize East Asia in the late
1930s and early 1940s. Japanese imperialism helped to bring an end to Western colonialism
in East Asia by destroying the mystique of Western invincibility, encouraging Asian
nationalists, and creating opportunities for Asian nationalists and communists to assert
themselves during and immediately after the Second World War.
Both Western powers and Japan had a direct impact on the developments of East Asian
IPE. The Westerners forcibly shaped the state system in East Asia by creating new states in
maritime Southeast Asia and settling the borders in mainland Southeast Asia. They also
brought modern education, institutions, technologies, and cultural products to East Asia and
integrated the region more closely to the global market. Japan brought a state-led
development strategy to its colonies and created the foundations for modern economy in
Taiwan and Korea by emphasizing public education and infrastructure and by creating a labor
force experienced with modern agricultural and industrial activities.
Furthermore, Western and Japanese imperialism helped to bring new ideologies such as
nationalism and communism to East Asia. Both ideologies, as powerfully and violently
demonstrated in the region, have had a profound impact on the nature of East Asian IPE.
While recognizing the importance of Western and Japanese imperialism, one should
recognize that modern East Asian political economy was not simply a story of Western
impact and Asian response. Westerners initially played the Asian game on Asian terms.
China, Japan, Vietnam, and Burma, among others, were engaged in their own empire-
building projects. Even when the West came to dominate after the mid-nineteenth century,
the new international order also created opportunities for Asian entrepreneurs to enter
markets of their neighbors, particularly Chinese and Indians who wove an extensive intra-
Asia network. Put simply, East Asians were responding to each other as well as to the
Western challenge.

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Economy,” World Politics 45, no. 4 (July 1993): 501–525.
101. Meredith Woo-Cumings, “Back to Basics: Ideology, Nationalism, and Asian Values in
East Asia,” in Economic Nationalism in a Globalizing World, ed. Eric Helleiner and
Andreas Pickel (Ithaca, N.Y.: Cornell University Press, 2005), 91–117.
102. Bee-Yan Aw, “Singapore,” in Liberalizing Foreign Trade, Vol. II, ed. Demetris
Papageorgiou, Michael Michaely, and Armeane M. Choksi (Cambridge: Blackwell,
1991), 350.
103. Seymour Martin Lipset, “Some Social Requisites of Democracy: Economic Development
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and Political Legitimacy,” American Political Science Review 53, no. 1 (1959): 69–105.
104. Samuel P. Huntington, Political Order in Changing Societies (New Haven: Yale
University Press, 1968).
105. Alice H. Amsden, Asia’s New Giant: South Korea and Late Industrialization (Oxford:
Oxford University Press, 1989), 48–52.
106. Shepherd and Alburo, “The Philippines,” 226–228.
107. Harold Crouch and James W. Morley, “The Dynamics of Political Change,” in Driven by
Growth: Political Change in the Asia-Pacific Region, rev. ed., ed. James M. Morley
(Armonk, N.Y.: M. E. Sharpe, 1999), 313–354.
139

T
CHAPTER 6
The Asian Financial Crisis

his chapter discusses the Asian financial crisis in 1997–1998, a momentous watershed in
East Asian political economy. The crisis hit the region hard and wide. Standards of
living, measured in U.S. dollars, dropped so dramatically for several crisis countries that
decades of efforts appeared to have been for naught. The crisis also revealed some
fundamental flaws in the East Asian political economy, appearing to ridicule the prior
discussion of an impending Asian century in the new millennium. Thus, an analysis of the
crisis helps us understand the nature of the contemporary East Asian political economy and
the power of the contemporary global capital market.
The chapter answers two questions. First, how did the Asian financial crisis spread
throughout the region? The crisis began in Thailand in July 1997 and spread like wildfire to
the rest of East Asia and then outside the region. By tracing the sequence of events prior to
and during the crisis, one will acquire not only a factual account of what happened but also an
understanding of the reasons for the crisis. I will show the variation in the impact of the crisis
on different countries and different policy choices made due to different institutional and
political contexts.
Second, why did the crisis happen? The chapter introduces three main schools of thought.
One school sees East Asia as a victim of the volatile global financial market. Another school
attributes the crisis to misguided macroeconomic policies and weak financial and corporate
sectors. The third school blames the crisis squarely on East Asian crony capitalism. Partly
based on the process of tracing the crisis, the chapter argues that all three factors are
necessary but none is sufficient in itself. The panic of the global financial market explains the
timing of the crisis. At the same time, weak economic fundamentals and crony capitalism
explain why some countries were affected more than others.
TRACING THE CRISIS
The Asian financial crisis was a global crisis, similar to the Latin American debt crisis in the
1980s. It was called the Asian financial crisis because it started in Asia and most of the
affected countries were in East Asia. The Asian financial crisis was the third currency crisis
of the 1990s, following the European Monetary System crisis of 1992–1993 and the Mexican
peso crisis of 1994–1995. The crisis occurred in several waves, each aggravating the previous
ones. For most crisis countries, the crisis followed a similar pattern: a foreign exchange crisis
led to a sharp depreciation of the local currency, to a banking crisis, to a full economic crisis,
to a social crisis, and to a political crisis.
In the first wave, the Asian financial crisis began as a foreign exchange crisis when
Thailand’s central bank was forced to float the Thai currency baht on July 2, 1997.1 In
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retrospect, there were strong reasons that Thailand was the first to fall. Thailand had sought
to create an international financial center in Bangkok in the early 1990s by liberalizing the
financial sector without introducing effective oversight. Foreign capital inundated Thai
financial institutions and companies, facilitated by the baht’s peg to the U.S. dollar at a rate
of 25 baht to one dollar since 1985, which minimized foreign exchange risk. Problems in the
financial institutions began in 1994, but powerful politicians serving in a weak coalition
government who were connected with the failing banks and finance companies prevented the
government from implementing the declared financial restructuring measures, which
weakened the confidence of investors.
The crisis began when speculators decided that Thailand would not be able to defend the
peg and began selling the baht. The Thai central bank tried to defend the peg by purchasing
the baht with U.S. dollars in its foreign reserve. Like any commodities, the value of a
currency is determined by supply and demand. If the relative price of a currency against
another currency is falling, the monetary authority may seek to prevent that by purchasing its
own currency, which increases its demand, and selling the other currency, which increases its
supply, provided that it has sufficient reserves to do so. In the end, the Thai central bank
could not hold the line when its foreign reserve was exhausted. The baht lost 15 percent of its
dollar value immediately and continued to fall, as shown in Figure 6.1. With a rapid flight of
capital and currency depreciation, Thailand asked the International Monetary Fund (IMF) for
help. The IMF offered a bailout package of $17.2 billion on August 11. As conditions for the
loan, Thailand raised interest rates to prevent capital flight; additional measures were adopted
in 1997 and 1998. A combination of sharp depreciation and high interest rates meant that the
proportion of nonperforming loans increased as most Thai banks had unhedged dollar-
denominated loans, much of which had been used for speculative property investments in a
real estate bubble. A banking crisis now took place, which led to a crash in the stock market.
A cheaper baht did not immediately facilitate exports. When the exchange rate is too
unstable, economic transactions become problematic. With a banking crisis, exporters are
also not able to get the credit they need for exports. In response to the crisis, the Thai
government cut spending and citizens lost much personal savings, leading to a demand-
driven recession, a full-blown economic crisis. Social crisis was the next stage, when people
lost their jobs and their savings in the stock market. In the third stage, Thailand experienced a
power transfer. Prime Minister Chavalit Yongchaiyudh resigned on November 3, 1997.
FIGURE 6.1
Decline in East Asian Currencies (monthly average rates)
Source: Calculated based on data from Bank of Korea, http://ecos.bok.or.kr/EIndex_en.jsp.
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http://ecos.bok.or.kr/EIndex_en.jsp

The Thai currency crisis was infectious. Investors were now worried about the
creditworthiness of other Southeast Asian countries that were perceived to be similar to
Thailand. In a cascading effect, the Thai baht’s collapse put competitive pressure on other
currencies. Thus, in 1998 other Southeast Asian nations followed Thailand in floating their
currencies, in the sequence of the Philippine peso on July 11, the Malaysian ringgit another
three days later, and the Indonesian rupiah on August 14.
The Philippines was hit relatively less. As Figure 6.2 shows, the Philippines had a
negative growth rate of 0.6 percent in 1998, much better than –10.5 percent for Thailand, –
13.1 percent for Indonesia, –7.4 percent for Malaysia, and –6.9 percent for South Korea. The
reform under President Fidel V. Ramos (1992–1998) contributed to the ability of the
Philippines to weather the storm. Moreover, the Philippine business community had been
more cautious than their Thai counterparts given their previous crises. But this was mainly a
case in which the country had not flown as high as Thailand, Malaysia, and Indonesia and
therefore did not fall as hard either. Specifically, the Philippines was not as attractive a
destination for foreign investments and accordingly did not suffer as much from capital
flights.2 As Figure 6.2 shows, the Philippines did not grow as fast as the tiger economies
despite progress made under Ramos. Also, the IMF came to the Philippines’ aid quickly, with
a $1.1 billion aid package on July 14.
FIGURE 6.2
GDP Growth for East Asian Economies Affected by the Crisis, 1990–2004
Malaysia took a different approach from Thailand, Indonesia, and South Korea.3 Finance
Minister Anwar Ibraham initially adopted a policy of fiscal and monetary austerity consistent
with the IMF approach, but Prime Minister Mahathir reversed the course. Malaysia imposed
selective capital controls in September 1998 to stem short-term portfolio flows and the ringgit
offshore market in Singapore. Investors were required to have a one-year holding period for
repatriation of portfolio capital flows. Mahathir essentially tried to insulate domestic
economy from the global market. The day after introducing capital controls, Mahathir fired
Anwar, which led to political instability. The capital controls allowed the Malaysian
government to achieve some monetary expansion through lower interest rates. The
government subsequently relaxed capital controls.
Indonesia suffered the most from the crisis.4 Few observers had anticipated such an
outcome. The perceived wisdom in the summer of 1997 was that Indonesia was in a stronger
position than Thailand, with moderate inflation, relatively smaller current account deficit,
absence of a bubble economy effect, and a more centralized decision-making structure.5 The
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Indonesian government initially fended off attack on the rupiah by expanding the intervention
band of the peg from 8 percent to 12 percent on July 11, but that effort made the country an
easy target for speculators. After losing $1.5 billion of foreign exchange to defend the peg,
half a billon on August 13 alone, the government floated the rupiah and increased the
overnight interest rates from 19.5 percent to 36 percent to prevent capital flight on August 14.
The depreciation and high interest rates led to a financial crisis because many banks and
companies were heavily exposed to foreign exchange risks. The government adopted
austerity measures following the IMF prescription in September. The government decided to
seek IMF assistance on October 8 and secured a credit line of $23 billion (increasing to $38
billion later) in exchange for policy reforms on October 31. However, President Suharto
began to send mixed signals about his resolve to implement promised reforms. The rupiah
began declining again in November, partly in reaction to the Korean currency crisis. The
political turmoil resulting from speculation that Suharto was seriously ill and might not seek
reelection sent the currency downward again in December. The IMF and Suharto clashed in
January 1998 when the IMF criticized his budget plan as breaching the targets agreed to with
the Fund. Suharto was forced to sign a second IMF program on January 15. More clashing
with the Fund ensued. The IMF withheld a $3 billion installment scheduled for disbursement
on March 15 to force the Indonesian government to implement agreed reform measures. On
May 4, Suharto raised the prices of fuel, gasoline, and electricity. On the same day, the IMF
approved $1 billion as one-third of the $3 billion credit line. The IMF had wanted price
increases. Protests and looting immediately broke out in the country. Indonesia now had a
major social and political crisis. Suharto resigned on May 21. The IMF bailout package was
augmented in July 1998.
In the second wave, Northeast Asian economies came under attack. Depreciation of
Southeast Asian currencies meant competitive pressure on the rest of East Asia. Deciding not
to intervene in support of the New Taiwan Dollar, Taiwan floated the currency on October
17, 1997. The Taiwan dollar fell by almost 20 percent in the next three months. The stock
market lost more in percentage relative to the local currency in the same period. Nevertheless,
in the end, Taiwan emerged largely unscathed by the crisis. Taiwan’s economy grew by 4.8
percent in 1998, which was not as strong as in 1997 but surely much better than the crisis
countries. Various reasons have been offered to explain Taiwan’s performance, including
sound economic fundamentals, limited reliance on foreign capital, conservative corporate
financing, stronger stock market, a large holding of foreign exchange reserves, and effective
institutions.6
Hong Kong became the next target.7 Hong Kong created a currency board to peg the
Hong Kong dollar to the U.S. dollar in 1983. Hong Kong held the peg, with Beijing’s help; it
was important for China to support Hong Kong right after Hong Kong’s handover to China.
Despite Hong Kong and China’s few hundred billion dollars in foreign reserves, Hong Kong
still took a beating in the stock market. The Hong Kong monetary authority drastically raised
overnight interest rates to prevent capital flight, which led to a sharp fall in the stock market
because Hong Kong was dominated by large development firms, whose profits are affected
by changes in interest rates (high interest is detrimental for development firms). Hong Kong’s
Hang Seng index fell by 10.41 percent on October 23, the largest fall in the history of the
Hong Kong market. The Hong Kong government intervened in the stock market by buying
shares, breaking with its free-market tradition. The turmoil in Hong Kong affected global
financial markets, particularly emerging markets. The Dow Jones industrial average lost
186.88 points or 2.33 percent that day.8
Facing a spreading crisis, investors became concerned about South Korea as well. South
Korea was already in a weaker position starting in 1997 when several large corporations
failed. S&P and Moody’s, two leading international rating agencies, downgraded South
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Korea’s credit rating in late October. Large South Korean conglomerates, or chaebol, had
expanded globally based on foreign borrowing, resulting in weak balance sheets that
investors could readily see. Foreign investors had already been selling stock shares from
August. The Korean stock market price index lost 41 percent from June to November.
Foreign bankers recalled their loans, which explained to a large extent South Korea’s
depleting foreign reserves, with merely $7.3 billion in November. The South Korean
government gave up support for the Korean won on November 21. On December 3, South
Korea agreed to reform measures in exchange for an IMF aid package of $58.4 billion. In the
third quarter of 1998, the country saw a –6.8 percent economic growth rate and a 7.4 percent
unemployment rate, which was a sharp reversal of fortunes considering its average growth
rate of over 7 percent and an average unemployment rate of below 3 percent for the previous
decade.9 Of all the crisis-affected countries, South Korea took the strongest reform measures.
By the end of 1997, a full-blown crisis had developed in most East Asian nations. As
shown in Figure 6.1, the Thai baht, Korean won, Indonesian rupiah, and Malaysian ringgit all
lost significantly against the U.S. dollar. Only the Hong Kong dollar and the Chinese yuan
maintained pegs to the U.S. dollar. The stock markets in the region also fell sharply. By the
end of 1997, Thailand’s stock market had lost 90 percent of its value, Indonesia 85 percent,
Korea 80 percent, and Singapore 60 percent.10
The crisis did not spread evenly throughout the region; some countries were affected
much more than others. Japan had already been in an economic recession and its economy
did not fall in the crisis. Among the tigers Taiwan was affected less than South Korea. In
Southeast Asia, Singapore was affected less than Malaysia partly because it had a managed-
float exchange rate, which preempted the speculative attack. China largely escaped and
emerged stronger after the crisis.11 China had a large holding of foreign exchange reserves,
and its capital control meant a limited short-term capital inflow in the first place. Moreover,
China had attracted mostly direct investment in fixed assets rather than portfolio investment
that can be pulled out in a hurry. Outside East Asia, India was in a similar situation with its
capital controls system.
In the next wave the crisis moved beyond East Asia. Russia defaulted on its foreign debt
in August 1998, and Brazil experienced serious difficulties in early 1999. The IMF
orchestrated a $41 billion package for Brazil in November 1998. Even in the United States,
the hedge fund Long-Term Capital Management collapsed in September 1998.
EXPLAINING THE CRISIS
There has been much heated debate between those who argue that the Asian financial crisis
was caused by external speculative capital and those who argue that the crisis was due to East
Asian crony capitalism.12 The debate was particularly furious during the crisis because it was
not just an intellectual debate. Rather, the outcome of the debate would affect politics and
public policy. In a way, the political debate was about whom to blame for the crisis. Most
Western observers and officials focused on crony capitalism, which was internal to East Asia.
Many Asians, supported by some Western scholars, blamed the volatile global capital market
and inappropriate IMF policy, although few went as far as Malaysia’s Mahathir to blame
Western investors such as George Soros.
With the benefit of hindsight, we may view the Asian financial crisis as a perfect storm.
To understand why it happened, we need to consider both external and domestic factors and
particularly how these factors interacted with each other to cause the outbreak of the crisis.
Both exogenous and domestic factors are necessary and neither is sufficient. To simplify
things, I divide these explanations into three interrelated broad categories: speculative capital,
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unsustainable economic policies in East Asia, and cozy government-business relations.
Speculative Capital
Speculative capital was obviously important for the Asian financial crisis. Without strong
movements of speculative capital across national borders, it would be hard to see how there
can be a regionwide financial crisis. Moreover, the countries that exercise greater capital
control like China and Vietnam did not suffer as much as those with less capital control. Not
only Asians blamed external factors; some prominent Western scholars also held such views.
Jeffrey Sachs felt that the policy fundamentals in East Asia remained sound. The main
problem was a financial panic.13 Robert Wade maintained simply that with the surge in
foreign capital movement, “even ‘best practice’ corporate governance and bank regulation in
Asia would have been unlikely to stop the bubble and crash.”14
The theoretical justification for free flow of capital is straightforward: It leads to a more
efficient allocation of savings and investment because capital can be used where it generates
the highest returns. Developing countries enjoy greater access to capital. An added benefit for
them is that with deregulation and entry of foreign banks, the financial system may be better
disciplined as foreign banks bring with them better accounting practices and create greater
competition in the financial sector. Investors now can seek highest possible returns all around
the world. They can also diversify the risk by spreading their investment portfolio.
The potential dangers of free flow of capital are also well understood. Free capital flow
generates instability because of speculation. Speculators try to make money from the change
in value of a currency by betting correctly on the direction and rate of change in the currency
market. One cannot speculate unless one can trade in currencies easily. Because of lack of
perfect information, people tend to influence each other, creating a herd effect. Thus, there is
an overshoot in market adjustments, more than is justified by economic fundamentals.
Speculators prey on easy targets, namely those governments that peg their currencies to a
strong one without adequate foreign reserves. Speculators bet that the currency will
depreciate and then attack the currency by dumping it on the market. To shore up the
currency, the targeted government has to buy the currency with hard currency, which depletes
official reserves.15 What the Asian financial crisis shows is that although there were structural
reasons such as crony capitalism, there was also a strong element of self-fulfilling panic
leading to the crisis.
Panics are back.16 A panic refers to a widespread fear about declining values of financial
assets that leads to desperate sale of financial assets, which in turn causes an economic
depression. Panics are caused by financial intermediaries, which borrow short (deposits) and
lend long (investments). As a result, a run on banks takes place when everyone tries to take
out their money before others, causing a self-fulfilling collapse of the bank. On the
international level, investors may pull out of a country in a herd effect, causing the country’s
financial collapse. Then the financial crisis may spread to other countries, causing a global
panic.
Financial panics used to be common but were largely absent from the 1930s to the 1980s.
To prevent panic, the U.S. federal government, for instance, created three mechanisms: (a)
deposit insurance to boost confidence of depositors, (b) regulations to prevent banks from
risky investments (moral hazard), and (c) use of the central bank to act as lenders of last
resort. These measures effectively prevented panics at the expense of an efficient allocation
of savings to best investors.
In recent years, deregulation has made the financial market more efficient, but that also
means that players take bigger risks to be competitive, which causes panics to recur. With a
global capital market, when investors become nervous, they want the U.S. dollar. There is no
best solution to financial crises. One has to make a tradeoff between efficiency and stability.
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The best we can hope for is to minimize the shock of a crisis through better monitoring and
strengthening of domestic institutions. It is also important to remember that financial
deregulation was partial and recent in Asia, which contributed to the crisis.
Thus, conditions for panic developed in East Asia. The most striking feature of East
Asian political economy before the crisis was the massive flow of short-term speculative
capital. The countries most affected by the crisis were largely those recently committed to the
idea of free movement of capital. Table 6.1 shows the heavy inflow of capital into the five
most seriously affected countries, namely Indonesia, Malaysia, the Philippines, South Korea,
and Thailand, amounting to $92.8 billion of U.S. dollars in 1996. Only $7 billion of that
amount was direct investment while the rest was debt.
At least five reasons explain why foreign investors had put their money in East Asia.
First, there was much liquidity looking for investment in emerging markets in the 1990s.
Second, investors could invest in East Asia since most East Asian governments deregulated
capital controls. The Thai government, for example, created the Bangkok International
Banking Facility to make Bangkok a regional financial center. While its original intent was to
conduct transactions among nonresidents, Thai banks and firms ended up using the facility to
borrow abroad.17 Third, the prospect of high-growing East Asia was bright. Fourth, foreign
investments appeared safe. Because the borrowers tended to be well connected politically,
investors expected to be bailed out by the host governments or international financial
institutions. There was also a perception of low foreign exchange risk since East Asian
economies pegged their currencies to the U.S. dollar. Fifth, one does it because everybody
else is doing it. But precisely because of such a herd effect, they would also retreat in a hurry.
That is exactly what happened.
TABLE 6.1
External Financing of Indonesia, Malaysia, the Philippines, South Korea, and Thailand,
1994–1998 ($ billion)
Source: United Nations Conference on Trade and Development, Trade and Development Report, 1998, 66.
Investors pulled out quickly in 1997 because their assessment of East Asian fundamentals
had shifted. As an early sign of weakening fundamentals, growth rates for East Asian
merchandise exports fell dramatically in 1996, as shown in Figure 6.3, which indicated to
investors that the Asian boom was ending.
Southeast Asia’s position was further weakened by what was happening in Northeast
Asia. Japan, which was sinking into economic stagnation in the early 1990s, failed to serve as
a locomotive for regional economy. In fact, because of the need to improve balance sheets,
Japanese companies pulled money from Southeast Asia, which was a contributing factor for
the Asian financial crisis. Also, the yen depreciated against the U.S. dollar in the mid-1990s.
Pegged to the U.S. dollar, the currencies of Southeast Asian nations suffered a real effective
exchange rate over valuation measured against June 1987 to May 1997 averages, ranging
from 4 to 12 percent for Indonesia, Thailand, Malaysia, and the Philippines. Although the
over-valuation was not that large, it demonstrated the region’s increasing weakness.18
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FIGURE 6.3
Growth Rates of East Asian Merchandise Exports, 1991–1996
Source: World Development Indicators Database. Data for Taiwan are from Ministry of Finance of the
Republic of China, www.mof.gov.tw/public/data/statistic/trade/2281.htm.
The China factor also contributed to the crisis. The Chinese government depreciated the
yuan against the dollar in 1994. More important, it became obvious by 1997 that China was
more competitive than most Southeast Asian nations in the global market. In retrospect, it
was not surprising that the crisis began in Thailand. Being pushed by China, Thailand needed
to upgrade its economic structure but could not because of its poor public education system.
It was difficult to establish factually that China was indeed taking away comparative
advantage from Southeast Asia and the country’s surging exports contributed to the
meltdown in Southeast Asia, but there was such a perception by some analysts.19 Perception
matters for investors.
By discussing the Japan and China factors, I am not saying that Japan and China are
responsible for the Asian financial crisis. What I am saying is that there was a regional
dynamic to the extent that one cannot formulate policy in isolation from what is happening in
other countries.
Unsustainable Economic Policies
Speculative capital preys on the weak. The Asian financial crisis took place also because of
fundamental weaknesses found in many East Asian countries. An IMF study concluded that
the Asian crisis resulted mainly from a combination of macroeconomic imbalances, external
developments (appreciation of the U.S. dollar), and weakness in financial and corporate
systems (unhedged foreign currency borrowing, excessive reliance on short-term external
debt, risky investments in stocks and property, rapid expansion of domestic credit, pegged
exchange rates, and weak supervision).20
To start with, the pegged exchange rate system became unstable for most East Asian
countries. The early scholars of currency crises argue that exchange rate policy cannot
conflict with other monetary and fiscal objectives and that a country’s ability to export is
important for a stable exchange rate regime.21 If a country had a pegged exchange rate and an
expansionist monetary policy at the same time, it would lead to reduction in foreign reserves.
The reason is that those with excess domestic currency will exchange them for foreign
securities or domestic interest-bearing bonds. The purchasing of foreign securities puts direct
downward pressure on the domestic currency by increasing demands for foreign currencies
and decreasing demands for the domestic currencies. The flow to domestic bonds will
increase demands for the bonds and lead to decreasing yields, which will then result in a shift
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http://www.mof.gov.tw/public/data/statistic/trade/2281.htm

to better earning foreign assets, with the same depreciating effect on the domestic currency.
The monetary authorities would have to float the domestic currencies as its foreign reserve is
being depleted.22 A key implication of the theory is thus that central bank borrowing to cover
budget deficits, current account deficits, and increasing foreign debt may trigger a currency
crisis when a fixed exchange rate regime is in place.
A second generation of currency models emphasizes the self-fulfilling interaction
between investor expectations and policy choices. Put simply, if investors believe that a
country may have to devalue its currencies, they would increase the cost of borrowing on
their loans, which in a self-fulfilling prophecy increases the cost of defending the peg.23 As
Nouriel Roubini and Brad Setser argued, a third generation of models, learning from the
Asian financial crisis, viewed the imbalance in the private sector as the cause of the crisis.24
Factually, the East Asian crisis countries did not suffer from fiscal deficits or government
debts prior to the crisis. Rather, they suffered from worsening current account deficits
resulting from investment bubbles in the private sector.
Some analysts have zeroed in on the fixed-but-adjustable exchange rate regimes adopted
in most East Asian countries before the crisis. W. Max Corden argued that this type of
exchange rate regime, combined with high capital mobility and lack of political credibility,
creates special problems and leads to recessions deeper than would occur under alternative
exchange rate regimes. The key argument against the fixed exchange rate regime under the
condition of capital mobility is that when speculators attack the peg, the affected country has
to raise interest rates to fend off the attack, which hurts the country’s financial sector.25
Before the 1997 crisis, most East Asian countries pegged their currencies to the U.S.
dollar. It made sense. The U.S. economy is the strongest economy in the world. In addition,
most of the economic transactions East Asian nations have with each other or with countries
outside the region are denominated in the U.S. dollar. One pegs one’s currency to a strong
one for two simple reasons. The first and more important reason is to ensure financial
stability. The second reason is to make it easier to trade and attract investments. But fixed
exchange rates may also lead to problems, particularly in an era of globalization. It is now
impossible for any governments to achieve the so-called “impossible trinity.”
Robert Mundell came up with the notion of the impossible trinity in the 1960s, which
basically says that it is impossible to have the following three simultaneously—namely a
fixed exchange rate, financial openness, and autonomy in monetary policy—and that one can
have only two of the three at any one point.26 If we want to regulate markets and maintain
sovereignty, integration with global financial markets will be compromised. If we want to
maintain sovereignty but allow capital markets to integrate, we must accept an entirely free
global financial market. If we want capital market integration and global regulation, we will
sacrifice national sovereignty.
In the case of East Asia, fixed exchanged rates and deregulation of capital accounts
created inflationary pressure because inflow of capital adds to money supply. Normally, a
country should appreciate its currency to fend off inflationary pressure, but it cannot do so
under a fixed exchange rate system (this would defeat the purpose of piggybacking on a
stronger currency to control inflation in other cases). Some East Asian nations tried to adopt a
monetary policy as an instrument while maintaining a pegged exchange rate and free capital
movement. Take Thailand, for example. The Thai government tried to cool the economy by
raising interest rates, but that led to a huge inflow of capital, which defeated the
government’s original purpose. In the first half of 1997, with a slowdown in economy, the
Thai central bank provided financial support to domestic banks and other financial
institutions, which effectively increased the base money by more than 66 percent. Investors
began to see pressure on the peg and the Thai foreign reserves diminishing. Thus, their exit
from baht-denominated assets began.
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Another problem with a fixed exchange rate is that inflation, which means rising of the
general price level, makes one’s exports less competitive. This problem was compounded by
two other factors. The first factor was that South Korea, Thailand, and Malaysia were already
under wage pressure because of a shortage of skilled workers and greater freedom to form
unions in a more democratic environment. The other factor was that the Japanese yen
depreciated sharply against the U.S. dollar in the mid-1990s and China depreciated the yuan
in 1994. Consequently, exports of Southeast Asian countries and South Korea began
declining after the mid-1990s. Export performance is a fundamental for investors. A decline
in export earnings means a decline in foreign reserves and thus decreasing ability to defend
the peg. Once investors sense weakness (e.g., weakening exports and increasing public debt),
they run and, worse, deliberately attack the currency to make money.
In the case of Thailand, the combination of pegged exchange rates and relaxed capital
control meant that Thais could now raise capital overseas. In fact, as interest rates were lower
on foreign loans, it was actually cheaper to borrow overseas. However, in the 1990s, there
was not that much opportunity to invest in the exporting sector, so they invested in office
building and executive apartments, which created a self-perpetuating bubble. Foreign
investors lent because of “irrational exuberance.” An added problem was that foreign
investors believed that since Thai borrowers had strong political connections, loans were
essentially guaranteed.
When several East Asian countries’ current account balances deteriorated, it became clear
to investors that they would not be able to defend the peg indefinitely. After all, the crisis
countries had sizable current account deficits in 1996, measured as percentage of GDP.
Thailand had a high 8.0 percent, the Philippines 5.9 percent, Malaysia 5.3 percent, South
Korea 4.8 percent, and Indonesia 3.4 percent. In fact, these countries had high percentages for
several years before 1996.27 The five crisis countries (Indonesia, Malaysia, the Philippines,
South Korea, and Thailand) had a combined current account deficit of $24.6 billion in 1994,
$41.3 billion in 1995, and $54.9 billion in 1996. As Figure 6.3 shows, East Asian exports
declined sharply in growth rates in 1996.
East Asian corporations became vulnerable as a result of excessive borrowing. The debt-
to-equity ratio for large Korean companies was exceedingly high, 577 percent for Hyundai
Motor, 660 percent for Hyundai E&C, 438 percent for Samsung Corp., 341 percent for SK
Telecom, 580 percent for LG Electronic, and 364 percent for Samsung Electronic. For
Malaysia, the debt-to-equity ratio was 363 percent for Sime Derby and 148 percent for
Petronas. By contrast, Taiwanese firms had low debt-to-equity ratios.28
Thus, the United Nations Conference on Trade and Development concluded in 1998 that
the Asian financial crisis was not that different from the Latin American debt crisis in the
1980s, the European Monetary System crisis in 1992, and the Mexican peso crisis in 1994.
There was much inflow of capital to take advantage of the differential interest rates,
facilitated by the pegged exchange rates. The problem was a high percentage of short-term
loans reaching maturity prior to the crisis.
Moreover, the heavy borrowing was related to a property bubble. Exposure to the
property sector accounted for 15–20 percent of total bank loans in the Philippines, 15–25
percent in South Korea, 25–30 percent in Indonesia, 30–40 percent in Malaysia, Thailand,
and Singapore, and 40–55 percent in Hong Kong. Worse, in Thailand and Indonesia, foreign
borrowing was short term and denominated in foreign currency.29 In a vicious cycle,
depreciation of a currency led to an increase in nonperforming loans, which further pushed
down the value of the currency.
Last but not the least, the financial sector in the crisis countries was poorly regulated and
nontransparent. In fact, some analysts argue that the health of the financial sector and
currency crisis are a mutually reinforcing pair.30
149

Crony Capitalism
For some analysts, the weaknesses described above are the logical outcomes of crony
capitalism in East Asia. While recognizing the importance of panic in a global financial
market, Paul Krugman argued that “crony capitalism in general, and moral hazard in banking
in particular, created a ‘bubble economy’ that had to burst sooner or later.”31
Crony capitalism refers to cozy government-business relations, a capitalist system based
on political patronages. The term cronyism comes from the Western context in which a clear
separation between the government and business is maintained and in which it is normally
inappropriate for the relatives of government leaders to engage in business activities and
receive government contracts.
TABLE 6.2
Maturity Distribution of Lending to East Asian Countries ($ million)
Source: United Nations Conference on Trade and Development, Trade and Development Report, 1998, 60.
Some analysts used to praise such a close government-business arrangement, a common
feature in East Asian political economy, as evidence of a developmental state central to the
East Asian miracle. For example, the East Asian governments typically pressured banks to
lend to companies with good political connections or that were considered important for the
country. While such a practice often channeled money into important sectors, it posed a
moral hazard issue because investors or lenders felt that the state would bail out well-
connected companies if they ran into difficulties. A weak financial system results from crony
capitalism.
150

Another major issue is weak corporate governance in East Asia. In the countries most
affected, large corporations tend to be controlled by families who prefer to borrow from
banks rather than raising capital in the stock market. So these companies tend to be heavily in
debt. On top of that, families who run these companies often have good political connections.
The previous section has already discussed the unusually high debt-to-equity ratios for
companies in some East Asian countries.
MANAGING THE CRISIS
As soon as the financial crisis broke out, the international community tried to fight it off.
Some economies that had not been affected seriously, namely Taiwan and Singapore, relied
on their own resources. Hong Kong had massive foreign reserves and could also count on
Beijing’s support. The focus of the international community was thus on the countries
affected the most: Thailand, Indonesia, Malaysia, the Philippines, and South Korea. The IMF
took the lead. The basic IMF approach is to provide standby loans for crisis countries. The
Philippines was the first to receive the IMF help by extending an existing standby
arrangement in July. Thailand arranged an agreement with the IMF in August, Indonesia in
November, and South Korea in December. The packages the IMF orchestrated also included
contributions from the World Bank, the Asian Development Bank (ADB), and bilateral
donors. The three packages amounted to a total commitment of $125.3 billion (including
augmentations), as shown in Table 6.3. However, not all committed funds were disbursed to
the crisis countries, only $66.6 billion as of May 30, 2000. In return for loans, the IMF
demanded restructuring programs, which typically involve deregulation, privatization,
austerity measures, and tighter monetary policy (i.e., higher interest rates) to prevent currency
depreciation and inflation spirals.
By contrast, Mahathir of Malaysia did not ask the IMF for help. Instead, on September 1,
1998, Malaysia fixed the exchange rate and imposed capital controls. With capital control,
the Malaysian government could lower interest rates and introduce a stimulus package. To
the surprise of many contemporary observers, Malaysia did not do badly. Malaysia’s relative
success and the fact that China, which had not completely deregulated its capital controls, had
not been seriously affected by the Asian financial crisis allow some critics of the IMF to
argue that free capital movement may not be the right approach under all conditions.32
TABLE 6.3
IMF-Orchestrated Packages for Thailand, Indonesia, and South Korea ($ billion)
Source: Adapted from International Monetary Fund (IMF), “Recovery from the Asian Crisis and the Role of
the IMF,” June 2000, Table 1, www.imf.org/external/np/exr/ib/2000/062300.htm.
Note: WB&ADB refers to World Bank and Asian Development Bank. Commitment for Indonesia includes
augmentations after July 1998.
Various criticisms of the IMF approach were offered even during the crisis, particularly in
the case of Indonesia. Some suggested that the IMF had made mistakes by failing to
recognize the large debts of the private sector and by forcing the Indonesian government to
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close sixteen insolvent banks in November 1997, which caused a banking panic and capital
flight.33 The IMF was accused of using the method developed to deal with the Latin
American debt crisis to deal with the Asian financial crisis. However, the private sector
accumulated large debt and there was little inflationary pressure. As a result, the high interest
rates and austerity measures proposed by the IMF created deflationary consequences,
resulting also in an outflow of capital.34 Thus, Joseph Stiglitz, the World Bank’s chief
economist, argued that the IMF had made a key error when it imposed high interest rates on
countries that were already headed for recession.35
The IMF did orchestrate large bailout packages, which compensated for the private
capital outflow.36 Without offsetting official inflow of capital, interest rates in East Asia
would not have been able to come down, something crucial for stimulating production and
consumption in the region. As Table 6.3 shows, the IMF itself put in about one-third of the
total commitments but accounted for half of the disbursements of the funds as of May 30,
2000. The crisis countries did recover, and the IMF packages contributed to that recovery. At
the same time, Malaysia, which did not follow the IMF prescription, also recovered. The
debate thus continues.
East Asians mostly equated the IMF approach with the American approach. The Japanese
resented what they saw as an American impulse to change Asian capitalism into the Anglo-
Saxon form of capitalism. Rather than seeing the crisis as resulting from structural problems
in Asia, they prefer to see the crisis as resulting from global capitalism.37 Some non-Asian
experts such as Robert Wade also argued that the U.S. factor contributed to the Asian
financial crisis with its chronic current account deficits, which meant increased liquidity for
East Asia. Moreover, the U.S. government pressured the East Asian governments to remove
capital controls to allow free movement of capital.38 At the same time, the United States
played an important part in organizing bailout packages and contributed to the ones for
Indonesia and South Korea. Equally important, the U.S. market was important for absorbing
distress goods from the crisis countries while the Asian markets were weak.
Japan pumped billions of dollars into the region. Japan was the largest bilateral donor in
the IMF packages and separately, totaling $42 billion, compared with $11 billion from the
United States and $5.4 billion from Europe. Japan contributed to the crisis countries
indirectly through its contributions to the IMF, the World Bank, and the ADB. Japan also
created a separate facility, the New Miyazawa Initiative, of $30 billion for the distressed
countries.39 At the same time, Japan failed to serve as the market for distress goods and its
public financing was offset by private Japanese capital leaving the region.
Unsatisfied with the IMF approach, Japan proposed an Asian Monetary Fund in August
1997 to deal with the crisis, with contributions from East Asia totaling $100 billion. The U.S.
Treasury killed the idea for fear that the IMF’s role would be diluted. China also failed to
support the Japanese initiative.
China emerged from the Asian financial crisis a stronger power. Even though it
contributed only $1.2 billion directly to the crisis countries, China’s decision not to revaluate
the yuan won praise from the countries in the region, which became a turning point in how it
views East Asian regionalism.
THE CONSEQUENCES OF THE CRISIS
There are three reasons why East Asia’s recovery was relatively fast.40 First, the crisis
reduced imports, which turned trade balances to surpluses, leading to increases in foreign
reserves for the crisis countries. Second, the governments of the crisis countries, except the
Philippines, stimulated economy in 1998. They also took over private debts and offered
152

depositor insurance, which gradually restored investors’ confidence. The exposure to short-
term loans decreased. Official flows in the form of IMF packages compensated partially the
loss of capital. Third, the booming U.S. economy helped to pull East Asia out of the crisis.
Not surprisingly, when the U.S. economy began to slow down in mid-2001, the East Asian
economy also suffered.
The Asian financial crisis had an impact on East Asian finance in that Asian governments
were more interested in increasing their foreign reserves to prepare for another crisis. East
Asian nations became capital exporters after the crisis because of decreased investment
against higher ratios of savings. China is different from the crisis countries in that its
investments as well as savings remain high and its increased foreign reserves have largely
come from the government’s purchase of dollars to maintain its exchange rates.41 Yet even in
China, saving/GDP ratios are higher than investment/GDP ratios, 50 percent versus 46
percent in 2005, reflecting in part the country’s worsening production overcapacity.42 Along
with U.S. budget deficits, the crisis thus contributed to an enlarging global financial
imbalance in the later years. Asian governments also became more interested in foreign direct
investment (FDI), which is less risky than portfolio investment.
The Asian financial crisis has also led to greater interest in creating regional institutions
in East Asia. Examples include the Asian Monetary Fund and free trade negotiations. There
was much hope at the beginning of the crisis that the crisis might have presented an
opportunity for further regional cooperation. Of the aid package for Thailand, more than half
came from fellow Asian countries. The United States was noticeably absent from the list of
bilateral donors.
In terms of strategic significance, the Asian financial crisis also created a regional impact.
China’s position improved. The crisis had a negative impact on Japanese companies in terms
of market sales and profits.43 There was a general sense that Japan had suffered from the
crisis as its development model came to be discredited.44
There were many proposals to reform the IMF, but without much long-term impact on
governance of international finance.45 One school of thought focuses on an internationalized
moral hazard created by the IMF bailout packages. Availability of such packages means that
developing governments will have no incentives to conduct reforms and international
speculators no incentives to avoid risky investments. There is also a perception that
speculators largely escaped unhurt from the Asian crisis. Some prominent economists
suggested allowing sovereign states to receive bankruptcy protection.46
Some senior IMF officials were also critical of the IMF approach. Stanley Fischer, the
No. 2 man in the IMF, argued that the IMF could have lessened the crisis if it had not
demanded fiscal tightening.47 The Independent Evaluation Office of the IMF drew a similar
conclusion in its evaluation of the IMF programs for Indonesia, Korea, and Brazil issued in
July 2003. Considering the initial stock of debt, the report concluded that fiscal tightening in
Indonesia and South Korea was not warranted. The report concluded that nonfinancial
structural reform measures are beneficial in the long run but should not be part of immediate
solutions to the crisis. The report also stated that it was inconclusive whether high interest
rates are effective in stabilizing exchange rates.48
A consensus is emerging among analysts that private lenders should take a hit too because
they have made risky decisions. So they should be involved in rescheduling, but not
surprisingly they resist such an approach. Creditors took losses during the Latin American
debt crisis but not in the Mexican peso crisis and the Asian financial crisis. It does not make
sense for taxpayers to pay for lenders’ mistakes. One concrete way to advance that objective
is to allow debtor nations to declare bankruptcy and then follow the same procedure for debt
adjustment as is done for firms in the United States. This way, it will give debtor nations time
and also let creditors bear some of the losses.
153

THE POLITICAL ECONOMY OF THE CRISIS
Complementing the economic explanation of the crisis offered in the second section, I focus
on the political economy explanation in a separate section consistent with the internal
organization of the East Asian miracle chapter and all the upcoming issue chapters. The
Asian financial crisis was as much a political event as an economic one. Political factors
partly explained the onset of the crisis. As discussed earlier, crony capitalism has been cited
by some as the main reason for the start of the crisis. Whether one uses that negative label or
considers crony capitalism a sufficient condition for the crisis, the overly cozy government-
business relations were clearly an important piece of the puzzle, a partial indictment of the
developmental state. As Stephan Haggard has shown, the concentration of private economic
power and close business-government relations in East Asia gave business great potential
power to influence public policy. State intervention in the financial sector created a moral
hazard problem in that financial institutions were less vigilant about monitoring their clients.
Moreover, the concentration of private economic power means that the liberalization
measures adopted by the governments were “captured” by private interests.49
Politics also mattered in the handling of the crisis. A government’s policy choices may
make things worse by creating greater uncertainties for investors. As a case in point,
Indonesian President Suharto’s mishandling of the implementation of the IMF package
exacerbated the crisis. The case thus supports the arguments made by some economists that
models of currency crises should include the interaction of policy and capital market, unlike
the first generation of models that emphasize unsustainable economic policies and structural
imbalances.50 Andrew MacIntyre argued that policy rigidity (inability to adjust) and policy
volatility (excessive policy shifts) at the extreme ends of a policy continuum create
uncertainties for investors and are thus detrimental in a time of crisis. Of the four Southeast
Asian crisis countries, Thailand suffered from policy rigidity because of a wide disperse of
veto power in the political system, Malaysia and Indonesia experienced policy volatility
because of a high concentration of veto power, and only the Philippines maintained a steady
policy position because the country does not have a wide dispersal or a high concentration of
veto authority.51
On first look, one may conclude that the type of political regime does not make that much
difference when it comes to the Asian financial crisis since the crisis hit democratic South
Korea and Thailand as well as semiauthoritarian Malaysia and Indonesia. Under further
scrutiny, however, Haggard has shown that whereas democratic South Korea and Thailand
indeed had a difficult time facing the crisis because of electoral pressure and coalition
government, the democratic regimes had an advantage in forming new governments to launch
reform based on public support. By contrast, while semiauthoritarian Malaysia and Indonesia
could be more decisive in the absence of strong political constraints, they were also prone to
offsetting policy blunders, particularly in the case of Indonesia. Furthermore, the succession
problem, typical of authoritarian regimes, created great uncertainties in both Indonesia and
Malaysia.52 More broadly, as MacIntyre argued, most advanced industrial countries, with
thick democracy, are able to avoid the two extremes of veto authority commonly found
among developing nations.53 Thus, a stronger democracy would have made a difference in
whether a country could handle the Asian financial crisis more successfully.
All economic crises have political consequences. Crises strain a country’s system of
political economy and unleash social and political forces that generate political change. The
Asian financial crisis was no exception. One striking feature of the political consequences of
the Asian financial crisis was that the political forces unleashed largely pushed for greater
accountability in the political system than for reversing to authoritarianism in the recently
democratized countries like South Korea, the Philippines, and Thailand. For the democracies,
154

the crisis led to newly elected governments under Kim Dae Jung in South Korea and Chavalit
in Thailand, both of whom introduced reforms. Of the crisis countries, South Korea
introduced the strongest reforms, which partly explained the country’s subsequent return to
strong economic growth. For both Malaysia and Indonesia, the crisis unleashed social forces
for change. In Indonesia, the crisis led to violence and overthrow of the Suharto regime. By
contrast, Mahathir managed to survive the crisis because of a strong political party and other
political institutions to co-opt opposition.54
CONCLUSION
The Asian financial crisis resulted from the interplay of multiple factors. East Asian financial
institutions and corporations accumulated large unhedged short-term loans denominated by
foreign currencies because of the availability of international capital and perceived absence of
foreign exchange risks from pegged exchange rates. Because of skewed incentives, weak
corporate governance, and ineffective prudential regulations, much of the foreign currency
borrowing went into nonproductive sectors such as real estate. With worsening current
account balances, Thailand became vulnerable to speculation that its peg to the U.S. dollar
would not hold. Thailand’s inevitable foreign exchange realignment in the face of mounting
attacks from speculative capital triggered a vicious cycle. Concerned about foreign exchange
losses of their financial investments, investors fled from the region, which pushed down the
values of the local currencies even further. Currency depreciation hit domestic companies
hard because of their large foreign currency debt obligations. Failing financial institutions
and companies created a banking crisis and a broad economic crisis.
When the Asian financial crisis occurred, some analysts were quick to suggest that the
crisis revealed the fundamental flaws of the East Asian system of political economy.
However, one crisis does not necessarily discredit a whole political economy system. As a
case in point, the Great Depression did not discredit the whole capitalist system. Rather,
reforms are called for in most crisis situations. The best way to evaluate the East Asian
development model is that it served its historical purpose: The model was more or less
successful, particularly compared with other developing nations. Massive input mobilization
for rapid economic growth may eventually be limited, but it did generate a few decades of
rapid growth. Cozy government-business relations also served their purpose. But now the
model has exhausted itself to a large extent.
The cases of the crisis countries discussed in the chapter, limited though they might be,
suggest that the democratic regimes are preferable to the authoritarian regimes in dealing
with the crisis because they have strong institutions to represent public interests and their
policies have stronger credibility because of the electoral and legislative support they enjoy.
The crisis generated demands for economic and political reforms and strengthened East
Asia’s commitment to integration with the global market.

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NOTES

1. For studies of the baht crisis, see Andrew MacIntyre, “Political Institutions and the
Economic Crisis in Thailand and Indonesia,” in The Politics of the Asian Economic Crisis,
ed. T. J. Pempel (Ithaca: Cornell University Press, 1999), 143–154; Ammar Siamwalla,
“Anatomy of the Crisis,” in Thailand Beyond the Crisis, ed. Peter Warr (New York:
RoutledgeCurzon, 2005), 66–104.
2. Paul Hutchcroft, “Neither Dynamo nor Domino: Reforms and Crises in the Philippine
Political Economy,” in The Politics of the Asian Economic Crisis (see note 1), 162–183.
3. Mahani Zainal-Abidin, “Implications of the Malaysian Experience on Future International
Financial Arrangements,” ASEAN Economic Bulletin 17, no. 2 (August 2000): 135–47; K.
S. Jomo, ed., Malaysian Eclipse: Economic Crisis and Recovery (London: Zed Books,
2001).
4. Anwar Nasution, “The Meltdown of the Indonesian Economy: Causes, Responses, and
Lessons,” ASEAN Economic Bulletin 17, no. 2 (August 2000): 148–62; Hal Hill, The
Indonesian Economy in Crisis: Causes, Consequences, and Lessons (New York: St.
Martin’s Press, 1999).
5. MacIntyre, “Political Institutions and the Economic Crisis in Thailand and Indonesia,”
154–161; Shinichi Watanabe, “Evolution of the Crisis in Indonesia: Part II,” Journal of
Research Institute for International Investment and Development 25, no. 3 (May/June
1999): 71–120.
6. Yun-han Chu, “Surviving the East Asian Financial Storm: The Political Foundation of
Taiwan’s Economic Resilience,” in The Politics of the Asian Economic Crisis (see note 1),
184–202; Norman Flynn, Miracle to Meltdown in Asia: Business, Government, and Society
(Oxford: Oxford University Press, 1999), 21.
7. Linda Y. C. Lim, “Free Market Fancies: Hong Kong, Singapore, and the Asian Financial
Crisis,” in The Politics of the Asian Economic Crisis (see note 1), 103–108.
8. The title of the headline story in The Washington Post on October 24, 1997, reads as
follows: “Sell-Off in Hong Kong Shakes Global Markets: Dow Falls 187; Asia, Europe Hit
Harder.”
9. Jisoon Lee, “An Understanding of the 1997 Korean Economic Crisis,” EXIM Review 19,
no. 2 (July 1999): 41.
10. Flynn, Miracle to Meltdown in Asia, 7.
11. Nicholas R. Lardy, “China and the Asian Contagion,” Foreign Affairs 77, no. 4
(July/August 1998): 78–88; Yu Yongding, “China’s Deflation During the Asian Financial
Crisis, and Reform of the International Financial System,” ASEAN Economic Bulletin 17,
no. 2 (August 2000): 163–174.
12. Stephan Haggard, Political Economy of the Asian Financial Crisis (Washington, D.C.:
Institute for International Economics, 2000); Iyanatul Islam and Anis Chowdhury, The
Political Economy of East Asia: Post-Crisis Debates (New York: Oxford University
Press, 2000); Wing Thye Woo, Jeffrey D. Sachs, and Klaus Schwab, eds., The Asian
Financial Crisis: Lessons from a Resilient Asia (Cambridge: MIT Press, 2000); Karl D.
Jackson, ed., Asian Contagion: The Causes and Consequences of a Financial Crisis
157

(Boulder: Westview Press, 1999); Gregory W. Noble and John Ravenhill, eds., The Asian
Financial Crisis and the Architecture of Global Finance (Cambridge: Cambridge
University Press, 2000).
13. Steven Radelet and Jeffrey D. Sachs, “The East Asian Financial Crisis: Diagnosis,
Remedies, Prospects,” Brookings Papers on Economic Activity, no. 1 (Spring 1998): 1–
90.
14. Robert Wade, “The U.S. Role in the Long Asian Crisis of 1990–2000,” in The Political
Economy of the East Asian Crisis and Its Aftermath: Tigers in Distress, ed. Arvid John
Lukauskas and Francisco L. Rivera-Batiz (Northampton, Mass.: Edward Elgar, 2001),
198.
15. Charles P. Kindleberger, Manias, Panics, and Crashes: A History of Financial Crises
(New York: Basic Books, 1978); Robert Gilpin, Global Political Economy:
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2001), 264–267.
16. For a succinct comment on panics, see Paul Krugman, “Start Taking the Prozac,”
Financial Times, April 9, 1998, 26.
17. Morris Goldstein, The Asian Financial Crisis: Causes, Cures, and Systemic Implications
(Washington, D.C.: Institute for International Economics, 1998), 13.
18. Goldstein, Asian Financial Crisis, 14–15.
19. Goldstein, Asian Financial Crisis, 16–17.
20. International Monetary Fund, “Recovery from the Asian Crisis and the Role of the IMF,”
Issue Brief, June 2000, www.imf.org/external/np/exr/ib/2000/062300.htm. See also
Timothy Lane, “The Asian Financial Crisis: What Have We Learned?” Finance and
Development 36, no. 3 (September 1999).
21. Paul Krugman, “A Model of Balance-of-Payments Crises,” Journal of Money, Credit,
and Banking 11, no. 3 (August 1979): 311–325; Robert P. Flood and Peter M. Garber,
“Collapsing Exchange-Rate Regimes: Some Linear Examples,” Journal of International
Economics 17, nos. 1–2 (August 1984): 1–13.
22. Paolo Pesenti and Cédric Tille, “The Economics of Crises and Contagion: An
Introduction,” Economic Policy Review 6, no. 3 (September 2000): 4–5.
23. Pesenti and Tille, “The Economics of Crises and Contagion,” 3–16. Also see Maurice
Obstefeld, “Rational and Self-Fulfilling Balance of Payments Crises,” American
Economic Review 76, no. 1 (March 1986): 72–81 and “Models of Currency Crises with
Self-Fulfilling Features,” European Economic Review 40, nos. 3–5 (April 1996): 1037–
1047; Allan Drazen and Paul Masson, “Credibility of Policies Versus Credibility of
Policymakers,” Quarterly Journal of Economics 109, no. 3 (1994): 735–754; Harold Cole
and Patrick Keohoe, “A Self-Fulfilling Model of Mexico’s 1994–95 Debt Crisis,” Journal
of International Economics 41, no. 3 (November 1996): 309–330.
24. Nouriel Roubini and Brad Setser, Bailouts or Bail-Ins? Responding to Financial Crises in
Emerging Economies (Washington, D.C.: Institute for International Economics, 2004),
35–36. Also see Rudi Dornbusch, “A Primer on Emerging Market Crises,” NBER
Working Paper 8326 (Cambridge: National Bureau of Economic Research, June 2001).
25. W. Max Corden, “Exchange Rate Regimes for Emerging Market Economies: Lessons
from Asia,” The Annals of the American Academy of Political and Social Science 579
(January 2002): 26–37. See also Ross Garnaut, “Exchange Rates in the East Asian
Crisis,” ASEAN Economic Bulletin 15, no. 3 (December 1998): 328–337.
26. Robert A. Mundell, International Economics (New York: Macmillan, 1968); Benjamin J.
Cohen, “The Triad and the Unholy Trinity: Problems of International Monetary
Cooperation,” in Pacific Economic Relations in the 1990s: Cooperation or Conflict?, ed.
Richard Higgott, Richard Leaver, and John Ravenhill (Boulder: Lynne Rienner, 1993),
158

http://www.imf.org/external/np/exr/ib/2000/062300.htm

133–158.
27. United Nations Conference on Trade and Development, Trade and Development Report,
1998, 67.
28. Flynn, Miracle to Meltdown in Asia, 19–24.
29. Goldstein, Asian Financial Crisis, 8–9.
30. Graciela L. Kaminsky and Carmen M. Reinhart, “The Twin Crises: The Causes of
Banking and Balance-of-Payments Problems,” American Economic Review 89, no. 3
(June 1999): 473–500.
31. Krugman, “Start Taking the Prozac.”
32. Joseph Stiglitz, Globalization and Its Discontents (New York: Norton, 2002), 122–125.
33. Paul Dibb, David D. Hale, and Peter Prince, “The Strategic Implications of Asia’s
Economic Crisis,” Survival 40, no. 2 (Summer 1998): 11.
34. Robert Wade and Frank Veneroso, “The Resources Lie Within,” The Economist,
November 7, 1998, 19–20.
35. Stiglitz, Globalization and Its Discontents, 89–132.
36. For IMF’s own defense, see International Monetary Fund, “Recovery from the Asian
Crisis and the Role of the IMF.”
37. Sakakibara Eisuke, “Crossing Swords with the Three Marketers,” Japan Echo 26, no. 6
(December 1999): 18–22.
38. Wade, “U.S. Role in the Long Asian Crisis of 1990–2000,” 195–226.
39. Ming Wan, Japan Between Asia and the West: Economic Power and Strategic Balance
(Armonk: M. E. Sharpe, 2001), 88–94.
40. World Bank, East Asia: Recovery and Beyond (Washington, D.C.: World Bank, 2000), 5–
6.
41. Taniuchi Mitsuru, “Ajia no shihon ryushutsunyu kozo no henka to kadai ajia kikigo no
ajia keizai” [Changing Capital Flows in Asia—New Developments After the Asian
Financial Crisis], Journal of JBIC Institute no. 28 (February 2006): 83–110.
42. The data come from the Chinese State Foreign Exchange Management Bureau, May 4,
2006, www.chinanews.com.cn/news/2006/2006–05-04/8/725785.shtml.
43. A large survey of the Japanese companies in May–June 1998 showed this effect. See
Shigeki Tejima, “The Effects of Asian Crisis on Japan’s Manufacturing FDI,” EXIM
Review 19, no. 3 (September 1999): 1–85.
44. For an opposing view, see Christopher W. Hughes, “Japanese Policy and the East Asian
Currency Crisis: Abject Defeat or Quiet Victory,” Review of International Political
Economy 7, no. 2 (Summer 2000): 219–253.
45. Roubini and Setser, Bailouts or Bail-Ins? 4–5. See also Barry Eichengreen,
“Strengthening the International Financial Architecture: Where Do We Stand?” ASEAN
Economic Bulletin 17, no. 2 (August 2000): 175–192.
46. Anne Krueger, “International Financial Architecture for 2002: A New Approach to
Sovereign Debt Restructuring,” Speech at the National Economists’ Club Annual
Members’ Dinner, American Enterprise Institute, Washington, D.C., November 26, 2001,
www.imf.org/external/np/speeches/2001/112601.htm; Stiglitz, Globalization and Its
Discontents; Stanley Fischer, “On the Need for an International Lender of Last Resort,”
Journal of Economic Perspectives 13, no. 4 (Fall 1999): 85–104.
47. See his speech in Singapore on June 1, 2001, reported in The Strait Times, June 2, 2001,
S17.
48. Independent Evaluation Office of the IMF, The IMF and Recent Capital Account Crises:
Indonesia, Korea, Brazil (Washington, D.C.: IMF, 2003).
49. Haggard, Political Economy of the Asian Financial Crisis, 15–46.
50. Pesenti and Tille, “Economics of Crises and Contagion,” 3–16.
159

http://www.chinanews.com.cn/news/2006/2006–05-04/8/725785.shtml

http://www.imf.org/external/np/speeches/2001/112601.htm

51. Andrew MacIntyre, “Institutions and Investors: The Politics of the Economic Crisis in
Southeast Asia,” International Organization 55, no. 1 (Winter 2001): 81–122.
52. Haggard, Political Economy of the Asian Financial Crisis, 47–72.
53. MacIntyre, “Institutions and Investors,” 118.
54. Haggard, Political Economy of the Asian Financial Crisis, 222–237.
160

T
CHAPTER 7
The Political Economy of East Asian Production

his chapter examines the political economy of East Asian production. When one talks
about East Asian political economy, one normally focuses on trade, foreign investment,
and exchange rates. But production is at the core of East Asian political economy. To East
Asians, modernization equates with industrialization, namely production of manufactured
goods. To enjoy a higher living standard and to create a strong nation, one has to “produce”
wealth. Reinforced practices and attitudes regarding production and vested interests created
in the process of industrialization have helped to shape the contemporary East Asian political
economy to the way it is today. For most East Asian governments, trade, foreign investment,
and exchange rates follow the imperative of production. Such an obsession with production
helps explain both the East Asian economic miracle and the subsequent economic crisis.
Industrial policy to promote manufacturing production and exports is at the core of the debate
over what explains the East Asian miracle. Production overcapacity was also an important
reason for the Asian financial crisis.
This chapter addresses five questions. The first question is about the current state of East
Asian production. The chapter shows that East Asia has become the factory of the world.
Next, the chapter focuses on transnational production networks. Production leads off the issue
chapters in the book to highlight the regional dimension of East Asian political economy. A
principal form of East Asian regional integration is the production network across national
borders. Industrial regional integration took place in East Asia prior to high-level political
efforts for regional groupings. Third, the chapter examines how the East Asian governments
pick winners to compete in the global market and their policies toward direct investment
inflow and outflow. A discussion of the East Asian companies follows. Last, the chapter
shows how production relates to politics in East Asia.
THE “FACTORY” OF THE WORLD
East Asian Industrialization
East Asia has enjoyed rapid industrialization, moving from labor-intensive to capital-
intensive to high-tech products, but not at the same pace. Through the 1980s, a Japan-led
flying geese formation moved up the industrial ladder in a tiered formation. Japan showed the
way for other East Asian nations even if they did not exactly copy the Japanese model
because of their own objectives and circumstances.
Japan was the first industrialized country in East Asia, a feat accomplished before the
Second World War. Thus, unlike other East Asian nations but similar to Western Europe,
Japan’s postwar mission was more about reconstruction than development. Still, Japan lagged
behind the West economically in the 1950s. Japan caught up with the West by the end of the
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1960s and established itself as an economic superpower by the late 1980s. Japan was a world
leader in labor-intensive products in the 1950s. It then moved up to capital-intensive
manufacturing. By 1976, Japan had an impressive share of 90 percent of motorcycle exports
by Organization of Economic Cooperation and Development countries, 70 percent in
televisions and radios, 43 percent in ships, 29 percent in steel, 23 percent in watches, and 20
percent in motor cars.1 Japan remains a world manufacturing leader in some areas and boasts
some of the largest and most successful firms in the world. According to the Consumer
Reports 2007 annual auto issue, the best models in ten categories in 2007 were all Japanese
(Toyota 4, Honda 3, Infiniti 2, and Mazda 1).2 Toyota surpassed General Motors as the
world’s largest automaker in the first quarter of 2007. Japan’s Sony and Sharp took the
number one position (14.6 percent) and number three position (13.6 percent), respectively, in
world liquid crystal display (LCD) TV unit shares in 2004–2005. Holland’s Philips was the
second (14.2 percent) and South Korea’s Samsung (11.6 percent) and LG (6.5 percent) were
fourth and fifth.3
In the second wave, South Korea, Taiwan, Singapore, and Hong Kong industrialized.
South Korea followed Japan’s model the closest, building world-class companies with world-
class brand names. Starting in the 1960s, South Korea took advantage of its competitiveness
in labor-intensive sectors such as footwear and apparel. South Korea began to move up to
capital-intensive heavy and chemical industries in the late 1960s, which remained the focus
for the country through the 1970s. South Korea is now a major exporter of automobiles,
machinery, and ships. In particular, South Korea has been the world’s leader in shipbuilding.
South Korea received orders for 14.5 million compensated gross tons (CGTs), a ship capacity
measure, for 2005, or 38 percent of the world total. The European Union came second with
8.5 million CGTs, followed by China (7 million) and Japan (6.2 million).4 South Korea began
to export high-tech products such as semiconductors and electronics by the mid-1990s. South
Korea is now the world’s largest producer of dynamic random access memory chips
(DRAMs).
Similar to Japan and South Korea, Taiwan’s industrialization began with exports of
textiles and apparel that expanded rapidly in the 1960s. Taiwan’s petro-chemical industry
began in the 1950s and took off in the late 1960s. Similar to South Korea, Taiwan promoted
heavy and chemical industries in the 1970s, but unlike South Korea the Taiwanese
government relied heavily on public enterprises. The government decided to move away from
energy-intensive industries after the second oil crisis. Instead, the government emphasized
high-technology, high value-added, low energy-intensive “strategic industries” in the early
1980s. Taiwan’s electronics industry became internationally competitive in the 1980s.
Taiwan was one of the largest information technology (IT) hardware exporters in the world.5
Its export has decreased in recent years only because it has shifted much production capacity
to mainland China. Despite Taiwanese foreign direct investment (FDI) in IT manufacturing
in the mainland, Taiwan remains a powerhouse for semiconductor production. Taiwan’s
industrialization differs from South Korea’s in that Taiwanese companies are smaller than
South Korean ones, Taiwan did not succeed in creating general trading companies like South
Korea, and Taiwanese firms have not built as many international brands as South Korean
firms. However, the more conservative nature of Taiwanese companies in contrast to debt-
burdened South Korean ones was one reason that Taiwan did not suffer as much as South
Korea in the Asian financial crisis.
Singapore has always depended on trade, as indicated by its annual trade volume
exceeding its gross domestic product (GDP). But the Singaporean government began to shift
from a port economy based on staples trade to an exporter of manufactured goods in 1960.
Manufacturing became a leading sector in Singaporean economy by 1970. The share of
nonpetroleum direct manufactured exports (not reexported) increased from 12.7 percent of
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GDP in 1966 to 47.1 percent in 1979 and 62.9 percent in 1990. The government depended on
multinational corporations for industrialization. Wholly or majority-owned foreign firms
accounted for 84.1 percent of direct manufactured exports in 1975 and 85.8 percent in 1990.6
Unlike South Korea and Taiwan, Singapore could concentrate more on industrial
development since it did not have an agricultural sector.
Similar to Singapore, Hong Kong is an urban economy. Adapting to the founding of the
People’s Republic of China in 1949 and a massive flow of refugees, Hong Kong made a
successful transition from an entrepôt economy serving China to an export-based
manufacturing economy in the 1950s and the 1960s.7 Unlike the other three tigers, the British
colonial government in Hong Kong did not actively engage in industrial policy. Rather, the
government protected law and order, provided public goods, and kept tax low by relying on
revenues from sale of public land for development. Hong Kong became a major producer of
several manufactured products, particularly labor-intensive garments initially and electronics,
watches, and toys later in the 1960s. Unlike other newly industrialized economies (NIEs) that
engaged in industrial upgrading in the 1970s, Hong Kong maintained its labor-intensive
industries even in the late 1970s because of “timely” immigrants from mainland China.8 But
as Hong Kong resumed its traditional entrepôt role after China reentered the world market in
the late 1970s, its service sector became more prominent relative to manufacturing.9
In the third wave, Southeast Asia has been undergoing a fast pace of industrialization
beginning in the early 1970s (the early 1980s for Indonesia). The region’s manufacturing
base has shifted from household to factories and has broadened from resource processing and
simple consumer goods to capital goods, heavy processing, and more sophisticated consumer
goods. Compared with Taiwan and South Korea, the Southeast Asian industrializing
countries have depended heavily on FDI. The share of manufacture in Malaysia’s GDP
increased from 8.7 percent in 1960 to 20.5 percent in 1980. Owing to dependence on foreign
capital, labor-intensive industries did not grow as fast as capital-intensive industries.10
Malaysia’s manufacturing sector grew further with a heavy industrialization drive that began
in 1981. The manufacturing sector came to account for 30 percent of GDP by 2000.11
Thailand also experienced industrialization, with shares of manufacturing in its GDP
increasing from 16.0 percent to 21.7 percent in 1980, to 23.0 percent in 1988, and with shares
of manufacturing in its exports increasing from 2.4 percent in 1961 to 68.6 percent in 1989.12
Industry came to represent 46 percent of Thailand’s GDP by 2006. The country has not been
able to upgrade its industries that fast, however, and its manufacturing remains largely in raw
material-based and labor-intensive industries.13 Though not as successful as Malaysia and
Thailand, Indonesia and the Philippines have also achieved some degree of
industrialization.14 Indonesia depended heavily on the petroleum industry but had to promote
non-oil industries after a sharp drop of crude oil prices in the mid-1980s. The Filipino
economy suffered from the corrupt Marcos authoritarian regime and the subsequent political
instability in the 1980s and regained modest growth in the 1990s.
The East Asian socialist countries made a detour. Drastic contrasts can be seen
particularly in the divided nations of China and Korea. East Asian communist countries also
emphasized industrialization, but their industrialization based on socialist planning distorted
the economic structure by emphasizing heavy industrialization at the expense of light
industry and agriculture.15 China initially put great emphasis on Soviet-style heavy
industrialization. Mao Zedong then decided to mobilize masses to catch up with the West in
steel production in 1958, which led to three years of the Great Famine. North Korea went
further in heavy industrialization and collectivization of agriculture than China and Vietnam.
North Korea achieved economic successes through the 1960s by mobilizing resources, often
the case in the early stage of a planned economy, but began to suffer the consequences of
distorted economic structure and exhaustion of resources by the 1970s.16
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Similar to South Korea and Taiwan, the Chinese government initially shifted to labor-
intensive industries to take advantage of the country’s comparative advantage after Deng
Xiaoping launched economic reform in the late 1970s. Despite being a late developer, China
has been climbing up the ladder at a faster pace and in many fields at the same time. China is
now a major producer of more and more manufactured products. As mentioned earlier in the
context of South Korean shipbuilding success, China has become a world-class shipbuilder,
trailing only South Korea and the European Union in 2005. China became the largest
producer of crude steel in the world for the first time in 1996, with its share of world total
crude steel production increasing from 13.5 percent in 1996 to 33.8 percent in 2006. Japan
was the second largest producer in 2006, with production about one-quarter of China’s.17
Quality aside, China is now the fourth largest automobile producer in the world, trailing only
the United States, Japan, and Germany, and may overtake Germany soon.18 China became a
net exporter of cars for the first time in 2005. While foreign firms produce cars in China for
the domestic market, most Chinese exports are from Chinese firms like Chery Automobile
Co.19 As a measure of industrial upgrading, China conducted $415.96 billion of high-tech
trade or 29.2 percent of its total trade in 2005.20
East Asian industrialization was at the core of the East Asian miracle. One way to
measure the importance of industrialization is the structural change of East Asian economy.
As shown in Table 5.3 in Chapter 5, the proportion of industry has increased dramatically in
East Asia.
East Asia has become a center of manufacture in the world. China accounted for 7.40
percent of global manufacturing export in 2005, increasing from 1.79 percent in 1990.
Japan’s share was 5.73 percent in 2005 and 8.28 percent in 1990. China and Japan trailed
only Germany and the United States in 2005.21
There are good economic reasons why East Asia has done well in manufacture. With a
global industrial structural shift taking place, high-tech industries have become more
important in advanced countries. It thus makes sense to move labor-intensive declining
industries to developing nations. Compared with other developing regions, East Asia is well
positioned to benefit from this global development. East Asia has a large, educated labor
force and continues to have labor cost advantages in the high-tech sectors. For example,
while it cost $300,000 to employ a computer chip design engineer in Silicon Valley in 2002
and $150,000 in Canada, it cost only $65,000 in South Korea, $60,000 in Taiwan, and
$24,000–$28,000 in China.22 High domestic savings and inflow of foreign investment
provide the capital needed for industrial expansion. In a virtuous cycle, East Asian countries
have learned by doing. Since the 1970s, East Asian industrialization has also come to be
largely based on technologies. Technological innovations have been a driving force for
Japan’s economic success. The electronics industrialization in the NIEs in the 1970s and the
1980s was central to economic growth in East Asia. East Asia is a rising power in high-tech
industries. In the IT industry, for instance, Asia consumed about 20 percent of the world total
IT goods while producing about 40 percent of the total in 2003.23 East Asia is better than
other regions in terms of share of new products in their export mix.24
As in developed countries before them, East Asian manufacturers a concentrated in
industrial clusters, often surrounding the countries’ capitals. The share of manufacturing in
the Bangkok area increased from 39.4 percent in 1970 to 54.6 percent in 1986.25 Even though
the Thai government began providing incentives to regions farther away from Bangkok in
1987, they have achieved only limited success. Given its massive size, China boasts three
major manufacturing centers. The Pearl River delta (Guangdong) has become a major IT
processing center and export base that exported $83.6 billion high-tech and new products in
2005. The Yangzi delta (Shanghai, Jiangsu, and Zhejiang) is now a center in
telecommunications, software, and microelectronics that exported $94.8 billion for the year.
164

The Bohai region (Beijing, Tianjin, Hebei, Liaoning, Shanxi, Shandong, and Inner Mongolia)
specialized in mobile, aerospace, and integrated circuitry, exporting $29.5 billion. These three
economic centers accounted for 95.3 percent of China’s total exports in high-tech and new
products in 2005.26 Such industrial clusters are crucial for East Asian nations’ success in
attracting FDI or moving up the technological ladder.
East Asian production has been defined by intense domestic competition and regional
competition, which often leads to excess production capacity. The impact of such
overcapacity is a push toward foreign markets. We have seen such a pattern. Japanese firms,
toughened at home, beat up foreign competitors. Now Chinese firms that have managed to
reduce production costs as a result of brutal domestic competition meet few challenges
overseas in sectors where they excel.
Foreign Direct Investment in East Asia
A large amount of FDI has flowed into East Asia, as shown in Table 7.1. China alone has
attracted over $50 billion of FDI annually for the past few years. East Asian economies
attracted 17.2 percent of world total FDI inflows in 2005.27 FDI has been an important reason
for East Asian industrialization, particularly for ASEAN and China. In fact, FDI was so
important for Southeast Asia after the mid-1980s that some analysts used “FDI-led
industrialization” to describe Southeast Asia’s growth. As a case in point, the foreign share of
Malaysia’s manufacturing was basically above 45 percent in 1968–1991.28 As shown in
Table 7.2, FDI accounted for 97.0 percent of gross fixed capital formation in Hong Kong,
78.9 percent in Singapore, 15.2 percent in Malaysia, 11.3 percent in Vietnam, and 9.2 percent
in China in 2005. In 2005 foreign firms exported from China $444.2 billion or 58.3 percent of
China’s total exports.29 This is particularly the case in high-tech industries. Foreign firms
accounted for 84.1 percent of China’s high-tech trade in 2005.30 By contrast, FDI has been
less important for Japan and South Korea, accounting for only 0.3 percent and 3.1 percent of
gross fixed capital formation, respectively, in 2005. The importance of foreign firms in local
industrialization goes beyond their share of capital formation given their possession of
technologies, management skills, and networks.
TABLE 7.1
Foreign Direct Investment (FDI) in East Asia ($ million)
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Sources: Data for 1985–1995 and 2001 are from UNCTAD, World Investment Report 2005, country fact
sheets. Data for 2002–2005 are from World Investment Report 2006, country fact sheets.
TABLE 7.2
Foreign Direct Investment (FDI) as a Percentage of Gross Fixed Capital Formation
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Sources: Data for 1985–1995, 2001, and 2002 are from UNCTAD, World Investment Report 2005, country
fact sheets. Data for 2003–2005 are from World Investment Report 2006, country fact sheets.
To highlight the importance of FDI for different countries, we can also measure inward
FDI stocks as a percentage of GDP. As Table 7.3 shows, Hong Kong had a high 299.9
percent by 2005, Singapore 158.6 percent, Malaysia 36.5 percent, Thailand 33.5 percent,
China 14.3 percent, and Taiwan 12.1 percent. By contrast, inward FDI stocks accounted for
only 2.2 percent of GDP for Japan, and 8.0 percent for South Korea. This divergence reflects
more deliberate policy choices as will be discussed in detail later in the chapter.
Since the end of the Second World War, there have been four waves of FDI into East
Asia. The first wave took place in the 1960s and the early 1970s, with joint ventures in
textiles and household electrical equipment to gain access to protected domestic markets. In
the second wave in the 1970s, foreign investors moved in to establish import substitution
operations and to export consumer electronics and semiconductors to the United States. The
third wave took place in the mid-1980s in the wake of the sharp appreciation of the yen.
Japan moved some manufacturing to East Asia. The second-tier economies South Korea and
Taiwan also became major investors. In fact, Hong Kong, Taiwan, and Singapore accounted
for 42 percent of total foreign investment in Thailand in 1990, more than Japan’s share at 30
percent.31 By the mid-1990s, Taiwan and Hong Kong had invested more in Vietnam than
Japan, followed by Singapore and South Korea. In an even bigger wave than the third, FDI
began to pour into China after the early 1990s.32 China continues to be a major destination of
FDI, attracting about one-third of all FDI into developing countries in 2002–2004.33 In 2006,
$69.5 billion of FDI flowed into China.34
The Investors of the World
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East Asian firms have also invested heavily overseas. Outward FDI flows from East Asian
economies amounted to 14.4 percent of the world total in 2005.35 There are two main reasons
for this. One is that East Asia has become a source of surplus capital based on strong exports
and high domestic savings. The other reason is that East Asian firms need to have a global
presence to be competitive with Western firms or with each other.
Japan leads East Asia in FDI outflows, which exploded after the 1985 Plaza Accord that
sharply appreciated the yen against the dollar. Endaka (strong yen) led to a drastic increase in
Japanese FDI in advanced economies. Japanese FDI in the United States amounted to $113
billion in 1987–1991, or three times the total in 1951–1986. Japan was America’s largest
foreign investor in 1992. Japanese FDI to Europe in 1987–1993 more than doubled its total
prior to 1986.36 Japan’s FDI overseas increased again in the early 1990s due to the second
endaka. But Japanese FDI outflows this time around were more concentrated in East Asia.
Some large Japanese companies have invested heavily overseas, partly to get around
protectionist pressure on Japanese exports. Japanese automobile companies, for example,
have become largely “domestic” in the U.S. market. Nissan produced 950,000 of 985,000
vehicles sold in the United States in 2004 in its factories in Tennessee and Mississippi.37
Japan continues to invest heavily overseas, more than $30 billion a year for the past few
years, as Table 7.1 shows.
TABLE 7.3
Foreign Direct Investment (FDI) Stocks as a Percentage of Gross Domestic Product ($
million and percentage)
Sources: Data for 1980, 1990, 2000, and 2003 are from UNCTAD, World Investment Report 2005, country
fact sheets. Data for 2004–2005 are from World Investment Report 2006, country fact sheets.
168

In the second wave, the four tigers also engaged in outward investments beginning in the
1980s.38 They poured much investment into Southeast Asia, actually surpassing Japanese
investments in some Southeast Asian countries, as discussed previously. As calculated from
Table 7.1, the four economies invested an annual average of $39.1 billion overseas in 2001–
2005, surpassing Japan’s $35.2 billion.
Hong Kong has been the largest source of FDI into China. Taiwanese firms have moved
much of Taiwan’s manufacturing to the mainland. Since much of Taiwanese investment was
disguised as from Hong Kong or the Virgin Islands, Taiwan is probably the largest investor in
China right now. Taiwanese companies are estimated to employ 10 million people in the
mainland. Taiwanese investment has turned China into a major power in production of IT
equipment. In 2002 China became the world’s second largest IT hardware producer, trailing
only the United States. At the same time, the mainland has imported a large quantity of IT
components from Taiwan.39 South Korea has become a major investor in China as well.
China is also investing overseas, with a sharp increase from less than half a billion U.S.
dollars in 2000 to $16 billion in 2006. China’s total FDI abroad reached $73 billion at the end
of 2006.40 China’s leading firms are venturing overseas, making headline-catching moves.
For example, International Business Machines Corp. (IBM) agreed to sell its personal
computer business, the ThinkPad line of notebook computers, for $1.75 billion to China’s
largest computer maker Lenovo Group Ltd. on December 7, 2004. The most controversial
case of Chinese acquisition of foreign assets was the failed attempt by China’s National
Offshore Oil Corporation (CNOOC) to purchase Unocal Corp. The Chinese firm made an
$18.5 billion bid for the American oil firm on June 22, 2005. If successful, this purchase
would become the largest purchase of a foreign firm by a Chinese firm. Chevron, which had
already bid for Unocal, sweetened its bid to more than $17 billion. The Chinese bid invited
strong congressional and media criticism. On August 2, 2005, CNOOC withdrew its bid.41
Chinese firms are moving overseas because they want to outflank considerable trade
barriers on Chinese products, following the examples of Japan and South Korea. In addition,
the China market has become so competitive that Chinese firms have to move overseas just to
remain competitive at home. Unlike Japanese and South Korean firms, however, Chinese
firms are seeking to take a shortcut in upgrading their products from low-cost to brand
premium by acquiring foreign brands.
REGIONALIZATION OF PRODUCTION
What is striking about contemporary East Asian political economy is the regionalization of
production. In the third section of Chapter 5, I have discussed at length the flying geese
formation theory and the product cycle theory to explain the regional dimension of the East
Asian economic miracle. Those two theories are used to explain intraregional movement of
direct investment and how FDI has contributed to East Asia’s rapid economic growth. My
discussion in the previous section has also shown how important foreign capital has been for
the capital formation and exports of East Asian economies, particularly ASEAN and China.
Put simply, firms increasingly organize production on a regional or global rather than
national basis, which means that much of the business they conduct is actually on an intrafirm
basis.
Regionalization of production is more than FDI, however. In recent years, some scholars
have used the term cross-border production networks (CPNs) or international production
networks (IPNs) to analyze a new form of market organization in the contemporary global
economy. By cross-border production networks, Michael Borrus, Dieter Ernst, and Stephan
Haggard meant “the inter- and intra-firm relationships through which the firm organizes the
169

entire range of its business activities: from research and development (R&D), product
definition and design, to supply of inputs, manufacturing (or production of a service),
distribution, and support services.”42 Thus, CPNs include not only firms and their affiliates
and subsidiaries but also suppliers, subcontractors, service providers, and other participants in
cooperative arrangements, particularly in R&D.
Traditionally, a firm vertically organizes all its R&D, production, distribution, and
services using affiliates based in the country of origin. In the 1970s, brand name companies
in the garment, footwear, furniture, and toy industries began outsourcing their manufactures
to IPN partners. The electronics industry began outsourcing in the mid-1980s. Cisco
represents the other extreme. Cisco does not do R&D. It focuses on definition of product and
some software development. It relies on alliances (no equities) for production, design, and
development. Its products are done by contract manufacturers in Asia and the United States.
Regionalization of production results from globalization of production. In a globalized
economy, companies increasingly have to form transnational interfirm alliances to remain
competitive. That is the case for East Asian companies. When we talk about production
networks, we need to discuss both the production networks created by Asian firms and those
by non-Asian firms. The fact that many production networks have been created by non-Asian
firms shows that East Asian production networks should be seen as part of the global
networks. IPNs thus characterize the changing division of labor in East Asia. More and more,
firms enter the region not just to take advantage of cheaper resources and labor and to expand
markets but also to take advantage of heterogeneous local technological capabilities in the
region. The variation in these local technologies resulted from both transfer of technologies
by multinational companies and local governments’ policies.43
Studies of specific sectors show an increasing regionalization of production in East Asia,
particularly in the electronics sector. However, it is harder to measure regionalization of
production than regional trade interdependence. One useful measure is to look at components
and parts trade statistics. East Asian trade in components has grown faster than Europe and
North America’s. By the end of the 1990s, components accounted for about 20 percent of
East Asian manufacturing exports. Intraregional components trade has grown faster than
global trade expansion. The Asian financial crisis did not stop this development.44 While
parts and components exports as shares of total exports increased worldwide from 1980 to
2002, East Asia saw the greatest increase.45 The degree of production sharing is particularly
high in the electronics industry.46
Using sophisticated tools of block multiplier decomposition and path decomposition to
analyze detailed trade data, David Roland-Holst showed that global supply chains that have
grown rapidly in recent years due to Western and East Asian FDI connect autonomous East
Asian firms as intermediate suppliers situated at different nodes of these chains. He found
that the majority of value creation and trade often comes from these linkages.47
It is largely private companies that have established intraregional linkages to seek
competitive advantages in the global market. The dominant players that have created
production networks in East Asia are Japanese, American, European, South Korean, and
ethnic Chinese firms. Constraint of space does not allow a nuanced comparison of the various
systems here. Rather, I will offer a stylized contrast of the Japanese, American, and Chinese
systems, viewing them as prototypes, the South Korean system as similar to the Japanese
system, and the European system as close to the American model.
Japanese firms tend to be centralized. Compared with Western firms, Japanese firms are
less willing to share technologies and more hesitant to employ local managers. Japanese
subsidiaries source most components from parent firms in Japan. When they increase local
sourcing, it often comes from Japanese suppliers that had invested in the country as well.
Japanese firms replicate their domestic production networks overseas to internationalize their
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ownership-specific advantages while keeping R&D at home.48 Moreover, the reverse exports
of the Japanese subsidiaries to Japan tend to displace exports from domestically owned firms
in Taiwan and South Korea. In key sectors such as electronics, the Japanese companies have
followed a similar approach in Southeast Asia and then in China.49
By contrast, American subsidiaries in East Asia are more willing to transfer technologies
and often assign the task of R&D for local as well as global markets.50 U.S. firms that are less
centralized in decision making follow open and flexible strategies. These national differences
have historical and social roots. They also reflect national policy.
For example, Japanese and Western electronics firms follow different strategies in
Malaysia. While Japanese and Western firms started out to exploit cheap labor, Western
firms turned to localization to exploit new Malaysian potentials and Japanese firms largely
remained unchanged in their focus. As a result, Japanese firms have largely taken a
production-cost focused, status-quo position on investment in Malaysia while Western firms
have been more aggressive in committing investment in the country.51
The Japanese and Chinese networks in East Asia are different. Unlike the Japanese, the
Chinese have had a much longer and deeper social root in Southeast Asia. The Chinese
networks are familial/clannish, horizontal, loose, and open. A survival mentality and the
Confucian tradition have shaped the first generation of Chinese entrepreneurs. They
emphasize thrift, trust family members irrespective of their competency, and prefer an
imperial organization in which professional managers have limited authority. The Chinese
network is flexible and open, connecting with the outside world as well.52 It is also important
to recognize that Chinese capitalism is dynamic and has been subject to globalizing forces.53
The organization of IPNs should have important implications for the competitiveness of
different countries. As a case in point, the U.S. electronics firms benefited from their
alliances in East Asia in competition with the Japanese firms. American firms were dominant
in the global electronic market in the 1950s. Japanese firms such as Matsushita and Hitachi
that emulated American firms and excelled in lean production techniques prevailed over
American consumer electronics producers by the late 1970s and came to challenge the U.S.
lead in other areas by the early 1980s. But technologies shifted by the mid-1980s. Firms
using microelectronics technologies now wanted their systems to interoperate. As a result,
technical standards became intellectual properties available for others in the value chain to
produce components, systems, or software. This meant a shift of market power from
assemblers to those who control product standards, such as Intel for microprocessors and
Microsoft for operating systems. Now U.S. firms linked with Asian suppliers to form
alternative production networks to reduce dependence on Japanese supplies. They began to
invest in electronics in non-Japan East Asia in the 1960s largely for exports back to the
United States and Europe, a purpose that necessitated sustained effort to help their Asian
partners upgrade their technological capability. By contrast, Japanese firms invested in East
Asia to enter the local market, which meant transfer of technologies just enough for a less
demanding market. By the 1990s, American firms became competitive against Japanese firms
by focusing on new product definition and design while relying on contract producers in
Taiwan and Singapore for production.54 In a way, a combination of American and ethnic
Chinese firms in East Asia helped erode Japanese dominance in electronics in Asia and to
lead to a resurgence of U.S. dominance in the industry.
But how effective a system is ultimately depends on circumstances, such as the type of
sector which partly explains why we do not see a convergence of a single organizing form of
regional production networks. The close and exclusionary networks Japanese firms have built
yield good results in the automobile sector because of the host countries’ protectionist,
industrial policy to promote the sector and because of the incremental innovation nature of
the sector. By contrast, the Japanese firms have not been that successful in the computer
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accessories sector, which the Asian governments have not sought to protect and because of
sudden and dramatic innovations of the sector.55
Japanese firms are facing tougher competition even in their strongholds. Japan’s auto
parts investment in Thailand is a case in point. While Japanese auto parts makers invested
heavily in Thailand to create a strong network, they faced a changed business environment in
the late 1990s when American and European auto parts manufacturers became rivals in the
Thai market. The Japanese companies also began to adopt a new, Western-style procurement
policy (away from a Japanese-style business association or keiretsu). A key development is
that Japanese automobile makers such as Isuzu, Mazda, and Mitsubishi are now partnered
with Western firms so they adopt a Western-style procurement policy. It is estimated that
now 70 percent of Thai auto production is using the Western-style procurement policy.56
THE EAST ASIAN STATE AND PRODUCTION
The East Asian state has been heavily involved in production politics. The East Asian
developmental state model essentially views the manufacturing sector as central to rapid
economic growth and transformation. This section examines how different East Asian nations
have dealt with the challenge of creating and maintaining manufacturing industries.
Picking the Winners
East Asian nations virtually all strive to create and maintain national champions and boost
industrial production through industrial policy. The essence of industrial policy is selective
state intervention. Marcus Noland and Howard Pack defined industrial policy as “an effort by
a government to alter the sectoral structure of production toward sectors it believes offer
greater prospects for accelerated growth than would be generated by a typical process of
industrial evolution according to static comparative advantage.”57 Thus, we may call
industrial policy simply picking the winners.
Japan was the first East Asian nation to adopt industrial policy and set a successful
example for others.58 Japan recognized the need to build a competitive manufacturing sector
by restructuring industry from labor-intensive to capital-intensive to knowledge-intensive
industries and by adopting aggressive domestic and international business strategies.59 Japan
created a powerful industrial bureaucracy to execute a production-oriented export policy,
channel scarce capital to targeted industries, and protect the domestic turf from foreign
competition. While internationalization has weakened Japan’s industrial policy, Japanese
bureaucrats continue to adopt industrial policy in high-tech sectors.60
South Korea took industrial policy to another level. South Korean strategies have been
somewhat different from the Japanese model, adapting to local conditions. The South Korean
government began to adopt industrial policy in the early 1960s, when the government
channeled money into infrastructure, labor-intensive export industries, and import
substitution of chemical, petroleum, and steel production. In the 1970s, the government
expanded labor-intensive exports and chemical industry and initiated industries of consumer
electronics, automobiles, and shipbuilding. The government allocated financial resources to
sectors or firms it deemed central for the country’s economic growth.61 While South Korea
turned more to market forces in the 1980s and the 1990s, it retained some key features of
industrial policy.62 The flip side of the state support for large companies was that large
companies threatened by bankruptcy could hide behind court-administered rehabilitation
procedures based on social values (i.e., employment) and prospect for improvement. Such a
system began to cause problems of misal-location of resources beginning in the early 1990s.63
The 1997 Asian financial crisis was a turning point for South Korea. Losing cost
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competitiveness to China and some other countries, the South Korean government has chosen
to move beyond skilled, low-labor, cost-based manufacturing to a knowledge-based
information and communications technology (ICT) sector. The South Korean government has
invested heavily in ICT infrastructure, such as high-speed computer links between cities and
free access to broadband Internet service and education and training in ICT for millions of
citizens.64 The government also reformed its bankruptcy system to lower exit barriers for
large companies by emphasizing the criteria of efficiency.65
Taiwan also engaged in state intervention although it does not have an economic
bureaucracy as centralized and as powerful as the South Korean industrial planning
bureaucracy.66 The Taiwanese government encouraged industrial upgrading to heavy
industries in the mid-1970s through fiscal incentives, control over trade regime, and public
funding for select industries. As Taiwan only achieved success in some heavy industries
because of rising oil prices, the government began to shift to technology-intensive industries
in the late 1970s. The government created the Hsinchu Science-Based Industrial Park in
1980, which has helped to make some domestic firms world leaders. The Hsinchu Park is
similar to Silicon Valley in California in many ways. Numerous Taiwanese entrepreneurs
used to work in Silicon Valley. But unlike Silicon Valley, Hsinchu has been the product of
deliberate government policy.67 By the mid-1980s, the Taiwanese government resorted more
to market forces, which proved successful as electronic and information industries came to
drive Taiwan’s exports in the late 1980s and the early 1990s.68 Similar to South Korea in the
face of mainland China’s challenge, Taiwan now needs to move from manufacturing to
knowledge-based industries. Taiwan has identified the semiconductor, the thin-film transistor
LCD flat-screen industries, digital content, and biotechnology as the next phase of economic
development.69
The Singaporean government has also used public enterprises to boost industrialization.
In July 1967, the British government announced its plan to withdraw all military forces from
Singapore by the mid-1970s. The British military bases had employed about 16 percent of
Singapore’s labor force and contributed 13–20 percent of its GDP. In response, the
Singaporean government decided the next year on a dramatic expansion of government
investment in manufacturing. By the end of 1970, the government held about one-quarter of
all shareholders’ funds in the economy. One-third of the loans went to the electrical
machinery and petroleum products industries, resulting in a large increase in the labor force
employed in manufacturing and values added in the two selected industries. With that initial
success, the Singaporean government continued to promote industry and economy, using
government corporations and statutory boards. By the 1980s, the Jurong Town Corporation
had built dozens of industrial parks and export processing zones. The government had a
complete ownership or a majority control in manufacturing firms in chemicals and
petrochemicals, iron and steal, shipbuilding and repair, food, textiles, and printing. The
government financed investment in manufacturing with loans and could afford to finance
public investment projects by keeping current expenditure lower than revenues by borrowing
from the country’s Central Provident Fund. The Central Provident Fund was established as a
social security agency in 1955 to mandate savings for retirement. In addition to domestic
investment, the government began to encourage foreign investment in 1968 with tax
incentives and strict restrictions on labor’s right to negotiate with management.70 Singapore
emphasized financial and business services after 1978, continuing its success in selective
government intervention. While the Singaporean government still welcomes foreign capital,
it now also seeks to develop domestic capital, particularly in biotechnology. The government
has committed billions of U.S. dollars to the endeavor, attracting top researchers from around
the world with top-of-the-line research facilities and strong government support without
meddling.
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Unlike other East Asian governments, the Hong Kong government has had limited
intervention in the economy while adopting measures to keep production cost low. The
government basically had low taxes and limited regulations to provide a suitable business
environment for all firms, local or foreign. The government does not get involved in the
manufacturing sector. Simply put, Hong Kong has been a showcase of free market economy.
The Malaysian government also emphasized manufacturing, introducing import
substitution industrialization from the late 1950s to the end of the 1960s, shifting to an
export-led industrialization in the early 1970s, and resorting to a protectionist heavy
industrialization in the early 1980s.71 Datuk Seri Mahathir bin Mohamad, who became prime
minister in 1980, launched a heavy industrialization drive in 1981, largely modeled after
South Korea. In 1986 the government launched the Industrial Master Plan, an industrial
policy with plans for targeted industries.72 Since Mahathir was also talking about “learning
from Japan” for Malaysia’s modernization drive, his plan was to seek Japan’s capital and
technology for heavy industrialization, particularly in automobile and steel sectors.73 In this
context, Malaysia formed a national automobile company, Perusahaan Otomobil Nasional
(Proton), in collaboration with Japan’s Mitsubishi to produce Malaysia’s national car, the
Proton Saga, which is really a remodeled Mitsubishi Lancer. Mahathir saw the Proton Saga as
a symbol of Malaysia’s status as an industrializing country in the world. The term was
favorable to Mitsubishi, which controlled technologies and faced little competition from other
foreign carmakers, including loans guaranteed by the Malaysian government and import
duties on foreign cars. The Japanese firm also came to occupy top management positions in
Proton.74
The Thai government has not engaged in industrial policy as actively as Northeast Asian
countries, but it set up the Board of Investment in 1959 to promote private investment. The
Ministries of Industry, Commerce, and Finance and the Bank of Thailand have adopted
policies to facilitate industrial development.75 Thailand has also adopted an open attitude
toward FDI, which increased dramatically in Thailand after the mid-1990s, led by Japanese,
Taiwanese, Korean, and Hong Kong firms in labor-intensive industries largely because of
low labor costs in Thailand.76
Indonesia followed a socialist economic approach from 1950 to 1965, a period referred to
as the Old Order, when the government sought to control the “commanding heights” of
industries by turning the nationalized Dutch enterprises into state-owned enterprises (about
20 percent of the country’s GDP), which denied sales of these firms to economically
powerful ethnic Chinese businessmen and allowed patronage of political supporters. That
policy was not successful. In the early 1970s, Indonesia grew economically thanks to its
drastically increased oil revenues. The oil windfall had a negative effect on non-oil tradable
goods, namely reducing their competitiveness against foreign firms, due to the real
appreciation of the currency. The Indonesian government responded by increasing protection
of domestic industries. Using oil revenues, the government launched an import substitution
industrialization plan and resorted to export promotion only after the mid-1980s.77
The Chinese government promoted heavy industrialization in the 1950s, first following
the Soviet planned economy model and then the Chinese mass mobilization model. When
reform began in the late 1970s, initial emphasis was placed on the agricultural and light-
industry sectors to adjust the distorted economic structure. With a growing economy and the
need to reform state enterprises, the Chinese government decided to create its own national
champions, initially modeled after the South Korean chaebol. Similar to Japan and South
Korea, the Chinese government channels cheap credit to the championed enterprises,
provides tax breaks, and helps them secure business deals at home and abroad. But unlike
Japan and South Korea, China has far more control over state enterprises. The Chinese
government created the State-Owned Asset Supervision and Administration Commission
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under the State Council in March 2003 to be in charge of large state enterprises, now around
170. Unlike Japan and South Korea, China has invited foreign companies to operate in China,
which has explained partly the explosive growth of Chinese manufacturing. In recent years,
the Chinese government has allowed some foreign acquisition of Chinese companies while
maintaining severe restrictions. At the same time, some Chinese are increasingly concerned
about technology dependency on Western and Japanese firms. As a sign of greater industrial
ambition, in March 2007, the Chinese State Council announced that the Chinese government
would push for R&D of large civilian planes. With a greater technological base and capital,
China is essentially taking on Airbus and Boeing in a strategic sector.
There have been debates over the effectiveness of industrial policy. Critics point out that
the states have often picked wrong winners. From a different angle, based on an examination
of Japan, South Korea, and Taiwan, Noland and Pack concluded that these countries’
industrial policy had only a modest positive impact on economic growth while creating
unintended negative effects. Industrial policy tends to breed corruption. It is in any case
difficult now for developing nations to adopt that model in the changed international
economic system we have today: The United States and other developed nations are more
driven by economic interests after the cold war ended, and selective subsidies are harder to
implement also because of a stronger enforcement mechanism of the World Trade
Organization.78 The flip side of picking winners is creating “losers.” From an economic
perspective, state intervention distorts allocations of resources, resulting in inefficiency.
Overemphasis on one sector leads to relative underdevelopment of other sectors. Also, the
practice of channeling soft credit to manufacturing firms from government-controlled or
government-guided banks has resulted in shallow financial markets in East Asia as well as
nonperforming loans in most East Asian countries. A focus on the manufacturing sector often
means a weak services sector. As a case in point, China’s financial support for state-owned
champions has resulted in insufficient financing for private firms that are generally more
efficient than state-owned enterprises. More broadly, a bias toward manufactured exports at
the expense of domestic consumption has contributed to a global financial imbalance.
Foreign Direct Investment Policies
Inward investments. There has been a sharp difference between East Asian nations in terms
of inward investments. Japan and South Korea largely discouraged FDI in their countries.
The government and the companies preferred to acquire technologies through licensing rather
than FDI.79 The South Korean government allowed FDI in the light-industry export sector but
discouraged foreign ownership in the import substitution and heavy industry sectors. The
government encouraged FDI in the high-tech sectors in the 1970s but the share of FDI in
these sectors remained low.80 After the Asian financial crisis, South Korea changed course
and now encourages FDI into the country.81 As Table 7.1 shows, inward FDI for South Korea
increased from an annual average of $697 million in 1985–1995 to $7,198 million in 2005.
However, as shown by recent South Korean backlash against American investors’ attempt to
take over South Korea’s KT&G, formerly the Korean Tobacco & Ginseng, South Korea has
yet to be truly welcoming to foreign investors.82 Former Japanese Prime Minister Koizumi
hoped to double FDI by 2008, but legislators in his own ruling party frustrated his effort to
reduce barriers to FDI. Resistance to FDI remains strong in Japan.83 As Table 7.2 shows, FDI
accounted for only 0.3 percent of Japan’s gross capital formation in 2005.
Other East Asian economies welcome foreign investment, although mainly in the
manufacturing sector. Hong Kong follows a laissez-faire approach to FDI. In fact, the British
colonial government did not distinguish between foreign and domestic firms.84 Taiwan
welcomed FDI with selective prohibitions. Singapore provided incentives to foreign firms.
Southeast Asia actively sought an FDI-led industrialization starting in the late 1980s.
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Thailand was cautious at first but became more welcoming. In fact, a 2005 World Bank study
found Thailand having a better investment climate than China, India, and most East Asian
countries. For example, firm managers in Thailand spend the fewest working hours dealing
with bureaucrats and regulators.85 The Philippines also were somewhat cautious. Indonesia
saw the most dramatic shifts, from nationalization (1950–1965) to openness (1967–1973) to
restrictive policies (1974–1984) and then back to openness in the early 1990s.86 Malaysia has
welcomed FDI. For political reasons, the Malaysian government encouraged foreign
investors at the expense of economically powerful local Chinese enterprises.87 Similar to the
Thai case, a World Bank study in 2005 found Malaysia’s investment climate better than even
the advanced regions in China judging by criteria such as customs clearance time.88
China enacted a joint venture law in 1979 and has also provided major incentives for
foreign investors since the 1980s. In fact, the Chinese laws and regulations have treated
foreign firms better than private Chinese companies although not as well as state-owned
enterprises.89 The Chinese government has also used its market potential as leverage to
achieve technology transfers, but this has not been that effective. Even the effort of
purchasing foreign brands will be only a temporary relief for state enterprises. There has been
growing concern in China in the past few years that FDI has not helped China upgrade
technologies as foreign firms continue to control core technologies. The Chinese government
is hoping to turn the country into a manufacturing powerhouse, not just a production base.
Since 2005 there has been a nationalist backlash against perceived foreign firms purchasing
core Chinese industrial enterprises to monopolize the Chinese market. The Chinese
government announced in August 2006 that starting on September 9, 2006, foreign
acquisition of key Chinese enterprises has to be reported to the Ministry of Commerce, a
signal that Beijing may tighten regulations in the name of national economic security.
The Vietnamese government now also actively seeks FDI, following the Chinese and
ASEAN models. North Korea issued a similar law in 1984 and enacted a few new business
laws in the early 1990s to encourage foreign investors and established the Rajin-Sonbong
Economic and Trade Zone.90
Outward investments. Japan led in outward investments. Japanese firms expanded overseas
initially to obtain primary products and to promote exports. The Japanese government
encouraged FDI overseas in mineral and energy sectors through tax breaks and financing
from the Japan Export-Import Bank. As Kojima noted in the late 1970s, Japanese FDI was
“trade-oriented,” meant to complement Japan’s comparative advantage position. Specifically,
Japanese firms that established production operation in Southeast Asia, where labor cost was
cheaper than in Japan, could substitute export of final products with exports of machinery,
equipment, and technological know-how.91 But with concerns over protectionist pressure in
North America and Western Europe, Japanese firms invested in these markets. Japanese firms
also turned to East Asia to avoid restrictions and to reexport to the United States and Europe.
The Japanese model was followed by South Korea, Taiwan, and Singapore.
The Chinese government now also encourages outward FDI. It follows the pattern
established by Japan and the NIEs. Pushed by insufficient demand at home, this new twist
began around 2000 and is meant to acquire natural resources, promote exports, and contract
projects. When purchasing foreign firms, Chinese firms tend to pledge to keep the managers
and labor force, unlike Western multinational corporations that would immediately
consolidate the new purchases. The reason is that Chinese firms need technology and
management skills, which is part of the reason that they are moving overseas in the first
place. The Chinese government has supported the efforts of the large state enterprises with
funding; after all, these companies mostly have narrow profit margins and are not that
competitive globally but for state support.92
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EAST ASIAN COMPANIES
East Asian companies are the engines of East Asian economic growth and economic
transformation, and they have become more prominent globally. Japan led the way. Brand
names by globally competitive Japanese firms abound, including Sony, Toshiba, Toyota,
Honda, Nissan, Mitsubishi, and Nintendo. As Table 7.4 shows, Japan accounts for more
global brands than any other East Asian country. While Japan has experienced a decade of
economic slowdowns and recessions, leading Japanese firms remain competitive
internationally. Through incremental reforms, Japanese companies have reduced debt by
saving more and by adopting more flexible labor policies, such as hiring part-timers and
contract workers who cost far less than regular workers.
Six large Japanese industrial groups or keiretsu (it literally means sequence) dominate
Japanese industries: Mitsubishi, Mitsui, Sumitomo, Fuyo, Daiichi-Kangyo, and Sanwa.
Mitsubishi, Mitsui, and Sumitomo are based on the prewar family-controlled business
conglomerates or zaibatsu, which the American Occupation authorities disbanded. A keiretsu
has member companies operating in various industries, which are organized around a main
bank and a trading company. The member companies are connected through cross-
shareholdings.93 The Japanese keiretsu system has made it difficult for foreign or domestic
firms to enter their turf. However, things have begun to change in recent years. In a
celebrated case, Renault SA of France merged with Japan’s Nissan Motor Co. in 1999, and
Carlos Ghosn, who came to lead both companies, became a symbol of change. Then in July
2006, as a first, a major blue-chip company, Oji Paper Co., mounted a $1.2 billion hostile bid
for another blue-chip company, Hokuetsu Paper Mills Ltd. That bid failed shortly when
Mitsubishi Corp. increased its stake to almost 25 percent with Hokuetsu’s sale of shares to
Mitsubishi below market price and when Nippon Paper Group Inc., number 2 paper maker in
Japan, also increased its share.
TABLE 7.4
Asia and Global Brands
Source: Interbrand, in Business Week, August 7, 2006, 60–66; August 1, 2005, 90–94; and August 9–16,
2004.
Note: Among the top 100 brands in 2006, 52 belong to American firms (including Accenture, which relocated
to Bermuda), 37 to European companies, and 11 to East Asian firms.
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South Koreans have followed Japan’s example with a similar set of manufacturing firms,
such as Hyundai, Samsung, Daewoo, LG (formerly Lucky Goldstar), and SK (formerly Sun
Kyung), the so-called chaebol (financial clique), which refer to business groups consisting of
large companies in different sectors controlled by family members.94 These large chaebol
have powered South Korean economic growth. Proportionally, South Korean chaebol are
more dominant in domestic economy than Japanese keiretsu. Unlike prewar Japanese
zaibatsu, a chaebol does not have a main bank at its core although it does have a general
trading company similar to the Japanese system.
Some South Korean brands have received much international media exposure, an
indicator of their rising name recognition. As Table 7.4 shows, South Korea’s Samsung,
Hyundai, and LG rank among the top 100 global brands in 2006. Samsung ranks number 20,
trailing only Toyota and Honda among Asian firms. Samsung Electronics has also built a
brand name of cutting-edge technologies and design in recent years. Since the Asian financial
crisis, the company has restructured itself and spent billions of U.S. dollars on research and
marketing to build a brand name that is now close to that of Sony.95 Detroit automakers now
consider Hyundai a serious rival similar to Japan’s major carmakers in the 1980s. Hyundai
was introduced in the United States in the 1980s. Its products were initially considered
shoddy, but Hyundai has become more competitive. It became the world’s seventh largest
carmaker in 2004, overtaking Honda and Nissan. In 2004 Hyundai tied for second place with
Honda in the United States in overall quality in a J.D. Power and Associates survey, trailing
only Toyota but ahead of Mercedes-Benz.96
Taiwanese companies are largely small and family-owned, partly because the government
continued their practice from mainland days to be highly restrictive of large firms. As a
result, businesses chose to establish new small firms rather than expanding existing ones.
Taiwanese companies now realize the importance of having their own brands. Unlike South
Korean firms, Taiwanese firms such as BenQ Corporation that makes consumer electronics
and mobile phones have chosen to make IT products for other firms that own the brands, a
practice known as original design manufacturing or original equipment manufacturing. As a
result, Taiwan has no entry on the list of the top 100 global brands reported by the
consultancy Interbrand. Taiwan now faces competition from China, more intense competition
for consolidated brand-name IT firms, and the burst of the IT bubble. Since around 2001,
some large Taiwanese firms have been trying to create their own brands. Acer, for instance,
has been selling more products under its own brand.97
Unlike South Korea, public or state-owned enterprises have played an important role in
Taiwan’s economic life, particularly strong in utilities, heavy industry, and infrastructure
projects such as transportation. Taiwan’s share of state-owned enterprises in nonagricultural
GDP was around 21 percent in the 1950s–1960s and 14–17 percent in the 1980s–1990s, a
level close to India and Indonesia. Public and state-owned enterprises basically focused on
the domestic market, whereas most exporting firms were private.98
As China is emerging as an economic superpower, its companies have also become more
active globally and attracted much international attention. The Chinese government has been
trying to privatize its state-owned enterprises.99 At the same time, the government has been
trying to create 30–50 state-owned national champions that are globally competitive by 2010.
To advance this objective, the government provides land, labor, and cheap credits from state
banks. The government also facilitates the companies in their overseas activities. Now they
have succeeded in creating some large companies that rank among Fortune Magazine’s
Global 500 measured by revenues. Nineteen Chinese companies (not including one from
Hong Kong) were listed among Fortune 500 in 2005, an increase of three over the previous
year. SINOPEC, China’s largest company for the year, ranked 23rd in the world. By
comparison, the U.S. had 170 companies and Japan had 70. Of the top 10 companies in Asia,
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Japan had 6, China 3, and South Korea 1.100
But are these Chinese firms truly competitive internationally? Most of these firms are
large because they enjoy monopoly or near monopoly in China and because they are
commodity producers for a fast growing market. The 19 Chinese firms listed among Fortune
500 are all state companies in oil, power, banking, telecommunications, steel, and chemistry.
If one looks at the brand names or technological capacity, the Chinese firms have not been
that successful. They cannot truly compete with Western, Japanese, or South Korean
consumer brand names. Some of the foreign purchases were designed to buy brand names.
However, this does not solve the basic problem of lack of technological innovation inherent
in the Chinese firms. As China’s own statistics show, although China’s exports of high-tech
products have increased drastically, less than 10 percent came from China’s own brands in
2004.101 Only 0.03 percent of the Chinese firms control their core technologies. Ninety-nine
percent of the firms have not applied for patent, and 60 percent of the firms do not have their
own brands.102 According to UNCTAD, China’s PetroChina was the largest spender on R&D
among China firms, but it ranked only 219 in the world in 2003. By contrast, 4 Japanese
firms (Toyota Motor, Matsushita Electric, Sony, and Honda Motor) ranked among the top 20
in the world. South Korea’s Samsung Electronics ranked the 33rd. China had only 2 firms
among the world’s 700 largest R&D spending firms in 2003. The United States had 296
firms, Japan 154, South Korea 10, and Taiwan 8.103
Similar to Taiwanese and Hong Kong companies, ethnic Chinese companies in Southeast
Asia are family firms that tend to be flexible and diversified in various businesses. Prominent
firms include the Pico Group in Singapore, Wee Cho Yaw’s United Overseas Bank in
Singapore, Robert Kuok’s Shangri-La Hotel in Malaysia, Liem Sioe Liong’s Salim Group in
Indonesia, and Charoen Pokphand Group in Thailand.104 The 500 largest local public
companies controlled by ethnic Chinese had total assets over $500 billion in the 1990s, and
Chinese firms accounted for 73 percent of market capitalization in Indonesia, 81 percent in
Singapore, 90 percent in Thailand, 60 percent in Malaysia, and 50 percent in the Philippines
in the same period.105 To be sure, market capitalization does not equate to a nation’s wealth.
One should not forget about a large public sector, the presence of foreign capital, the land,
and other assets controlled by the bumiputras or sons of the soil.106 But few would dispute
that the ethnic Chinese firms are major economic forces in Southeast Asia.
Successful non-Chinese companies also abound in Southeast Asia.107 But they face
challenges. For example, a survey of the Malaysian firms finds them suffering from a serious
shortage of skills and lacking innovation.108 Similar to China, Southeast Asia often sees large
state enterprises in manufacturing, mining, and energy. State companies such as Malaysia’s
Proton, Perwaja Steel, and Petronas (petroleum) and Indonesia’s Pertamina (petroleum) are
international players.
The behavior of companies has important implications for the politics and economy of
East Asian countries as elsewhere. From an economic perspective, Japan’s recession in the
past decade can be explained in part by the efforts of Japanese companies to balance their
sheets by reducing debt in a time of economic slowdown.109
East Asian businesses traditionally recognize the legitimacy of state interference or accept
it as an unpleasant reality. At the same time, these companies are gradually becoming more
independent and powerful in domestic politics. This is particularly the case for those
internationally competitive companies. The government depends on them to deliver
economic growth and jobs. Unlike in the United States that has a strong antitrust tradition, the
chance of breaking a national champion company in East Asia is not good.
As East Asian countries have become more integrated into the global market,
globalization has affected how these firms operate in terms of governance and
organization.110 International norms and practices of business are diffusing into East Asia
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through networks of production and also international education. Asian companies often hire
non-Asian managers, and Asians work in non-Asian companies. Many Asian
businesspersons, particularly the second generation, have been educated in the West.
DOMESTIC POLITICAL ECONOMY OF PRODUCTION
How does East Asian production relate to East Asian political economy? The first question
that needs to be addressed is why production has been so important for East Asia. In some
ways, all countries want production because they want a strong economic base for national
power and the employment that manufacturing provides. Thus, Paul Kennedy warned that the
United States was losing manufacturing, which indicated that the country was declining like
all previous great powers.111
It is obvious why a developing nation might want to emphasize manufacturing
production. When developing nations began economic development, they easily concluded
that the gap with advanced countries was the degree of industrialization. Early intellectual
leaders also told them that they could not depend on agricultural commodities because of
deteriorating terms of trade caused by decreasing input ratio in the industrialized countries;
the share of agriculture became smaller and smaller and technological advance meant that
industrialized countries would not need as much input, both of which make agricultural
exports less profitable.112 The state then needs to give industrialization a big push, nurturing
and protecting national industries. Thus, late industrializers or late-late industrializers tend to
adopt centralized, state interventionist political economy regimes.113 What made East Asia
different was not ideologies but that they made far more progress than other developing
regions.
Politics matters in policy toward production. Who doesn’t want the rent from state
protection and state support, which are by definition scarce commodities? State favors have
led to crony capitalism to different degrees in various East Asian economies.
Corruption aside, the East Asian governments seek various objectives in their
industrialization plan. Taiwan’s heavier dependence on public and state-owned enterprises
than South Korea’s was partly due to the political logic that Taiwan’s Nationalist government
had political interest not to turn mainlander-dominated public enterprises to the private sector
dominated by native Taiwanese businessmen.114
As another striking example, the Malaysian government has sought to enhance the
economic position of the indigenous Malay population in its foreign-capital-based
industrialization. The Malaysian government adopted an import substitution industrialization
strategy beginning in the late 1950s, but the Malay population did not benefit that much. A
widening income gap contributed to mounting racial tensions that erupted in anti-Chinese
riots in May 1969.115 Mahathir’s main purpose for industrialization was to elevate his country
to the rank of the four Asian tigers and to help achieve the goal of the New Economic Policy
adopted in 1970 to enhance the economic status of the indigenous Malays vis-à-vis more
affluent ethnic Chinese and Indian communities in Malaysia.116 Thus, Malaysia’s picking of
winners were not “the true winners” in the domestic context since Chinese firms were not
favored and the Japanese firms have enjoyed a privileged position in this relationship.
For political economy of production, political concerns factor into decisions regarding
FDI. One of the reasons for Singapore’s early encouragement of FDI into the country was
that the government wanted foreign powers to have a stake in Singapore to enhance the
country’s survival. The Malaysian government encouraged FDI to dilute the Chinese control
of the economy in the country.117
The flip side of picking the winners is to create losers. Unlike the Western states that have
180

developed social welfare systems, East Asian governments have largely relied on a growth-
with-equity philosophy, informal social support mechanisms, and control or repression of
opposition. As discussed in Chapter 5, East Asia’s rapid growth has benefited many. At the
same time, as revealed by the Asian financial crisis, there are limitations in this model. A new
social contract is needed and demanded.118
Japan has performed the best in East Asia in maintaining social stability. In the Japanese
system, the state has followed the logic of a rising tide lifting all boats. To soften potential
opposition, the government has provided side payments for losing sectors.119 The government
has also tried to shield weak sectors from international competition. While bureaucrats may
be credited with picking winners for growing sectors, they have not been able to resist
political pressure from troubled industries.120 However, foreign pressure makes it
increasingly difficult to support losing sectors. Other East Asian countries face far greater
challenges than Japan in this regard.
The irony is that the government helps create stronger companies and industrial
associations, which over time have acquired greater bargaining capacity vis-àvis the state.
This is particularly the case in a time of globalization when companies now respond more to
the market than to bureaucratic directives. The large Japanese firms that have moved overseas
now may raise funds abroad and become less beholden to bureaucrats. Take Taiwan’s textile
industrialists for another example. The government actually became more involved in helping
the textile industry to upgrade as a result of greater external protectionist pressure and
competition. At the same time, with greater funds available and greater technological
expertise, the textile manufacturers became stronger players, challenging the state policies,
especially in the 1980s.121
The bigger picture is that economic success combined with changes in external
environment leads to a changed situation. For example, when a country has become more
successful economically, it loses comparative advantages in labor-intensive industries. The
more skilled labor force also provides conditions for structural shift. From a political
economy perspective, a simple story would be one between “the old forces” and “the new
forces.” An important intervening variable is ideas. Again, take Taiwan for an example. The
government gradually shifted to liberalization and high-tech industries in the early 1980s
because of new economic and social interests, the policy suggestions of U.S.-based
Taiwanese neoclassical economists, and the experience of Taiwanese returnees, particularly
those who worked in Silicon Valley. One should also recognize the crucial leadership role
played by President Chiang Ching-kuo in economic and political liberalization in Taiwan.122
Such transitions are easier said than done. It is inherently difficult to reconcile conflicting,
evolving interests and ideas.
CONCLUSION
East Asia has industrialized rapidly and has become a major center of manufacturing in the
world. The state has played a prominent role in shaping production in East Asia. On one
extreme, the South Korean state has been the most detail-oriented interventionist, learning
from Japan and moving to another level. On the other extreme, the Hong Kong government
has basically adopted a free-market approach. Most East Asian governments clearly have a
strong tendency toward state intervention. Nowhere is state intervention more visible than in
the issue of industrial policy. There has been much debate over the benefits of industrial
policy. But the fact remains that East Asia has become industrialized and the state has played
a central role in shaping the nature of East Asian industrialization, for better or for worse.
At the same time, there are market forces at work in East Asian production. East Asia has
181

excelled because of advantages in production cost, proximity, and skills. Market forces are
also reflected in that foreign firms have found it important and to their advantage to invest in
the region. With greater integration into the global market, it is no longer easy for the state to
control firms.
A production bias has skewed the East Asian political system, which has had unintended
negative economic and political consequences. From an economic perspective, picking
winners creates losers and an imbalance of the economic structure. From a political
perspective, industrial firms have acquired too much economic and political power without
being checked by financial institutions, which have been kept weak. More broadly,
dominance of big business contributes to authoritarian regimes.

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“The Political Consequences of the Product Cycle: Industrial History and Political
Outcomes” International Organization 33, no. 1 (Winter 1979): 1–34. It has been
argued in recent years that IT industry has a democratic effect.
114. Hsueh, Hsu, and Perkins, Industrialization and the State, 106–107.
115. Jomo and Edwards, “Malaysian Industrialization in Historical Perspective,” 24–25.
116. R. S. Milne, “Malaysia: Beyond the New Economic Policy,” Asian Survey 26, no. 12
(December 1986): 1364–1382.
117. K. S. Jomo, “Introduction: Southeast Asia’s Ersatz Miracle,” in Southeast Asian Paper
Tigers? From Miracle to Debacle and Beyond, ed. K. S. Jomo (London: Routledge,
2003), 8.
118. Haggard, Political Economy of the Asian Financial Crisis, 183–237.
119. Kent E. Calder, Crisis and Compensation: Public Policy and Political Stability in
Japan, 1949–1986 (Princeton: Princeton University Press, 1988).
120. Robert M. Uriu, Troubled Industries: Confronting Economic Change in Japan (Ithaca,
N.Y.: Cornell University Press, 1996).
121. Ying-yi Tu, “The Textile and Apparel Industries,” in Industrialization and the State: The
Changing Role of the Taiwan Government in the Economy, 1945–1998, ed. Li-min
Hsueh, Chen-kuo Hsu, and Dwight H. Perkins (Cambridge, Mass.: Harvard Institute for
International Development, 2001), 219–223.
122. Hsueh, Hsu, and Perkins, Industrialization and the State, 50–80.
188

189

T
CHAPTER 8
The Political Economy of East Asian Trade

his chapter examines the political economy of East Asian trade. Trade is the most
politically sensitive economic issue, and trade calculations have been important for East
Asian governments. As discussed previously, the East Asian economic miracle has been
partly based on strong export performance, and a sharp slowdown in exports among some
Southeast Asian countries contributed to the Asian financial crisis.
The chapter answers two questions. First, what are the basic characteristics of East Asian
trade and why did they develop? East Asia has experienced the world’s fastest growth in
trade due to both market forces and government policies. A global trade expansion brought
about by trade liberalization and new technologies has provided a favorable external
environment for East Asians, who have responded better than other developing regions
because East Asian governments promote trade or are at least less restrictive than others.
Second, what trade policies have East Asian nations adopted and why? Is there anything
unusual about East Asian trade politics? East Asian nations have created almost a cult of
export. Starting with Japan, they have relied heavily on exports, which were highly beneficial
at first but came to have a negative effect later on. But in a path dependent logic, it has been
difficult to shift course. A country’s trade policy includes its handling of disputes with
trading partners and its participation in the multilateral institutions, which will also be
discussed in the chapter.
TRADE PATTERNS IN EAST ASIA
Rapid Expansion in Trade
East Asian trade has expanded rapidly, which is a powerful engine for the region’s economic
success. Based on the World Bank statistics, China, Hong Kong, Indonesia, South Korea,
Malaysia, the Philippines, Singapore, Taiwan, and Thailand achieved an 11.5 percent average
annual growth rate in trade in 1970–1995, twice as fast as the world average of 5 percent.
Their share in world trade increased from 4 percent to 16 percent in the same period.1
Merchandise exports have been particularly important for East Asian economic growth.
World merchandise exports expanded 82.1 times from 1960 to 2005.2 But as shown in Figure
8.1, Japan’s merchandise exports expanded 146.9 times, the four tigers 492.9 times
(including Hong Kong and Singapore’s reexports), ASEAN 4 (Indonesia, Malaysia, the
Philippines, and Thailand) 123.6 times, and a latecomer China 296.4 times.
East Asian economies have become major trading powers, which can be measured by
exports as shares of world import markets. As shown in Table 8.1, Japan’s share tripled from
3.0 percent in 1960 to 8.1 percent in 1990 but decreased to 5.6 percent in 2005. The
combined share of the four tigers, ASEAN 4, and China increased from less than 6 percent in
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1960 to 20 percent in the same period. China surpassed Japan as the world’s third largest
trading nation in 2004, trailing the United States and Germany. As shown in Table 8.2,
China, Japan, Hong Kong, South Korea, Taiwan, Singapore, and Malaysia ranked among the
top 25 exporters and importers in the world in 2005. Four other East Asian countries ranked
among the top 50 that year.
As another indicator of East Asia’s growing importance in the global trade, if we look at
maritime transport, 27.4 million twenty-foot equivalent units (TEU) left East Asian ports in
2002, accounting for 45.0 percent of the global container transport (60.9 million TEU), and
19.7 million TEU arrived in East Asian ports or 32.3 percent of the world total. Intraregional
container flow amounted to 8.9 million TEU. In terms of containers handled, East Asia had
the top six ports in the world in 2004, namely Hong Kong (21.9 million TEU), Singapore
(20.9 million), Shanghai of China (14.6 million), Shenzhen of China (13.7 million), Busan of
South Korea (11.3 million), and Kaoshiung of Taiwan (9.7 million), ahead of Rotterdam (8.3
million), Los Angeles (7.3 million), Hamburg (7.0 million), and Long Beach (5.8 million).
Shanghai and Shenzhen grew faster than the others in 2001–2004 by 131.7 percent and 174.0
percent, respectively.3 East Asia also had four of the ten top air freight airports in the world in
2003, namely Hong Kong (2), Tokyo (3), Seoul (5), and Singapore (10), among Memphis (1),
Anchorage (4), Los Angeles (6), Frankfurt (8), and Miami (9).4
FIGURE 8.1
East Asian Expansion in Merchandise Exports, 1960–2005
Source: World Bank, World Development Indicators Database. Data for Taiwan’s export growth rates in
1969–1990 are from Council for Economic Planning and Development of the ROC, Taiwan Statistical Data
Book 1996, 1–1b, and data for 1991–2005 come from Ministry of Finance of the ROC,
www.mof.gov.tw/public/data/statistic/trade/2281.htm.
TABLE 8.1
East Asian Export Shares of World Imports
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http://www.mof.gov.tw/public/data/statistic/trade/2281.htm

Source: World Development Indicators Database. Data for Taiwan’s export growth rates in 1969–1990 are
from Council for Economic Planning and Development of the ROC, Taiwan Statistical Data Book 1996, 1–
1b, and data for 1991–2005 come from Taiwan’s Ministry of Finance,
www.mof.gov.tw/public/data/statistic/trade/2281.htm.
Merchandise trade has been important for East Asia, which can be measured by
increasing merchandise trade as shares of gross domestic product (GDP), as shown in Figure
8.2. Although Japan is a major trading nation, its exposure to international trade actually did
not change much, hovering around 20 percent in 1960–2005. Not surprisingly, Hong Kong
has a high exposure to international trade. A city state, Singapore, not shown in the figure, is
as dependent on trade as Hong Kong. China’s merchandise trade as shares of GDP increased
dramatically from 5.0 percent in 1970 to 63.6 percent in 2005. Of the five countries most
affected by the Asian financial crisis, Indonesia’s ratio increased from 21.8 percent in 1970 to
54.2 percent in 2005, South Korea from 31.7 percent to 69.3 percent, the Philippines from
34.1 percent to 89.5 percent, Thailand from 28.3 percent to 129.3 percent, and Malaysia from
72.2 percent to 196.1 percent. As a contrast, the world exposure to merchandise trade
increased only from 20.4 percent to 47.3 percent.
TABLE 8.2
Leading Exporters and Importers in World Merchandise Trade, 2005 ($ billion and
percentages)
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http://www.mof.gov.tw/public/data/statistic/trade/2281.htm

Source: World Trade Organization, International Trade Statistics 2006, 17.
FIGURE 8.2
East Asian Merchandise Trade as Shares of GDP, 1960–2005
Source: World Development Indicators Database.
Note: EMU refers to the European Monetary Union.
East Asian trade expansion has resulted from an expanding and liberalizing global market
to which East Asia has also contributed. One should thus not attribute the success of East
Asian trade solely to East Asian trade policies, which are discussed in the next section.
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At the same time, increasing dependence on trade creates vulnerability to the changing
global market. As Figure 8.3 shows, East Asian exports suffered with the first oil crisis in the
early 1970s and the second oil crisis in the early 1980s. In particular, Southeast Asian nations
experienced severe economic difficulties during most of the 1980s. As discussed in Chapter
6, a significant slowdown in exports in 1996 was an important contributing factor to the
Asian financial crisis. East Asian exports bounced back after the crisis. The Asian financial
crisis had revealed the danger of relying too much on exports, thus Southeast Asian
governments adopted measures to boost domestic consumption as an engine of growth, but
they came short. Exports have grown much faster than domestic consumption. The flip side is
that global economic ups and downs would affect the region more. The economic difficulties
experienced in the developed countries after the terrorist attacks in the United States on
September 11, 2001, had a large negative impact on Hong Kong, Singapore, and Taiwan,
which had largely escaped from the Asian financial crisis.
FIGURE 8.3
Growth Rates of East Asian Merchandise Exports, 1961–2005
Source: World Development Indicators Database. Data for Taiwan’s export come from Ministry of Finance of
the ROC, www.mof.gov.tw/public/data/statistic/trade/2281.htm
The merchandise export performance of East Asian economies varies over time. As
shown in Table 8.1, while Chinese export was about two-thirds of Japan’s in 1960, that ratio
decreased to about one-seventh by 1980. In the same period, the share for the four tigers
increased dramatically, from smaller than China’s in 1960 to over four times in 1980.
ASEAN 4 maintained their shares, widening the gap with China from 20 percent to 2.6 times.
China’s declining export performance was due to disastrous domestic politics and increasing
isolation from the global market. China’s fortune began to change with Deng Xiaoping’s
reform and opening policy adopted in 1978. By 2005, China had a significantly larger share
than Japan and ASEAN. While China’s share in 2005 was smaller than that of the four tigers,
much of trade by Hong Kong and increasingly by Taiwan was transshipment trade with
China. The four tigers saw the most dramatic rise in exports. In particular, South Korea’s
shares increased from 0.02 percent in 1960 to 2.67 percent in 2005.
As shown in Table 8.1, the share of East Asia excluding Japan of world trade increased
dramatically after the mid-1980s, which has had much to do with a drastic increase in
Japanese foreign direct investment (FDI) after the Plaza Accord as well as FDI from Western
nations and other East Asian economies. In particular, China’s exports are increasingly
conducted by foreign firms operating in China, more than half by Beijing’s own estimates.
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http://www.mof.gov.tw/public/data/statistic/trade/2281.htm

Production networks discussed in the previous chapter mean that increasingly we need to take
a regional perspective of East Asian exports because of exports transferring from one country
to another through direct investments.
Structural Change in Trade
Structural change in trade refers to change in the composition of trade. East Asia shifted from
export of primary commodities and resource-intensive manufactures to labor-intensive
manufactures, and some advanced economies in the region are now moving toward capital-
intensive and technology-intensive manufactures. As Figure 8.4 shows, the shares of
manufactures in merchandise exports increased dramatically for East Asian economies from
1962 to 2005. Industrialized Japan and Hong Kong always had a high percentage. South
Korea’s shares increased from 18.2 percent in 1962 to 90.8 percent in 2005. Singapore
jumped from 26.2 percent to 81.1 percent. Malaysia, the Philippines, and Thailand increased
their shares from below 5 percent to 74–90 percent in the same period. China nearly doubled
its shares from 47.7 percent in 1984 to 91.9 percent in 2005. Another transitional country,
Vietnam started much later than China and saw modest gains. Vietnam’s new World Trade
Organization (WTO) membership achieved in November 2006 is expected to facilitate
Vietnamese manufacturing exports, particularly in the textile sector.
The nonsocialist East Asian nations diversified exports in the 1970s to reduce dependence
on products such as clothing and raw materials such as iron ore and wood.5 This structural
change has accelerated since the 1980s when foreign investment came into the region to take
advantage of low-cost labor and to enter domestic markets.
To illustrate a sharp structural shift in trade in individual economies, we can use the
example of Taiwan, not listed in Figure 8.4. Taiwan exported sugar and rice to Japan during
the Japanese colonial period. Primary and processed agricultural products accounted for 91.9
percent of Taiwan’s exports in 1952. Once Taiwan shifted to export promotion and currency
devaluation in the late 1950s, the structure of Taiwanese exports changed rapidly. The share
of industrial products in exports increased to 78.6 percent in 1970 and 90.8 percent in 1980.
Based on its comparative advantages, Taiwan’s early industrial exports concentrated in labor-
intensive light industrial products such as textiles, clothing, shoes, umbrellas, and toys. Even
its agricultural exports were labor-intensive.6 Now Taiwan has become a major exporter of
high-value-added goods, particularly in information technologies.
FIGURE 8.4
Manufacture Exports as Shares of Merchandise Exports, 1962–2005
Source: World Development Indicators Database.
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As another example, Thailand had a large service sector in the 1950s, at around 45
percent of GDP. But manufacturing expanded at the expense of agriculture, which decreased
from about 40 percent in the 1950s to below 10 percent in 1996. Manufacturing accounted for
30 percent of exports in the early 1980s, 80 percent in 1993, and 87 percent in 2004.7
One striking feature of East Asian trade after the mid-1980s was a sharp increase in
exports of high-value-added products such as electronics and machinery. For China, high-
tech and new products accounted for 29 percent of China’s total exports in 2006.8 Figure 8.5
shows an increase of high-technology exports as shares of manufactured exports for East
Asia in 1988–2005 (information before 1987 not available). The high-technology exports
statistics are reported by nation-states. With that caveat, the technology component of East
Asian exports has clearly increased, reflecting industrial upgrading of regional economies.
FIGURE 8.5
High-Technology Exports as Shares of Manufactured Exports for East Asia, 1988–2005
Source: World Development Indicators Database.
Surplus with the World
East Asia’s rapid trade expansion has contributed to the global economy by offering greater
opportunities for trade and investment. At the same time, East Asia’s continuous large trade
surpluses put political pressure on the governments in other regions. As Figure 8.6 shows,
most East Asian economies now have large surpluses in merchandise trade with the world.
Japan had huge trade surpluses since the late 1970s except during the second oil crisis in
1979–1980. The rest of East Asia increased their surpluses significantly after the early 1990s.
In particular, China caught up with Japan by 2005 and posted a startling $117.5 billion
surplus in 2006. Conversely, Figure 8.7 shows sharp, continuous increases of American trade
deficits since the late 1970s.
From an economic perspective, East Asia’s trade surpluses have largely resulted from the
region’s high savings and the low savings of countries like the United States. But from a
political perspective, the non-Asian governments find it easier to blame the trade imbalances
on the “unfair” trading practices of East Asian economies.
Japan sets the trend. There was much complaint about Japanese trading practices,
particularly Japan’s low levels of intraindustry trade unlike some major Western trading
nations.9 Japan’s bilateral trade tensions with the United States cooled in the late 1990s. But
as Figure 8.8 shows, Japan’s surpluses as shares of U.S. trade deficits remain high. Statistics
on bilateral trade flows can be misleading because countries are involved in multilateral
trade; thus a country may have a large trade surplus with another country while maintaining a
196

balanced trade with other parts of the world. The challenge of many East Asian economies
lies in the large trade surpluses with the world in contrast to America’s even larger deficit
with the world. Japan had a much larger share than China’s until 2005, peaking at slightly
over 100 percent in 1992. Given the regionalization of production discussed in the previous
chapter, much of the surplus has been transferred to China. Following in Japan’s footstep,
South Korea and Taiwan also began to accumulate trade surpluses with the United States,
leading to U.S. pressure on them as well. In recent years China has increased its pressure on
the rest of the world in labor-intensive, low-tech products, reaching 12.3 percent of U.S.
deficits in 2005 and 20.1 percent in 2006. As will be discussed later in the chapter, China’s
surging trade surpluses against the United States and the world reflect to a large extent the
transfer of exports from other East Asian economies to China. Unlike Japan, China is
embracing foreign capital into the country, which accounts for more than half of its exports.
FIGURE 8.6
Merchandise Trade Balances for East Asia, 1960–2006
Source: Calculated from World Trade Organization, Statistics Database.
FIGURE 8.7
Merchandise Trade Balances for the United States, 1960–2006
Source: Calculated from World Trade Organization, Statistics Database.
197

FIGURE 8.8
East Asian Merchandise Trade Balances as Shares of U.S. Trade Deficit, 1976–2006
Source: Calculated from World Trade Organization, Statistics Database.
Trade surpluses with the world are linked to regionalization, to be discussed in the
following paragraphs. Protectionist pressure partly explains FDI from Japan and then the four
tigers to the rest of East Asia as well as to the rest of the world. Investors have essentially
transferred their exports from their home economies to host economies.
Greater Regional Trade Interdependence
East Asian economies have turned increasingly to each other for trade. The share of world
exports of East Asia excluding Japan almost tripled from 1975 (4.4 percent) to 2001 (12.1
percent) while the share of exports to each other increased more than sixfold (from 1.0
percent to 6.5 percent), at a faster pace than the North American Free Trade Agreement
(NAFTA) region and the European Union.10 Based on intraregional trade as a share of total
trade, East Asia has become more interdependent in trade to the extent that East Asia now
begins to look like the European Union. East Asian economies sent 31 percent of their total
exports to the other economies in the region and imported 32 percent from them in 1981. The
export and import ratios increased to 41 percent and 50 percent, respectively, in 2001.11
Increased intraregional trade does not mean that East Asian economies discriminate
against nonregional countries. East Asia’s share of the global trade has increased so they
should trade with each other more proportionally. To control for the expanding size of East
Asian trade, we can use a trade intensity index, which measures whether East Asian
economies have traded more or less than predicted by their shares of world trade.12 East Asia
has intense intraregional trade even adjusted for distance and that intensity increased from
1985 to 1995 to 2001. East Asian economies also became more complementary in trade over
this period.13 But another study shows that trade intensity for East Asia (Japan, South Korea,
Taiwan, Hong Kong, China, and ASEAN-10) declined slightly from 2.5 in 1980 to 2.2 in
2003, making it smaller than the NAFTA region (2.5) but larger than the European Union
(1.7) in 2003. ASEAN-10 had a high intensity index of 4.1 in 2003 although smaller than its
index of 4.8 in 1980.14
China has become a major destination for East Asian exports. At the same time, much of
that import into China ends up in Chinese exports to the outside world, particularly to the
United States, a phenomenon called export-transferring. Production networks are important
channels for trade flows as well. Foreign firms operating in China exported $444.2 billion in
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2005, accounting for 58.3 percent of China’s total exports.15 More important politically,
foreign firms accounted for 83 percent of China’s $101.9 billion trade surplus in 2005.16
Regionalization has resulted for several reasons. It makes economic sense because of
increasing shares of East Asian trade in the global market, geographical proximity, and FDI-
based production networks. Also, most East Asian governments have become more open in
their economic orientation, which facilitates trade. In particular, they encourage FDI, which
creates a positive nexus with trade, pulling each other up. A higher degree of intraregional
trade is also the flip side of greater economic integration of the European Union, which has a
discriminatory effect on East Asian exports.17 The formation of the NAFTA and other
regional free trade agreements (FTAs) are having a similar effect on East Asian
regionalization.
EAST ASIAN TRADE STRATEGIES
The trade strategies of East Asian economies have gone through roughly three stages: import
substitution, export-led growth, and liberalization. But this has not been a neat sequence.
While export promotion replaced import substitution, some economies have at times gone
backward. Malaysia adopted a more laissez-faire economic policy in the 1960s and reversed
to a more protectionist policy in the 1970s. Malaysia then adopted an import substitution
heavy industrialization plan in 1981. The Indonesian government practiced trade
liberalization in 1966–1971 but resorted to protectionism after the 1973 tariff reform.18 The
Taiwanese government shifted from export-led growth to another round of import
substitution in the textile industry in the 1970s.19 While Taiwan began export promotion in
the late 1950s, the government promoted heavy and chemical industries in the Sixth Four-
Year Economic Plan (1974–1979) to substitute imports of intermediate materials and capital
goods and introduced the second period of import substitution after the first oil crisis.20 Hong
Kong followed a free trade policy from the beginning, and some East Asian economies began
partial liberalization even before the early 1980s. Resource-rich countries of Indonesia,
Malaysia, Thailand, and the Philippines depended on exports of primary products through the
1970s, and their trade policy was thus heavily focused on the terms of trade. Socialist
countries like China followed a totally different path of following import and export plans
that covered virtually all their foreign trade. Most East Asian economies still pursue plans to
create national champion industries to replace foreign imports.
Import Substitution
Like most other developing nations, East Asian noncommunist economies largely adopted an
import substitution strategy (henceforth referred to as IS strategy) in the early stage of
economic development after the Second World War. The dominant intellectual thinking at
the time was that developing nations needed to protect their infant industries. The state-led
development thinkers also wanted to have overvalued currencies based on the argument that
cheap currencies would worsen the terms of trade and make inflation worse. As a major
exception, Hong Kong followed a free trade policy.
While Japan had low GDP per capita in the early 1950s, it had been an economic
powerhouse before the war and still possessed a highly educated labor force and strong
managerial skills. Japan essentially adopted an IS strategy in the 1950s, selecting what the
government considered to be potential industrial winners, such as steel, electric power,
chemicals, and newer industries. Some of these industries began to export in the 1960s.21
Japan would continue to protect its domestic market while nurturing internationally
competitive industries.
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Of the four tigers, Taiwan and South Korea adopted an IS strategy early. The Chinese
Nationalist government moved to Taiwan after losing the mainland in 1949 and spent the first
three years controlling high inflation and settling refugees. The government adopted an IS
strategy in its first four-year plan (1953–1956), focusing on cement, glass, fertilizer, and
textiles based on state targeting of industries, recruitment of private businesses for the
preferred projects, and state-directed credit. The government particularly emphasized labor-
intensive textile industry, providing materials and purchasing finished products in 1951–
1953. The government temporarily stopped imports of cotton fabrics and cotton yarn, raised
tariffs on imports, controlled domestic production and sales and restricted new production
capacity, and used a multiple exchange rate system to allow favorable rates for imports of
materials and machinery for the protected textile industry.22 The government did not promote
merchandise exports, although it did encourage exports of traditional products such as sugar,
tea, canned pineapple, and rice.23
South Korea adopted an IS strategy after the Korean War ended in 1953. The Korean
government used high tariffs to protect substituting sectors, mainly consumer products. The
government did try to promote exports as well, but these exports were mainly agricultural and
primary products. With such a strategy, South Korea initially achieved some growth, but the
strategy was not successful owing to a weak domestic market and a strong need to import
materials. South Korea had a trade deficit. The government’s emphasis turned to export
promotion after 1963. While import substitution contributed to 24.2 percent growth of
manufactured output in 1955–1960, such contribution decreased to 0.9 percent in 1960–1963,
14.4 percent in 1963–1966, and –0.1 percent in 1966–1968. By contrast, export expansion
contributed to 5.1 percent growth in 1955–1960, 6.2 percent in 1960–1963, 29.4 percent in
1963–1966, and 13.0 percent in 1966–1968.24
Traditionally an entrepôt trade port, Singapore became autonomous only in 1959 and
followed an IS strategy after 1961. The government introduced protective tariffs and quotas
in the early 1960s, and the protected items increased from 8 before Singapore’s 1963 merger
with Malaysia to 183 by the end of 1965. Import substitution appeared to make sense since
Singapore would benefit from a larger protected market within the Federation of Malaysia.
Singapore turned outward after its involuntary separation from Malaysia and after it was
denied the access to the larger Malaysian market.25
In the rest of Southeast Asia, the Philippines underwent the easy stage of import
substitution in the 1950s and suffered slow industrial growth and balance of payments
difficulties in the 1960s. With comprehensive and high tariffs and nontariff barriers, the
Philippines had higher effective protection rates, 86 percent in 1965 and 77 percent in 1974,
than most other Southeast Asian countries (20 percent in 1965 and 17 percent in 1970 for
Malaysia, and 45 percent in 1974 for Thailand). Only Indonesia was more protected, with
effective protection rates of 137 percent in 1975 and 58 percent in 1980.26 Thailand went
through the easy phase of import substitution in the 1960s. Similar to Thailand, Malaysia
lagged behind Northeast Asia in economic development by a decade. Malaysia launched
import substitution industrialization based on tax incentives and high effective protection in
the late 1950s, which was exhausted toward the end of the 1960s. Unlike Japan and South
Korea, the majority of Malaysian import substitution industries were controlled by foreign
firms. After a decade of export-led industrialization in the 1970s, Malaysia went back to
protective import substitution heavy industrialization that relied heavily on foreign capital.27
Indonesia adopted an IS strategy until the early 1980s, employing policies like import tariffs,
higher import sales taxes, and nontariff restrictions. Exports of certain products were
restricted to meet domestic needs.28
As became clear, IS strategy is biased against manufactured exports as well as agriculture
because of greater incentives to focus on protected domestic markets and because of
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overvalued currencies. Moreover, the East Asian economies exhausted import substitution
quickly as a result of their limited domestic markets. To move from a simpler stage of import
substitution of nondurable consumer goods to durable consumer goods, intermediate goods,
and capital goods would be more difficult for East Asia because of limited economies of
scale and dependence on foreign technologies. Thus, most East Asian economies, starting
with Taiwan and South Korea, moved to export promotion.
China followed an extreme case of import substitution industrialization in its trade policy
before its launch of reform in 1978. China imported capital goods or materials to support its
industrialization plans and organized exports to pay for imports. As a socialist country, the
state monopolized imports and exports and used overvalued currency to make it cheaper to
import what was needed for its industrialization plans. As typical of a planned economy, the
Chinese government set prices for materials, intermediate goods, and final products, resulting
in a separation of domestic and international prices, which offered little incentive for Chinese
firms to export.29
Export Promotion
Export-led strategy (henceforth referred to as EL strategy) proved better than IS strategy.
Exporting firms may take advantage of economies of scale given a far larger external market.
Tougher competition also forces exporting firms to perform better than nonexporting firms,
with much higher productivity and better wages although exporters were often good firms
before they turned to export and exporting is not a panacea for firm performance.30 A 2005
World Bank study showed that Malaysia’s exporting firms enjoy a 4 percent Total Factor
Productivity advantage over nonexporting firms. While the lead in Malaysia is not as
significant as in some other countries, this may have resulted from the fact that a large
number of exporting firms that have operated for a long time have allowed diffusion of
knowledge and productivity to nonexporting firms.31 As discussed in Chapter 5, East Asia’s
successful shift to an EL strategy from an IS strategy, compared to difficulties in doing so in
other developing regions, particularly Latin America, has been explained as resulting from
the presence of a strong developmental state.
Japan had emphasized exports all along because of the country’s almost total dependence
on imports of energy and materials. In a way, the whole Japanese political economy system
was geared toward merchandise exports. Japan understood that to be successful in catching
up with developed nations and to expand trade, a company must ensure that its domestic costs
are lower than international prices and that the quality of the product must be good.32 The
Japanese state was involved heavily in promoting exports. Take exports of the consumer
electronics industry for an example. The Japanese government protected the domestic market
with nontariff barriers and allowed the major firms to engage in collusion and price fixing to
charge higher prices for the same products at home than in overseas markets.33 Japan
developed general trading companies (GTCs) with extensive operations overseas to identify
Japan’s niches, organize exports, and promote FDI aimed at increasing exports. GTCs had
certain advantages over individual firms marketing their products overseas because of their
extensive knowledge of the foreign market, financing of export production, reduction of risks
and transaction costs for exporting firms, and organization at times of new products for
export. And they have adapted to the new business environment with more open markets.34
The Taiwanese government made a shift from import substitution to export promotion in
1959. To encourage exports, the government provided rebates for import duties, supplied
low-interest export credit, made it less costly to import components or capital goods needed
for export, and devaluated the currency. In the first stage of export promotion, Taiwan
focused on exports of processed imported materials and processed agricultural products such
as canned pineapples and canned mushrooms to take advantage of Taiwan’s comparative
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advantage in labor and skills.35 Taiwan’s protected textile industry became saturated in cotton
fabrics by the mid-1950s. The government began providing incentives for exports, removed
the restrictions on founding new textile factories, and allowed freer textile trade.36 Taiwan
was an early innovator in custom export processing zones, setting the first one in East Asia in
Kaohsiung in December 1966. Investing firms in the zone enjoyed simplified regulations,
relaxed foreign exchange and foreign trade control, and preferential tax treatment. The
government created two more zones in 1972. Taiwan’s highly successful experience with
export zones helped the spread of various versions of export zones to other economies in East
Asia and elsewhere in later years.37
The South Korean government adopted an EL strategy after the 1961 military coup, with
subsidized long-term loans and export subsidies in the form of a large difference between
official exchange rates and export-effective exchange rates (exporters received far more won
than they would from the official exchange rates). President Park Chung Hee strongly urged
exports in his State of the Nation message on January 16, 1965. The Korean government
combined subsidies and heavy-handed pressure on enterprises (such as setting export targets).
At the same time, the government used a variety of methods to restrict imports into the
Korean market.38 The government initially put emphasis on light industries to take advantage
of educated but cheap labor in the country and then moved up to heavy industries in the
1970s. One strategy adopted was to set up highly specialized industrial zones to produce
competitive products for export. The government also supported some trading companies
modeled after the Japanese GTCs, starting in 1975. Unlike Taiwan, the South Korean
government did not set up public enterprises but actively promoted national champion
industries to lead the export drive.
Hong Kong was the first East Asian economy to adopt an export-oriented trade policy.
Hong Kong shifted from entrepôt trade for China to processing of imported materials out of
sheer necessity. The victory of the Chinese Communist Party in the mainland and the UN
embargoes on China after outbreak of the Korean War virtually cut off Hong Kong’s trade
with the mainland. Hong Kong could not export primary products or follow an IS strategy
given its small domestic market. Hong Kong built a manufacturing sector, and its exports
increased rapidly based on the entrepreneurial and managerial talent and capital in the
economy (from many who fled from Shanghai), a cheap labor force from over a million
refugees from the mainland, and a favorable external environment since Hong Kong was part
of the British Commonwealth. Unlike the rest of East Asia, however, the Hong Kong
government did not adopt any industrial policy. Rather, it maintained law and order and kept
taxes low for a stable business environment. Hong Kong was arguably the freest economy in
the world, with no tariffs on imports and virtually no restriction on foreign investment.39
In Southeast Asia, Singapore was the first to adopt an EL development strategy in 1968
although the government began to promote exports as early as 1965. With the Economic
Expansion Incentives Act adopted in 1967, the government collected only 4 percent of the
profits from government-approved manufactures and products for export of “pioneer” firms
instead of 40 percent for a typical firm. Singapore also welcomed foreign capital. The
government set criteria for tax benefits and took away the pioneer status when necessary—
labor-intensive industries, for instance, lost the status in the early 1970s. It also made
preferential loans available for targeted industries.40
Malaysia followed suit in the early 1970s. The government introduced free trade zones in
1972, attracting mainly foreign capital rather than domestic capital, unlike free trade zones in
Taiwan and South Korea. The country’s emphasis on heavy industries led to less attention to
exports in the early 1980s. But Malaysia intensified export promotion again after 1986,
following losses in the heavy industrialization plan and a recession.41 The Philippines adopted
the Export Incentives Act in 1970 and promoted nontraditional exports in the 1970s. The
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government essentially provided export subsidies in the form of tax deductions and other
incentives for exporters. The government also introduced export taxes on leading exports,
which combined with export incentives to favor nontraditional manufactured exports over
traditional agricultural and mining exports.42 Thailand continued import substitution
industrialization in the 1970s. But the government also began to promote exports actively
from 1972 with the adoption of the Investment Promotion and Export Promotion Acts. It
offered exporting firms tax exemption on imported inputs, tax rebates, and short-term loans.43
Indonesia enjoyed high oil prices in the 1970s, with oil counting as two-thirds of its exports
and government revenues by the early 1980s, and only began to promote non-oil products
actively in the early 1980s when oil prices dropped.44
Trade Liberalization
Trade liberalization refers to a process by which a government reduces its intervention in
trade by lowering tariffs or simplifying trade regulations and takes more of a neutral stance,
favoring neither exports nor imports. Within a global free trade regime, the East Asian
economies have gradually opened up their markets either by choice or under external
pressure. Through the 1950s, most East Asian nations adopted protectionist IS strategies.
Their shift to EL strategies starting in the early 1960s did not mean that these governments
liberalized imports as well. However, they knew that protection of some industries might hurt
exports. This happens because protected sectors draw primary factors of production away
from the export sector and raise the prices of nontradable goods, some of which are important
inputs for export. East Asian governments sought to correct the distortion by providing export
subsidies or exemptions of duties on imports used for export. They also set up export-free
zones. However, export subsidies and duty exemptions can also create biases, and export
zones have long-term limitations when surplus capital is used up. The most efficient way is to
liberalize imports as well as exports.45
There were early liberalizers in East Asia. Hong Kong has been a free trader all along. As
Table 8.3 shows, Hong Kong’s mean tariffs rates have been 0.0 percent. Singapore started out
the same as Hong Kong. Singapore’s autonomy from Great Britain and then merger with the
Federation of Malaysia led to a period of import substitution. An EL strategy followed
Singapore’s breakup with Malaysia in 1967. But Singapore’s export promotion went hand in
hand with import liberalization. The government replaced quantitative import quotas with
tariffs between 1968 and 1969 and then reduced tariffs and eventually abolished all quotas in
1970–1973.46 As Table 8.3 shows, Singapore had a mean tariff rate of 0.3 percent in 1980.
Indonesia experimented with liberalization in 1966–1971 after seven years of “guided
economy,” an Indonesia-style socialist policy that led to an economic crisis by the mid-
1960s, but trade protection measures reappeared and accelerated after 1971.47
TABLE 8.3
Lowering Tariffs in East Asia
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Sources: James Gwartney and Robert Lawson, Economic Freedom of the World: 2006 Annual Report
(Vancouver: The Fraser Institute, 2006) and the 2005 report. Data retrieved from www.freetheworld.com.
The rest of East Asia has gradually reduced import tariffs since the early 1980s. Taiwan
began liberalization around 1986, partly due to American pressure. The Taiwanese
government removed many of the previous restrictions on imports and FDI. Formal tariffs
were drastically reduced, informal barriers such as local content requirements were removed,
and import procedures were simplified. Similar to Taiwan, South Korea began import
liberalization as early as 1965 by relaxing import quotas, but the country’s liberalization
stalled in the 1970s because of balance of payments difficulties.48 As shown in Table 8.3,
South Korea’s mean tariff rates dropped by half from 1980 to 2004.
Trade liberalization took place throughout Southeast Asia. The Philippines introduced a
major policy program of tariff reduction and liberalization of residual import controls (import
controls were removed in the early 1960s) in 1981. The reform stalled after the economic
crisis in the early 1980s and was resumed in 1986.49 Indonesia’s trade liberalization was part
of a package of reforms to deal with the crisis triggered by the worldwide economic recession
of 1982–1983 and the sharp fall of oil prices in 1983–1986. The government simplified its
trade protection regime and lowered tariffs on manufacturing imports while keeping the
system of monopoly importing rights in place. Indonesia also devalued its currency by 28
percent in March 1983 and 31 percent in September 1986. The reform yielded results as the
country’s non-oil exports increased from $5 billion in 1983 to $14.4 billion in 1990.50
Thailand also began liberalization in the early 1980s, facing much domestic resistance.51
Malaysia introduced a significant reduction in tariffs and relaxation of requirements for
ownership in manufacturing and financial sectors from the mid-1980s. In the 1990s the
government also began to reduce tariffs on import substitution industries. However, as
Malaysia was also promoting exports with subsidies, the proportion of imports did not
increase drastically.52
The East Asian socialist countries belatedly joined other East Asian economies in export
promotion and trade liberalization. After China adopted a policy of economic reform and
openness in 1978, the Chinese government began to shift away from trade plans, which
constituted a process of liberalization. China promoted exports with export credits and other
measures in the 1980s, although not well publicized given China’s decision to apply for a
General Agreement on Tariffs and Trade (GATT) membership in 1986. China’s adjustment
of exchange rates to a more realistic level also facilitated Chinese exports. At the same time,
the Chinese government maintained a relatively high tariff and used licenses and quotas to
restrict imports through the 1980s.53 China began trade liberalization in 1992 by cutting
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http://www.freetheworld.com

tariffs, which fell to about 15 percent prior to China’s entrance into the WTO in January
2002. China also sharply decreased use of import licenses and quotas from about half of all
imports at the end of the 1980s to 18 percent by 1992 and 8 percent by 2001. In addition, the
government extended the right to engage in foreign trade, and the number of firms authorized
to engage in foreign trade increased from 12 in 1978 to 5,000 in 1988 and 35,000 in 2001.
Much of China’s import goes into export processing. Thus, China’s effective tariffs are
actually lower than the statutory rates suggest.54 China has embraced globalization more than
Japan and Korea because of low tariffs, high imports as a share of GDP, and an open FDI
regime. Similarly, Vietnam joined the WTO on November 7, 2006, after twelve years of
negotiations.
Trade liberalization is often used as a measure for globalization, along with foreign trade
as a share of GDP. China, Thailand, South Korea, and a number of East Asian countries are
globalizers, with positive results to show for it. By contrast, Myanmar is a nonglobalizer.
David Dollar of the World Bank argued that globalizers that adopted liberalization policies in
the 1980s and the 1990s grew faster than nonglobalizers.55 By contrast, Dani Rodrik argued
that the integration of globalizers like China and South Korea came from their social and
economic development, and only gradually, rather than following the policy prescriptions of
the World Bank and the International Monetary Fund. Countries should first put emphasis on
institutions and good policy. Global integration at present demands a long list of
administrative requirements for developing nations and thus distorts their policy priorities.56
Nevertheless, while global integration may not be a sufficient condition for strong economic
performance, it has been an important contributing factor.
East Asian trade liberalization results from a combination of factors. First, a global trend
of trade liberalization in the framework of the GATT/WTO, regional, and bilateral
preferential trade arrangements has had an impact on East Asia, which in turn feeds into it.
As Table 8.3 shows, other emerging countries have also been reducing their formal trade
barriers. Intellectually, East Asia has been influenced by the ideas coming out of respected
international organizations such as the World Bank. For example, Southeast Asian
governments were convinced by exhaustive studies done by the World Bank and domestic
think tanks that showed the negative effect of protectionism.57 Moreover, international
organizations such as the GATT/WTO had a long list of binding requirements. China agreed
to comply with a long list of liberalization measures in phases to join the WTO. Vietnam had
to adopt similar measures. Moreover, regional and bilateral trade agreements have all
included targeted trade liberalization.
Second, using the access to the largest market in the world as a bargaining chip, the U.S.
government has won concessions from East Asian economies, first Japan, then the four tigers,
and now China. The next section will discuss this issue in greater detail.
Third, trade liberalization serves East Asia’s own interests. Much of East Asia’s trade
liberalization has taken place unilaterally because the governments have decided that
liberalization would help improve the productivity of their industries by testing their
enterprises in the international market. In fact, as a World Bank study on regionalism
calculated, unilateral cuts accounted for 66 percent of the 21 percentage point reduction in
average weighted tariffs for all developing nations between 1983 and 2003. The commitment
associated with the Uruguay Round accounted for 25 percent of the reduction while regional
trade agreements (RTAs) explained the remainder 10 percent.58 China and Vietnam both
sought WTO membership, with all its liberalization commitments, as a logical outcome of
years of economic reforms, which was viewed correctly as essential to their prosperity.
As East Asian economies have matured, their interest also began to shift. Some of their
industries have become highly competitive in the global market, no longer justifying state
protection. Rising living standards and labor costs have led to shifting comparative
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advantages. More important, as East Asia depends so much on exports, global trade
liberalization would be most beneficial for the region. In accordance with the reciprocity
principle embedded in the global trade regime, East Asia has to liberalize trade in exchange
for liberalization elsewhere.
Trade liberalization so far has not put East Asia’s fundamental interests at risk. The
Chinese government, for example, concluded three years after joining the WTO that Chinese
industries had not suffered more serious a shock than anticipated. According to a senior
official at the Chinese Commerce Ministry, although China was still in a transitional period,
its economy had grown rapidly and sustained no serious setbacks in the three years.59 In fact,
Long Yongtu, the Chinese chief negotiator for the WTO, gave a high mark to the results of
joining the WTO in the past three years. China’s internal and external business environments
had improved.60 Factually, China’s trade volume increased sharply to over $1 trillion in the
period. Such an assessment reinforced the resolve of the government to continue trade
liberalization.
FACING THE WORLD
As discussed previously, East Asia has sizable trade surpluses with the world, particularly
with the United States, and these trade imbalances have triggered trade disputes. There have
also been disputes among East Asian economies, but they are less serious than those with
countries outside East Asia. East Asia’s trade relations with the world are not just disputes, of
course. This section will also discuss the role of East Asia in the global trade regime.
Managing Trade Disputes
As East Asian economies became trading powers, their increased exports led to trade disputes
with other countries. The United States initiated most disputes with East Asia. Since 1974 the
U.S. government employed Section 301 of the 1974 Trade Act (amended a few times later) to
pressure trade partners. The law gave the administration the legal power to investigate,
negotiate, and retaliate against what the U.S. government considers to be unfair trading
practices. East Asian economies were major targets. Besides actually bringing countries to
disputes, the Office of the United States Trade Representative (USTR) also puts some
countries on its Section 301 priority watch list as a way to exert pressure. Often, the threat of
Section 301 is sufficient to make trading partners promise change.61
Japan was the first East Asian country to encounter a backlash, and its labor-intensive
textile industry was the first serious battleground. The United States initiated the first trade
dispute with Japan over textiles in the late 1960s.62 Japan-U.S. trade disputes intensified and
broadened after that until the issue subsided in the late 1990s when Japan had been in an
economic slowdown for several years. Japan’s strategy for negotiating with the United States
combined stalling, brinkmanship, last-minute concessions, and large market-opening
packages for their public relations effect.63 The Japanese negotiators also used the American
pressure to serve their bureaucratic interests at home and to exploit domestic divisions in the
United States.64 At the height of U.S.-Japan trade tensions, negotiations seemed drawn out,
and agreements seemed to have yielded little result. Frustrated American officials and
scholars began to view Japan as different from the United States and therefore constituting a
threat to the United States.65
Since Japan had trade surpluses with virtually every country except oil exporters, Japan
also had trade disputes with Western Europe and other trading partners. Japan responded with
some market-opening measures, side payments in terms of official development assistance
(ODA), and investment capital. Japan’s shifting strategy from exporter to investor affected
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East Asian political economy of production. Japan also agreed to appreciate the yen sharply
in accordance with the 1985 Plaza Accord. A stronger yen furthered Japanese investment
flows to East Asia and elsewhere. As will be discussed in the next chapter, however, the
Japanese monetary authority’s loose-money policy to encourage outflow of capital to reduce
pressure on the yen to appreciate further, along with a tightening budget, contributed to a
stock market and real-estate bubble in the late 1980s. The burst of the bubble in the early
1990s led to a decade-long economic stagnation.
Despite being a free trade port, Hong Kong came under American pressure for voluntary
export restraint (VER) on cotton products. With Japan agreeing to a VER earlier, Hong
Kong’s exports to the United States increased rapidly. Unlike Japan, Hong Kong refused to
yield in negotiations with the United States in 1959–1960. America’s failure allowed Hong
Kong to benefit from export growth in the short run, but Hong Kong suffered a long-term
loss when the U.S. government used a newly created bargaining power, the Short-Term
Arrangement of October 1961, to severely restrict Hong Kong’s cotton manufacture exports.
Hong Kong had to agree to restrict exports by 30 percent below the 1960 level.66
Compared with Hong Kong, Taiwan and South Korea were subject to U.S. trade pressure
in far more cases.67 Taiwan and South Korea were the principal targets of Section 301,
second only to Japan. Similar to Japan, the South Koreans and Taiwanese engaged in tough
negotiations with the Americans. In the end, the United States achieved results close to their
specific objectives. South Korea and Taiwan essentially traded short-term concessions for
long-term access to the all-important U.S. market. But they also limited the damage by using
negotiation strategies such as problem redefinition, looking for legal loopholes, and
transnational coalition-building.68 The South Koreans and Taiwanese undoubtedly studied
Japan’s handling of trade disputes with the United States. Taiwan sent delegations to the
United States to purchase large-ticket items. In the scheme of things, the South Koreans and
Taiwanese yielded to American pressure because their overall exports continued to expand,
particularly to the U.S. market. Similar to Japan, South Korea and Taiwan appreciated their
currencies after the mid-1980s, which also led to outflow of capital to lower-cost countries. In
later years, even though China has attracted more attention, Japan, South Korea, and Taiwan
continue to be watched by the United States and be subject to Section 301. The U.S.
antidumping charge against the steel exports of Japan, South Korea, and a number of other
countries in the late 1990s is a case in point.69
New in the trade dispute game, Beijing reacted angrily to Washington’s decision to
restrict Chinese textile exports to the United States in 1982–1983 and retaliated with
restrictions on American agricultural products to China. But like Japan and the tigers before
it, China has learned to handle trade disputes pragmatically. For China, trade pressure also
comes from other developed nations as well as fellow developing nations that compete with
China in labor-intensive products.70 Many of the antidumping cases brought against Chinese
exports are from emerging countries like India, Argentina, Mexico, Brazil, and Peru. China
has learned from other East Asian economies about negotiating trade disputes. China also
sends delegations to the United States to purchase politically sensitive large items such as
Boeing airplanes. China has been under pressure to appreciate the yuan. Partly reflecting on
Japan’s experience with the 1985 Plaza Accord, the Chinese government has sought to
manage a gradual appreciation. Trade disputes have emerged as an important issue between
the United States and China.71
Global Rules, Asian Plays
East Asian trade has expanded dramatically since the end of the Second World War in the
context of an increasingly free global trade regime. East Asians are eager participants in the
GATT/WTO that has managed global trade. That is not surprising. If one focuses on exports,
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one wants to have a stable trading arrangement. Virtually all East Asian economies are now
WTO members. China’s decade-long effort to join the GATT/WTO reveals the attractiveness
of such a membership, which China saw as important for its modernization program and for
its standing and influence in the international community. From a domestic political economy
perspective, China’s reformers wanted to lock in reform policy by joining a rule-based global
trade regime.72
At the same time, the fact that it took China such a long time to join the GATT/WTO
shows that the global trade regime demands serious commitments from member states. The
GATT/WTO requires several norms, namely nondiscrimination, liberalization, reciprocity,
safeguards, and development. The difficult negotiations over China’s entrance centered on
China wanting to join as a developing nation while the United States and some other
developed nations wanted China to join as a developed nation that would require greater
liberalization, and large developing nations wanted safeguards against a potential surge in
Chinese exports. Interests aside, the United States wanted China to meet the global standard,
namely rules-based, tight legal procedures acceptable to the international community.73 In
China’s GATT/WTO negotiations, the most difficult ones were conducted with the United
States and the European Union, powers outside East Asia. By contrast, the talks with Japan
were far easier.74 Expected to adopt global trade rules, Vietnam also had to meet the demands
mainly by non-East Asian nations. Both China and Vietnam had to adapt to WTO norms and
rules, not the other way around.
Earlier East Asian members of the GATT/WTO did not have that much impact on the
creation of global trade rules either. As the only developed nation in the region, Japan was a
principal player along with the United States, Western Europe, and Canada. But even Japan
had little impact on the rules of the game and was often criticized as deviant from the
international norms. South Korea was a far less prominent player than Japan. Taiwan was not
even a formal member of the GATT. Even though the Nationalist government was one of the
23 founding members of the GATT, it was forced to withdraw in 1950, after losing the civil
war in mainland China. Taiwan was an observer in the GATT until 1971, reapplied to join in
1990, and joined the WTO immediately after China. ASEAN nations were on the sideline of
the rounds of multilateral trade negotiations before the Uruguay Round.75
East Asian economies have recently achieved some success in the WTO. After heavy
lobbying and tough negotiation, Supachai Panitchpakdi of Thailand split terms as the WTO
director general with Mike Moore of New Zealand. Moore served first in 1999–2002 and
Panitchpakdi followed in 2002–2005. At the same time, East Asian economies have not been
that active in the current Doha Round of negotiations. While the United States and the
European Union remain dominant players and large developing nations such as India and
Brazil have asserted themselves to counter Western domination, the East Asian voice is
barely visible. At the WTO meeting held in Hong Kong in December 2005, for instance, as a
semihost, although the Chinese delegation played a more visible role than before, China
recognized that it was not nearly as active as India and Brazil. The reasons cited for China’s
low-key style were China’s status as an inexperienced latecomer, a shortage of competent
negotiators, and Beijing’s unwillingness to take the lead for the developing nations to
challenge the West because China’s own commercial interests have diverged from those of
the developing world.76 At a meeting that suspended the Doha Round in Geneva in July 2006,
the only East Asian nation present was Japan.
East Asia’s less than prominent place in the global trade organization is not the principal
reason for East Asian economies to seek regional trade integration. After all, many analysts
view regionalism as building blocks for a global free trade regime. In that sense, East Asia
largely wants both global free trade and regional integration. In fact, one important reason for
accelerated efforts in East Asia to create free trade arrangements is the stalled global trade
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negotiations.
Some other analysts have pointed out that East Asian regionalism may be detrimental to
global free trade, citing the greater illiberal tendencies in East Asia. The United States
violates its own liberal trade principles from time to time but the principles are held. By
contrast, the natural instinct in East Asia is protectionism. Take Japan, for example. Japan has
more nontariff barriers to keep foreign imports away and has the least FDI in the country,
which facilitates foreign imports. If that is the case for the largest economy in the region, how
can East Asian regionalism be a liberal project?77 Another criticism is that East Asians are
less willing to enforce global rules and prefer to free ride on the global system.
But as will be discussed later, earnest government policies aside, East Asian regionalism
remains largely open, partly as a hedge against growing regionalism in other regions. East
Asia would have the most to lose from an eroded global trade regime and would have little to
rely on to deal with intraregional trade tensions. As a result, key East Asian countries are
likely to prefer global trade regime to regional trade arrangements for a long time.
Moreover, East Asians can use global rules to defend their trade interests. With its dispute
settlement mechanism, the WTO commands respect as a useful multilateral institution.78
Greater familiarity with and trust in the WTO mean that Japan finds the WTO expanding its
options to manage trade disputes. Japan has won some important battles against the United
States, particularly the 1994–1995 Japan-U.S. auto and auto parts negotiations.79 Japan has
also filed two cases against Indonesia. Similarly, South Korea shifted from its traditional
aversion of legal settlements at the GATT to a more legalistic approach at the WTO because
of greater trust in a strengthened dispute settlement mechanism at the WTO and because of
its emerging deficits with major trading partners.80 China has also come to view the WTO as
an important instrument for defending its economic interests.81 As a latecomer, China
committed much energy to negotiations for entrance into the GATT/WTO because it viewed
the organization as beneficial. China is the respondent of four cases, two from the United
States and one each from the European Union and Canada. China is the complainant of one
case against the United States.82 The WTO is an equal-opportunity arena for dispute
settlements for major East Asian trading powers.
EAST ASIAN TRADE REGIONALISM
East Asian regionalism has evolved in the past decades. Since the Asian financial crisis, East
Asian regionalism has moved away from an open, institutionally weak regionalism to a more
exclusive, institutionally stronger regionalism. Also, rather than a single project, East Asian
regionalism has attempted regionalism projects at broader and narrower levels, with all their
promises and weaknesses.
East Asian regionalism has been discussed in different circles for decades. The decisive
moment came when the Asia-Pacific Economic Cooperation (APEC) forum was launched in
1989. The first APEC leaders’ meeting was held in Seattle in 1993 at President Clinton’s
suggestion. APEC includes ten-member ASEAN, Australia, Canada, Chile, China, Hong
Kong, Japan, South Korea, Mexico, New Zealand, Papua New Guinea, Peru, Russia, Chinese
Taipei (Taiwan), and the United States. At the 1994 Bogor summit in Indonesia, the APEC
members agreed to reduce tariffs to 0–5 percent by 2010 for the developed members and by
2020 for the developing members. But APEC has stalled in trade liberalization. Japan’s
opposition to the Early Voluntary Sectoral Liberalization (EVSL) was a major reason.
Japan’s powerful agricultural sector was opposed to inclusion of fishery and forestry in a
whole package to be implemented. Some other major players in the APEC also contributed to
the eventual failure of EVSL due to divergent interests and expectations.83
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APEC differs from the WTO. As a global trade organization, the WTO has explicit
obligations and procedures to prevent cheating. By contrast, APEC has a voluntary
compliance structure, which will not have any legally binding commitments from member
states.84
ASEAN was the most successful regional organization in East Asia, but it started out
more as a political rather than economic organization. ASEAN became engaged in industrial
cooperation and trade liberalization in the 1980s. The ASEAN early six (Brunei, Indonesia,
Malaysia, the Philippines, Singapore, and Thailand) initiated the ASEAN Free Trade Area
(AFTA) in January 1992, aiming at reducing tariffs in phases by 2008. The four new
members, Vietnam (1995), Laos and Myanmar (1997), and Cambodia (1999), agreed to join
AFTA although with a longer period to fulfill the required obligations. AFTA was later
accelerated to be completed by 2003. After the Asian financial crisis, the ASEAN early six
decided to push forward the completion date to 2002. AFTA was designed to make Southeast
Asia more attractive for foreign investors rather than to create an exclusive regional bloc. The
main mechanism for AFTA, the Common Effective Preferential Tariff (CEPT), requires
reduction of tariffs on ASEAN products with at least 40 percent ASEAN content to 0.5
percent by 2002/2003 (2006 for Vietnam, 2008 for Laos and Myanmar, and 2010 for
Cambodia). CEPT is supposed to cover 98 percent of the tariff lines. But AFTA allows a
large number of exceptions: temporary exclusions, sensitive agricultural products till 2010,
and general exceptions for reasons a member considers important such as national security,
public morality, and health. For example, Malaysia employed temporary exclusion in 2000 to
delay tariff reductions on automobiles. The problem is that exporting firms have to apply for
tariff cuts and need to comply with complex country-of-origin rules.
APEC and AFTA do not correspond to East Asia as defined in this book, with APEC
much broader and AFTA much narrower. Malaysian Prime Minister Mahathir tried to create
an East Asian trading group, the East Asia Economic Caucus, but did not succeed. However,
that project has revived under the guise of the “ASEAN Plus Three.” In yet another turn,
ASEAN has signed FTAs with China, Japan, and South Korea separately as well as with
countries outside East Asia before an ASEAN Plus Three FTA.
What explains the growth of East Asian regionalism? Chapter 11 will offer a more
detailed analysis of East Asian regionalism in general. This section provides specific
explanations for East Asian trade regionalism. East Asian trade regionalism has grown both
because of a perceived need for greater regional cooperation and in reaction to the global
trends. First, a greater trade regionalization, as discussed earlier, makes it logical to form
mechanisms to better coordinate trade policies. The Asian financial crisis, which was partly
attributed to forces outside East Asia, has also convinced many in the region of the necessity
of achieving greater regional cooperation.
Second, there has been a dramatic increase in regional trade agreements (RTAs) since the
early 1990s. The RTAs in force quadrupled from 50 in 1990 to almost 230 by the end of
2004. Another 60 are under negotiation.85 East Asia has fallen behind other regions.
Developing East Asia and the Pacific region have only two RTAs per country, trailing all the
other regions in the world. The world average is five.86 Western European nations took the
lead. The United States shifted its position on RTAs from avoidance to participation in the
early 1990s. The U.S. government has become more active in RTAs since 2002 when it
received trade promotion authority. Also, the global free trade negotiations have experienced
difficulties, which help to channel energy to easier RTAs.
A detailed 2005 World Bank study on regionalism explains the pros and cons for RTAs.
RTAs may have a positive effect on regional economies. First, with fewer members, RTAs
are easier to make than multilateral ones. Second, RTAs may lower institutional and policy
barriers to trade, which would help expand trade. Third, RTAs may address issues not done
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by global negotiations, such as standards. Fourth, these arrangements contribute to regional
stability and domestic reform, both of which offer a better environment for economic
development. On the other hand, RTAs may incur economic costs by discriminating against
more efficient products from outside the region. Moreover, as a country participates in
overlapping RTAs with different rules regarding origins of country and other procedures, this
may lead to longer processing times. Delay means reduction of trade for the whole economy.
The report concludes that the RTAs most conducive to wealth creation follow open
regionalism, namely low external tariffs, few exceptions, nonrestrictive rules of origins,
measures to promote across-border competition, large regional markets, and appropriate rules
on investment and intellectual property.87
AFTA has much lower external tariffs than its counterparts in Latin America, Africa, and
South Asia. AFTA’s external tariffs are only somewhat higher than those of NAFTA.88 At the
same time, some of the deals have so many exceptions that they become less meaningful. For
example, South Korea excluded rice from its FTA deal with ASEAN in May 2006, which
Thailand has refused to sign.
The diversity of East Asian regionalism projects can be explained by the fact that regional
countries have different interests and concerns. On the trade front, even though most
countries recognize that it is in their mutual interests to lower trade barriers, they all want
other countries to make more concessions while protecting their own pet industries, such as
automaking for Malaysia and agriculture and fisheries for Japan and South Korea.
Moreover, East Asian regionalism is more than trade interests. It has been tied to
geopolitical interests of the major players in the region. This is particularly the case when
China’s rise has led to alarm in countries like the United States and Japan. The great power
rivalries, particularly one between China and Japan, are hindering the growth of East Asian
regionalism. Chapter 11 will discuss this issue.
DOMESTIC POLITICAL ECONOMY OF TRADE
Trade has always been highly political. People often equate trade surpluses with job creation
and deficits with job losses. Many also blame wage stagnation in developed nations on cheap
imports from developing nations.89 Trade policy and domestic politics have a mutual impact
on each other. On the one hand, trade policy results from domestic politics. On the other
hand, trade affects domestic politics.
In terms of how politics affects trade, one question we may ask is as follows: If free trade
is so logically beneficial and protectionism has logically and empirically proven to be
disastrous for the states involved and the international community, why is it so difficult for
states to practice free trade? One explanation is that the state may follow a particular
economic philosophy. Import substitution strategy is a case in point. Another explanation
based on strategic interaction among states is that states have the incentives to free ride on the
international free trade system, namely letting others reduce their trade barriers more than
their own. These two reasons are often used to explain East Asian trade policies that tend to
be less liberal than those of the West.
A domestic political economy explanation is that even if the state endorses free trade in
principle, it seeks exceptions to the rules. This is particularly the case in domestic political
economy where losers will fight politically to fend for their interests. A minority group with a
direct stake in the issue tends to be better organized and fights harder than the majority,
which has diffuse interests in the issue. Thus, the minority group often wins. As issue
minorities are numerous, the free trade regime may be picked to a skeleton. Even if a state is
interested in free trade, it sometimes has to balance between the larger interest and special
211

interest by giving in somewhat to protectionist pressure to prevent larger damage to the free
trade regime.90 In addition, political leaders often decide that short-term noneconomic reasons
are more important than the general liberalization principle. Put simply, economic policy
distortions are often politically efficient. Political efficiency means increased chance for a
political party to be elected.91 For example, politicians may need the votes of the agricultural
sector and have to protect the groups politically important for their electoral success.
Sometimes, the state may also have legitimate political reasons to adopt inefficient economic
policies. After all, the business of the state is not just business. Inclusion, fairness, and other
goals are important, particularly for democracies. In fact, political arrangements in the
domestic arena (welfare state) and in the international arena (international organizations) are
necessary for a successful global free trade regime.92
The explanation above has been used to contrast East Asia and other developing nations
in terms of policy adjustment. As discussed in Chapter 5, it has been suggested that most
successful East Asian economies have a strong state insulated from special interests. Thus,
unlike Latin America where entrenched special interests limited state options, the East Asian
economies like Taiwan and South Korea could make a decisive shift from import substitution
strategy to export-led strategy and to liberalize their trade regime more than other developing
nations to the benefit of the nations. However, one should not push the strong state argument
too far. Sectoral interests played an important role in shaping trade policy in South Korea and
Taiwan. For example, the quota system imposed by the Multi-Fiber Agreement introduced in
the early 1970s led to serious disputes between the state and the industries in Taiwan in the
early 1980s. The government argued that it was within its right to distribute quotas, whereas
the industrialists argued that the quotas were private properties because they had invested in
the equipment. Although the government won, it also made adjustments in its quota system.93
In addition, a strong state does not necessarily engage in free trade, as revealed in East Asia’s
own experience.
Moreover, the East Asian experience does not suggest a strong correlation between how
insulated a government is and how open its trade is. After all, democratic countries that are
“weak” as measured by the degree of societal influence on the state have more open trade
policies than the developmental states in East Asia. Using the United States as an example,
some scholars have shown that institutional arrangements created to structure trade conflict
help promote free trade policy.94
Democratic or not, the East Asian state has to play a two-level political game to balance
its trade policy. An example is Japan’s policy toward FTAs with East Asian nations. It is well
known that the Japanese government was hesitant to strike deals because of opposition from
its politically powerful agricultural sector. However, China’s activism in this area means that
the Japanese government views FTAs—or, as Japan prefers to call them, economic
partnership agreements (EPAs)—as something strategically important. Not surprisingly, the
Japanese government tries to have its cake and eat it too, namely to have deals without
hurting its agricultural sector. The Japanese government has also begun to offer some benefits
from EPAs for farmers to reduce political resistance to free trade. In July 2004, the Japanese
negotiators requested that Malaysia remove tariffs on some Japanese agricultural exports
such as apples, pears, mandarin oranges, and other items. This was the first time the Japanese
government had made such a request. This shift reflected the government’s desire to move
from protecting farming to promoting exports.95
In another important area where sectors lobby governments for actions, East Asian
economies have increasingly taken on a fair trade approach, using the WTO to level the field
in protected markets. Again using Japan as an example, the automobile and steel sectors have
managed to file most of the Japanese complaints at the WTO. This is because the two sectors
are particularly motivated politically and advantaged institutionally in the Japanese system.96
212

Trade affects domestic politics as well. First, the degree of exposure to global trade and
the size of the countries affect the nature of the political system. It is sometimes argued that
small but highly trade-dependent states like Singapore need to have a highly disciplined
government to allow them to make timely adjustments. Larger states like Japan may adopt a
strategic stance to anticipate future shifts in the global markets.97
Second, trade is linked to economic performance and thus political legitimacy in a
developmental state commonly found in East Asia. Trade policies matter in that they help
determine a country’s economic performance. The student demonstrations in South Korea in
March 1960 had something to do with the weak economic performance under President Lee,
which was in part caused by an unsuccessful import substitution strategy. General Park, who
seized power after the May 1961 coup, realized the importance of economic development and
shifted South Korea’s development strategy. In Indonesia, a collapse of the economy under
President Sukarno’s guided democracy in 1958–1965 facilitated Suharto’s success in
acquiring political power after the 1965 coup attempt and the following bloody crackdown
and contributed to the New Order’s sudden shift to a more liberalized economy after 1966.98
In China, the share of exports in goods and services to GDP increased from 6.6 percent in
1978 to 34.0 percent in 2004.99 The Chinese government believed that exports contributed 2
percent to its annual GDP growth.100 This puts foreign firms and the political economic
interests they represent squarely within the Chinese domestic context. Trade exposure thus
affects public policy as it becomes difficult to restrain foreign firms. This dynamic has
become even more important as East Asia has become more exposed to trade.
Third, trade policy can also lead to shifting political power. As a case in point, the
Sukarno government adopted an Indonesianization program in the 1950s that discriminated
against ethnic Chinese businesses in terms of allocation of import rights. This policy helped
to create a new class of indigenous traders that depended on and supported Sukarno’s Partai
Nasional Indonesia (PNI).101 More broadly, an import substitution or export-led strategy
favors import-substituting and exporting firms, respectively, and enhances their political
influence relative to others.
CONCLUSION
This chapter shows that East Asian trade has expanded dramatically since the end of the
Second World War, which has obviously contributed to the East Asian miracle. East Asian
success in exports has resulted both from market forces and government strategies. East
Asian economies have capitalized on their comparative advantages and an expanding global
trade. However, government policies also matter. After all, East Asia’s own experience
shows that those that hinder market forces have failed, as shown by the import substitution
strategy and the socialist countries. The basic feature of East Asian state policies toward trade
is a retreating illiberal strategy in a global free trade regime.
East Asian export prowess has led to trade disputes with the rest of the world, particularly
the United States. At times, trade disputes dominated some bilateral relationships, for
example, the U.S.-Japan relationship in the early 1990s. Although it is a major force in the
marketplace of global trade, East Asia continues to punch below its weight in the global trade
regime, reflecting both institutional weaknesses as latecomers and a tendency to avoid
conflict and to free ride on others. Despite skepticism by many outside the region, East Asian
governments have shown amazing enthusiasm for regional cooperation. While a latecomer in
this game, East Asia is moving forward and is well positioned to become a more coherent
third center of global economic power.
Domestic and trade policy influence each other. The resistance of “losing” sectors or
213

industries in a country explains the tendency of a government to endorse free trade in
principle but to demand exceptions in practice. The relative insulation of the state from
society in some East Asian economies explains East Asia’s shift from an import substitution
strategy to an export-led strategy although the strong state may and has often adopted unwise
economic policies. Trade with the outside world has also affected East Asian politics. High
exposure to the global market partly explains why the political regime in small states like
Singapore is disciplined and tough in order to allow flexible adjustments. Trade performance
also affects the political legitimacy of a developmental state.

SUGGESTED READINGS

Ahn, Dukgeun. “WTO Dispute Settlements in East Asia.” NBER Working Paper Series No.
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Effect, or Both?” Journal of International Economics 47, no. 1 (February 1999): 1–25.
Corbo, Vittorio, Anne O. Kueger, and Fernando Ossa, eds. Export-Oriented Development
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Destler, I. M., Haruhiro Fukui, and Hideo Sato. The Textile Wrangle: Conflict in Japanese-
American Relations, 1969–1971 (Ithaca, N.Y.: Cornell University Press, 1979).
Drysdale, Peter, and Ross Garnaut. “The Pacific: An Application of a General Theory of
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C. Fred Bergsten and Marcus Noland (Washington, D.C.: Institute for International
Economics, 1993), 183–223.
Hufbauer, Gary Clyde, Yee Wong, and Ketki Sheth. U.S.-China Trade Disputes: Rising Tide,
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Lardy, Nicholas R. Foreign Trade and Economic Reform in China, 1978–1990 (New York:
Cambridge University Press, 1992).
Lincoln, Edward J. East Asian Economic Regionalism (Washington, D.C.: Brookings
Institution Press, 2004).
Lincoln, Edward J. Japan’s Unequal Trade (Washington, D.C.: Brookings Institution, 1990).
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Whom and Why?” World Bank Policy Research Working Paper No. 2197, October 1999.
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Pekkanen, Saadia M. “International Law, Industry, and the State: Explaining Japan’s
Complainant Activities at the WTO.” The Pacific Review 16, no. 3 (September 2003):
285–306.
Prestowiz, Clyde V. Trading Places: How We Allowed Japan to Take the Lead (New York:
Basic Books, 1988).
Ravenhill, John. “APEC and the WTO: Which Way Forward for Trade Liberalization?”
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Ryan, Michael P. Playing by the Rules: American Trade Power and Diplomacy in the Pacific
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(New York: Columbia University Press, 1997).
214

Scollay, Robert, and John P. Gilbert. New Regional Trading Arrangements in the Asia
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Wan, Ming. “The U.S., Japan, and the EU: Comparing Political Economic Approaches to
China.” The Pacific Review 20, no. 3 (September 2007), 397–421.
Warr, Peter G. “Export Processing Zones and Trade Policy.” Finance and Development 26,
no. 2 (June 1989): 34–36.
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(New York: Columbia University Press, 1983).

NOTES

1. World Bank, East Asia: Recovery and Beyond (Washington, D.C.: World Bank, 2000), 45.
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3. Judith Rehak, “Every Port in a Storm,” International Herald Tribune, March 25–26, 2006,
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Pacific Region?” Kaihatsu kinyu kenkyushoho [Journal of JBIC Institute] 25 (July 2005):
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5. Chung H. Lee and Seiji Naya, “Trade in East Asian Development with Comparative
Reference to Southeast Asian Experience,” Economic Development and Cultural Change
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6. S. C. Tsiang, “Foreign Trade and Investment as Boosters for Take-Off: The Experience of
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Industrializing Countries, ed. Vittorio Corbo, Anne O. Kueger, and Fernando Ossa
(Boulder: Westview Press, 1985), 39–40.
7. Kaspar Richter, “Thailand’s Growth Path: From Recovery to Prosperity,” World Bank
Policy Research Working Paper No. 3912, May 2006, 15–17.
8. China Ministry of Commerce, February 5, 2007,
www.mofcom.gov.cn/aarticle/ae/ai/200702/20070204354875.html.
9. Edward J. Lincoln, Japan’s Unequal Trade (Washington, D.C.: Brookings Institution,
1990).
10. Francis Ng and Alexander Yeats, “Major Trade Trends in East Asia: What Are Their
Implications for Regional Cooperation and Growth?” World Bank Policy Research
Working Paper No. 3084, June 2003, 4.
11. Edward J. Lincoln, East Asian Economic Regionalism (Washington, D.C.: Brookings
Institution Press, 2004), 45.
12. Peter A. Petri, “The Interdependence of Trade and Investment in the Pacific,” in
Corporate Links and Foreign Direct Investment in Asia and the Pacific, ed. Edward K. Y.
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13. Ng and Yeats, “Major Trade Trends in East Asia,” 21–28. East Asia is defined as
including Cambodia, China, Hong Kong, Indonesia, Korea, Malaysia, the Philippines,
Singapore, Taiwan, Thailand, and Vietnam.
14. Masahiro Kawai and Taizo Motonishi, “Is East Asia an Optimum Currency Area?” in
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15/8/690649.shtml.
17. Peter Drysdale and Ross Garnaut, “The Pacific: An Application of a General Theory of
Economic Integration,” in Pacific Dynamism and the International Economic System, ed.
C. Fred Bergsten and Marcus Noland (Washington, D.C.: Institute for International
Economics, 1993), 202.
18. Booth, Indonesian Economy in the Nineteenth and Twentieth Centuries, 222–227.
19. Ying-yi Tu, “The Textile and Apparel Industries,” in Industrialization and the State: The
Changing Role of the Taiwan Government in the Economy, 1945–1998, ed. Li-min
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International Development, 2001), 203.
20. Ying-yi Tu, “The Petrochemical Industry,” in Industrialization and the State (see note
19), 239–240.
21. Hugh Patrick and Henry Rosovsky, “Japan’s Economic Performance: An Overview,” in
Asia’s New Giant: How the Japanese Economy Works, ed. Hugh Patrick and Henry
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22. Tu, “Textile and Apparel Industries,” 188–190.
23. Hsueh, Hsu, and Perkins, Industrialization and the State, 14–17.
24. Charles R. Frank Jr., Kwang Suk Kim, and Larry E. Westphal, South Korea (New York:
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92.
25. Aw, “Singapore,” 335–341; Huff, Economic Growth of Singapore, 307–309.
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Asian Studies, 1992), 30.
27. Jomo and Edwards, “Malaysian Industrialization in Historical Perspective,” 18–34.
28. Richard R. Barrichello and Frank R. Flatters, “Trade Policy Reform in Indonesia,” in
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Michael Roemer (Boston: Harvard Studies in International Development, 1991), 275–
279.
29. Nicholas R. Lardy, Foreign Trade and Economic Reform in China, 1978–1990 (New
York: Cambridge University Press, 1992), 16–36.
30. Empirical research generally supports this claim. See Andrew B. Bernard and J. Bradford
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31. World Bank, Malaysia: Firm Competitiveness, Business Climate, and Growth, Report
No. 26841-MA, June 30, 2005, 30–31.
32. Kojima, Japan and a New World Economic Order, 152–153.
33. Yamamura, “Caveat Emptor,” 178–185.
34. Lawrence B. Krause and Sueo Sekiguchi, “Japan and the World Economy,” in Asia’s
New Giant (see note 21), 389–398; Alan T. Shao and Paul Herbig, “The Future of Sogo
Shosha in a Global Economy,” International Marketing Review 10, no. 5 (December
1993): 37–55; Tom Roehl, “Markets Nurture Relationships: Changing Relationship
Patterns of Japanese GTCs in the Post-Bubble Era,” Asian Business & Management 3, no.
4 (December 2004): 417–434.
35. Little, Industry and Trade in Some Developing Countries, 254–258.
36. Tu, “Textile and Apparel Industries,” 195–196.
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37. Hooshang Amirahmadi and Weiping Wu, “Export Processing Zones in Asia,” Asian
Survey 35, no. 9 (September 1995): 828–849. Ireland was actually the first to create an
export-processing zone in 1959, followed by India in 1965.
38. Amsden, Asia’s New Giant, 64–70.
39. Ho, Trade, Industrial Restructuring, and Development in Hong Kong, 4–9.
40. Aw, “Singapore,” 349–354.
41. Rajah Rasiah, “Free Trade Zones and Industrial Development in Malaysia,” in
Industrializing Malaysia: Policy, Performance, Prospects, ed. K. S. Jomo (London:
Routledge, 1993), 118–146, and “Pre-Crisis Economic Weaknesses and Vulnerabilities,”
in The Malaysian Eclipse: Economic Crisis and Recovery, ed. K. S. Jomo (London: Zed
Books, 2001), 48–51.
42. Shepherd and Alburo, “The Philippines,” 214–217.
43. Narongchai Akrasanee and Juanjai Ajanant, “Manufacturing Industry Protection in
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Protection: Experiences of ASEAN and Australia, ed. Christopher Findlay and Ross
Garnaut (Sydney: Allen and Unwin, 1986), 79–80.
44. Barrichello and Flatters, “Trade Policy Reform in Indonesia.”
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26, no. 2 (June 1989): 34–36.
46. Aw, “Singapore,” 409.
47. Mark M. Pitt, “Indonesia,” in Liberalizing Foreign Trade, vol. 5, ed. Demetris
Papageorgiou, Michael Michaely, and Armeane M. Choksi (Cambridge, Mass.: Basil
Blackwell, 1991), 1–196.
48. Kwang Suk Kim, “Korea,” in Liberalizing Foreign Trade, vol. 2 (see note 47), 1–131.
49. Shepherd and Alburo, “The Philippines,” 240–263.
50. Iwan J. Azis, “Indonesia,” in The Political Economy of Policy Reform, ed. John
Williamson (Washington, D.C.: Institute for International Economics, 1993), 387–415;
Barrichello and Flatters, “Trade Policy Reform in Indonesia,” 279–291.
51. Akrasanee and Ajanant, “Manufacturing Industry Protection in Thailand,” 91–92.
52. Rasiah, “Pre-Crisis Economic Weaknesses and Vulnerabilities,” 50.
53. Lardy, Foreign Trade and Economic Reform in China, 1978–1990, 37–82.
54. Lee Branstetter and Nicholas Lardy, “China’s Embrace of Globalization,” Woodrow
Wilson International Center for Scholars, Asia Program Special Report 129 (July 2005):
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55. David Dollar and Aart Kraay, “Spreading the Wealth,” Foreign Affairs 81, no. 1
(January/February 2002): 120–133.
56. Dani Rodrik, “Trading Illusions,” Foreign Policy no. 123 (March 2001): 54–62.
57. Christopher Findlay and Ross Garnaut, The Political Economy of Manufacturing
Protection Policy in ASEAN and Australia (Sydney: Allen and Unwin, 1986); Mohamed
Ariff and Tan Loong Hoe, eds., The Uruguay Round: ASEAN Trade Policy Options
(Singapore: Institute of Southeast Asian Studies, 1988).
58. World Bank, Global Economic Prospects: Trade, Regionalism, and Development
(Washington, D.C.: World Bank, 2005), 42.
59. China News Agency, December 10, 2004, www.chinanews.com.cn/news/2004/2004–12-
10/26/515406.shtml.
60. Renmin ribao, December 7, 2004, http://news.sina.com.cn/c/2004–12-
07/05485143054.shtml.
61. Michael P. Ryan, “USTR’s Implementation of 301 Policy in the Pacific,” International
Studies Quarterly 39, no. 3 (September 1995): 333–350.
62. I. M. Destler, Haruhiro Fukui, and Hideo Sato, The Textile Wrangle: Conflict in
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64. Leonard J. Schoppa, Bargaining with Japan: What American Pressure Can and Cannot
Do (New York: Columbia University Press, 1997).
65. Clyde V. Prestowiz, Trading Places: How We Allowed Japan to Take the Lead (New
York: Basic Books, 1988).
66. David B. Yoffie, Power and Protectionism: Strategies of the Newly Industrializing
Countries (New York: Columbia University Press, 1983), 64–79.
67. Michael P. Ryan, Playing by the Rules: American Trade Power and Diplomacy in the
Pacific (Washington, D.C.: Georgetown University Press, 1995).
68. John S. Odell, “The Outcomes of International Trade Conflicts: The U.S. and South
Korea, 1960–1981,” International Studies Quarterly 29, no. 3 (September 1985): 263–
286; Steve Chan, “The Mouse that Roared: Taiwan Management of Trade Relations with
the United States,” Comparative Political Studies 20, no. 3 (October 1987): 251–292.
69. Hidetaka Yoshimatsu, “U.S.-East Asian Trade Friction: Exit and Voice in the Steel Trade
Regime,” Asian Affairs: An American Review 30, no. 3 (Fall 2003): 200–217.
70. Ming Wan, “The U.S., Japan, and the EU: Comparing Political Economic Approaches to
China,” The Pacific Review 20, no. 3 (September 2007), 397–421; Franco Algieri, “EU
Economic Relations with China: An Institutionalist Perspective,” China Quarterly 169
(March 2002): 64–77.
71. Gary Clyde Hufbauer, Yee Wong, and Ketki Sheth, U.S.-China Trade Disputes: Rising
Tide, Rising Stakes (Washington, D.C.: Institute for International Economics, 2006).
72. Wing Thye Woo, “Recent Claims of China’s Economic Exceptionalism: Reflections
Inspired by WTO Accession,” China Economic Review 12, no. 2 (Summer 2001): 107–
136.
73. Mark A. Groombridge and Claude E. Barfield, Tiger by the Tail: China and the World
Trade Organization (Washington, D.C.: American Enterprise Institute, 1999).
74. Wan, “U.S., Japan, and the EU: Comparing Political Economic Approaches to China.”
75. Mohamed Arif, “Multilateral Trade Negotiations: ASEAN Perspectives,” in The Uruguay
Round: ASEAN Trade Policy Options, ed. Mohamed Ariff and Tan Loong Hoe
(Singapore: Institute of Southeast Asian Studies, 1988), 1–37.
76. Jingji Guanchabao [Economic observation], December 17, 2005,
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77. Lincoln, East Asian Economic Regionalism, 33.
78. Dukgeun Ahn, “WTO Dispute Settlements in East Asia,” NBER Working Paper Series
No. 10178, December 2003.
79. Saadia M. Pekkanen, “Aggressive Legalism: The Rules of the WTO and Japan’s
Emerging Trade Strategy,” The World Economy 24, no. 5 (May 2001): 707–737, and
“International Law, Industry, and the State: Explaining Japan’s Complainant Activities at
the WTO,” The Pacific Review 16, no. 3 (September 2003): 285–306.
80. Dukgeun Ahn, “Korea in the GATT/WTO Dispute System: Legal Battle for Economic
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81. Youngjin Jung, “China’s Aggressive Legalism: China’s First Safeguard Measure,”
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82. WTO, www.wto.org/english/thewto_e/countries_e/china_e.htm (accessed July 10, 2006).
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85. World Bank, Global Economic Prospects: Trade, Regionalism, and Development, 28.
86. World Bank, Global Economic Prospects: Trade, Regionalism, and Development, 30.
87. World Bank, Global Economic Prospects: Trade, Regionalism, and Development, xi–xiii.
See also Seiji F. Naya, The Asian Development Experience: Overcoming Crises and
Adjusting to Change (Hong Kong: Asian Development Bank, 2002).
88. World Bank, Global Economic Prospects: Trade, Regionalism, and Development, xii.
89. For criticism of those views, see Paul Krugman, Pop Internationalism (Cambridge: MIT
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90. Robert O. Keohane, “Reciprocity in International Relations,” International Organization
40, no. 1 (Winter 1986): 1–28.
91. Stephen P. Magee, William A. Brock, and Leslie Young, Black Hole Tariffs and
Endogenous Policy Theory: Political Economy in General Equilibrium (Cambridge:
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92. John Gerard Ruggie, “International Regimes, Transactions, and Change: Embedded
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1982): 379–416.
93. Tu, “Textile and Apparel Industries,” 212–214.
94. Michael A. Bailey, Judith Goldstein, and Barry R. Weingast, “The Institutional Roots of
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95. “Japan Wants Tariffs Removed from Farm Exports to Malaysia,” The Japan Times, July
22, 2004, www.japantimes.com/cgi-bin/getarticle.pl5?nb20040722a2.htm.
96. Pekkanen, “International Law, Industry, and the State.”
97. For the logic and evidence, see Peter J. Katzenstein, Small States in World Markets:
Industrial Policy in Europe (Ithaca, N.Y.: Cornell University Press, 1985); Ronald
Rogowski, “Trade and the Variety of Democratic Institutions,” International
Organization 41, no. 2 (Spring 1987): 203–223.
98. Mark M. Pitt, “Indonesia,” in Liberalizing Foreign Trade (see note 47), 1–196.
99. World Bank, World Development Indicators Database.
100. China Ministry of Commerce, January 4, 2005,
www.chinanews.com.cn/news/2004/2005–01-04/26/523941.shtml.
101. Pitt, “Indonesia,” 13–14.
219

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F
CHAPTER 9
The Political Economy of East Asian Finance

inance connects people who have savings with those who need capital. Financial systems
include direct finance through financial markets and indirect finance through financial
intermediaries such as banks and financial companies. The financial sector is central to the
whole economy. According to Joseph Stiglitz et al., “Financial markets essentially involve
the allocation of resources. They can be thought of as the ‘brain’ of the entire economic
system, the central locus of decision-making: if they fail, not only will the sector’s profit be
lower than would otherwise have been, but the performance of the entire economic system
may be impaired.”1 My previous discussion in the book bears this out. The East Asian
miracle had much to do with the allocation of resources to speed up economic growth, and
the Asian financial crisis devastated most East Asian economies.
This chapter studies how East Asian economies have mobilized domestic financial
resources. They created financial systems that were largely effective in pooling domestic
resources for industrialization, but those systems now need serious reforms. The chapter also
discusses international finance, which means the movement of capital across national
borders. East Asian nations started out capital-poor and needed foreign capital. International
capital flows include foreign aid, short-term (one year or less) trade credit, medium-term
suppliers’ credit, direct foreign investment, portfolio investment (investment by purchase of
securities, which are claims on companies’ future incomes such as bonds), and medium- to
long-term bank loans. Financial globalization means that national markets are being
integrated.
This chapter discusses the following questions. First, what are the basic features of East
Asian finance? Second, how have East Asian governments handled their financial affairs?
Third, how is East Asia situated in the global financial system? Fourth, is there a regional
financial system in East Asia? I discuss East Asian finance in the global context before
discussing regional context for a good reason. Globalization of finance has affected the
region far more than regionalization of finance.
EAST ASIAN FINANCE
The basic features of East Asian finance since World War II are high capital accumulations
intended for high economic growth and dependence on banks rather than financial markets,
except for Hong Kong and Singapore. Most East Asian economies have experienced serious
nonperforming loan problems. East Asian financial markets have grown over time but remain
troubled with serious problems.
East Asian Capital Accumulation
To achieve development, a country needs to accumulate capacity for growth. Accumulation
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includes three components: human capital, savings, and investments. I will focus on the last
two components in this chapter.
Chapter 7 has discussed East Asia as a destination of foreign direct investment (FDI). At
the same time, East Asia has become an important source of global finance thanks to high
domestic savings that feed into high capital formation. As Table 9.1 shows, East Asia’s
saving rates have been consistently higher than the world average since the mid-1970s. Japan
was the trendsetter in East Asia. As shown in Figure 9.1, which traces select East Asian
countries yearly, Japan’s savings/GDP ratio increased from 34.1 percent in 1965 to 41.1
percent in 1970 and began a slow decline after the 1973–1974 oil crisis but maintained rates
over 30 percent until 1995. Japan’s savings rate decreased to 24.6 percent in 2004, but it was
still higher than the world average of 21.4 percent. Japan remains a net saver as its investment
has decreased even more.
FIGURE 9.1
Gross Domestic Savings as Shares of GDP, 1965–2005
Source: World Bank, World Development Indicators Database.
TABLE 9.1
East Asian Gross Domestic Savings (percentage of GDP)
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Source: World Bank, World Development Indicators Database. The data for Taiwan in 1965–1980 that
measure gross national savings as percentage of GNP are from the Council for Economic Planning and
Development (Taiwan), Taiwan Statistical Databook (1996), 1. The data for Taiwan from 1985 are from the
Asian Development Bank Statistical Database System: Key Indicators, various years.
For the four tigers, as shown in Table 9.1, while Hong Kong always had high savings
rates comparable with those of Japan, South Korea and Singapore started below 10 percent
and Taiwan just over 20 percent in 1965. The three economies caught up with Japan in the
1980s. Malaysia followed a similar trajectory as South Korea. For the rest of the six original
ASEAN members, Indonesia and Thailand came to have high savings rates in the 1990s, a
decade behind the tigers. As an outlier, the Philippines began with savings rates comparable
with its neighbors but saw them declining to below 20 percent mostly starting in the mid-
1990s. China had high savings rates all along but came to have over 40 percent in the past
few years, among the highest in the world. Vietnam’s savings rate was a low 3.3 percent in
1990 but reached 30.1 percent in 2005.
The World Bank’s 1993 East Asian Miracle report concluded that East Asian high
savings largely resulted from rather than caused the high economic growth. Also, falling birth
rates meant higher savings rates because of lower needs to support children and the elderly.
The report also credited the governments’ policies of keeping down inflation to encourage
savings and of maintaining high public savings through restrained public expenditure. The
East Asian governments also adopted measures to remove hindrances to savings, such as lack
of insurance and high transaction costs. Some governments used mandatory pension plans to
force savings although the report could not find sufficient evidence that these measures
actually work.2 At the same time, as discussed in Chapter 5, developmental state theorists go
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much further to explain the role of the state in facilitating high savings for investment.
East Asian high savings have gone into investment. Table 9.2 shows high domestic
capital formation for East Asian economies. The World Bank miracle report argues that there
has been a virtuous cycle of high growth, high savings, and high investment in East Asia.3 As
shown in Figure 9.2, Japan’s shares began to decrease significantly since the early 1990s,
reflecting its economic slowdown. Capital investment in Malaysia and South Korea has
decreased significantly since the Asian financial crisis. On the other hand, China continues its
trend of high savings and high investment, reflecting its continuous economic boom.
East Asia’s savings and capital formation have not matched neatly over time and across
economies. As Table 9.3 shows, Taiwan had a significant mismatch in the 1980s owing to
large trade surpluses and domestic savings against decreasing investment opportunities. But
the mismatch did not last into the 1990s. South Korea and Singapore had sizable deficits
between domestic savings and domestic capital formation through the early 1980s. China is
investing heavily, but it is saving even more. Chinese households save because of rising
income, weak pension plans, and financial needs for health and education. The government
saves by investing in infrastructure and transferring capital to state firms. Chinese firms also
save although they spend much as well.
TABLE 9.2
East Asian Gross Fixed Capital Formation (percentage of GDP)
Source: World Bank, World Development Indicators Database. The data for Taiwan are calculated from the
Asian Development Bank Statistical Database: Key Indicators, various years.
FIGURE 9.2
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Gross Fixed Capital Formation as Shares of GDP, 1965–2005
Source: World Bank, World Development Indicators Database.
What is striking about the saving-investment ratios for East Asia in recent years is a
savings glut, as shown in Table 9.3. China had a net savings ratio minus investment ratio at
6.7 percent of GDP in 2005, although the country had always had large ratios. Singapore and
Malaysia had incredibly high ratios of 26.8 percent and 23.5 percent, respectively, in 2005.
The Asian financial crisis started this trend when the crisis countries simultaneously sought to
increase reserves to prepare for another financial crisis and saw investment decreasing. I will
address this issue of savings glut in the larger global context later in the chapter.
East Asian Banking
Savings need to be put into use. Financial intermediation handles the process of linking the
ultimate savers and the ultimate investors. East Asian financial assets have grown rapidly,
particularly compared with other developing regions. Their growing financial depth can be
measured by increasing ratio of M2 (currency, demand deposit, time deposit, and savings
deposit)/GDP. But observers came to recognize that East Asian finance was weak and needed
reforms, an assessment confirmed by the 1997–1998 financial crisis. East Asian finance has
been too dependent on banking rather than equity and debt securities. Hong Kong and
Singapore are exceptions. Moreover, East Asian banking and financial markets have serious
problems, particularly weak financial institutions such as corporate governance, disclosure,
prudential regulations, and auditing practice. East Asia has made significant progress in
financial reforms since the crisis, but much remains to be done.4
TABLE 9.3
East Asian Savings-Investment Gap (percentage of GDP)
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Source: Calculated from Tables 9.1 and 9.2.
The Japanese government created a financial system that separated long-term banking
from short-term banking and banks from security firms, with specialized banks and
administrative guidance from the Ministry of Finance. Unlike in the United States where
banks keep an arm’s length from firms, the Japanese created a keiretsu, or an industrial group
system, in which groups of companies were built around a main bank at the core. The banks
and firms had an interlocking long-term relationship with cross-shareholdings. Japanese
nonfinancial sectors received most external funding through bank loans (45–63 percent in
1954–1984) and trade credits (20–36 percent) rather than stocks (4–15 percent) or bonds (2–5
percent). The shares of stocks actually decreased from 15 percent in 1954–1958 to 6.1
percent in 1979–1983.5 While this Japanese financial system offered Japanese competitive
advantages and ensured access to financing and financial services from banks through the
1980s, it came to hurt the Japanese economy given the institutional tendency of the main
banks to continue to lend to troubled affiliated firms, aggravating a nonperforming loan
problem. In fact, the Japanese financial system has been blamed as a principal reason for
Japan’s great stagnation since 1990.6
The South Korean government turned private commercial banks to public enterprises in
the early 1960s. The government introduced a principal transactions bank system in 1974,
essentially assigning a principal commercial bank for a business group. Unlike the main bank
system in Japan, the transactions bank did not hold cross-sharing arrangements with the
companies; its business relationship with the firm was solely through government regulations.
Through the 1970s, the government used banks as a policy instrument for channeling funds to
preferred industries and companies. Along with foreign loans guaranteed by the government,
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bank loans accounted for two-thirds of external funding for South Korean firms until the mid-
1980s. The state privatized several commercial banks and allowed establishment of nonbank
financial institutions in the 1980s. Although securities became a more important source of
external funding than bank loans after the mid-1980s, credits actually remained the dominant
form of funding since bonds and commercial papers were largely guaranteed by financial
institutions.7
State-owned banks dominated in Taiwan’s banking sector, and the government controlled
the banking sector tightly, setting interest rates and restricting entry of new banks. The
government then channeled bank credit to favored state enterprises and exporting firms. The
government adopted a new policy to move away from financial repression in 1989, and new
banks were created starting in 1992.8 For the formal financial sector, bank loans accounted
for 70 percent of the total financing from money market, capital market, and domestic banks
in 1977 and 60.7 percent as late as 1984.9
Banks also dominated in financial sectors in Southeast Asia. In Malaysia, banks
dominated till the 1990s. Of the funds raised by the private sector, 67 percent in 1980–1985
and 51 percent in 1991–1996 came from bank loans. The stock market has gained in
importance since the end of the 1980s, with the shares of funds raised from the equity market
increased from 9 percent in 1980–1985 to 19 percent in 1990–1996.10 Commercial banks
dominate in Thailand as well. In terms of total assets, total savings mobilized, and total
credit, commercial banks continued to be dominant, taking up close to or above 70 percent
through the 1980s. The Thai banking sector was also highly concentrated, with the top four
banks accounting for three-fifths of the banking industry.11
As Southeast Asia has over 200 million Muslims, there also exists an early stage of
Islamic banking. Islamic banking is characterized by rejection of predetermined interest-
bearing transactions and by an emphasis on sharing of profit and loss between the lender and
user. But Muslims can trade stocks that are real assets. While informal financial arrangements
consistent with the Shariah principles have always existed in the Muslim communities in
Southeast Asia, formal Islamic banking in the region is not yet as advanced as in the Middle
East. Islamic banking was introduced in Malaysia in 1983 and allowed in Indonesia in 1992.
Islamic banking assets accounted for 9.4 percent of the banking sector in Malaysia and only
0.12 percent in Indonesia in 2003. The Malaysian government now wants to turn Kuala
Lumpur into a regional hub of Islamic banking, particularly based in the Labuan International
Offshore Financial Centre. Singapore is also hoping to tap into the Islamic financial market.12
China depends on bank loans even more than any other East Asian economy. Bank loans
accounted for 85.1 percent of the funds raised in the domestic financial market in 2003 and
78.1 percent in 2005. By contrast, treasury bonds accounted for 9.5 percent in 2005,
corporate bonds 6.4 percent, and stocks merely 6.0 percent.13 China’s banking system is deep,
as measured by total credit divided by GDP. However, most bank credits go to state and
listed sectors. Chinese companies are turning more to share and debt markets. There is also
some indication that Chinese firms lend to each other informally even though Chinese law
does not allow it.14
East Asian banks have nonperforming loan (NPL) problems. NPLs are bad loans that will
not be repaid to lenders. NPLs are costly for a country’s economy because the affected banks
need to be recapitalized, often with public money. NPLs have to be dealt with to ensure the
stability and functioning of the banking system.15 Asian banks are having NPL problems
because governments make banks lend to companies that may not be profitable and because
banks themselves lend irresponsibly for risky projects.16
It is difficult to get accurate data since most countries tend to undercount their NPL
problem, but it is generally agreed that virtually all East Asian economies have had a serious
NPL problem at one time or continuously. According to World Bank statistics, as shown in
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Table 9.4, China, Indonesia, Malaysia, the Philippines, and Thailand have remained troubled
by NPLs since 2000. As a contrast, the United States does not have any problem with NPLs,
which is below 1 percent of total loans, and the world average has decreased from 9.5 percent
in 2000 to 4.4 percent in 2005. The World Bank data are based on official reports and cover
only the period from the year 2000. Some independent estimates put East Asia’s NPLs at a
much higher level.
Shallow Financial Markets
East Asian financial markets have grown, but they still need better financial intermediation to
allocate their growing financial assets more efficiently. East Asia also needs to manage risks
and enhance risk sharing (derivative markets). My discussion here focuses on the equity and
bond markets.
TABLE 9.4
East Asian Nonperforming Loans (share of total loans)
Source: World Bank, World Development Indicators Database.
Not all East Asian economies are problematic. Hong Kong has been a highly efficient
financial center for the region and is one of the most important in the world.17 Hong Kong’s
success lies in open financial institutions, a stable currency, a location right between the
European and American capital markets, large flow of capital into Hong Kong, low taxes,
and a good legal structure. Hong Kong has one of the three largest gold exchanges in the
world. It has well-functioning financial markets of foreign exchange, gold, stocks, and
futures. It is also developing a bond market. Hong Kong firms have handled many
consortium loans in the Asian Pacific region. Along with London, Hong Kong surpassed the
New York Stock Exchange in initial public offerings in 2006. New York’s relative decline
was due to litigations, more stringent regulations that increase costs of doing business in the
city, and tighter immigration rules after September 11, 2001.18
Trying to outdo Hong Kong, Singapore has also been successful in creating a strong
financial sector since the early 1960s. Singapore is now a major financial center in East Asia,
along with Tokyo and Hong Kong.19 Based on stable politics, highly favorable regulatory
environment, low taxes, skilled labor force, and no barriers to the entry and repatriation of
capital, Singapore has attracted a large number of leading foreign financial institutions that
offer a wide array of financial instruments. Singapore is now the fourth largest foreign
exchange trading center in the world, trailing only London, New York, and Tokyo. The city
state has created the first derivatives market in Asia and is part of the global futures markets.
It is also building a formidable asset and wealth management industry that may rival
Switzerland in the future.
East Asian equity markets. The East Asian stock markets have grown in East Asia as
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measured by capitalization of listed companies. East Asia, including here China, Hong Kong,
Indonesia, South Korea, Malaysia, the Philippines, Singapore, and Thailand but excluding
Japan, increased its capitalization of listed companies from $334 billion (2.9 percent of the
world total) in 1989 to $3,139 billion (7.2 percent) in 2005, as shown in Table 9.5. In
particular, China began with $2 billion capitalization in 1991 and came to have a market
capitalization of $781 billion in 2005. East Asia, not including Japan, has had a major
increase in equity market capitalization since the Asian financial crisis, the 2005 amount
being more than two times that in 1996. Japan saw a dramatic fall in relative shares of market
capitalization, from a high $4.4 trillion (125.1 percent of the U.S. and 37.5 percent of the
world total) in 1989 to $4.7 trillion (27.9 percent of the U.S. and 10.9 percent of the world
total) in 2005. Japan’s equity market capitalization went down as low as $2.1 trillion in 2002.
While China, Japan, and Indonesia still have a bank-based financial system, South Korea,
Malaysia, the Philippines, and Thailand had adopted a market-based financial system by the
mid-1990s.20
TABLE 9.5
Market Capitalization of Listed Companies (current U.S. $ billion)
Source: World Bank, World Development Indicators Database.
The Japanese stock market was initially meant to protect companies. The Tokyo stock
market was designed not for companies to raise funds but to allow them to form long-term
relationships with cross-share holdings in the keiretsu system. Unlike the American system,
the Japanese equity market was also designed to protect the weak from unfriendly
takeovers.21
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As a British colony, Malaysia had share trading as early as the 1870s. Public share trading
began with the Malayan Stock Exchange established in May 1960. The Kuala Lumpur Stock
Exchange and the Stock Exchange of Singapore operated as a unified exchange with separate
locations in Kuala Lumpur and Singapore. The Kuala Lumpur Stock Exchange was used by
the government as a policy tool of the New Economy Policy introduced in 1970. After 1976,
all listed firms had to sell 30 percent of the shares below market prices to native bumiputra.
The two markets split in 1990. The Kuala Lumpur Stock Exchange grew rapidly after that.
The equity market came to be as important a source of corporate finance as bank loans in the
early 1990s. But much of the funds raised went into privatization of public sector assets
rather than into expansion of production capacities. With financial liberalization, foreign
investors came to acquire about one-quarter of the stock in the market by early 1997.22
China created the Shanghai Stock Exchange and the Shenzhen Stock Exchange in 1990.
The main purpose of the Chinese stock markets in the 1990s was to help channel capital to
state enterprises. Controlled by the provincial governments, the markets were poorly
regulated and plagued by manipulation by professional investors. Moreover, prices and
behavior of investors do not reflect the fundamental values of listed companies. The Chinese
stock market is inefficient despite its rapid expansion and stronger regulations from the
central government in recent years. The cost for nonstate enterprises to list is high. The
Chinese state companies issue both tradable and nontradable shares. The nontradable shares
are owned by the state institutions or other public institutions. A large proportion of the
shares owned by the government create uncertainties for investors. If prices go up,
government agencies may purchase the share and stop the rise. The boards that include
government officials are selected secretly. The government is both the regulator and the
holder of large numbers of shares. Outside investors have little influence on the management
of the firms, and the state or family-owned companies tend to underpay the dividends to
shareholders.23
East Asian bond markets. Since the Asian financial crisis, much attention in East Asia has
been given to development of local currency bond markets. Local currency bond markets
prevent a currency mismatch where a firm has assets in local currencies but liabilities in a
foreign currency. Such a mismatch makes a country vulnerable to fluctuations in exchange
rates.24 A currency mismatch explained the spiraling 1997–1998 financial crisis because the
local currency’s depreciation worsened the balance sheets for the government and the private
sector. Analysts often add another mismatch of maturity between long-term investment goals
and short-term capital flows. A logical solution is then to develop a long-term local financing
source denominated in local currencies.25
TABLE 9.6
Asian Local Currency Bond Markets ($ billion outstanding, percentage of GDP)
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Source: Asian Development Bank, Asian Bonds Online: Asia Bond Indicators,
http://asianbondsonline.adb.org/asiabondindicators/default.php.
East Asian bond markets have grown since the Asian financial crisis. As Table 9.6 shows,
East Asia excluding Japan increased its local currency bond outstanding from $448.3 billion
by the end of 1995 to $2,840.1 billion by the end of 2006. While growing slowly, Japan had
2.5 times bonds outstanding than the rest of East Asia by end of 2006.
More broadly, East Asian economies have turned to domestic debt more than elsewhere
since the Asian financial crisis. Asia as a whole has switched from external debt to domestic
debt. The ratio of domestic to external debt increased from about parity in 1997 to three times
in 2002. As a dramatic example, Indonesia’s domestic debt increased from extremely low
before the crisis to about 42 percent of GDP at present while its public sector external debt
decreased from 70 percent to 40 percent.26
Despite their growth, East Asian bond markets are still underdeveloped. The size of the
markets is still relatively small as measured by bonds outstanding as a percentage of GDP.
East Asian bond markets are also dominated by the government issues rather than corporate
issues. East Asian firms do not depend on bond markets to raise capital.
At the end of 2005, East Asia excluding Japan had less than $2 trillion in bonds in local
currencies (plus $135 billion in dollar-denominated bonds) compared with $7 trillion of
Japanese bonds and $22 trillion American bonds. In the big picture, what all this means is
that most of East Asian foreign reserves end up being invested in U.S. financial markets,
particularly the Treasuries, which then cycle back to East Asia in the form of portfolio
investments and FDI. The East Asian governments increasingly question the wisdom of such
a situation and urge development of national and regional bond markets. Dependence on
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http://asianbondsonline.adb.org/asiabondindicators/default.php

foreign financial markets makes the region vulnerable to international investors, and it makes
sense to shift some savings from bank accounts to investments. At the same time, American
bonds are safe and liquid, and moving away from them necessarily leads to a greater
concentration of risks.27
EAST ASIAN FINANCIAL POLICIES
Mobilizing Domestic Capital
A rapid expansion in East Asian capital accumulation comes from the success of the East
Asian governments to mobilize domestic capital. East Asian governments were able to avoid
long-term fiscal deficit and to restrain inflation, creating a positive environment for savings.
Moreover, East Asian governments monitored banks to achieve the same results as deposit
insurance. They simultaneously restricted deposit and lending rates. Most East Asian
economies, following Japan’s lead, also created postal savings systems to lower the
transaction costs for smaller and distant savers. The governments could also force savings by
creating pension plans such as Singapore’s Central Provident Fund.
East Asian governments then used development banks and other specialized financial
institutions to channel high savings as long-term financing to targeted areas. East Asia has
been far more successful than other regions in using development banks. East Asian
development banks have tried to use commercial banking principles and create institutions to
minimize political intervention. The governments provided tax incentives for investment, tax
holidays, credits, accelerated depreciation, and special exemptions. Also, they held down the
relative price of capital goods. They created risk-sharing mechanisms for private investors,
but firms were monitored for performance. Lastly, they restricted outflows of capital to more
attractive foreign financial instruments.28
An active role by the state to direct cheap credits to favored industrial projects was at the
core of the East Asian miracle discussed in Chapter 5. Without effective mobilization of
resources, the developmental state theorists argue, East Asia would not have been able to
grow as rapidly as it did. By contrast, other developing regions fell behind because their
governments were far less effective in this regard. At the same time, as discussed in Chapter
6, East Asia’s approach toward savings and investments came to be viewed as a principal
problem for the Asian financial crisis and Japan’s economic stagnation before then. While the
East Asian system might have contributed to strong economic growth in the catch-up stage,
the system that distorts economic structure has become more detrimental to the whole
economy when East Asian economies have come to possess surplus capital. Japan is a
primary example in this regard.
The Japanese government has been highly effective in channeling high savings to projects
deemed important for the country. The best-known Japanese financial institution to serve this
purpose is the Japan postal savings system invented in 1875. Japan Post not only handles mail
but also serves as a bank and insurance provider for Japanese households. It has ¥386 trillion
($3.6 trillion) in savings and insurance assets, which makes Japan Post the largest financial
institution in the world.29 The Japanese government has created a secondary budget based on
the deposits to fund important projects. Besides Japan Post, Japan has other state-owned
financial institutions, which possessed a total of ¥143.7 trillion in loans outstanding as of
December 2004.30
More than specific measures to boost savings, the Japanese system was structured to
promote investment to catch up with the West, which meant rationing cheap credits to target
industries to spur faster economic growth. The flip side was relatively low personal
consumption. While a relatively lower consumption as share of GDP was understandable
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during high-growth years that necessarily relied on investment, Japan became an outlier
among developed nations after the 1973–1974 oil crisis when its personal consumption
declined further.31 As Yukio Noguchi put it succinctly, the bubble of the late 1980s was
created in the following sequence. Japanese economic growth and productivity gains led to a
stronger yen, which should allow consumers to benefit from cheaper imports. However, the
producers and distributors captured the yen appreciation benefits and they then channeled the
profits into financial speculation (so-called zai-tech). They could raise money easily because
of their rising stocks and then speculated in land deals, which pushed up further land and
stock prices.32
South Korea took the directed credit approach to another level. The South Korean
government simply took over private commercial banks to channel domestic savings at cost
to preferred industries or companies. Given that South Korean companies typically had a high
debt-asset ratio and that their principal source of financing was bank credit, they had strong
incentives to follow state directives. Unlike the other three tigers, South Korea had a serious
foreign debt burden by the early 1980s because the country needed foreign borrowings to pay
for current account deficits in the 1970s. But the state was still in control since it guaranteed
all the foreign loans, which made it necessary to monitor corporate activities. Unlike Taiwan,
the South Korean government favored large corporations as champions of its big push for
rapid industrialization.33 The flip side of a state-controlled financial system was a thriving
informal private money market, with high risks and high returns for small businesses.34 South
Korea did achieve rapid industrialization partly thanks to its development strategies. At the
same time, South Korea paid a heavy price for this development model in the Asian financial
crisis.
In Taiwan’s case, the government realized early on the importance of boosting saving
rates for long-term economic development. In the 1950s the orthodoxy among development
economists was that the government should keep interest low to encourage investment and to
prevent cost-push effect on inflation. However, the Taiwanese government decided to raise
the real interest rate as early as 1950. Since the inflation rate was over 100 percent, the Bank
of Taiwan adopted a special system of savings deposits with a nominal interest of 125 percent
a year. As a result, savings grew rapidly and the inflation level came down. The government
then gradually lowered the interest rates. The government also adopted other measures such
as tax incentives. Taiwan’s domestic savings exceeded the need of capital investment in
1963. Taiwan became a capital exporter by the mid-1970s.35 Similar to South Korea, the
government’s direction of relatively cheap credit to large companies meant that small and
medium-sized companies had no choice but to turn to the informal financial market for
funding. The informal financial sector provided 32.9 percent of domestic borrowing by
private firms but only 3.2 percent of public enterprises in 1964–1994.36
In the 1980s, Taiwan saw a mismatch of high domestic savings and large trade surplus
vis-à-vis relatively low domestic investment. Similar to Japan, investors looked for
alternative ways to invest their money, leading to a real estate and stock market boom as well
as to investment overseas. But unlike Japan, the mismatch did not last long in Taiwan as
savings and trade surpluses began to decline by the 1990s and the economy continued to
grow despite the burst of the bubble.37 Taiwan’s healthier financial sector was an important
reason that it was not affected by the Asian financial crisis as much as South Korea and some
other regional economies.
Singapore managed to run budget surpluses as public sector savings, which were used as
loans to finance the government investment projects for industrialization and economic
growth. Singapore’s public sector savings increased from 22.8 percent of gross national
savings in 1974 to 66.8 percent in 1985. Also, Singapore established the Central Provident
Fund in 1955 as a scheme to force private savings. The government collected and invested
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savings from employees to be used as retirement payments. The government borrowed from
the fund with low interest rates to finance construction of infrastructures, which in turn attract
foreign companies to invest in the city state.
In Malaysia, Bank Negara, the central bank established in 1959, focused on the
mobilization of domestic savings by creating confidence in the national banking system
through stronger bank regulations and spread of government bank branches into smaller
towns. The government also created the state-owned National Savings Bank, which
originated from the Post Office Savings Banks, and the compulsory savings fund the
Employees Provident Fund. The government was less interventionist in allocation of bank
credits than Japan and South Korea, although Bank Negara did urge credits to various
categories of borrowers such as bumiputra, small businesses, and low-cost housing. Also
unlike Northeast Asian countries, the Malaysian government did not seek to repress interest
rates partly because, as part of the Sterling Area until 1973, Malaysia, Singapore, and Brunei
allowed free movement of capital.38 Malaysia’s capital accumulation maintained a high level
in the 1990s, but much of the expansion took place in nontradable property markets.
Malaysia’s investment outpaced savings in the 1990s prior to the Asian financial crisis, with
the gap filled by inflows of foreign capital. But increasingly short-term foreign capital
inflows covered Malaysia’s current account deficits, which in turn were caused mainly by
growing imports of input and equipment for nontradable infrastructure and property.39 This
situation contributed to Malaysia’s sharp fall during the Asian financial crisis.
The Philippines under the Marcos regime sought to follow a state-led development
strategy in the second half of the 1970s, more for political than economic reasons, by
directing credits to the favored and protected business groups. Without sufficient domestic
savings, the government relied on foreign borrowings to finance public infrastructure and
energy development projects, which worsened the trade and current account balances and led
to a debt crisis in the early 1980s.40
The socialist countries used more direct measures to force savings for industrialization.
China, for example, saw rapid industrialization as a priority. Besides receiving aid from the
Soviet Union in the early years, the Chinese government extracted resources from forced
savings and indoctrination of frugality among citizens to keep consumption low and free up
resources for industrial investment, keeping a high investment to national income ratio.41 This
was a typical socialist approach.
Since the reform, the Chinese government on all levels has been boosting production
based on high savings and high investments following the East Asian model. Similar to Japan
before the bubble, much of the profits have been captured by the Chinese companies,
particularly monopoly state enterprises, rather than consumers. China’s investments as share
of GDP were above 40 percent in 2005. Much of this investment boom comes from retained
earnings of Chinese state-owned companies. While state-owned enterprises often lost money
in the early 1990s, they are largely profitable now because of their monopoly of strategic
sectors. Since they do not pay dividends to the state, their savings have grown dramatically.
Investment generates more investment. But this investment-driven growth model is not
sustainable since it depends on exports to the rest of the world, which invites trade
protectionism and strains the world markets in energy and materials. In the end, despite two
decades of reform, the Chinese investment system still exhibits some of the features of a
planned economy, leading to seasonal fluctuations, low returns, excess capacity, and distorted
factor prices.42
Financial Liberalization
In the 1980s there was a global movement for financial liberalization. East Asia was no
exception. Financial liberalization refers to liberalization of the financial market aimed at
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allowing domestic and foreign capital to flow to the most profitable investment opportunities
according to market forces. Financial liberalization includes measures such as liberalization
of interest rates, capital account transactions, and the financial services sector to foreign
firms. The intellectual arguments for free flow of capital are that a more efficient allocation
of savings and investment results when capital goes where it generates the highest returns.
Developing countries enjoy greater access to capital. Investors now can seek the highest
possible returns all around the world. Also, investors can diversify the risk by spreading their
investment portfolio more widely. However, economists have been less united in opposing
capital control than trade protectionism.43 In fact, while promoting trade liberalization
through the 1960s, advanced countries mostly imposed capital controls. In the Bretton Woods
system that ensured stable exchange rates, capital control was seen as necessary for a stable
exchange rate system since capital flows would create balance of payments problems.
The theory of financial liberalization rejects financial repression, a practice of keeping a
ceiling on interest rates through regulations of the financial market. Financial repression is
based on the notion that since developing nations are capital scarce, the market will have
overly high interest rates. The practice was dealt a serious blow by the intellectual
contributions of Ronald I. McKinnon and Edward S. Shaw in the early 1970s.44 They pointed
out that financial repression explains low savings rates and underdevelopment of the financial
sector in many developing nations because there is less interest in financial assets, and this
creates a moral hazard for investors, who become less careful. Governments should liberalize
domestic financial markets to let the market determine interest rates. McKinnon argued that
monetary reform is more important for development than trade liberalization, tax reform, or
incentives to attract foreign capital.
The intellectual influence of the Shaw and McKinnon theory aside, one important reason
for financial liberalization for developing nations was the debt crisis in the early 1980s when
flows of external loans changed from positive to negative. This major shift helped to
convince the developing countries that they needed to shift from an interventionist financial
policy to one based more on market forces. Some East Asian economies had become more
modern and complex, which made it necessary to reform the financial sector that was now
increasingly inefficient. The international organizations and the Western governments also
encouraged financial liberalization as a natural follow-up to trade liberalization.
Most Asian governments have introduced financial reform. Limited financial reform
began in the 1970s. The reforms that began after 1985 were more serious. For most East
Asian economies, financial liberalization had made significant progress by the mid-1990s.
According to some estimates, Hong Kong, Indonesia, South Korea, Malaysia, the Philippines,
Taiwan, and Thailand had the same level of domestic financial liberalization as most Western
European countries. Japan and South Korea announced “Big Bang” reforms in the mid-
1990s, modeled after the British Big Bang. The 1997 Asian financial crisis paved the way for
further reforms.45
Japan began financial reform as a result of both external and internal pressure. There was
increasing external pressure on Japan to change its economic structure to reduce trade
surpluses. Moreover, by the 1980s, large Japanese corporations had shifted much of their
financing from Japanese banks to corporate bonds in the international market. With a
shrinking operational base, major Japanese banks were forced to enter new business areas
such as real estate financing. Japan also introduced the internationalization of its domestic
bond market after the mid-1980s. The Financial Reform Act of 1993 allowed banks to
establish securities subsidiaries and securities companies and trust banks to create banking
and securities subsidiaries. To indicate a break from the past gradualist approach, Japanese
Prime Minister Hashimoto Ryutaro announced in November 1996 the Big Bang reform to
make the Japanese markets free (liberalization of entry, products, and pricing), fair
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(transparency and investor protection), and global (a global market with monitoring and
accounting systems), aimed at a comprehensive deregulation of Japan’s financial services by
2001.46 The aim of the Big Bang was to make Tokyo as prominent an international financial
center as New York and London. One wants a financial center because it is more costly to
raise money overseas and because a financial center attracts financial firms to locate nearby.
However, although almost all the measures have been implemented, the position of the
Tokyo financial market has declined in recent years.47
While Japan was not one of the crisis countries in the Asian financial crisis, it came close
to a meltdown. In fact, Japan’s financial problems that emerged in 1994 and intensified in the
spring of 1997 were a prelude to the crisis. The government had to bail out some failing
financial institutions. Then the Long Term Credit Bank (LTCB) failed in the fall of 1998.
LTCB was one of the largest banks in the world, and its collapse revealed the depth of
Japan’s banking crisis. In response, the government injected public money and created an
independent regulator, the Financial Services Agency. Japan made much progress in putting
bad loans under control after Koizumi Junichiro became prime minister in 2001. By
September 2005, his banking reforms had managed to reduce by half the $480 billion bad
loans reported in 2002.48 As an indicator of progress, net bank lending increased again in
2005. Koizumi also managed to pass a bill for reforming Japan Post, which would partly
privatize the system by 2017.
One major development in the Japanese banking sector is consolidation of major banks
into three megabanks. Of the fourteen big commercial banks that existed before the Asian
financial crisis, some collapsed and the rest merged into MUFG (a merger of Bank of Tokyo-
Mitsubishi and UFJ), Mizuho (a merger of Industrial Bank of Japan, Dai-Ichi Kangyo Bank,
and Fuji Bank), and SMBC (a merger of Sumitomo Bank and Mitsui Bank).
The South Korean government introduced financial reforms in the early 1980s. One
reason for liberalization measures was that the state-directed credit to promote heavy and
chemical industries in the mid-1970s led to excess production capacities and to large current
account deficits. The government privatized some commercial banks and allowed
establishment of new commercial banks and nonbank financial institutions. The equity
market also grew.49 The government liberalized FDI in the 1980s and financial capital flows
in the 1990s. But there were limits to the financial liberalization of the 1980s, and the
weaknesses of the financial system were revealed later in the Asian financial crisis.
In return for an IMF standby arrangement in December 1997, the South Korean
government committed to drastic reform measures of closing nonviable financial institutions,
restructuring and recapitalizing viable ones, disposing of NPLs, creating a limited deposit
insurance plan, and improving banks to international standards. South Korea created new
financial supervisory institutions and followed through on the promised reform measures,
including closure of 30 percent of the banks and 21 percent of nonbanking financial
institutions.50
Taiwan liberalized FDI and financial capital flows at a similar pace as South Korea’s. The
government adopted several measures in the 1980s to liberalize the banking sector and the
financial market. Following interest rate liberalization, the government relaxed restrictions on
foreign banks after the mid-1980s. The Banking Law of 1989 privatized the banking sector.
Foreign investors were allowed to participate in the Taiwanese stock market after March
1996. The money market and the capital market became more important sources of funds for
companies.51
In Malaysia, financial reforms largely began in the 1980s and continued in the 1990s.
Reform measures included deregulation and development of the financial sector. The stock
market expanded in the early 1980s. The market turnover increased rapidly in the late 1980s
and the early 1990s to the extent that companies now could turn to the market more for
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financing. The government control over the direction of bank credits weakened and the
state’s role in direct lending and transfer to the private sector decreased after the mid-1980s.52
In 1990, the Malaysian government also created an offshore banking facility, the Labuan
International Offshore Financial Centre, which has attracted some leading international
financial institutions such as Standard Chartered Bank, Hongkong and Shanghai Bank, Bank
of Tokyo-Mitsubishi, Dresdner Bank AG and Deutsche Bank AG, and Citibank Malaysia.
Like South Korea and Thailand, Malaysia liberalized financial capital flows in the 1990s. As
discussed in Chapter 6, Malaysia chose capital control during the Asian financial crisis, thus
diverging from most other East Asian economies.
The Philippines began financial sector reform in 1980, aiming to increase competition,
encourage savings, and expand financial markets. Financial deepening took place but mainly
because of transfer of savings from the informal financial sector to the formal sector. Not
accompanied by prudent banking regulations, the reform was not very successful. After the
fall of the Marcos regime in 1986, the Philippines continued financial sector reforms,
focusing on introduction of new financial products in the 1990s. The Filipino financial sector
made progress but failed to develop a corresponding institutional infrastructure.53
The Indonesian government adopted some financial reform measures in the 1980s,
particularly the lifting of interest rate ceilings in 1982 and the permission for new banks to
enter the financial sector and the simplification of procedures for opening new bank branches
in 1988.54 Indonesia suffered the most from the Asian financial crisis. None of the seven
original state banks and the ten largest commercial banks were solvent. The net cost of
cleaning up the banking sector was estimated to be at least 40 percent of GDP. The
government established the Indonesian Bank Restructuring Agency (IBRA) under the
Finance Ministry in January 1998. It offered guarantees for bank depositors. IBRA
nationalized and recapitalized some of the failed banks to rid them of NPLs (reaching 38
banks by 1999) and removed top management from the failed national banks. The public
funding came from government bonds larger than the total liabilities of the banking system.
Nationalized banks sold to domestic and foreign investors were allowed to operate again in
2003.55 But in the scheme of things, the Indonesian financial reform has been slow.
Thailand began financial liberalization with current account transactions in May 1990.
The government then liberalized capital account transactions in April 1991 and relaxed
controls on outward FDI and travel expenses.56 In the 1990s Thailand also sought to create
the Bangkok International Bank Facility (BIBF), an offshore banking system that allowed
Thai companies to have access to foreign-denominated loans, and BIBF loans, mostly short
term, increased drastically and accounted for two-thirds of the new external debt in 1992–
1996. Due to weak oversight, much of BIBF lending went to nontraded sectors.57 The
conditions for the Asian financial crisis were thus laid. In the aftermath of the crisis, the Thai
government closed or forced mergers of dozens of financial companies and commercial
banks and needed further capital injection to recapitalize the financial institutions.
China has introduced more market mechanisms into its economy. Creation of a stock
market has been part of that overall strategy. But the Chinese government sought to use the
stock market to advance its policy objectives of finding new sources of funding for state-
owned enterprises in the areas that it deemed essential for the state industrialization. In fact,
the provincial governments captured the Chinese stock markets based in Shenzhen and
Shanghai to serve their local political and economic agenda. Private Chinese enterprises
found it difficult to list in the Chinese stock market.58
Starting in 2000, the Chinese government sought to recentralize the Chinese stock market
and to better enforce regulations. Some progress has been made. The Chinese government
has also used the stock market as a way to privatize a large number of Chinese state
enterprises in a stealth fashion.59 At the same time, the Chinese stock markets are still
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troubled by the chronic problems of lack of disclosure by listed companies, the stripping of
list company assets, disregard for minority shareholders, and political interference. The
government has become more determined since August 2005 to improve the stock market,
and the volume is increasing. The current government’s strategy is to allow listed state
enterprises to gradually convert previously nontradable shares, about two-thirds of the total
shares, to ordinary shares and then sell them to investors. As an indicator of a more active
stock market, mergers and acquisition deals involving Chinese companies have increased
drastically, reaching $62 billion in the first seven months of 2006, twice as much as in the
same period in 2005, with $28 billion involving only Chinese firms.60
China has also been trying to reform banks since 1997, paying particular attention to
NPLs.61 In August 1998, Premier Zhu Rongji injected 270 billion yuan ($32.6 billion) as
special government bonds into the four state-owned commercial banks. In 1999, China
created four state asset management companies (AMCs) for the four state commercial banks
(the China Construction Bank, the Bank of China, the Agricultural Bank of China, and the
Industrial and Commercial Bank of China). The AMCs purchased 1.4 trillion yuan ($169
billion) of NPLs from the four banks at full book value, using government bonds. The
government thus simply transferred bad loans from one government agency to another. The
Chinese government has been hesitant to force bankruptcy of thousands of state enterprises,
which would create unemployment and social unrest. The AMCs were not as effective as
initially envisioned given a lack of government guarantee for their bonds. It was thus not
surprising that the Chinese government has had to revisit the NPL problem. Using a newly
created investment wing, the People’s Bank of China has injected $60 billion of foreign
reserves for equity into the four state commercial banks since late 2003. After 2004, the
People’s Bank of China purchased 780 billion yuan from three state banks and then auctioned
them off at 26–40 percent of the book values to the AMCs. The Chinese taxpayers have
essentially paid for the huge costs of NPLs.
Since 2002 the Chinese government has adopted a new strategy of attracting foreign
capital to help improve Chinese banks and diversify their ownership. Foreign financial
institutions have been encouraged to purchase equity stakes in the Chinese state banks, which
will then list in stock markets. Declared FDI amounted to $16.5 billion, or 15 percent of the
core capital of the Chinese banking system, by the end of 2005.62 More has taken place since
then.
The Asian financial crisis has taught East Asians a lesson. The crisis shows that the
transitional countries like Malaysia, Thailand, and South Korea were vulnerable. The
availability of international capital allowed East Asian financial institutions and companies to
borrow large amounts of short-term, unhedged foreign currency credit. The flight of foreign
capital created pressure on the pegged exchange rates and triggered the crisis. Although
financial liberalization is a desirable policy, governments need to monitor it closely and to
create legal and institutional infrastructure and stronger domestic financial markets.63
Intellectually, some scholars have pointed out the danger of capital market liberalization
accompanied by certain types of exchange rate regimes. Capital market liberalization, which
essentially means elimination of restrictions on short-term capital flows across national
borders, can hurt unprepared developing nations. The basic argument is that high growing
countries like China and India did not liberalize the financial sector. Growth is based on
increasing investment rather than speculative capital moving in and out of a country quickly.
Speculative capital causes volatility that makes investment less attractive. With capital
market liberalization, a fixed exchange rate regime becomes vulnerable to speculative
attacks.64 Some maintain that financial liberalization creates too much risk while delivering
small benefits. As a result, it makes sense to adopt a cautious approach toward capital
account liberalization, which is what China has been doing.65 In fact, as some analysts have
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argued based on the experience of East Asian economies, even a gradualist approach does not
allow a liberalizing country to avoid volatility once it passes a certain threshold of
openness.66 In response, some noted that financial liberalization is still beneficial in the long
run. Besides, repressed East Asian economies also experienced banking problems.67
EAST ASIA IN GLOBAL FINANCE
East Asian political economy of finance cannot be understood outside the context of global
politics and finance. East Asian economies have developed their distinct mobilization
systems partly out of a perceived weak position in the global system, and the variation in
institutional setup and performance reflects more variation in capacity than in desire. But the
persistence of East Asian patterns, particularly high domestic savings, has been made
possible by low savings in other parts of the world, particularly the United States. Put simply,
the high savings in East Asia and high spending in the United States reinforce each other.
Cross-Border Capital Flows
Flow of foreign capital includes foreign aid, export credit, bank loans, FDI, and portfolio
investment. East Asian economies typically first received foreign aid from developed
countries or multilateral aid organizations, followed by export credit, direct investment,
portfolio investment, and short- to medium-term bank loans. What type of capital one attracts
is largely consistent with one’s stage of development. Much of foreign capital is private, and
private investors calculate risk. The higher the stage of development, the more confidence
foreign investors will have in investing in the country. In the first stage, a developing country
is in a weak position to attract private capital and has to depend on aid money. Once a
developing nation has grown and become more capable of attracting private foreign capital,
that nation will normally graduate from foreign aid. The more advanced East Asian
economies have shifted from net capital importers to capital exporters.
Government aid was important for most East Asian nations in the 1950s. The United
States offered massive aid to Japan, South Korea, Taiwan, the Philippines, and others. As a
case in point, U.S. aid was equivalent to 6.6–9.5 percent of Taiwan’s GDP and about half of
its imports in the 1950s.68 Great Britain also offered aid to Malaya and subsidized the Hong
Kong administration until the 1960s. For the socialist camp, China, North Korea, and North
Vietnam received significant aid from the Soviet Union. The Soviet Union helped China
build some strategic turnkey enterprises. The newly independent Indonesian government
under President Sukarno also received aid from the Soviet bloc as he followed a socialist
policy and allied with the Indonesian Communist Party. Beijing also provided considerable
aid in cash and goods to East Asian communist countries and to a lesser extent to developing
countries through the 1970s. According to recently declassified Chinese diplomatic archives,
China offered 4.028 billion yuan from 1950 to mid-1960, of which 3.539 billion yuan went to
fellow socialist countries, mostly to Vietnam, Mongolia, and North Korea. The total Chinese
aid amounted to one-tenth of the national capital construction investment in the first Five-
Year Plan (1953–1957).69
In the 1960s, the U.S. aid to Northeast Asia decreased significantly. These economies
now received much financial assistance from the World Bank. Japan was the second largest
recipient of World Bank loans, next only to India. Starting in the 1960s, Japan transferred
capital to East Asia in the form of reparations. The Europeans also became significant donors,
although they paid more attention to regions elsewhere. The Soviet Union stopped aid to
China after its quarrels with China escalated, but Soviet aid continued to flow to North Korea
and North Vietnam. China began the self-reliance phase and also began giving aid to other
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Asian socialist countries.
In the 1960s, East Asia also began borrowing from foreign banks as it became worthy of
private loans. Industrial countries used packages of FDI, suppliers’ credit, and bank loans to
facilitate projects in East Asia.
In the early 1970s, Hong Kong, Singapore, and Taiwan graduated from foreign aid and
began attracting foreign capital. Foreign capital accounted for a large percentage of capital
formation. East Asia benefited from capital inflows. This is particularly the case for exporting
sectors of primary sources, traditional sectors such as textiles, and other manufacturing
sectors. FDI also contributes in transfer of technologies and skills.
South Korea was particularly dependent on foreign capital for fixed capital formation. In
the early 1960s, the government selected major five-year plan projects that needed foreign
capital and sent missions to advanced countries to solicit foreign financing. The government
approved and guaranteed foreign loans and provided favorable treatments such tax
concessions as incentives. Foreign capital was crucial for South Korea’s rapid
industrialization, accounting for 78.3 percent of total investment and 8.5 percent of GNP in
1960 and 26.7 percent of investment and 5.6 percent of GNP in 1972.70 But foreign capital
came in the form of loans rather than direct investment. Japan and South Korea have been
different from the rest of East Asia in that they have not really encouraged FDI because of
nationalist sentiment against foreign ownership. Korea’s heavy dependence on foreign capital
explains why South Korea had a more serious foreign debt burden than most other East Asian
nations.
In the early 1980s, East Asia continued to attract foreign capital, unlike Latin America
that was experiencing a serious debt crisis. The main source of capital flows was commercial
bank credit, followed by official development assistance. After the mid-1980s, FDI into East
Asia became more significant than before while commercial bank loans continued to grow.71
Except for Japan and South Korea, all East Asian governments tried to attract FDI. China
entered the reform stage, adopting a new policy of accepting bilateral and multilateral aid,
attracting foreign investments, and raising funds in international capital markets.
Increasingly, capital inflows into East Asian economies came from other East Asian
economies. Japan led the way, recycling its large foreign capital. Japan emerged as a
significant source of capital for global economy after the 1985 Plaza Accord. Following
Japan’s footsteps, several newly industrialized economies in East Asia became significant
capital exporters in the late 1980s. Taiwan became a net exporter in FDI and portfolio
investment. South Korea emerged as a net FDI exporter but also a major recipient of portfolio
investments after the early 1990s. In a reversal, Singapore became a major portfolio investor
overseas while a major destination of FDI.72
With financial liberalization and pegged exchange rates, hot money flowing into East
Asia increased dramatically, which was an important reason for the Asian financial crisis.
Right before the crisis, the five crisis countries increased their foreign reserves mainly
through private commercial borrowings of short-term debt rolled over year after year. Net
interbank lending to the five crisis countries increased from $14 billion per year in 1990–
1994 to $43 billion in 1995–1996. Two-thirds of the short-term loans in 1995–1996 had
maturities of less than a year. By contrast, FDI was $11 billion and $17 billion over the same
periods.73 One major difference between East Asia in the mid-1990s and Latin America in the
1980s is that the foreign borrowing was done mainly by the private sector for investment in
the East Asian case.
With the Asian financial crisis, $88.4 billion of commercial bank capital fled from
Indonesia, South Korea, Malaysia, and Thailand in the second half of 1997 and 1998. For the
whole of East Asia, $93.4 billion left in the same period.74 Foreign capital has returned to
East Asia since 1998. In 2004, the Asian Pacific region was a principal destination of
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international private capital flows, attracting $146 billion in net capital flows compared with
$97 billion to the emerging markets in Europe, $26 billion to Latin America, and $9.2 billion
to Africa and the Middle East, according to a report by the Institute of International Finance
Inc. released on January 19, 2005.75
One notable feature of East Asian finance is that the central banks of Japan and
developing East Asia have moved their hard-earned currencies to the United States, mainly in
the form of low-interest U.S. Treasury bills. In fact, most developing nations have been
building up their reserves for the past few years to be better prepared for a repeat of the Asian
financial crisis. They purchase U.S. treasuries with the dollars earned from exports to the
United States and other countries. Former U.S. Treasury Secretary Lawrence Summers has
argued that the problem for the developing nations is that their foreign reserve increase has
been excessive, as defined by reserves above the amount of foreign debts due for the year.
Summers estimated that developing nations now have $2 trillion in excess reserves,
increasing from less than $500 billion in 1997, which could have generated much higher
yields if invested more productively.76 As will be shown below, such a pattern of capital
flows creates problems.
Global Saving Glut
One important debate at present is whether East Asian countries and some others have saved
too much and thus caused a global imbalance. The conventional argument is that
overspending in the United States has caused a global imbalance in trade and current
accounts. However, Ben Bernanke, who became the chairman of the Federal Reserve in
January 2006, raised the issue of “a global saving glut” at a meeting in Virginia on March 10,
2005. Excessive savings mean that a strong economy does not have to lead to higher interest
rates to prevent inflation and that the United States has been able to finance its high annual
current account deficits.77 Essentially, the growing U.S. current account deficits have been
financed partly through foreign reserve accumulations of countries like Japan and China.
Current account balances measure trade in goods and services, income, and unilateral net
current transfers. As Table 9.7 shows, the United States suffered a deficit of $805.0 billion in
2005, an increase from $668.1 billion in 2004. By contrast, East Asian economies have
enjoyed large current account surpluses. Japan, China, South Korea, Taiwan, Singapore,
Hong Kong, and Malaysia had a combined current account surplus of $432.4 billion in 2005,
or more than half of the U.S. current account deficit that year.
TABLE 9.7
East Asian Current Account Balances (current U.S. $ million)
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Source: World Bank, World Development Indicators Database. The data for Taiwan are from the Asian
Development Bank (ADB) Statistical Database: Key Indicators, various years. The data for China, South
Korea, Singapore, Indonesia, Malaysia, and the Philippines in 2005 are also from ADB Key Indicators.
Note: EMU is the European Monetary Union that evolved into the euro area, which currently includes
Belgium, Germany, Greece, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal,
and Finland.
To measure the magnitude of current accounts, we can look at their shares of GDP. As
Figure 9.3 shows, East Asia has collectively moved to highly positive since the Asian
financial crisis, except the Philippines in 1999–2002 and Thailand in 2005. In 2005,
Singapore had 28.4 percent and Malaysia 15.3 percent; in contrast, the United States had a
negative 6.4 percent. Not included in the figure, the United Kingdom suffered from deficits
of –2.6 percent and Saudi Arabia had a high surplus of 28.1 percent in 2005.
With sharply increasing budget deficits during the Bush administration, the United States
has become increasingly dependent on foreign financing. According to the latest U.S.
Treasury report, including short-term debt securities, the United States had a total of $7,779
billion worth of U.S. securities held by foreigners as of June 30, 2006, of which Japan
(ranked first) had $1,106 billion, China (2) $699 billion, Singapore (15) $163 billion, Taiwan
(16) $135 billion, South Korea (17) $124 billion, and Hong Kong (19) $110 billion. Five
emerging East Asian economies ($1,231 billion) surpassed Japan’s holdings of U.S.
securities. The six East Asian economies accounted for 30 percent of the total foreign
holdings of U.S. securities. While Middle East oil exporting nations (Bahrain, Iran, Iraq,
Kuwait, Oman, Qatar, Saudi Arabia, and United Arab Emirates) had a large current account
surplus on par with East Asia, they actually financed only $243 billion of U.S. debt
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securities.78 Through purchase of U.S. debt securities, the East Asian governments have
sought to prevent an appreciation of their currencies, which will be discussed in detail in the
next chapter.
Much of East Asian financing of U.S. debt securities is reflected in a sharp increase in
foreign reserves. One way to see how much East Asia has accumulated these assets is to tally
the combined foreign reserves, which amounted to $2.57 trillion in 2005, as calculated from
Table 10.2 in the next chapter.
The danger of such an international financial imbalance is that it will sooner or later
become unsustainable. A sharp adjustment would most likely cause serious global economic
difficulties. A likely scenario is that foreign investors would reduce purchase of U.S.
securities when they become concerned about the growing U.S. debt burden due to
continuing current account deficits. Put differently, capital inflow into the United States
would stop or even reverse. If this shift takes place too suddenly, the value of the U.S. dollar
will drop sharply. With sharp dollar depreciation, the interest rates would go up and the stock
market would fall. A recession would follow and would affect the global market.79 Another
problem is that the developing nations should put more resources into their own infrastructure
and social development rather than exporting capital to the rich countries in the form of safe
but low-yielding U.S. treasuries.
FIGURE 9.3
Current Account Balances (percentage of GDP), 1970–2005
Source: World Bank, World Development Indicators Database. The data for Taiwan are from Asian
Development Bank Statistical Database: Key Indicators, various years.
EAST ASIAN FINANCIAL REGIONALISM
East Asia is trying to integrate financially. The Asian financial crisis was a main catalyst for
regional financial cooperation.80 The East Asian economies participated actively in
supporting each other, particularly in the first bailout package for Thailand, while the United
States failed to lend money. The crisis revealed common challenges facing East Asian
nations, which require cooperation to prevent future currency crises. Moreover, East Asia’s
relative weight in the international financial system has increased. Trade links are another
factor. For all these reasons, financial integration makes sense for East Asia.
East Asia appears to have a different approach toward international finance. In fact, some
analysts see East Asia trying to create an alternative financial structure to the West-
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dominated IMF system.81 On the other hand, some other scholars suggest that East Asian
financial regionalism, as it is evolving now, is compatible with the global financial
institution.82 In fact, most East Asian economies have continued to anchor their currencies to
the U.S. dollar since the crisis.83
Any discussion of East Asian financial integration has to begin with a failed attempt,
namely the Asian Monetary Fund (AMF), which Japan proposed at the Asia-Europe Meeting
(ASEM) in Thailand in September 1997. Japan wanted to create a $100 billion fund on the
argument that regional countries needed to pool resources together to deal with the Asian
financial crisis. The Japanese Ministry of Finance lobbied actively for the proposal. However,
the United States and the IMF opposed the idea for fear of undermining the influence of the
IMF. The Chinese government was also hesitant, because the bureaucracy needed time to
form a consensus and the country was not yet ready for ambitious regional integration
projects. The Japanese proposal basically died in a meeting in Manila in November 1997.
However, the desire for a regional framework did not die with the AMF. The Japanese
government announced the New Miyazawa Initiative in October 1998 to facilitate recovery
from the crisis among the five crisis-affected countries with a commitment of $30 billion.84
Of various measures taken, the Chiang Mai Initiative has drawn much attention because
the initiative is often viewed as a revival of the AMF in disguise.85 The initiative was
launched at the ASEAN Plus Three meeting in Chiang Mai, Thailand, in May 2000. The
initiative extended the existing ASEAN swap arrangements to cover the ASEAN Plus Three
region, supported by Japan as the main supplier of swap funds. Since May 2000, the ASEAN
Plus Three member countries have concluded a large number of bilateral swap agreements,
ranging from $1 billion to $7 billion, with the Japan-Korea agreement the largest. Japan was
the dominant player since the power specific for this arrangement is based on foreign
reserves. Japan had more foreign reserves than any of the other regional economies at the
time. Half of the money is from Japan. Japan is now supporting local currency bond markets
because the Japanese institutions want to play a major role in the region. China was viewed
as a lender rather than a borrower. As of now, the program is small and has a high threshold
for tapping into the swap funds. With growing foreign reserves, East Asian economies do not
expect much from the program. Without IMF approval, it is hard to tap into the money. There
is a need to clarify the activation process and improve surveillance. Nevertheless, the key
word about the Chiang Mai Initiative is its potential.
East Asia now has two main initiatives to promote regional bond markets, namely the
Asian Bond Markets Initiative (ABMI) and the Asian Bond Fund (ABF). The ASEAN Plus
Three financial officials created the ABMI in Chiang Mai in December 2002 to deal with the
mismatch between supply and demand of funds by increasing regional supplies of bonds.
ABMI has created a number of working groups to study how to improve domestic and
regional bond markets. The Asian Development Bank provides technical assistance to the
groups.
ABF was created by the Executives Meeting of East Asia and Pacific Central Banks and
Monetary Authorities (EMEAP) in June 2003. EMEAP comprises Australia, China, Hong
Kong, Indonesia, Japan, South Korea, Malaysia, New Zealand, the Philippines, Singapore,
and Thailand. ABF pooled $1 billion of reserves from members to purchase U.S. dollar-
denominated bonds from eight members. EMEAP created a second fund called ABF2, which
pooled $2 billion of reserves to invest in local currency sovereign or quasi-sovereign bonds
issued by the governments in the same eight economies. Unlike ABF, ABF2 is open to retail
investors.86 EMEAP asked the Bank for International Settlements (BIS) to manage the fund.
Both ABMI and ABF are still small, and there is still limited regional interest in
purchasing regional assets. Some analysts have called on the East Asian governments to take
an active role in promoting the development of local currency bond markets with ideas such
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as Asian basket currency bonds (against a collection of individual East Asian local
currencies). Others argue that purchasing of other Asian bonds does not help East Asian
economies to diversify their debt portfolios since they share similar business cycles.
Moreover, owing to the lack of transparency and poor accounting and auditing of East Asian
corporations, empirically East Asians do not exhibit a regional bias in favor of the bonds
issued by other economies in the region. Therefore, a market-based strategy is preferable to a
state-led strategy.87
All this shows that it is harder to achieve regional financial integration because of the
gravity of financial globalization. Ever since the crisis, East Asian stock markets have largely
correlated more closely with the American stock market than previously, but there is also
some sign of regional integration.88 Many agree that East Asian finance is connected closely
to New York and London rather than regionally. East Asian financial liberalization has made
East Asian economies develop stronger financial ties with advanced countries than with each
other.89 At the same time, one has to ask why the East Asian governments have been so
interested in regionalization since the Asian financial crisis. There are clearly political
reasons and drivers behind all this.90 Some have argued that East Asian financial integration
is greater than one might think judging by the share of bonds under-written and loans
syndicated going to East Asians.91
EAST ASIAN POLITICAL ECONOMY OF FINANCE
Politics has always been important for financial policy. Finance is about allocation of capital
within the economy, which is at the heart of state power. After all, politics can be understood
as allocation of scare resources. The importance of politics was particularly prominent
through the 1960s when capital was scarce in most East Asian economies. With financial
globalization, East Asian firms and individuals have acquired greater abilities to evade state
control, but the state remains important albeit in a changed way.
With the exception of Hong Kong, all East Asian governments made sure that they
controlled the flow of capital. Thus, where the money went reflected the governments’
political agenda and political calculations. The East Asian governments’ preference for a
bank-based financial system rather than a securities-based system reflects their desire for
rapid industrialization.92 As a late developer, the Japanese government channeled capital to
selected companies to enable them to compete in the international market. As a late-late
developer, the South Korean government went all out for the biggest company groups. Being
homogeneous, the Japanese and South Korean governments did not have to worry about
ethnic divisions. The mainlander Taiwanese government had no incentives to strengthen the
economic power of the Taiwanese businesses and channeled money to state enterprises that
controlled the key infrastructure, utilities, and industries. The Malaysian government wanted
to help improve the economic power of the indigenous population relative to ethnic Chinese
starting in the early 1970s.
China adopted a socialist planned economy that was the opposite of the market economy.
With reform launched in 1978, the Chinese government tried to reform its financial sector,
letting banks run more like commercial banks and nurturing the financial market. However,
the government did not have the natural instinct for a market economy. Rather, they
fundamentally see the financial sector as one of the instruments to advance their policy. The
finance and economy are one of several xitongs in the Chinese political. Politics explains why
state-owned enterprises receive most of the state economic resources even though they are
the least efficient firms. By contrast, more efficient Chinese private firms receive the least
support.93 Despite reforms, Chinese state banks continue to offer loans to losing state-owned
244

enterprises, which leads to accumulation of bad loans. Private firms have found it difficult to
borrow loans from state banks and have to resort to higher risk and legally murky informal
financial institutions.94 The government has also used the financial market unabashedly as an
instrument to support state-owned enterprises with additional resources in the 1990s and for
privatization of many state-owned enterprises since 2000. The bureaucrats determine which
firms can list in the Chinese stock markets. Given the priority and vested interests, it is thus
not surprising that private firms find it difficult to list in the Chinese stock markets.
State-directed credit can work, as demonstrated by the East Asian development
experience. Mobilization of domestic resources could help promote faster growth. But
politics may go wrong. The governments needed to benefit as broad a population base as
possible. The overemphasis on political cronies in the Philippines shows that a strong state
could do evil as well as good. Another lesson is that a politics-in-command approach without
any regard for underlying economic dynamic is bound to fail. The ultimate failure of socialist
countries is a case in point.
Equally important, the state intervention in the financial sector also creates long-term
problems by distorting incentives, as shown by the experiences of Japan and others in the
region. The fact that the state in East Asia mobilized finance to advance state objectives
necessarily meant that the practice created institutions to favor certain political actors at the
expense of others. Vested political interests make the necessary financial reform difficult if
not impossible. In the case of Japan, entangled political and institutional interests have
slowed down the pace of financial reforms.95 For example, Japan Post gave the state the
option to seek state objectives without going to the taxpayers. But the system favored the
ruling Liberal Democratic Party (LDP) by funding projects that helped LDP win votes. Prime
Minister Koizumi had to threaten to destroy the LDP itself and waged a huge fight against the
rebels of his postal reform within his own party to win a watered-down reform package in
2005.
Financial reforms cannot escape politics either. Malaysia’s financial reform in the 1980s
and the 1990s was partly based on political favoritism, particularly bumiputra businesses
connected with the ruling party. Cronies pocketed large profits from preferential allocation of
stock shares.96 For example, the reform and expansion of the Kuala Lumpur Stock Exchange
in the early 1990s led to a casino atmosphere. Much of the funds raised in the market went
into privatization of public sector assets.97
While politics affects financial policy, domestic and global financial markets affect
politics in return. Financial capital is a highly liquid asset, which provides both opportunities
and challenges for the state. Integration into the global capital market creates both winners
and losers in the domestic context.
On the domestic front, once created, a country’s financial sector constrains its policy. For
example, the Chinese government has been trying unsuccessfully to restrict high investments
in recent years to prevent an overheated economy. The country’s investment as share of GDP
approached an impossibly high 50 percent in 2005 and may well exceed 50 percent in 2006.98
Preventing an overheated economy and a resulting economic collapse is a fundamental
political interest for the party, but its ability has been constrained.
Financial difficulties also serve as catalyst for political and institutional change. Japan’s
burst of the economic bubble and the long stagnation were reasons that led to institutional
change, including a significant weakening of the power of the Ministry of Finance, which lost
its Japanese name Okurasho (Great Treasury Ministry) at the end of 2000. The bureaucrats
were blamed for their mishandling of money.
The global financial market makes it difficult for national governments. As Robert
Mundell reasoned in the 1960s, it is impossible to achieve a fixed exchange rate, free capital
movement, and national sovereignty at the same time. A government can hope to achieve two
245

objectives at a given time. For example, if a government wants to maintain national
autonomy in financial policy but also wants to fully integrate with the global financial
market, it will have no choice but to adopt a free-float exchange rate system.
Financial globalization means that foreign financial institutions are becoming
increasingly powerful players in a country’s domestic financial market. For example, with its
entry in the WTO, foreign banks were allowed to operate in China in December 2006.
One direct impact on the state institutions is that the challenge to manage the global
capital market means that the central banks often need to be shielded from interest-group-
based politics. There are historical and institutional backgrounds to the national central banks
that have generated much research.99 However, a more independent central bank does not
necessarily mean that all problems have been solved. In fact, one may argue that the
resistance of the Bank of Japan to increase money supply to fight off deflation contributed to
a painfully slow economic recovery in Japan.100
Also, the nature of financial issues has affected decision making. As a case in point,
advanced nations sought to liberalize capital controls while showing less enthusiasm for trade
liberalization in the 1970s and the 1980s. Two reasons cited for this difference are low
political visibility of financial issues compared with more politically charged trade issues and
the inherent difficulty in controlling capital movement given capital’s mobility and
fungibility.101
Last but not least, a bank-based financial system affects domestic politics in that it favors
exporters and investment and consequently also a stable, and preferably undervalued,
exchange rate regime. By contrast, a securities-based financial system does not really favor
domestic producers.102
CONCLUSION
East Asia has experienced a virtuous cycle of high savings, high investment, and high
growth. Deliberate government policies have played a prominent role in forcing savings and
channeling savings to targeted investments. The state has served a role of financial
intermediation, relying heavily on the banking sector. This strategy of capital accumulation
and directed credit largely worked in that it enabled East Asian economies during their catch-
up stage. However, the example of the Philippines shows that the state-directed credit
strategy could also be used for supporting political cronies, with disastrous consequences.
Even if directed credits reached the “right” sectors, this strategy still created a number of
long-term negative results, namely bad-loan problems and weak financial markets. A
combination of dependence on bank loans and pegged exchange rates meant that domestic
firms sought short-term foreign bank loans, leading to greater exposure to foreign debt and
consequently an important reason for the Asian financial crisis. A more developed and
diversified financial sector that offered greater investment opportunities would have
alleviated the threat of a financial crisis triggered by sharp shifts in short-term capital flows.
East Asia has transformed from a capital-poor to a capital-rich region. High savings and
relatively low investment for a large number of East Asian economies since the Asian
financial crisis have contributed to a major global financial imbalance in which East Asia
with a large current account surplus lends to the United States troubled with large current
deficits. This unsustainable situation threatens the long-term prosperity of the global
economy. Whereas the United States should gradually reduce its budget deficits, East Asian
economies also need to put greater emphasis on domestic demands. East Asia has also made
some progress in financial regional integration since the Asian financial crisis, but East Asian
financial regionalism remains limited because East Asia is really part of financial
246

globalization.
Finance is at the core of a country’s political economy system because it is about
distribution of scarce resources. Political agenda and political calculations of the East Asian
governments have shaped their developmental state approach to mobilize financial capital to
achieve rapid industrialization in the early years and how they have approached financial
liberalization in the later years. As a highly liquid asset, finance has also affected the nature
of East Asian political economy and East Asian policymaking.

SUGGESTED READINGS

Amyx, Jennifer A. Japan’s Financial Crisis: Institutional Rigidity and Reluctant Change
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Ariff, Mohamed, ed. Islamic Banking in Southeast Asia: Islam and the Economic
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Bryant, Ralph C. International Financial Intermediation (Washington, D.C.: Brookings
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de Brouwer, Gordon, with Wisarn Pupphavesa, eds. Asia Pacific Financial Deregulation
(New York: Routledge, 1999).
Ghosh, Swati R. East Asian Finance: The Road to Robust Markets (Washington, D.C.: World
Bank, 2006).
Goldstein, Morris, and Philip Turner. Controlling Currency Mismatches in Emerging
Markets (Washington, D.C.: Institute for International Economics, 2004).
Green, Stephen. The Development of China’s Stock Market, 1984–2002 (London: Routledge,
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Hamilton-Hart, Natasha. Asian States, Asian Bankers: Central Banking in Southeast Asia
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Controls Than Trade Barriers?” Policy Sciences 27, no. 4 (December 1994): 299–318.
Henning, C. Randall. East Asian Financial Cooperation (Washington, D.C.: Institute for
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Hiwatari, Nobuhiro. “Embedded Policy Preferences and the Formation of International
Arrangements After the Asian Financial Crisis.” The Pacific Review 16, no. 3 (September
2003): 331–359.
Hutchison, Michael M., and Frank Westermann, eds. Japan’s Great Stagnation: Financial
and Monetary Policy Lessons for Advanced Economies (Cambridge: MIT Press, 2006).
Ito, Takatoshi, and Anne O. Krueger, eds. Financial Deregulation and Integration in East
Asia (Chicago: University of Chicago Press, 1996).
Jomo, K. S., ed. The Malaysian Eclipse: Economic Crisis and Recovery (London: Zed Books,
2001).
Lardy, Nicholas R. China’s Unfinished Economic Revolution (Washington, D.C.: Brookings
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McKinnon, Ronald I. Money and Capital in Economic Development (Washington, D.C.:
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Noguchi, Yukio. “The ‘Bubble’ and Economic Policies in the 1980s.” Journal of Japanese
Studies 20, no. 2 (Summer 1994): 291–329.
Park, Yung Chul, Takatoshi Ito, and Yunjong Wang, eds. A New Financial Market Structure
for East Asia (Northampton, Mass.: Edward Elgar, 2005).
Rawski, Thomas T. “Will Investment Behavior Constrain China’s Growth?” China Economic
Review 13, no. 4 (December 2002): 361–372.
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Shaw, Edward S. Financial Deepening in Economic Development (New York: Oxford
University Press, 1973).
Tett, Gillian. Saving the Sun: A Wall Street Gamble to Rescue Japan from Its Trillion-Dollar
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Tsai, Kellee S. Back Alley Banking: Private Entrepreneurs in China (Ithaca, N.Y.: Cornell
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Tsurumi, Masayoshi, ed. Financial Big Bang in Asia (Aldeshot, England: Ashgate, 2001).
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NOTES

1. Joseph E. Stiglitz, Jaime Jaramillo-Vallejo, and Yung Chal Park, “The Role of the State in
Financial Markets,” Proceedings of the World Bank Annual Conference on Development
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2. World Bank, East Asian Miracle, 203–221.
3. World Bank, East Asian Miracle, 221–242.
4. Swati R. Ghosh, East Asian Finance: The Road to Robust Markets (Washington, D.C.:
World Bank, 2006).
5. Koichi Hamada and Akiyoshi Horiuchi, “The Political Economy of the Financial Market,”
in The Political Economy of Japan, vol. 1, The Domestic Transformation, ed. Kozo
Yamamura and Yasukichi Yasuba (Stanford: Stanford University Press, 1987), 224–228.
6. Michael M. Hutchison, Takatoshi Ito, and Frank Westermann, “The Great Japanese
Stagnation: Lessons for Industrial Countries,” in Japan’s Great Stagnation: Financial and
Monetary Policy Lessons for Advanced Economies, ed. Michael M. Hutchison and Frank
Westermann (Cambridge: MIT Press, 2006), 1–32.
7. Bon-Ho Koo, “Industrial Policy and Financial Reforms in Korea,” in Financial Sector
Reforms in Asia and Latin American Countries: Lessons of Comparative Experience, ed.
Shakil Faruqi (Washington, D.C.: World Bank, 1993), 167–178; Sang-Woo Nam, “The
Principal Transactions Bank System in Korea and a Search for a New Bank-Business
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Park, “Financial Reform and Its Impact on Corporate Organization in Korea,” in Asia
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York: Routledge, 1999), 207–231.
8. Hsueh, Hsu, and Perkins, Industrialization and the State, 78–79.
9. Ya-Hwei Yang and Jia-Dong Shea, “Evolution of Taiwan’s Financial System,” in East
Asia’s Financial Systems, ed. Seiichi Masuyama, Donna Vandenbrink, and Chia Siow Yue
(Singapore: Institute of Southeast Asian Studies, 1999), 272.
10. Chin Kok Fay and K. S. Jomo, “Financial Liberalization and System Vulnerability,” in
The Malaysian Eclipse: Economic Crisis and Recovery, ed. K. S. Jomo (London: Zed
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11. Naris Chaiyasoot, “Commercial Banking,” in The Thai Economy in Transition, ed. Peter
G. Warr (Cambridge: Cambridge University Press, 1993), 226–264.
12. Angelo M. Venardos, Islamic Banking and Finance in Southeast Asia (Singapore: World
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13. People’s Bank of China, China Monetary Policy Report, 2004 Quarter 4,
248

www.pbc.gov.cn/english//detail.asp?col=6612&ID=27, 30; 2005 Quarter 4, 21.
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89. Eichengreen and Park, “Financial Liberalization and Capital Market Integration in East
Asia.”
90. Paul Bowles, “Asia’s Post-Crisis Regionalism: Bringing the State Back In, Keeping the
(United) States Out,” Review of International Political Economy 9, no. 2 (May 2002):
244–270.
91. Robert N. McCauley, San-Sau Fung, and Blaise Gadanesz, “Integrating the Finances of
East Asia,” BIS Quarterly Review (December 2002): 83–95.
92. For a broader discussion of the political consequences of bank-based versus securities-
based financial systems, see John Zysman, Governments, Markets, and Growth (Ithaca,
N.Y.: Cornell University Press, 1983).
93. Yasheng Huang, Selling China: Foreign Direct Investment During the Reform Era (New
York: Cambridge University Press, 2003).
94. Kellee S. Tsai, Back Alley Banking: Private Entrepreneurs in China (Ithaca, N.Y.:
Cornell University Press, 2002).
95. Jennifer A. Amyx, Japan’s Financial Crisis: Institutional Rigidity and Reluctant Change
(Princeton: Princeton University Press, 2004).
96. Jomo and Hamilton-Hart, “Financial Regulation, Crisis, and Policy Response,” 78–79.
97. Fay and Jomo, “Financial Liberalization and System Vulnerability,” 100–108.
98. Diyicaijing ribao [First finance and economics daily], May 31, 2005,
http://finance.sina.com.cn/g/20060531/01252610670.shtml.
99. Paulette Kurzer, Business and Banking: Political Change and Economic Integration in
Western Europe (Ithaca, N.Y.: Cornell University Press, 1993); Natasha Hamilton-Hart,
Asian States, Asian Bankers: Central Banking in Southeast Asia (Ithaca, N.Y.: Cornell
252

http://www.mof.go.jp/english/soken/kiep2005/kiep2005_03

http://finance.sina.com.cn/g/20060531/01252610670.shtml

University Press, 2002).
100. Richard Werner, Princes of the Yen: Japan’s Central Bankers and the Transformation of
the Japanese Economic Structure (Armonk, N.Y.: M. E. Sharpe, 2002).
101. Helleiner, “Free Money.” Two other reasons cited are pressure from the United States
and Britain and the possibility that a country may not maintain financial and trade
liberalization at the same time.
102. Hiwatari, “Embedded Policy Preferences.”
253

I
CHAPTER 10
The Political Economy of East Asian Monetary
Relations

nternational monetary affairs, which are mainly about exchange rates, are conceptually
different from international finance, which is about the flow of money across national
borders. Exchange rates and international finance influence each other, particularly for an
open economy with free flow of capital across national borders. For example, as shown in
Chapter 6, a pegged exchange rate regime that reduced foreign exchange risks encouraged
increased inflow of foreign capital, but the fear of an expected local currency depreciation led
to a sudden exodus of capital, which forced the government to depreciate in a self-fulfilling
effect.
This chapter discusses East Asian monetary relations on both the domestic and
international level. On the domestic level, the chapter describes and explains the evolution
and nature of East Asian exchange rate policies, which is narrower than a country’s monetary
policy that also covers issues such as money supply and interest rates. While being influenced
by the international monetary system, individual countries’ exchange rate policies constitute
the international monetary system. For the international monetary system, the chapter
addresses where East Asia is situated in the global monetary system and how the East Asian
regional monetary system has evolved. The East Asian economies have been largely
operating under the dollar standard since the end of World War II. The nonsocialist countries
were part of the Bretton Woods system, which provided a stable monetary environment for
these economies to flourish when they turned to export promotion. They virtually all
maintained undervalued exchange rates that gave them significant export advantages. They
maintained a soft peg to the U.S. dollar after the collapse of the Bretton Woods system in the
early 1970s. Asian regionalism is taking place slowly.
EAST ASIAN EXCHANGE RATE POLICIES
Money is a standardized medium of transaction. Money includes coins, paper currency, and
bank deposits. Money serves as a medium of exchange to replace barter trade, as a unit of
account to measure value, and as a store of wealth. Money is a promise that the money one
possesses will maintain its value in the future. Otherwise, a currency would not be that
valuable. Money is an important issue for international political economy because the
evolution of national currencies has been at the core of state building.1 Domestic monetary
policy covers also interest rates and inflation targeting, but this chapter focuses on exchange
rates and foreign reserves.
Exchange Rate Policies
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International money is needed for the international market. However, unlike in the domestic
context, the international system is anarchical; that is, there is not an overarching political
authority that can issue a global currency to facilitate international transactions. Transnational
barter trade is too complicated to facilitate trade. The international community may also use
precious metals such as gold as liquidity. However, a limited supply of gold means that we
will not have sufficient liquidity to support expanding trade and will suffer a deflation as a
result. Exchange rates thus become the international currency.
A government has to make at least four key decisions regarding exchange rates. First,
should the country peg its currency to another one such as the U.S. dollar or allow the value
of its currency to float? Like any commodity, the value of a national currency is
fundamentally determined by supply and demand. If supply of a currency exceeds demand
for it, the price of the currency goes down and vice versa. If the government wants to
maintain the peg, it has to intervene in the currency market. The government may purchase
its currency with foreign reserves, which increases the demand for its currency, when the
value of its currency is pressed down by excessive supply. Conversely, the government may
sell its currency in exchange for hard currencies such as the dollar, which increases the
supply of its currency, when the value of its currency is pushed up by too much demand. A
float exchange rate policy means that the government lets the currency market determine the
value of its currency.
In practice, governments often choose to let their currencies float between certain limits
to ensure stability in international transactions. A government’s choice of exchange rate
policy reflects its basic policy objectives at a given moment and is informed by the prevailing
ideas about exchange rates. Economists tended to think in the early 1990s that a high-
inflation country could introduce a soft peg (a target rate and a band around it) of its currency
against the currency of a lowinflation country or a group of currencies without generating
much loss in employment and growth. But with a subsequent explosion of cross-border
capital flows, financial crises caused by reversal of capital flows, and contagion of crises
between pegged exchange regimes, economists now tend to think that it is no longer possible
to maintain a middle ground between a floating regime and monetary union.2
Second, governments need to make a choice about how strong they want their currencies
to be relative to another currency or a group of foreign currencies. This choice is related to
the first choice; the issue would be moot if a government adopted a free float policy. The
relative strength of a currency is different in that the said currency may peg to another
currency at different levels. Unlike arguments about free trade, there is not a clear-cut
efficiency argument for a particular level of exchange rates.3 The reasons for keeping a
currency weak or strong vary. In recent decades a government keeps its currency weak to
seek advantage in exports. For example, the Chinese yuan was pegged to the U.S. dollar at
8.28 yuan per U.S. dollar until recently. That means that a China-made product that sells for
828 yuan should be sold in the United States for $100 if we disregard transportation and other
costs. However, if the Chinese currency appreciates by 30 percent to 5.80, as some would
like to see, the same product would now cost $143 in the U.S. market, which would
obviously make the China-made product far less competitive.
It is real exchange rate (net) rather than nominal exchange rate (gross) that is important.
Real exchange rate determines how much one pays for foreign currency. Effective exchange
rates are nominal rates plus other additional charges. A large nominal devaluation may be
small in real terms, thus having little impact on trade.4
How do we know what is a fair exchange rate? One basic measurement to use is
purchasing power parity (PPP); that is, a correct level of exchange between two currencies
should equalize the prices of the same basket of goods and services in the two countries. In a
creative way, the Economist proposed a Big Mac index in 1986. The basic idea is that the
255

same hamburger should cost about the same in different countries, thus creating a Big Mac
PPP. The difference between the Big Mac PPP and the actual exchange rate would show
whether a currency is overvalued or undervalued. The Big Mac index for 1999, for example,
shows China and Malaysia 51 percent undervalued against the U.S. dollar.5
Third, a government has to decide on the size of its foreign reserves. This is particularly
important for pegged exchange rates. Foreign reserves may serve as a war chest to fend off
future attacks. How much reserve does a country need? It is generally believed that a country
needs sufficient reserves to cover three months of imports or pay for short-term debt. By that
standard, most East Asian economies have excessive foreign reserves. As an example, as of
October 2006, China’s foreign reserves are sufficient for 15 months of import and six times
more than its short-term debt.6
Foreign reserves may take several forms: (a) gold holdings; (b) international money
created by international bodies, such as Special Drawing Rights (SDRs); or (c) widely
accepted and valuable foreign currencies, which is the most common component of reserves.
What currency one holds as reserves is affected by a number of factors. It makes sense to
hold the currency of the country to which one owes money, so as to minimize exchange risks,
or the currencies of one’s major trading partners. Another consideration is the value of the
currency one holds. A currency that is expected to lose its value would not be a good
currency. One then tries to reduce the share of that currency in one’s reserves.
Fourth, a country has to decide whether it should allow its currency to be freely
convertible. This is about how open or closed a country’s capital market is. This decision
matters for the international monetary system because it affects financing of trade and other
economic transactions. During the Bretton Woods period, International Monetary Fund (IMF)
Article 8 requested currencies to be made freely convertible, but Article 9 gave exemption for
a transition period, which essentially meant indefinitely for developing nation members. The
IMF was mainly concerned about elimination of multiple exchange rates.7 Whether or not the
IMF puts pressure on this issue, a government has to make a choice about the currency
convertibility of its currency.
East Asian Exchange Rate Policies Through the Early 1970s
East Asia was divided into two parts during the cold war. The nonsocialist world was part of
the Bretton Woods system, with currencies pegged to the U.S. dollar. As shown in Table
10.1, the exchange rate between the yen and the dollar was ¥360 to $1 between 1953 and
1970 (¥361.1 in 1950 and 1951). Similarly, Singapore and Malaysia pegged their currencies
to the dollar from 1950 to 1970. Thailand’s baht and Hong Kong’s dollar were pegged to the
dollar as well, with slight variations. The Philippines’ peso saw greater depreciation against
the dollar. Taiwan depreciated its New Taiwan Dollar (NT$) in the 1950s and then
maintained a rate of NT$40 per U.S. dollar in the 1960s. What is most noticeable in the table
is how South Korea’s nominal exchange rates depreciated continuously against the dollar
from 1950 to 1970. Most of these currencies did not become fully convertible until the 1960s.
Moreover, many nonsocialist countries adopted multiple exchange rate systems to advance
their policy objectives.
Nonsocialist East Asian economies benefited from the Bretton Woods system. The
Bretton Woods system ensured a stable international monetary system, which facilitated
trade. Japan, for example, benefited from cheap yen and cheap oil for its economic miracle.
The United States did not object to this unfair arrangement because of its dominant economic
position and its hegemonic interests. This changed in 1971 when President Richard Nixon
ended the Bretton Woods system.
The Bretton Woods system was a U.S.-dollar-dominated currency region writ large. It
was a hegemonic system in which the United States dominated. The unique position of the
256

dollar gave the United States advantages in terms of macroeconomic stability and
microeconomic efficiency. Put simply, the United States alone did not have foreign exchange
risks. In the early stage, the United States also gained real resource benefits because it could
simply pay for foreign purchases. However, as time went by, the fact that there were a large
amount of dollars offshore also restricted U.S. ability to adopt interest rate polices at home
and its ability to address its balance of payments deficits, which were needed to provide
liquidity for expanding global trade. If the United States wants to raise interest rates to cool
down the U.S. economy, dollars will flow back into the country, thus increasing money
supply that heats up the economy. If the United States enjoys current account surpluses, the
supply of international liquidity will decrease, thus hurting expanding global trade.
TABLE 10.1
East Asian Exchange Rates (per U.S. dollar, period average)
257

258

Source: International Monetary Fund, International Financial Statistics Yearbook, various years, for the data
1950–1978 (period average of market exchange rates) for the economies listed in the table except for Hong
Kong. The data for Hong Kong in 1960–2006 are from the World Bank, World Development Indicators
Database. Data for 1979–2006 for every economy except Taiwan are from the World Bank, World
Development Indicators Database. The data for Taiwan in 1979–1980 are from the Council for Economic
Planning and Development, Taiwan Statistical Databook, 1996, 4. The data for Taiwan in 1981–2004 are
from the Asian Development Bank Statistical Database System. The data for 2005–2006 are from the Central
Bank of the Republic of China (Taiwan), www.cbc.gov.tw/total_index.asp.
The American Occupation authority formulated Japan’s initial exchange rate policy.
Under the advice of Joseph Dodge, the dollar-yen exchange was set at ¥360 to the dollar in
April 1949, which was lower than the ¥330 considered to be appropriate at the time. With
slight variation in the early 1950s, that rate remained unchanged until 1971 when the Bretton
Woods system collapsed. The ¥360 rate facilitated Japan’s goal of achieving international
competitiveness, which grew visà-vis other advanced countries over the years and helped
secure balance of payment surpluses in the second half of the 1960s.8 Japan did not allow
currency convertibility until 1964, about six years later than Western European countries.
The Hong Kong dollar was pegged to the British sterling (1 pound = HK$16.00), which
was the IMF parity, in December 1946. In November 1967, the Hong Kong dollar revalued to
14.55 but remained pegged to the sterling. In December 1971, the Hong Kong dollar pegged
to SDR. The Hong Kong dollar was pegged to the U.S. dollar for the first time in July 1972 at
5.65 with a band of 2.25 percent, after the floating of the sterling.
The Kuomintang government in Taiwan introduced currency reform in June 1949, which
was a key to controlling high inflation to ensure its political survival. Some Taiwanese
economists saw the import substitution strategy as impractical since the small economy in
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http://www.cbc.gov.tw/total_index.asp

Taiwan could not achieve economies of scale or allow Taiwan to take advantage of its
comparative advantage. They pushed for devaluation and trade liberalization. In August
1959, the government set the exchange rate at NT$38.08 per U.S. dollar buying and
NT$38.38 selling. The New Taiwan Dollar’s exchange rate depreciated further to 40 in 1960
and became the pegged exchange within the IMF until 1973.9 Taiwan’s major currency
depreciation gave its exports an edge in the global market.
South Korea had a multiple exchange rate system in the 1950s and the early 1960s. In the
multiple exchange rate system, the official rate was overvalued but trade and other
commercial transactions were conducted with different exchange rates cheaper than the
official one. The South Korean government sharply devalued the won and then failed in an
attempt to unify exchange rates. After the military coup, South Korea devalued the official
rate from 103 won to 256 won per U.S. dollar and shifted to a unitary exchange rate in May
1964. In March 1965 the government allowed the floating of the won in the exchange market.
But the Korean Monetary Authority promptly reverted to a pegged exchange rate regime.
From 1968 to 1971, the government gradually depreciated the won to be consistent with the
inflation rates of South Korea and its major trading partners.10
Singapore was part of the Sterling Area before 1972, which meant a peg of the Singapore
dollar to the pound sterling within a band of 1 percent. Most of Singapore’s foreign reserves
were the sterling pound. Singapore left the sterling zone in June 1972 because the pound was
now floated. Singapore’s capital account was gradually liberalized. Singapore also switched
to a peg to the U.S. dollar at S$2.8196 per U.S. dollar. Singapore was mainly interested in
price stability and chose a strong Singapore dollar to prevent increases in import prices and
cost of living, which were considered more important than export advantages. Singapore
turned to a managed float in 1973 to fight imported inflation and inflow of hot money. The
exchange rate was stable until 1970 and appreciated in 1971–1974, but with falling relative
prices the real term exchange rate was the same in 1979 as in 1970.11
The Philippines initially did not possess the sovereign right over exchange rates due to the
independence agreement with the United States in 1946. With the United States in control,
the Philippines had an overvalued exchange rate of 2 pesos to a U.S. dollar. The government
adopted a foreign exchange control regime in 1949 to ration foreign exchange for essential
imports. The Philippines regained sovereignty in monetary affairs in 1954 but maintained the
overvalued exchange rate to protect import substitution industries. The government began to
depreciate the peso in 1960 in a framework of multiple exchange rates. The government
removed exchange controls and adopted a uniform exchange rate regime except for exports in
1962. Exchange controls were reintroduced in 1967 due to balance of payments difficulties.
The peso floated in February 1970 after a foreign exchange crisis but was eventually fixed at
6.4 pesos per dollar by December. The Philippine exchange rate regime was designed to
promote import substitution and exports. The PPP-adjusted effective exchange rates grew by
5.2 times for imports of nonessential consumer goods and 3.2 times for imports of
nonessential producer goods from 1949 to 1971, but only 1.2 times for traditional exports
from 1950 to 1971.12
Similar to some of the nonsocialist economies at this time, China allowed its yuan
currency to be overvalued to allow cheaper imports of foreign capital goods. Like other
socialist countries China adopted the exchange control regime, which means that the state
sets the exchange rate and no individuals or firms are allowed to hold foreign currencies.
They need to apply for foreign currencies and trade foreign currencies earned in exports for
the yuan. Violators would be punished severely. The advantage of this system was to ensure
smooth adjustments, but these states had liquidity problems in that they needed hard
currencies to purchase things they needed from abroad. For China, Hong Kong was left as a
British colony partly because it served a useful purpose for Beijing to acquire hard
260

currencies. The market forces worked in socialist countries as well. Despite severe
punishments, black markets for hard currencies gradually developed, which undermined the
exchange control regime.
North Vietnam essentially adopted a barter trade arrangement with the socialist countries
and used the Soviet convertible ruble (equals five domestic rubles) as the unit of account. As
a result, Vietnam had little foreign currency holding prior to 1985.13
From the Early 1970s to the 1997 Financial Crisis
Prior to the Asian financial crisis, East Asian countries chose to describe their currency
policy as a managed float, but most East Asian economies in practice adopted an adjustable
pegged exchange rate regime; that is, the authorities intervened in the currency market to peg
their currencies to the dollar.14 It is common that a government’s actual exchange rate policy
differs from its declaration.15
President Nixon’s New Economic Program announced in August 1971 essentially ended
the Bretton Woods system because a key component of the plan was to end the dollar’s
convertibility to gold, a pillar of the system. Japan was part of the reason for Nixon’s drastic
measures, which were designed to depreciate the dollar against major currencies such as the
yen to reduce trade deficits. After some effort to maintain the ¥360 rate, the Japanese
government set a new rate at ¥308 and then moved to a managed float. Japan was an outlier
in East Asia in that virtually everyone else maintained a managed peg to the U.S. dollar or a
basket of currencies heavily weighted toward the dollar.
Japan’s ascendancy and its chronic current account surpluses led to increasing
international pressure, particularly from the United States. Intended to help divert growing
protectionist sentiment in the U.S. Congress, the finance ministers and central bankers of the
Group of Five (G5)—the United States, Japan, Germany, Great Britain, and France—reached
a landmark agreement to depreciate the dollar against the yen and the European currencies at
Plaza Hotel in New York on September 22, 1985. The agreement, known as the Plaza
Accord, was a success. The G5 countries sold $2.7 billion to intervene in the currency market
in the following week, with $1.25 billion from Japan, $635 million from France, and $408
million from the United States. The Japanese yen appreciated by 11.8 percent against the
dollar, the German mark by 7.8 percent, the French franc by 7.6 percent, and the British
pound by 2.9 percent. By January 1986, the dollar had depreciated by 25 percent over the
previous year.16 Figure 10.1 for annual average official yen-dollar exchange rates in 1950–
2006 shows a sharp appreciation between 1985 and 1988. The sharp yen appreciation, large
current account surpluses, and insufficient domestic consumption led to a property bubble,
the burst of which led to a decade-long economic stagnation. The Chinese government would
later draw from the Plaza Accord what it considers to be a lesson not to appreciate its
currency against the dollar too quickly.
FIGURE 10.1
Dollar-Yen Exchange Rates, 1950–2006 (yearly average)
261

Source: Data for 1950–1959 are from IMF, International Financial Statistics Yearbook, various years; data
for 1960–2006 are from World Bank, World Development Indicators Database.
From 1992 to 1998, the yen-dollar exchange rate varied between 100 and 135, but with a
period of appreciation to 80 in the spring and summer of 1995. The Japan Ministry of
Finance considered the appreciation to be detrimental to exports and intervened to push the
rate back to the 100 level.17 As explained in Chapter 6, Japan’s depreciation after mid-1995
put pressure on export-dependent East Asian economies.
Hong Kong adjusted the exchange rate to HK$5.085 per U.S. dollar in February 1973 and
floated its currency in November 1974. Hot money attacked Hong Kong in September 1983.
In October 1983, the Hong Kong government adopted a currency board exchange rate policy
in response to a sharp fall of the Hong Kong dollar due to market nervousness about the Sino-
British talks on Hong Kong’s future status. The currency board choice stabilized Hong
Kong’s financial system.18 Currency board is a type of fixed exchange rate designed to
withstand speculative attacks. Hong Kong is and has been the only East Asian economy to
adopt a currency board. In a currency board regime, a government holds reserves of hard
currency, gold, or IMF position that at least equal the quantity of domestic base money at the
fixed exchange rate. Put differently, the government cannot issue additional domestic
currency unless it has additional reserves to back it up. Because the government sets an
exchange rate but does not set monetary policy, a currency board offers a stable and
predictable exchange rate regime but deprives the government of the ability to affect
domestic economy with interest rates.
Until 1980, South Korea adopted a de facto dollar-peg system. In February 1980, South
Korea adopted the Multiple Currency Basket Peg System, aimed at real effective exchange
rate (REER) depreciation, an objective achieved in the 1980s. South Korea managed to
reduce current account deficits and its huge foreign debt. South Korea adopted the Market
Average Exchange Rate System in March 1990 to allow the exchange rates to reflect the
market fundamentals.
Indonesia allowed an open capital account and adopted a managed float against a basket
of currencies until the Asian financial crisis. Malaysia also had a managed float, and its
capital account gradually liberalized after the early 1970s. From November 1984 to July
1997, Thailand maintained a managed peg.19 Thailand pegged with the U.S. dollar in the
1960s and 1970s. When the dollar appreciated sharply, Thailand shifted to a peg to a basket
of currencies in the mid-1980s.
Once the Chinese reform began, the Chinese government was concerned about balance of
payments crisis and shortage of foreign reserves, learning a lesson from the Latin American
debt crisis. Beijing therefore maintained capital controls that included restriction of short-
262

term foreign debt. Beijing also gradually depreciated the yuan to promote exports. As Table
10.1 shows, the value of yuan to the dollar decreased from 1.68 in 1978 to 8.62 in 1994, and
the exchange rate appreciated slightly afterward and became essentially pegged at 8.28.
Another feature of the Chinese exchange rate system was the existence of an official
exchange rate and an unofficial exchange rate prior to 1994. Until the Asian financial crisis
China did not face any external pressure for depreciation or appreciation.20
Vietnam’s exchange rate policy began to change in 1986. The government unified the
multiple exchange rate regime in 1989 and introduced a dramatic depreciation to bring the
official rate close to the black market rate. Vietnam’s foreign currency holding increased
drastically from $2.4 million in 1986 to $2.2 billion in 1989 and $7.9 billion in 1993.
Measured as U.S. dollars in operation in the country as a ratio of the domestic currency and
as the propensity of domestic residents to turn to the dollar in response to changes in
macroeconomic conditions such as the inflation rate, Vietnam had a higher degree of
dollarization than East Asian countries such as Indonesia. Vietnam’s dollarization since the
mid-1980s was due to a shift of trade to the U.S. dollar for international transactions, wide
use of the dollar in illegal trade, and remittance and investment of overseas Vietnamese. The
government tried to limit the dollarization with tighter exchange controls in 1994, to no
avail.21
Postcrisis East Asian Exchange Rate Regimes
The Asian financial crisis, for many observers, revealed a fundamental problem with the
pegged exchange rate regime. The theory of “impossible trinity” discussed by Robert
Mundell in the 1960s became popular again.22 The impossible trinity refers to the hypothesis
that it is impossible to have the following three goals simultaneously, namely a fixed
exchange rate, free capital flow, and an autonomous monetary policy. If we want to regulate
markets and maintain sovereignty, the goal of integrating with global financial markets will
be compromised. If we want to maintain sovereignty but allow capital markets to integrate,
we must accept an entirely free global financial market. If we want capital market integration
and global regulation, national sovereignty will be compromised.
A dominant trend in recent years is that the Asian governments have intervened in the
currency market to prevent appreciation of their currencies. Official declarations aside, the
East Asian economies, except for Japan, have largely maintained a soft peg to the dollar.23
After the crisis, the governments tend to overstate the flexibility and the degree of floating.
However, East Asian monies have remained on a de facto dollar standard.24 The dollar
standard issue will be discussed in the next section.
After the Asian financial crisis, China’s exchange rate policy became a focal point for
critics of the country’s enlarging trade surpluses. As Table 10.1 shows, after a major
depreciation in 1994, China essentially maintained a peg around 8.3 yuan per U.S. dollar
from 1995 to 2004. There has been much international pressure on the Chinese government
to appreciate the yuan. The assessment of how undervalued the yuan is varies, but some long-
term China observers believe that the yuan is undervalued by 15–20 percent.25 It is in China’s
own interest to appreciate its currency. When the currency is off its real value, it creates
efficiency loss. One important benefit from appreciation is to decrease the inflationary
pressure. With rapidly increasing foreign capital flow into China, the Chinese government
has to increase the supply of yuan to purchase the dollars. Much of the additional money has
gone into real estate, which has led to increased demands for materials. A stronger yuan
could also reduce the payment of foreign debt and force industrial upgrading. But the Chinese
government is concerned that a stronger yuan will hurt exports of labor-intensive products
and will thus worsen the unemployment situation.
The Chinese government officially adopted a managed float against a basket of currencies
263

in July 2005, along with a 2 percent appreciation against the dollar and the introduction of a
0.3 percent daily fluctuation band against the dollar. Thanks to the April dry run and other
advance preparations, the financial market reacted to the Chinese decision mildly.26 With
continuous pressure, the yuan appreciated to 7.70 yuan to the dollar on May 8, 2007. On May
18, 2007, the People’s Bank of China announced that the daily fluctuation band against the
dollar would expand from 0.3 to 0.5 effective May 21, the day before high-level economic
talks between China and the United States were to be held in Washington, D.C. The yuan
appreciated to 7.65 yuan to the dollar on May 24, 2007.
While China has attracted the most international criticism for its currency policy, the
Japanese yen has weakened against the dollar. This means that the yen has weakened against
the East Asian currencies pegged to the dollar as well, which gives its exports an advantage
and may provoke international criticism accordingly. The Japanese government was
interested in preventing premature appreciation to maintain export competitiveness and in
expanding the money base through purchase of dollars to counter deflation. Figure 10.2
shows that Japan’s REER index has decreased from 108.2 in 1995 to 79.4 in 2005, with the
REER rate in 2000 as 100. Japan intervened heavily in the currency market starting in
January 2003 to keep the yen low against the dollar. The Japanese government stopped doing
that in March 2004. In a period of five quarters, the Ministry of Finance and Bank of Japan
(MOF-BOJ) sold ¥35 trillion (about $317 billion), with 42 percent done in the first quarter of
2004. By contrast, the MOF-BOJ purchased less than ¥34 trillion from April 1991 to
December 2002. The Japanese government did not publicize the intervention, which was
meant to prevent yen appreciation.27 This development has much to do with Asian purchases
of the higher-yield dollar and the eurodenominated overseas assets. In fact, Japan’s real trade-
weighted value fell to the lowest point in September 2006 since 1982.28 There has been
support in Japan for depreciating the yen to reverse a devastating deflation in the Japanese
economy through import inflation. But some empirical analysis suggests that the yen’s
depreciation is not as effective in creating an inflationary pressure as previously.29
FIGURE 10.2
Real Effective Exchange Rate Index for Japan, China, and the United States, 1975–2005
Source: World Bank, World Development Indicators Database.
Since 2001, the East Asian governments have dramatically increased their foreign
reserves, partly due to intervention in the exchange market. The main reason for such
intervention is to maintain stability, which suits domestic firms that find it difficult to hedge
against foreign exchange risks because of weak domestic financial markets. There is also
much concern about future international financial crises. As an exception, China’s increase in
264

foreign reserves reflects the fact that foreign capital flows heavily into China while capital
outflows are subject to greater restrictions. The government has been intervening in the
exchange market to alleviate upward pressure on the yuan.30 China assumed the number one
position in foreign reserves in the world by the end of February 2006. By March 1, 2007,
China had $1,202.0 billion in foreign exchange reserves excluding gold.31 As Table 10.2
shows, the eleven East Asian economies listed in the table had combined official reserves of
$2.55 trillion at the end of 2005. Their combined foreign reserves accounted for 55.5 percent
of the world total in 2004. Some analysts have pointed out that the recent increase in the East
Asian reserves can be explained more by the inflow of capital than by deliberate government
intervention to keep exchange rates undervalued.32
EAST ASIA IN THE GLOBAL MONETARY SYSTEM
International Monetary Regime
International monetary regime is in essence exchange rate regime, but it also relates to the
nature of reserves and the flow of capital.33 I have previously discussed the different
exchange rate policies East Asian economies have adopted over the years. Similarly, an
international monetary system may be dominated by fixed exchange rate regime, a free-
floating regime, or a hybrid of both.
TABLE 10.2
East Asian Foreign Reserves, Including Gold (current U.S. $ billion)
Source: World Bank, World Development Indicators Database. The data for Taiwan are from the Asian
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Development Bank Statistical Database System.
An international monetary regime serves three basic functions: liquidity, adjustment, and
confidence.34 Liquidity and adjustment are closely linked. Liquidity refers to money as the
facility of exchange of goods and services; volatile exchange rates weaken the liquidity
function. Adjustment refers to the use of exchange rates to address imbalance of payments.
Because an important source of payment imbalance is trade imbalance, the trading partners
may resort to change in exchange rates to adjust the imbalances. The surplus country
appreciates its currency whereas the deficit country depreciates its currency, a mechanism
that decreases the exports of the surplus country by making its products and services more
expensive and increases the exports of the deficit country by making its products and services
less expensive. The other ways to address balance of payments deficits are to finance deficits
or make painful domestic adjustments such as cutting expenditure. Politicians have incentives
to avoid domestic adjustment and resort to manipulation of exchange rates to resolve their
problems, which are in a crucial way caused domestically. This “dirty float” may cause an
economic warfare, hurting the international community. A good international monetary
system tries to facilitate settlement of payments through financing, exchange rate changes,
exchange control, and adaptation of national policies.
Besides liquidity and adjustment, countries or individuals that hold a foreign currency
must have confidence in the ability of that currency to maintain its value. Erosion of
confidence often leads to instability of the monetary system. As a case in point, if East Asian
economies lose their confidence in the dollar and start selling their dollar holdings massively,
the whole international monetary system would be shaken, with a strong negative impact on
the global economy.
East Asia and the Bretton Woods System
As discussed above, most East Asian economies were part of the Bretton Woods system.
There is no question that the Bretton Woods system was a U.S.-led hegemonic system, only
the second global monetary hegemony in human history, the other being the Gold Standard-
British Sterling hegemony in the nineteenth century. The IMF has remained an important
institution despite the collapse of the Bretton Woods system. As shown in Chapter 6, the IMF
took a lead in dealing with the Asian financial crisis.
For East Asia, an important issue is its representation in the IMF, which has been
dominated traditionally by the United States and Europe. East Asia’s economic power has
grown. In addition, Asian nations have been building up foreign reserves after the Asian
financial crisis to avoid bailout packages from the IMF. This development makes some
concerned that the IMF might become irrelevant. It thus makes sense to get Asian nations
more involved. In particular, China’s voting share in the IMF does not reflect its economic
power. China has an economy twice that of Belgium and Holland combined, but the two
European countries have 1.5 times as much voting power. The U.S. Treasury Department
officials argued that adjustment of voting power will make adjustment of exchange rates
easier.35 The challenge was whether the Europeans would be willing to give up some share of
voting power. At the IMF-World Bank meeting in April 2006, the IMF agreed on a plan to
reshape the fund. The IMF decided to start a process to reapportion voting power to countries
like China and South Korea. The shares of China, South Korea, Mexico, and Turkey
increased modestly at the IMF-World Bank meeting in September 2006. China’s voting share
increased from 2.98 percent to 3.72 percent.
The Dollar Standard
The breakdown of the Bretton Woods system in the early 1970s did not end the dominant
position of the dollar in international monetary affairs. In fact, the dollar standard was
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extended in East Asia when China joined the system with reforms that began in 1978 and
Vietnam followed in the mid-1980s. However, a major difference in the post–Bretton Woods
system is that while virtually all East Asian economies followed a dollar standard, the
Japanese yen largely floated against the dollar.
A dollar standard means that the U.S. dollar is a store of value (foreign reserves), unit of
accounting (trade invoicing), and means of exchange for trade and investment. It also serves
as the preferred intervention in foreign exchange markets. In fact, there is some degree of
dollarization in some countries in that the dollar partially or completely substitutes domestic
currencies legally or de facto. Another important way to see the dominance of the U.S. dollar
is that most East Asian nations peg their currencies to the U.S. dollar. I have already
discussed the role of pegs to the U.S. dollar in the Asian financial crisis.
The dollar did not dominate just in East Asia but in the whole international economic
system. In 1996, the dollar was 75 percent of external bond issues, 64 percent of official
holdings of foreign exchange, and 45 percent of Eurocurrency deposits. The dollar accounts
for between 40 and 80 percent of the various categories of international currency use.36 It is
also the currency of choice in foreign exchange markets (in organizing foreign exchange
markets, large commercial banks can reduce transaction costs if they quote against only one
vehicle). The dollar now accounts for almost 90 percent of interbank transactions. It also
dominates in commodity trading, which is centralized and located largely in American cities
such as Chicago and New York. This is important because about 70 percent of Japanese
imports are denominated in the dollar because it imports many commodities and
manufactured goods from the United States. Invoicing (statement of charges) for export is
different. Countries with strong currencies tend to invoice exports in home currencies, as in
the case of Germany and now the European Union. By contrast, Japan typically invoices only
about 36 percent of its exports in the yen, mainly to maintain market shares. This is a good
arrangement for the United States but not for Japan, since the United States is shielded from
foreign exchange risk but Japan is not.37
After the Asian financial crisis, some East Asian economies officially gave up on the peg,
but the dollar remains dominant because some Asian countries like China still peg to the U.S.
dollar and because of other monetary functions the dollar continues to serve in East Asia. By
2004, most East Asian currencies were back to a soft peg to the U.S. dollar, measured by
stable day-to-day exchange rates against the dollar, a stability backed by growing foreign
reserves.38
The dominance of the dollar has a profound impact on East Asian economy. To start with,
the exchange rate between the dollar and the yen, the currency of the strongest Asian
economy, can be highly volatile. Figure 10.3 shows a drastic appreciation of the yen from
¥237.10 to the dollar in August 1985 to ¥122.00 in December 1987. Then the yen depreciated
from ¥83.19 in May 1995 to ¥126.92 in April 1997 and ¥143.79 in July 1998. It has been
argued that the yen was pushing upward continuously due to the expectation that it would
appreciate in the long run because of U.S. pressure on Japan to appreciate the yen to reduce
its trade surpluses with the United States. At the same time, the depreciation of the yen
against the dollar in 1995–1998 had a negative impact on the East Asian economies that
pegged their currencies to the dollar.39 The yen’s depreciation against the dollar in 1995
meant the appreciation of the East Asian currencies pegged to the dollar.
As discussed by Ronald McKinnon, it makes sense for the East Asian economies to peg
their currencies to the dollar because the dollar is used for invoicing of East Asian trade.
However, because of the inability of East Asian economies to raise debt in their own
currencies, East Asian companies cannot hedge against exchange rate volatility, and the
government has to maintain stable exchange rates against the dollar. For debtor economies
(the situation of some East Asian economies before the 1997–1998 crisis), they experience a
267

vicious cycle when companies seek to borrow dollar assets because of their lower risk
premiums than domestic assets. For creditor nations (the case for most East Asian economies
after the crisis), they lend in the dollar rather than in their own currencies. This creates a
“conflicted virtue,” virtue being high savings. When a country’s dollar assets increase, the
holders become worried that their dollar assets would take a loss if the domestic currency
appreciates. Because of trade surplus, the country is under pressure to appreciate the
currency, which may lead to deflation. This was a situation Japan faced in the 1980s and a
situation China is facing now.40
Since the Asian financial crisis, Asian governments have been willing to finance
America’s current account deficits by purchasing U.S. Treasury bills because they want to
keep their currencies relatively cheap to give their exports an edge. East Asian purchase of
American debt instruments keeps U.S. bond yields low and overspending behavior
unchanged. As discussed previously, a global imbalance exists. East Asia’s foreign reserves
have increased dramatically partly as a result of market intervention.
FIGURE 10.3
Yen-Dollar Exchange Rates, 1981–1998 (¥ per $ Tokyo market, end of month)
Source: Bank of Japan, www.boj.or.jp/en/type/stat/dlong/fin_stat/rate/cdab0780.csv.
By the end of 2004, there was much concern about the declining U.S. dollar. The major
problem is America’s growing budget deficit and current account deficits, which put
downward pressure on the U.S. dollar. The value of the dollar has dropped against the euro
and the yen. This should be a serious concern for those who hold the dollar as foreign
reserves. A depreciated dollar would reduce the value of their foreign reserves. The share of
the dollar in the global foreign exchange reserve has decreased from 80 percent in the mid-
1970s to around 65 percent in 2004.41
On February 22, 2005, out of concern over a sliding dollar, the Bank of Korea, South
Korea’s central bank, announced that it was planning to diversify its foreign reserves to more
currencies.42 Japanese Prime Minister Koizumi said on March 10, 2005, that the Japanese
Central Bank should diversify the foreign currencies held by the bank. These remarks caused
a stir in the global currency market. The value of the dollar dropped against the euro.
A depreciation of the U.S. dollar essentially taxes the holders of American securities to
continue subsidizing American spending deficits. But East Asian countries like Japan and
China are in a bind. If they start selling holdings of American securities, their action would
move the market and decrease the values of their remaining holdings. They are already in too
deep. All parties involved in the global imbalance need to participate to prevent a sharp
adjustment that may lead to a global recession, tightening of U.S. monetary policy, relaxing
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http://www.boj.or.jp/en/type/stat/dlong/fin_stat/rate/cdab0780.csv

of European monetary policy relative to the United States, and managed appreciation of East
Asian currencies.43
EAST ASIAN REGIONAL MONETARY SYSTEM
My discussion above about the East Asian dilemma in monetary affairs points to the
importance of a regional solution. East Asian economies need regional cooperation also
because they need to avoid competitive depreciation. They watch, and often complain about,
each other’s foreign exchange.
Interstate monetary relations are characterized by cooperation, competition, and coercion.
Whether a country’s monetary policy will be considered cooperative is based on the
objectives and interests of other players. This can be reflected in different ways. A principal
area of cooperation and conflict is exchange rate. During the Asian financial crisis and
afterward, China received high praise in East Asia and the United States for pledging not to
depreciate the yuan. Beijing’s action was meant to be cooperative and was seen as such.
China meant to be cooperative because it said so. Others saw Beijing’s pledge as cooperative
because a cheaper yuan would put further pressure on the crisis countries in East Asia. Of
course, China had self-interests in not depreciating the yuan, but that is not the point. To be
cooperative, one does not have to deny one’s own interests.
More than monetary cooperation, people have been discussing regional integration. One
way for that to happen is to create currency regionalism whereby a currency is used beyond
the sovereign jurisdiction of its issuing government. Another possibility is currency union,
which may come about based on a strong anchor currency or based on regional cooperation.
Monetary Union
Currency union is not necessarily the same as creation of a common currency. Typically,
currency union takes place before a common currency is created. Currency union means that
the member states peg their currencies to each other and may or may not float against a third
currency. Robert Mundell formulated the optimal currency area (OCA) theory in a seminal
paper dated back to 1961.44 Mundell defined a currency area as “a domain within which
exchange rates are fixed.” A zone in which factors of production, particularly labor, are
mobile should have a common currency. This theory is now popular because of the
experience of the European Monetary Union and other groupings. The idea was to figure out
what is the most appropriate domain for a currency irrespective of national borders. More
specifically, OCA theory studies the advantages and disadvantages for a country to abandon
monetary autonomy to participate in a common currency or in a fixed exchange rate regime.
Factors important for considerations of a common currency or fixed exchange rate include
the following: wage and price flexibility, factor mobility, geographic trade patterns, the
degree of commodity diversification, size and openness of economies, inflation trends, and
the nature, source, and timing of potential payments disturbances.
Reasons for a common currency or fixed exchange rate are a more useful currency as a
medium of exchange (reduced transaction costs), store of value (reduced exchange risk as
number of currencies is reduced), and unit of account (reduced number of price quotations).
Moreover, as part of a larger exchange rate market, one experiences decreasing currency
volatility. Also, as part of the internationalization of a shared currency, participating countries
enhance their purchasing power.
Conversely, one reason against forming a currency union is the loss of monetary authority
to use macroeconomic measures such as interest rate and exchange rate to adjust to domestic
disturbances or balance of payment problems. Moreover, some recent empirical research
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suggests that membership in the European Monetary Union has not brought as much benefit
in trade and growth as widely thought.45
A government needs to consider all the factors mentioned above. The higher the potential
gains and lower the potential loss, the more incentives a government has to join a currency
area.
The 1997–1998 Asian financial crisis and the launch of the European Monetary Union in
January 1999 were important reasons for growing discussion and initiatives in monetary
integration in East Asia. It became accepted wisdom after the crisis that a government faces
difficult choices of capital controls that discourage foreign direct investment and flexible
exchange rates that remain volatile. In such a situation, regional monetary union is one
solution to prevent future crises. Put differently, since the crisis was viewed as resulting from
dependence on the dollar, some East Asians naturally yearned for independence from the
dollar, and an Asian currency was viewed as a solution.46 The European Monetary Union
showed that regional monetary integration could work. Top East Asian leaders such as
Malaysian Prime Minister Mahathir Mohamad and Philippine President Joseph Estrada talked
about creating a common currency, and there have been studies and meetings about East
Asian monetary integration.
There are debates whether East Asia is ready to launch monetary integration. On the one
hand, the conditions for a pegged East Asian exchange rate regime are not met because of
weak economic convergence in terms of inflation between East Asian economies.47 On the
other hand, the economic conditions in East Asia are no less suitable than those in Europe for
monetary integration. The barriers to integration are mainly political, namely China-Japan
tensions, Japan’s unwillingness to shoulder costs, and America’s strong influence.48
Recognizing the absence of political will for monetary integration, Robert McKinnon
suggested a less politically demanding solution of creating a common monetary standard
based on an anchor currency, which he proposed should continue to be the U.S. dollar.49
Some empirical studies suggest that a currency basket system would help stabilize trade
and capital flows in East Asia. The challenge to create a currency basket is that a country’s
decision to shift exchange rate policy depends on what its neighbors do. The solution is for
East Asian economies to make coordinated moves.50
East Asia has made progress with the creation of an Asian Currency Unit (ACU),
modeled after the European Currency Unit. Note that the ACU is not meant to be a common
currency. Rather, ACU is meant as an accounting unit for economic transactions. It would be
calculated based on a basket of the thirteen regional currencies. The Asian Development
Bank has taken a lead on this. On May 4, 2006, the finance ministers of China, Japan, and
South Korea agreed to consider the creation of ACU for the first time.51
A Yen Bloc
East Asia is generally seen as one of three possible currency regions, the dollar, the euro, and
the yen. With Japan emerging as the world’s largest creditor nation in the late 1980s, it made
sense then to believe that the yen should be a central international currency. However, it
became clear under scrutiny that, while gaining more international use, the yen was far
behind the dollar and the deutsche mark as an international currency. In fact, Japanese
exports and imports were largely invoiced in a currency other than the yen, mainly the dollar.
The share of Japanese exports invoiced in yen increased from 17.5 percent in 1975 to about
35 percent in the late 1980s, and the share of imports increased from less than 1 percent in
1975 to 14 percent in 1989. By contrast, the shares of exports and imports invoiced in their
own currencies were about 96 percent and 85 percent for the United States and 40–80 percent
and 27–52 percent for major Western European countries during the same period.52 This
situation has not changed much. In 2002, 48 percent of Japan’s total exports and 68.7 percent
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of imports were invoiced in dollars and only 38.4 percent of exports and 24.6 percent of
imports were invoiced in yen.53 Even in Asia, the yen accounted for 11.5 percent of official
reserves in 1992, compared with 61.4 percent for the U.S. dollar, 13.1 percent for the German
mark, and 8.0 percent for the British pound.54
Several reasons explain Japan’s problems in this area. First, the Japanese financial sector
remained more regulated and less developed than the financial markets in the United States
and Europe. Second, Japanese firms prefer to use the dollar to maintain market shares in the
North American market. Third, the share of imports invoiced in the dollar is high because
Japan imports most of the primary resources it needs and because homogeneous primary
products tend to be invoiced in the dollar. Fourth, there is inertia and economies of scale in
use of an international currency, which favors the existing hegemonic currency, the dollar.55
Until the early 1990s, the Bank of Japan did not want the internationalization of the yen
out of concern that this would compromise its ability to conduct monetary affairs at home.
This attitude changed in the 1990s when the Japanese monetary authority became less
concerned about maintaining a tight monetary policy.56 The Japanese government began
promoting the internationalization of the yen, particularly after the Asian financial crisis.
Some analysts in Japan argued that the crisis revealed the limitation of pegging to the U.S.
dollar. Furthermore, Japan had recently adopted the Big Bang for financial reform. Moreover,
to avoid dollar-yen volatility, it was reasoned that East Asian economies should peg to the
yen or give more weight to the yen in a currency basket. East Asia would benefit in
macroeconomic stability and in microeconomic efficiency.57 Internationalization of the yen
would reduce exchange risks for the Japanese and would also enhance Japan’s international
status. The October 1998 Miyazawa Initiative to provide $30 billion aid to the crisis countries
was also designed to encourage use of the yen by East Asian economies.
It is not clear whether a shift from the dollar to the yen would resolve the problem of
dollar-yen volatility. Such a shift would clearly serve Japan’s interest. But if the U.S. dollar
and the yen are about the same, shifting pegs would shift costs of fluctuation to the United
States without clear benefits to the rest of East Asia. Moreover, if there is volatility in the
dollar-yen exchange, which currency should one choose? The dollar remains a better choice
than the yen, particularly when the Japanese economy is not doing well. At the government
level, East Asia largely depends on the United States for political and military support. The
market still prefers the dollar, which makes transactions with the whole world easier, and the
United States has a stronger and healthier economy than Japan. It will be difficult for the yen
even under better circumstances. Japanese exporters choose non-Japanese currencies
themselves. Only about 35–40 percent of Japanese exports (different estimates) and only 20
percent of Japanese imports are on a yen basis.58 The Japanese capital outflows have also
been largely denominated in currencies other than the yen, and borrowing in foreign
currencies has some advantages over yen-denominated borrowing because of factors such as
reserve requirements. In the scheme of things, the U.S. economy is expanding while the
Japanese economy is shrinking. The market size matters. One important reason that East Asia
chooses the dollar for trade invoicing is that they are more dependent on the U.S. market than
the Japanese market.
The Big Bang was supposed to create a fair and open financial center by the end of 2001.
That has not happened. To internationalize currencies, one needs to have strong, open, deep,
and broad financial markets. For example, the U.S. dollar dominates in commodity trade
because of well-developed commodity markets in Chicago and New York. As recognized by
Japanese analysts, the Tokyo financial market has declined in both quantitative and
qualitative terms in recent years, compared with London and New York financial centers.59
Hong Kong and Singapore are competing financial centers in East Asia, followed by rising
financial centers such as Shanghai.
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The Yuan’s Arrival
The yuan is a new kid in the block. Some suggest that the yuan will replace the yen as the
dominant East Asian currency. The yuan’s growing influence reflects China’s growing
economic strength and financial and political stability. Now that China has joined the World
Trade Organization, foreign banks are allowed to operate in China. An additional plus is that
the Chinese government has put inflation under control since the mid-1990s.
The yuan has already become popular in countries neighboring China, partly because of a
growing number of tourists from China. Another reason is increasing border trade. Also, the
yuan has been stable, even during the Asian financial crisis, and the currency is based on a
growing economy. With expanding ties and tourism, the yuan is also being used as a currency
in Hong Kong.
As an indicator of things to come, trading on the yuan has increased dramatically. The
traditional foreign exchange market turnover daily average over yuan grew by 530 percent
from 2001 to 2004. At the same time, however, the absolute volume of yuan trading was still
small, merely $1.8 billion in April 2004, compared with $1,573.1 billion for the U.S. dollar,
$659.4 billion for the euro, and $359.2 billion for the yen.60 In addition, a weak Chinese
banking system and a nontransparent political and financial system remain serious problems
for internationalization of the yuan. Last but not least, the yuan cannot be an anchor currency
until it becomes fully convertible. As a result, it is unwise even for the Hong Kong dollar to
be pegged to the yuan, let alone other currencies.
EAST ASIAN POLITICAL ECONOMY OF MONEY
East Asian monetary practices both result from and affect East Asian domestic political
economy. Logically, the exchange rate policy has a distributional effect on domestic politics,
and the sectoral preferences would in turn fight to shape the country’s exchange rate policy. I
have discussed above that a government considers the degree of flexibility (floating vs. fixed)
and the level of exchange rate (appreciation vs. depreciation) when thinking about exchange
rates. In general, companies that engage in international trade prefer stable exchange rates. It
matters to them less whether the state maintains its capacity to formulate macroeconomic
policies at home. By contrast, domestic firms of nontradable goods and import-competing
products prefer floating exchange rates because of their high stake in a country’s
macroeconomic policies. On a different dimension, producers of tradable goods prefer
currency depreciation to increase their competitiveness whereas producers of nontradable
goods or importers prefer a stronger currency.61 We do not have as much empirical evidence
on exchange rate policy in the domestic context as on trade policy.62 More needs to be done
empirically about the domestic politics of East Asian exchange rates, but there is some
evidence that the distributional logic discussed above applies to East Asia.
Whatever foreign exchange rate policies one adopts creates further developments. With
an overvalued currency, one has incentives to invest in nontradable domestic industries rather
than export or import substitution industries. Overvaluation leads to balance of payments
difficulties, which leads to foreign exchange controls that have obvious impact on allocation
of resources. Entrenched domestic interests make it difficult to shift gear. For example, in the
Philippines, there was a heated policy debate between traditional exporters in sugar and
import substitution industries. The overvalued exchange rate the Philippines had at the time
was disadvantageous to exporters. In the end, with pressure from Congress and from public
backlash against corruption within the import substitution sector, the Philippines depreciated
the peso.63
Conversely, with an undervalued currency, one has incentives to invest in export
272

industries. A cheap currency leads to balance of payments surpluses, resulting in greater
foreign pressure. However, entrenched domestic interests make it difficult to change the
course. China’s resistance to a sharp currency appreciation is a case in point. The Bush
administration has been asking the Chinese government to delink the yuan with the dollar in
an effort to reduce growing U.S. trade deficits. A cheap yuan also has a negative impact on
domestic political economy by encouraging speculative capital to rush in. The increasing
foreign reserve adds to the money supply, which creates inflationary pressure. Many in the
Chinese policy community now understand that the yuan has to appreciate to avoid an
overheating of the Chinese economy, excessive demand for resources, and growing trade
frictions. However, it is difficult to adjust exchange rates politically. The Chinese Central
Bank wants to appreciate the yuan to avoid an overheated economy, its main responsibility,
but cabinet ministries want to stay the course. In particular, the Ministry of Commerce wants
to minimize adjustment. Chinese exporters predictably oppose appreciation. Consequently,
the State Council is taking a middle road, trying to appreciate a few percentage points a year.
The global financial market also affects domestic political economy profoundly. East
Asian governments all want financial stability and flow of capital into their economies, and
they jealously guard their national independence. However, as the impossible trinity
discussed earlier shows, governments cannot meet the policy objectives of stable exchange
rates, integration with the global economy, and national autonomy simultaneously. This is
particularly the case for small countries that are particularly vulnerable to the volatility of the
global market. Moreover, as discussed in Chapter 6, the Asian financial crisis that resulted
partly from pegged exchange rates led to economic and political reform measures in various
East Asian economies.
CONCLUSION
East Asian economies have sought stable and advantageous exchange rate policies to
facilitate their main objective of rapid industrialization. Most chose overvalued currencies in
the early 1950s based on the idea that such an approach would reduce the cost of imports and
would not overly impact exports since it was difficult to export in any case. Nonsocialist
economies were part of the Bretton Woods system dominated by the United States and
pegged their currencies to the U.S. dollar (a few pegged to the British pound at some point,
but the British pound itself was pegged to the dollar). The socialist countries largely
maintained overvalued currencies pegged to the dollar and adopted the exchange control
regime necessary to handle a situation of excessive demand for “cheap” dollars. With a break
from the Soviet Union and rapprochement with the United States, China became part of the
mainstream international monetary system.
After the Bretton Woods system collapsed in the early 1970s, East Asian monetary affairs
were characterized by a managed float between the U.S. dollar and the Japanese yen, whereas
virtually every East Asian economy pegged its currency to the dollar. The sharp appreciation
of the yen after the 1985 Plaza Accord had a profound impact on East Asian political
economy as Japanese investment poured into East Asia and elsewhere. The subsequent
appreciation of the New Taiwan Dollar and the South Korean won furthered the diffusion of
industries and strengthened regional production networks. The depreciation of the Chinese
yuan in 1994 and the depreciation of the yen after the mid-1990s put competitive pressure on
Southeast Asia, contributing to the outbreak of the Asian financial crisis. Most East Asian
economies returned to a de facto dollar standard a few years after the crisis ended.
It makes sense for East Asian economies to peg to the dollar, because the dollar is used
for invoicing for their trade and the United States is the most important final market for their
273

exports. However, since East Asian economies cannot raise debt in their own currencies, they
cannot hedge against exchange rate fluctuations. The dollar assets East Asian economies have
accumulated would suffer large losses if East Asian currencies appreciate against the dollar.
Because of this well-understood problem, East Asian economies are now eager to increase
regional monetary cooperation. East Asia has made some progress in this regard, creating an
Asian Currency Unit, which is based on a basket of thirteen regional currencies, as an
accounting unit for financial transactions. However, considerable obstacles to East Asian
monetary regional integration exist.
Exchange rate policies have a significant distributional effect on domestic political
economy, namely creating winners and losers. Consistent with East Asia’s focus on
production and exports, East Asian governments prefer stable but low exchange rates against
the dollar. Like any other economic policies, exchange rate regimes also create vested
interests, making adjustment politically difficult. Although East Asian governments want
financial stability, gains from the global financial market, and national autonomy, they cannot
simultaneously achieve all three.

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Development 28, no. 2 (June 1991): 2–5.
Volcker, Paul, and Toyoo Gyohten. Changing Fortunes: The World’s Money and the Threat
to American Leadership (New York: Random House, 1992).
Williamson, John. “The Evolution of Thought on Intermediate Exchange Rate Regimes.” The
Annals of the American Academy of Political and Social Science 579 (January 2002): 73–
86.

NOTES

1. Eric Helleiner, The Making of National Money: Territorial Currencies in Historical
Perspective (Ithaca, N.Y.: Cornell University Press, 2003).
2. George S. Tavlas, “The Economics of Exchange-Rate Regimes: A Review Essay,” World
Economy 26, no. 8 (August 2003): 1215–1216; John Williamson, “The Evolution of
Thought on Intermediate Exchange Rate Regimes,” The Annals of the American Academy
of Political and Social Science 579 (January 2002): 73–86.
3. J. Lawrence Broz and Jeffry A. Frieden, “The Political Economy of International Monetary
Relations,” Annual Review of Political Science 4 (June 2001): 319.
4. Anne O. Krueger, Foreign Trade Regimes and Economic Development: Liberalization
Attempts and Consequences (New York: National Bureau of Economic Research, 1978),
69–78.
5. “Big MacCurrencies,” The Economist, April 3, 1999, 66.
6. “China’s Foreign Reserves,” The Economist, October 28, 2006, 85.
7. Ian M. D. Little, Economic Development: Theory, Policy, and International Relations
(New York: Basic Books, 1982), 306–307.
8. Nakamura, Postwar Japanese Economy, 38–39, 56–58.
9. S. C. Tsiang, “Foreign Trade and Investment as Boosters for Take-Off: The Experience of
Taiwan,” in Export-Oriented Development Strategies: The Success of Five Newly
Industrializing Countries, ed. Vittorio Corbo, Anne O. Krueger, and Fernando Ossa
(Boulder: Westview Press, 1985), 35–37.
10. Kim, “Korea,” 22–27; Frank, Kim, and Westphal, South Korea.
11. Aw, “Singapore,” 347–349.
12. Robert E. Baldwin, The Philippines (New York: National Bureau of Economic Research,
distributed by Columbia University Press, 1975).
13. Suiwah Leung and Ngo Huy Duc, “Dollarization and Financial Sector Developments in
275

Vietnam,” in Vietnam and the East Asian Crisis, ed. Suiwah Leung (Northampton, Mass.:
Edward Elgar, 1999), 84.
14. W. Max Corden, “Exchange Rate Regimes for Emerging Market Economies: Lessons
from Asia,” The Annals of the American Academy of Political and Social Science 579
(January 2002): 26–37.
15. Carmen M. Reinhart and Kenneth S. Rogoff, “The Modern History of Exchange Rate
Arrangements: A Reinterpretation,” Working Paper No. 8963 (Cambridge, Mass.:
National Bureau of Economic Research, June 2002).
16. Paul Volcker and Toyoo Gyohten, Changing Fortunes: The World’s Money and the
Threat to American Leadership (New York: Random House, 1992), 228–258.
17. Takatoshi Ito, “The Yen and the Japanese Economy, 2004,” in Dollar Adjustment: How
Far? Against What? ed. C. Fred Bergsten and John Williamson (Washington, D.C.:
Institute for International Economies, 2004), 184.
18. For currency board, see Steve H. Hanke, “Currency Boards,” The Annals of the American
Academy of Political and Social Science 579 (January 2002): 87–105.
19. Gordon de Brouwer, Financial Integration in East Asia (Cambridge: Cambridge
University Press, 1999), 45–46.
20. Yu Yongding, “China’s Capital Flow Liberalization and Reform of Exchange Rate
Regime,” in Financial Interdependence and Exchange Rate Regimes in East Asia, ed.
Masahiro Kawai, conference proceedings, Korea Institute for International Economic
Policy and Policy Research Institute of Japan Ministry of Finance, December 2–3, 2004,
Tokyo, 130–154, www.mof.go.jp/english/soken/kiep2005/kiep2005_03 .
21. Leung and Duc, “Dollarization and Financial Sector Developments in Vietnam.”
22. Robert Mundell, “Capital Mobility and Stabilization Policy Under Fixed and Flexible
Exchange Rates,” Canadian Journal of Economics and Political Science 29, no. 4
(November 1963): 475–485 and Robert A. Mundell, International Economics (New
York: Macmillan, 1968).
23. Guillermo A. Calvo and Carmen M. Reinhart, “Fear of Floating,” Quarterly Journal of
Economics 117, no. 2 (May 2002): 379–408.
24. Ronald I. McKinnon with Gunther Schnabl, “The East Asian Dollar Standard, Fear of
Floating, and Original Sin,” in Exchange Rates Under the East Asian Dollar Standard:
Living with Conflicted Virtue, ed. Ronald I. McKinnon (Cambridge: MIT Press, 2005),
13–52.
25. Morris Goldstein, “China and the Renminbi Exchange Rate,” in Dollar Adjustment (see
note 17), 197–230.
26. Guonan Ma, Corrinne Ho, Robert McCauley, and Eli Remolona, “Managing the
Renminbi Regime Shift,” BIS Quarterly Review (September 2005): 7–8.
27. Ito, “Yen and the Japanese Economy.”
28. “Yen and Yang,” The Economist, September 30, 2006, 81.
29. Eiji Fujii, “Exchange Rate Pass-Through in Deflationary Japan: How Effective Is the
Yen’s Depreciation for Fighting Deflation,” in Japan’s Great Stagnation: Financial and
Monetary Policy Lessons for Advanced Economies, ed. Michael M. Hutchison and Frank
Westermann (Cambridge: MIT Press, 2006), 211–237.
30. Taniuchi, “Global Imbalances and Asian Economies,” 18–23.
31. The People’s Bank of China, www.pbc.gov.cn/diaochatongji/tongjishuju/gofile.asp?
file=2007S09.htm (accessed on May 5, 2007).
32. Hans Genberg, Robert McCauley, Yung Chul Park, and Avinash Persaud, Official
Reserves and Currency Management in Asia: Myth, Reality, and the Future, Geneva
Reports on the World Economy 7 (Geneva: International Center for Monetary and
Banking Studies, 2005).
276

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http://www.pbc.gov.cn/diaochatongji/tongjishuju/gofile.asp?file=2007S09.htm

33. Richard N. Cooper, “Prolegomena to the Choice of an International Monetary System,”
International Organization 29, no. 1 (Winter 1975): 63–97.
34. Benjamin J. Cohen, Organizing the World’s Money: The Political Economy of
International Monetary Relations (New York: Basic Books, 1977).
35. Paul Blustein, “U.S. to Support More IMF Votes for China,” The Washington Post,
August 24, 2006, D5.
36. George S. Tavlas, “The International Use of Currencies: The U.S. Dollar and the Euro,”
Finance and Development 35, no. 2 (June 1998): 46–49.
37. Ronald I. McKinnon, “Euroland and East Asia in a Dollar-Based System: The Future of
International Monetary Policy,” The International Economy 13, no. 5 (September–
October 1999): 40–45, 67.
38. McKinnon and Schnabl, “East Asian Dollar Standard,” 13.
39. Ronald I. McKinnon with Kenichi Ohno, “Japan’s Deflation and the Syndrome of the
Ever-Higher Yen, 1971–1995,” in Exchange Rates Under the East Asian Dollar Standard
(see note 24), 77–102. Also see Ronald I. McKinnon and Kenichi Ohno, Dollar and Yen:
Resolving Economic Conflict Between the United States and Japan (Cambridge: MIT
Press, 1997).
40. Ronald I. McKinnon, “Introduction: The East Asian Exchange Rate Dilemma,” in
Exchange Rates Under the East Asian Dollar Standard (see note 24), 1–12.
41. “The Passing of the Buck?” The Economist, December 4, 2004, 71. This is an important
article on the declining dollar.
42. Paul Blustein, “Korea to Limit Its Dollar Holdings,” The Washington Post, February 23,
2005, E1.
43. World Bank, Global Development Finance: Mobilizing Finance and Managing
Vulnerability (Washington, D.C.: World Bank, 2005), 3–4.
44. Robert A. Mundell, “A Theory of Optimum Currency Area,” American Economic Review
51, no. 3 (September 1961): 657–665. Also see Paul R. Masson and Mark P. Taylor,
“Currency Unions: A Survey of the Issues,” in Policy Issues in the Operation of Currency
Unions, ed. Paul R. Masson and Mark P. Taylor (Cambridge: Cambridge University
Press, 1993), 3–51; George S. Tavlas, “The ‘New’ Theory of Optimum Currency Areas,”
The World Economy 16, no. 6 (November 1993): 663–685; Benjamin J. Cohen, “The
Political Economy of Currency Regions,” in The Political Economy of Regionalism, ed.
Edward D. Mansfield and Helen V. Milner (New York: Columbia University Press,
1997), 56–76.
45. Richard E. Baldwin, “In or Out: Does It Matter? An Evidence-Based Analysis of the
Trade Effects of the Euro,” Center for Economic Policy Research, May 2006.
46. Group 21, “Japan Must Introduce an Asian Currency,” Japan Echo (June 1999): 24.
47. Jung Sik Kim, “Is the Pegged Regime a Feasible Alternative in East Asia,” in Financial
Interdependence and Exchange Rate Regimes in East Asia, ed. Masahiro Kawai,
conference proceedings, Korea Institute for International Economic Policy and Policy
Research Institute of Japan Ministry of Finance, December 2–3, 2004, Tokyo, 204–229,
www.mof.go.jp/english/soken/kiep 2005/kiep2005_04 .
48. Yeongseop Rhee, “East Asian Monetary Integration: Destined to Fail?” Social Science
Japan Journal 7, no. 1 (April 2004): 83–102.
49. Robert I. McKinnon, “Optimum Currency Areas and Key Currencies: Mundell I versus
Mundell II,” in Exchange Rates Under the East Asian Dollar Standard (see note 24),
224–225.
50. Eiji Ogawa and Kentaro Kawasaki, “Creating a Common Currency Basket for East Asia:
Prospects and Key Issues,” in New East Asian Regionalism: Causes, Progress, and
Country Perspectives, ed. Charles Harvie, Fukunari Kimura, and Hyun-Hoon Lee
277

http://www.mof.go.jp/english/soken/kiep 2005/kiep2005_04

(Northampton, Mass.: Edward Elgar, 2005), 283–305.
51. Yomiuri Shimbun, May 4, 2006, www.yomiuri.co.jp/atmoney/news/20060504it14.htm?
from=top.
52. George S. Tavlas and Yuzuru Ozeki, “The Internationalization of the Yen,” Finance and
Development 28, no. 2 (June 1991): 2–5.
53. McKinnon and Schnabl, “East Asian Dollar Standard,” 20.
54. Toru Iwami and Kiyotaka Sato, “The Internationalization of the Yen: With an Emphasis
on East Asia,” International Journal of Social Economics 23, no. 10–11 (October–
November 1996): 192–208.
55. Tavlas and Ozeki, “Internationalization of the Yen”; Iwami and Sato,
“Internationalization of the Yen.”
56. Iwami and Sato, “Internationalization of the Yen.”
57. Chi Hung Kwan, Yen Bloc: Toward Economic Integration in Asia (Washington, D.C.:
Brookings Institution, 2001).
58. Group 21, “Japan Must Introduce an Asian Currency,” Japan Echo (June 1999): 24.
59. Ogawa, “Tokyo Financial Market as a Financial Center in East Asia.”
60. Corrinne Ho, Guonan Ma, and Robert McCauley, “Trading Asian Currencies,” BIS
Quarterly Review (March 2005): 49–58.
61. Jeffrey A. Frieden, “Invested Interests: The Politics of National Economies’ Policies in a
World of Global Finance,” International Organization 45, no. 4 (Autumn 1991): 444–
450.
62. Broz and Frieden, “Political Economy of International Monetary Relations.”
63. Shepherd and Alburo, “The Philippines,” 178–193.
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T
CHAPTER 11
The Political Economy of East Asian Regionalism

he origin, nature, and consequences of regionalism are important issues in East Asian
political economy. If it succeeds, East Asian regionalism would usher in a new regional
order. The previous chapters have demonstrated a strong regional dimension of East Asian
political economy. Historically, East Asia was linked in a tribute system centered on China.
While the Western powers created an imperialist order in East Asia after the mid-nineteenth
century, an intra-Asia trade network expanded as well, with merchants and governments
taking advantage of greater access to their neighboring countries and responding to
competitive pressure from fellow Asians. The Japanese attempted unsuccessfully to create a
Greater East Asian Co-Prosperity Sphere in the 1930s–1940s. The postwar East Asian
economic miracle was a regional phenomenon. Most East Asian economies sank together in a
regional contagion in the Asian financial crisis of 1997–1998. The chapters on production,
trade, finance, and currencies have demonstrated extensive regional links in East Asia and
have discussed some regional institutions in those areas. This chapter provides an overview
of different, often competing approaches to East Asian regional integration.
The chapter addresses three sets of questions. First, how far has East Asian
regionalization gone compared with other regions and from a historical perspective? Second,
what are the basic features of East Asian regionalism? Why has East Asian regionalism
evolved the way it has? What are some economic explanations for East Asian regionalism?
What are some political economy explanations for East Asian regionalism? In particular, why
did East Asians hesitate to develop formal and legalized institutions within Asia? Why did
East Asians shift to a more formalistic approach after the Asian financial crisis? Third, how
will East Asian regionalism affect the global and regional balance of power and the United
States? How will East Asian regionalism affect the domestic economy of participating East
Asian countries?
DEFINING REGIONALIZATION AND REGIONALISM
If we use geographical proximity as a key factor to define region or regionalism, regionalism
may refer to a state of affairs, namely an unusually high concentration of economic
transactions. Regionalism may also refer to the coordination of policy to promote economic
transactions. One debate among analysts of regionalism is whether regionalism reflects
natural forces such as proximity and comparative advantages or deliberate government
efforts. Another way to define regionalism is to use nongeographical factors such as
economic flows or cultural affinity. Benedict Anderson used “imagined community” to
describe a nation.1 In the same way, if some countries imagine themselves to be part of a
community, then they are. In a survey of definitions, Andrew Hurrel pointed out five
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elements of regionalism: regionalization, regional awareness and identity, regional interstate
cooperation, state-promoted regional integration, and regional cohesion.2
I adopt a geographical definition here. It is true that concentration of economic flows does
not overlap with geographical location neatly, but it is better than the alternatives. Besides,
this book has followed a geographic definition of East Asia, as discussed in Chapter 1. I
differentiate regionalization from regionalism.3 Regionalization here refers to a concentration
of economic activities, whether caused by market forces or government policies. Regionalism
refers to coordinated government policies to promote greater regional economic transactions.
EAST ASIAN REGIONALIZATION
There has been an increasing degree of regionalization in East Asia as reflected in trade and
investment.4 As discussed in Chapter 7, regionalization of production is a striking feature of
contemporary East Asian political economy. Foreign direct investment (FDI), export
promotion, and alliance and partnership among firms have helped to link production of East
Asian economies to each other as well as to the West. The sharp appreciation of the yen and
the currencies of the Asian tigers led to a major wave of direct investment to Southeast Asia,
enhancing dramatically a regionalization of production. As Chapter 8 has shown, however we
measure it, East Asia has experienced greater regional trade integration since the mid-1980s
even if we factor in the region’s increasing share in the global trade. While the United States
remains the largest final export market for East Asian goods, East Asian economies have also
become more dependent on each other for exports and capital investment. At the same time,
the center of gravity in regional trade flows is shifting from Japan to China.
As Chapter 9 has shown, compared with trade, East Asian financial integration has
progressed unevenly. Related to regionalization of production, flow of direct investment has
shown greater regional interdependence. But judging by other measures of financial
integration such as interest rate parities, shared regional bond issues, and flows of portfolio
investments, East Asia has not experienced nearly as significant a regional financial
integration as Europe. In fact, East Asia is tied closely with the financial centers of the West,
particularly New York and London. Financial globalization rather than financial
regionalization defines current East Asian finance. In terms of exchange rate regimes, as
discussed in Chapter 10, East Asia is fundamentally fragmented in that the yen, the most
powerful East Asian currency, floats against the U.S. dollar and the euro, while virtually
every other East Asian currency remains pegged to the dollar, official declarations aside. Put
simply, East Asia remains on the dollar standard, and the situation will not change much in
the near future.
Closer economic ties mean that it is important for East Asian economies to cooperate to
achieve greater economic efficiency. In addition, more than regional concentration, the fates
of East Asian economies have become increasingly bound together. Since they are viewed as
part of the same group, they go up (with inflow of capital) and down (with a sudden reversal
of capital flows that led to the 1997–1998 financial crisis). Also, since the early 1980s, Hong
Kong, Indonesia, South Korea, Malaysia, Taiwan, and Thailand had synchronized business
cycles while the Philippines and Singapore also loosely correlated in growth rates.5
A growing share of trade among countries in the region does not necessarily indicate
discriminatory action against others. As East Asian economies became bigger traders relative
to other regions, their share of trade with each other should naturally increase as well. To be
discriminatory, East Asian nations would have to adopt trade and investment policies that
deliberately favor their neighbors, which is not the case in East Asia. Moreover, growing
regionalization in other parts of the world, particularly in Europe and North America, means
280

greater intraregional concentration in East Asia.
Much of East Asian integration is market based. Fundamentally, firms rather than
governments have been driving regionalization of production. This was particularly the case
before the Asian financial crisis.6 There are three major groups of agents that drive the
regional integration, namely Japanese, Western, and ethnic Chinese capital. Japanese firms
are stakeholder capitalist, Western firms are shareholder capitalist, whereas ethnic Chinese
capital is largely family based. But they all adopt transnational market strategies. One should
also note that it is not necessarily Japanese competing against Chinese or Western firms.
Alliances and rivalries go in all directions.
Government programs have been important, but firms will not do what is against their
basic economic interests. As a case in point, Taiwanese businesses eagerly go to mainland
China for investment despite government discouragement. At the same time, the state has
been involved in the integration process. Japan had to promote FDI, and its monetary and
fiscal policy also had the implication for moving operations to the rest of East Asia. The rest
of East Asia had to liberalize their economies and encourage inflow of FDI. The Chinese
government was at the center of an emerging Greater China Circle. Moreover, the state has
taken the center stage in regional cooperation since the Asian financial crisis.
EAST ASIAN REGIONALISM
Two features stand out in East Asian regionalism. First, despite great diversities in traditions,
cultures, stages of economic development, and political systems, East Asians have actively
engaged in building regionalism, spearheaded by the governments, business communities,
academics, and nongovernmental organizations.7 Second, East Asians practiced a so-called
“open regionalism” before the 1997–1998 Asian financial crisis, turned to more exclusive
and formal regionalism after the crisis, and are recently taking another turn to formal but less
exclusive regionalism.
East Asian regionalism based on voluntary participation has been a phenomenon since the
end of World War II, particularly in light of ongoing integration in Western Europe and
elsewhere. Engaging in intergovernmental economic regionalism only in the 1980s, East Asia
has fallen behind Europe and North America.8 Western Europe began integration shortly after
World War II. The United States, Canada, and Mexico launched the North American Free
Trade Agreement (NAFTA) in January 1994.
Scholars and businesspeople dominated in the initial efforts for Asian regional
integration. The Pacific Trade and Development Conference (PAFTAD) created in 1968 by
academics evolved into a major network of economists and policy experts throughout the
region. The Pacific Basin Economic Council (PBEC) created in Tokyo in 1967 by business
representatives from Japan, Australia, and New Zealand now includes the United States,
Canada, and some other countries outside the region. The Pacific Economic Cooperation
Council (PECC) created in 1980 includes some leaders of PAFTAD and PBEC as well as
government officials. There is a reason that the word Pacific was so prominent. The countries
most interested in these ideas were the United States, Japan, and Australia. The governments
became formally involved in regional integration with the creation of the Asia-Pacific
Economic Cooperation forum (APEC) in 1989.
Open Regionalism
Before the 1997 Asian financial crisis, East Asia was known as practicing an “open
regionalism,” a notion closely associated with APEC. The 1993 APEC meeting announced
the goal of open regionalism. The term open regionalism has never been officially defined,
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but most analysts view it as meaning that APEC member countries would adopt a Most
Favored Nation standard that does not discriminate against nonmembers, that APEC
membership is open to all Asian countries or the countries bordering on the Pacific Ocean,
and that APEC members would continue to promote unilateral trade liberalization and
participation in the global free trade negotiations.9 Put simply, open regionalism means that
East Asia wants to use regionalism to become more integrated into the global economy.
APEC is open, now with 18 members from East Asia, Oceania, North America, and Latin
America. Since the APEC meeting in Seattle in 1993, APEC has become an occasion for
summits of leaders, providing a platform for leaders to discuss global, regional, and bilateral
issues.
East Asia’s open regionalism principle was striking when other regions were
institutionalizing regional integration. The European Union (EU) was formally established
with the ratification of the Maastricht Treaty, and NAFTA was ratified by the U.S. Congress
in November 1993, right before the APEC summit.
APEC follows a gradualist and consensual approach. When Australian Prime Minister
Bob Hawke proposed the idea of APEC in early 1989, he envisioned the organization to be
similar to the Organization for Economic Cooperation and Development (OECD) to promote
technical and economic cooperation. Over time, however, the United States, Canada,
Australia, and New Zealand wanted to put trade liberalization on the agenda. An Eminent
Persons Group was formed in 1993, which recommended establishment of a free trade
agreement (FTA) for developed countries by 2010 and for developing nations by 2020. That
vision was adopted at the APEC meeting in Bogor, Indonesia, in 1994. However, that goal
soon appeared unrealistic.
An important reason for the failure of the Bogor vision is that East Asian governments
resisted pressure from the West and introduced the principles of “concerted unilateralism,”
namely voluntary unilateral actions and granting these concessions on a nonreciprocal basis
to all World Trade Organization (WTO) members. The United States was not interested in
unilateral trade liberalization. Japan did not want to use APEC as a forum for trade liberation
because of domestic concern. When the United States succeeded in putting a sectoral-based
trade liberalization plan, so-called Early Voluntary Sectoral Liberalization (EVSL), on the
APEC agenda, Japan destroyed the proposal by opposing liberalization of the fisheries and
forestry sectors at the 1998 Kuala Lumpur meeting.10 The failed EVSL process and the Asian
financial crisis weakened APEC so much that it is now simply a diplomatic forum. The best it
can hope for is to be what Hawke had envisioned in the first place, namely a forum for
technical and economic cooperation. The United States has shifted attention elsewhere. East
Asians are building East Asian–only groups.
A strong institution such as the WTO has specified obligations, legally binding
commitments, reciprocity, and nondiscrimination. APEC, by contrast, has only uncertain,
unilaterally defined commitments.11 In fact, East Asian regional groups have exhibited weak
institutionalization in general.12 There was certainly not an Asian version of Maastricht, a
grand scheme for regional integration.
While APEC dominated on the diplomatic agenda in the early 1990s, there were
alternative institutional schemes for economic regionalism. The importance of the
Association of Southeast Asian Nations (ASEAN) cannot be overstated. Created in 1967,
ASEAN had five original members—Indonesia, Malaysia, the Philippines, Singapore, and
Thailand—and later admitted Brunei (1984), Vietnam (1995), Laos and Myanmar (1997),
and Cambodia (1999). ASEAN took on regionalism in the early 1990s, formulating a plan for
the ASEAN Free Trade Area (AFTA). AFTA followed the principle of open regionalism.13
AFTA has made some progress, but free trade is defined loosely, which explains why
countries like Singapore have been trying to establish bilateral FTAs with outside countries
282

on their own.
In a direct challenge to the West, Malaysian Prime Minister Mahathir bin Mohamad
proposed in December 1990 an East Asian Economic Group (renamed the East Asian
Economic Caucus or EAEC in 1991 on Indonesia’s initiative) that would include only East
Asian economies. However, faced with Washington’s strong opposition and Tokyo’s
unwillingness to challenge the United States at the time, the Mahathir proposal failed to
materialize. The EAEC was integrated into the APEC framework at the ASEAN Foreign
Ministers’ Meeting in June 1993.14 Ironically, while opposing an East Asian trading group,
the United States negotiated with Canada and Mexico to form NAFTA, which came into
effect in 1994. Washington’s perceived double standard was one reason why East Asian
economies continue to explore East Asian regional cooperation.
The New East Asian Regionalism
The 1997–1998 Asian financial crisis was a watershed in East Asian political economy. East
Asian economies have embraced a new form of regionalism since the crisis. The new East
Asian regionalism was essentially a type of regionalism more institutionalized and more
exclusive in membership, diverging significantly from the open regionalism principle
discussed above.15
Monetary cooperation took the lead in East Asia’s postcrisis regionalism. This made
sense. After all, the threat to regional economy revealed by the crisis was financial
volatility.16 By contrast, a typical process is for trade agreements to happen first. Besides the
financial crisis, other motivating forces for East Asian cooperation include regionalization of
trade and investment, ASEAN’s difficulties after the crisis, Northeast Asia’s interest in
joining AFTA, and defensive measures in response to the growth of EU and NAFTA.17
Since 1997 the East Asian group envisioned by Mahathir has quietly taken shape in the
framework of “ASEAN Plus Three” (China, Japan, and South Korea), which has a
membership virtually identical to that of the EAEC (Taiwan is not included in the current
structure). ASEAN Plus Three convened its first meeting in Malaysia in December 1997. The
discussion centered on monetary issues. In November 1999 in Manila, the third meeting of
East Asian leaders issued a joint statement on East Asian cooperation for the first time. The
areas for cooperation include trade and investment, monetary and financial cooperation
through policy dialogues, human resource development, and security dialogue. Philippine
President Joseph Estrada declared that the goal of ASEAN Plus Three was to create a
common market, monetary union, and an East Asian Community.
At ASEAN’s initiation, ASEAN Plus Three countries set up a currency swap scheme in
Chiang Mai, Thailand, in May 2000 after earlier agreements among financial and banking
officials. Although there had been similar agreements to swap and repurchase reserves, the
Chiang Mai Initiative established a framework for future discussion on regional monetary
cooperation. The swap basically means that when a country is in a currency crisis, it can
borrow from the reserves of other East Asian countries. The Chiang Mai Initiative was
reaffirmed at the ASEAN Plus Three leaders’ meeting in Singapore in November 2000. The
East Asian Vision Group was established to consider an East Asian FTA, a regional monetary
fund and exchange rate regime, and regional institutional building.
The swap agreements are more symbolic than real at this point. Japan pledged up to $3
billion to South Korea, up to $2 billion to Thailand, and up to $1 billion to Malaysia.
However, only 10 percent of the pledged funds would be automatically available. The rest is
subjected to International Monetary Fund (IMF) approval. Nevertheless, the Chiang Mai
currency swap agreements indicated East Asia’s desire for deeper regional integration.
When it comes to trade, bilateral FTAs rather than an ASEAN Plus Three FTA have
made the most progress so far. All major trading powers engage in bilateral FTA negotiations
283

with countries in and outside East Asia. For example, Singapore launched formal negotiations
with Japan for an economic partnership agreement (EPA) in October 2000 and with the
United States for an FTA in November 2000, reaching agreements with Japan in January
2002 and with the United States in May 2003. Singapore reached an FTA agreement with
South Korea in November 2004.
Although a latecomer in free trade talks, China has moved fast, reflecting and reinforcing
its rapid rise in the region.18 China and ASEAN announced in November 2000 a plan to
create an FTA within 10 years. The proposed ASEAN-China FTA is a first for both ASEAN
and China. Significantly, the ASEAN-China pact bypassed Japan and the United States, the
two largest economies in the Asia Pacific region. Even a partially realized ASEAN-China
FTA, which has a combined market of $1.7 billion and a total GDP of $2 trillion, would
enhance China’s political and economic influence in East Asia relative to Japan and the
United States, an important objective for Beijing in the first place. Besides expanding trade
and securing a friendly environment for economic development, Beijing also wants to be a
founding member of a trading arrangement. Fifteen years spent in negotiation over WTO
membership showed China’s leaders the influence rule makers wield. Now Japan or others
that want to join the new FTA will have to abide by the rules established by China and
ASEAN.
The fact that it took China and ASEAN only one year to reach an agreement reflects
strong mutual economic interests and political resolve from the two sides. China had an
“early harvest” agreement with ASEAN, according to which China and ASEAN would begin
to reduce tariffs on 600 categories of agricultural products and remove tariffs by 2006. On
October 1, 2003, China and Thailand removed tariffs on 188 categories of fruits and
vegetables, leading to a sharp increase in bilateral trade volumes in fruits and vegetables, with
Thailand enjoying a significant surplus. In January 2007 China and ASEAN signed a service
trade FTA.
China is uniquely positioned to take a proactive stance in FTA initiatives. First, China has
a long way to go in trade liberalization, thus it has more room for concessions and greater
incentives for potential partners. Second, although the United States and Japan have larger
economies, China has an expanding market. Third, China is partly developed and partly
developing, thus a better fit with ASEAN. By contrast, Japan prefers free trade talks with
countries of similar stages of development. Moreover, this is free trade’s moment in China.
China joined the WTO on November 10, 2000, and could ride on that momentum for further
trade liberalization arrangements. Fights for trade liberalization have already been fought and
won. In the context of WTO-related structural adjustments, a new trade deal with ASEAN is
unlikely to cause new domestic fights.
Weakened by the Asian financial crisis and facing intense global competition, ASEAN is
desperately reaching out to strong economic partners, be it the United States, Japan, China,
Australia, South Korea, or India. ASEAN has been discussing free trade with Japan, India,
Australia, and New Zealand. ASEAN and the United States signed a trade and investment
framework agreement in August 2006, which laid the foundation for FTA negotiations.
Facing Chinese competition, Japan made a bigger push for EPAs with ASEAN countries.
Japan signed an EPA with Singapore in January 2002, with Thailand in principle in
September 2005, with Malaysia in December 2005, and with the Philippines in September
2006. Japan is also negotiating with South Korea. Japan began studies of EPA with Vietnam
in September 2006. Japan began negotiations with ASEAN in April 2005 and reached an
EPA in principle on May 4, 2007.
East Asian countries have also been creating bilateral FTAs with countries outside East
Asia. Japan signed an EPA with Mexico in September 2004 and with Chile in March 2007.
China reached an FTA with Chile in November 2005 and began FTA negotiations with New
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Zealand in December 2004 and with Australia in May 2005. The United States has an FTA
with Singapore, signed an FTA with South Korea in April 2007, and is now talking with
Thailand. The United States and ASEAN reached a trade and investment framework
agreement in August 2006, which laid a good foundation for a U.S.-ASEAN FTA. Thailand
has an FTA with Australia. Singapore also has an FTA with Mexico.
The real progress in East Asian regionalism has been modest despite heavy activities in
the diplomatic and academic realms.19 Moreover, East Asian economies remain linked
closely with outside powers like the United States. Nevertheless, the eagerness of the East
Asian governments to pursue regionalism still needs to be explained. One should also not
dismiss East Asian regionalism even if it is not as closed as the traditional regional blocs. In
fact, it has been suggested that both Asia and Europe are “porous” regions because of
globalization and American influence.20
“East Asia Plus” Versus “East Asia Minus” Regionalism
Former South Korean President Kim Dae Jung proposed the “East Asia Community.” The
East Asia Study Group explored the feasibility of the proposal in 2002. It had seventeen
short-term objectives and nine medium- and long-term objectives to create an FTA zone,
financial cooperation, and antiterrorism coordination. The special Japan-ASEAN Summit
held in December 2003 passed the Tokyo Declaration, which treated the creation of the East
Asian Community as an objective. At the ASEAN Plus Three Summit held in Laos in
November 2004, a basic agreement on the East Asian Community was reached. Malaysia was
selected to host the first East Asian Summit in December 2005, including ASEAN Plus Three
countries as well as Australia, New Zealand, and India. Russia and Pakistan also want to join
the East Asian Summit. Now the East Asian Summit members are considering the possibility
of creating an FTA within 10 years.
Japan wanted to include Australia, New Zealand, and India in the East Asian Summit, a
position supported by the United States. Both countries are concerned about China’s growing
influence in Asia and worry that an East Asian regional club would necessarily mean Chinese
domination in the group. Mixing in outside powers like Australia and India in the East Asian
Summit necessarily balances China’s influence.
Japan proposed an East Asian EPA, starting in early 2006, that includes Japan, China,
South Korea, ASEAN states, India, Australia, and New Zealand. Nikai Toshihiro, from
Japan’s Ministry of Economy, Trade, and Industry (METI), told journalists on August 24,
2006, that ASEAN had accepted the proposal to discuss the East Asian EPA at the East Asian
Summit to be held in the Philippines in December 2006.21 The Japanese government is
hoping to create an East Asian version of OECD, based on Japanese funding. METI is thus
pushing for an East Asia plus regionalism. As Naoko Munakata put it simply, “the East Asia
summit could accelerate cooperation between East Asian countries and the three new
participants—Australia, India, and New Zealand—and thus might lead to the redefinition of
an appropriate geographical scope of regional integration and community-building for the
countries in East Asia.”22 Japan’s EPA is broader than FTA and is often accompanied by
discussion of values and other software issues. Not surprisingly, the Chinese government
viewed the Japanese proposal as a ploy to win leadership in East Asia.
By contrast, China has been involved in studies of a Northeast Asia FTA as well as the
ASEAN Plus Three FTA. Beijing made a proposal in 2004 for an East Asian FTA. It is too
early to see whether the Japanese or the Chinese vision will prevail. It is harder for China
because it cannot openly oppose inclusion of major powers like Australia and India, whose
friendship Beijing is also seeking. However, what is likely to happen will be China’s greater
energy devoted to its FTA with ASEAN, which is really an East Asia minus regionalism. The
Chinese government now frequently expresses its strong desire to open its growing market
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for Southeast Asian exports.
THEORIES OF REGIONALISM
Economic Theories of Regionalism
Economists who study trade regionalism focus on two questions. First, will trade regionalism
increase or decrease welfare (i.e., material requisites of well-being)? Second, how does
regionalism affect global trade negotiations? Their empirical research has yielded mixed
results.23
Regional integration both creates and distorts trade. Some scholars have argued that
regional cooperation is particularly beneficial for developing nations. First, regional
cooperation contributes to peace and stability, which are necessary conditions for economic
growth. Second, regional cooperation contributes to sound macroeconomic policies that are
often required for the purpose. Third, regional cooperation facilitates greater technology
transfers. Fourth, regional cooperation increases economies of scale. Fifth, regional
cooperation improves production standards. Sixth, regional cooperation facilitates
liberalization of national economy policies. Last, regional integration leads to greater
participation in multilateral economic integration.24
For Asia, some empirical research has suggested that larger FTAs such as a would-be
APEC FTA would bring great benefits to member states with little effect on nonmembers. By
contrast, an ASEAN FTA would mean few benefits for members.25
Economists also debate the impact of regional trade agreements on the global trade
regime.26 Some see regional trade agreements as a stumbling block to global trade
liberalization, using the trade diversion theory developed by Jacob Viner or the argument that
regional agreements erode political support for global free trade negotiations.27 The opposite
view is that FTAs may be stepping stones or building blocks in that the member countries of
FTAs have to adopt policy reforms.28
As discussed in Chapter 10, there are also economic theories such as the optimal currency
area (OCA) theory about monetary integration. Similar to economic theories of trade
regionalism, the focus of OCA theory is on costs and benefits.
As some scholars have pointed out, the economic theories of regional integration are
wanting. For instance, why do states sometimes enter into trading arrangements that are not
welfare maximizing?29 This is particularly the case for East Asian regionalism. There are
political economy reasons why East Asian governments have been so eager to build regional
institutions even when economic rationale is not always convincing.
Political Economy Theories of Regionalism
Political scientists have developed a number of approaches to study regionalism. In their
edited book on regionalism, Edward Mansfield and Helen Milner discussed four approaches,
namely functional/institutionalist, realist, constructivist, and domestic approaches.30 I will not
address the domestic politics approach here since the domestic political economy of
regionalism will be covered in the next section. Instead, I will discuss a strategic approach
toward regionalism, which I think is the most useful for understanding East Asian
regionalism.
Functional/institutionalist explanations. Studies of regional institutions were popular in the
late 1950s and the early 1960s because a large number of regional groups were being created.
In particular, several Western European countries were creating a European Economic
Community. Integration thus became an important research topic. Integration is understood
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as a process that is multidimensional, political, economic, social, and cultural. Integration
scholars see integration as a process that leads to the creation of a political community. Ernst
Haas defined integration as a “process whereby political actors in several distinct national
settings are persuaded to shift their loyalties, expectations, and political activities toward a
new center, whose institutions possess or demand jurisdiction over the pre-existing national
states.”31 Integration scholars share a common concern about how loyalty is being shifted
from nations to a larger grouping, and they study communication and transactions within
units of an integrating body. They also argue that there is a spillover effect; nations that have
learned to cooperate in one area may also cooperate in other areas.
The integration school adopted a functionalist or neo-functionalist approach to regional
integration. It is functional in that regional integrations were created to meet certain
functional needs. David Mitrany laid the functionalist foundation for later works on
integration and cooperation. In his 1943 book, A Working Peace System, he argued that in the
twentieth century countries needed to cooperate to resolve many functional problems that go
across national borders, accomplished by technicians outside the political context. Successes
in one functional area set examples for cooperation in other functional areas (he called this
ramification).32
Neo-functionalism built on the functionalist school and modified and tested hypotheses
about integration. Ernst Haas, for example, is considered a neofunctionalist. Others include
Philippe Schmitter, Leon Lindberg, Joseph S. Nye, Robert O. Keohane, and Lawrence
Scheineman. In particular, Nye highlighted seven process mechanisms, namely functionalist
linkage of tasks or spillover, rising transactions, deliberate linkages and coalition formation,
elite socialization, regional group formation, ideological-identitive appeal, and involvement
of external actors. He also used integrative potential for the conditions for integration, namely
symmetry of unity, elite value complementarity, existence of pluralism, and capacity to adapt
and respond.33
We can also use the theory of international regime to explain regionalism. International
regimes refer to principles, norms, rules, and decision-making procedures. International
regimes can be both formal and informal. International regimes overcome collective action
problems by reducing transaction costs and encouraging reciprocity because of repeated
interactions.34 Basically, international regime theorists see regionalism as resulting from the
incentives institutions may provide for countries in the region to cooperate for a common
good.
Does functionalism/institutionalism apply to East Asia? Superficially, like regionalism
everywhere else, East Asian regionalism is meant to serve functional purposes. That is why
much focus was put on financial regionalism after the Asian financial crisis, because of the
perceived needs. Trade regionalism is meant to increase intraregional trade, and monetary
regionalism is meant to create stability in the regional monetary system. However, we do not
see a process of regional integration as is seen in European integration. There is simply not an
accepted process of shifting loyalties from national to regional institutions. Thus, functional
arguments may explain the creation of the EU and NAFTA but not developments in East
Asia and Latin America.35 As discussed above, East Asian economies have made greater
efforts at institutionalization since the Asian financial crisis, but we still see a weak
institutionalized East Asia. Using institutionalist arguments, we can explain the weak
regional institutionalization by failure to overcome the collective action problem in achieving
regional cooperation.
Realist explanations. For neo-realists, domestic and transnational politics are not important in
an anarchical world. As sovereign states need to fend for their survival, interstate cooperation
is limited. Realism is a big tent, however, and some scholars who consider themselves realists
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have discussed international political economy issues.
First, security alliances shape the pattern of international trade.36 Second, some scholars
are interested in relative gains in international economic transactions, meaning that countries
are supposed to be more concerned about whether other countries will gain relatively more
than they should be about their own absolute gains from the interaction. Third, the presence
of hegemony is important for the creation and maintenance of regional groups.37
East Asia does not have hegemony, which partly explains its difficulty in achieving
economic cooperation. If we consider the United States to be the real hegemon in East Asia,
that would create a serious problem for East Asian regionalism, since the United States would
be suspicious of such a move. Moreover, dependence of some East Asian nations such as
Japan on the United States weakens the resolve for regional integration. Last but not the least,
tensions between major powers in the region such as China and Japan are problems for
regionalism. In fact, narrow nationalisms have impeded regional integration in Northeast
Asia.38
On the other hand, competition with other regions in the world is a major driving force
for East Asian regionalism. In fact, the IMF handling of the Asian financial crisis has led to
much resentment in the region toward the IMF and the United States. East Asians feel that
they should unite to have a collective voice in global political economy.39
East Asian economies do exhibit some relative gains concerns. This is particularly the
case for Japan worrying about China’s rise. However, virtually all governments want to push
for more rather than less regional integration. Moreover, smaller economies in the region
often choose to bandwagon onto major powers, on Japan in the late 1980s and on China at
present. As for the correlation between alliances and trade flows, the United States does trade
heavily with its Asian allies, namely Japan, South Korea, and the Philippines. At the same
time, it is absence of hostility rather than alliances per se that has had the greatest impact on
trade distribution. After all, China, which does not have any formal alliance with any country,
has become a major trading partner for all East Asian economies.
Constructivist explanations. The basic constructivist argument is that the world is what we
make of it.40 Put simply, it is not just material interests that shape developments in the world.
To operationalize this approach, we examine issues like ideas, norms, and identity.
One impetus for East Asian regionalism is the familiarity with some of the ideas for
regional integration that have been tested elsewhere in the world, particularly in Western
Europe and North America. More broadly, the idea of East Asian regionalism matters in that
proponents continue to promote regionalism against apparent odds.
If we look at norms and identity, we see formidable obstacles to East Asian regionalism.
Norms of rules of law and democracy are not universally shared in the region. A rising China
is not democratic. Compared with Europe and Latin America, East Asian awareness and
identity are relatively weak, which is a major hindrance to regional integration.41
However, things are beginning to change in East Asia. First, on the political level, there
has always been much rhetoric of an East Asian community. Although this has been largely
reactive to Western pressure and criticism, over time, there has been more substance to it.
Second, a significant development in East Asia is the emergence of a young generation of
businesspeople who travel extensively in the region. Third, with advances in
telecommunications, there has been a greater degree of Asian fusion movement: Hong Kong
martial arts movies, Japanese cartoons and fashion, Taiwanese and South Korean pop music,
and so on.42 Note, however, that while regional awareness is growing in East Asia, it has
largely grown along with global awareness. A stronger East Asian identity does not have to
mean us against them.43
Last but not least, there are competing regionalist projects by the United States, Japan,
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China, and, to a lesser extent, other regional countries. These projects are related to the
identities of these countries, namely a U.S.-dominated market economy, a Japan-led flying
geese formation, a China-centered regional economy.44
Strategic explanations. Why does East Asia have weak institutionalization? Some have
argued that Asian values and cultures explain weak institutionalization in the region.45
However, the cultural argument does not make sense since East Asian nations have resorted
to global legalized institutions. An alternative argument is that East Asia’s weak
institutionalization has resulted from state strategies.46
From a strategic perspective, the way to examine regionalism is to see the pros and cons
for decision makers facing both the domestic and international arenas. Regionalism can be
seen as a flexible policy instrument to meet a variety of objectives.
Why did East Asian nations insist on treating APEC as an open regionalism? The answer
is straightforward: East Asians did not want to turn APEC into another trade forum in which
the West dominates.47 Why did East Asians turn to a more exclusive form of regionalism
after the Asian financial crisis? Again, they did not want the West to dominate in these
groups. Why do many East Asians reach out to players like India and Australia? The answer
is that they do not want to see China dominate too much in regional groups.
One challenge East Asia faces in institutionalization is the very different national
preferences and national strategies. For example, ASEAN nations have followed a
noninterference approach since 1967. Non-Asians tend to be critical of this practice and
believe that ASEAN cannot truly become an effective institution until it adopts a more
assertive approach. ASEAN wants regional integration, but it has also been afraid that its role
will be diluted in a larger grouping. ASEAN began the first preferential trade agreement in
East Asia, forming the ASEAN Free Trade Area (AFTA) in 1992. While a similar effort was
rejected after the mid-1980s due to concerns that regionalism would reduce the members’ ties
with the global economic system, regionalism came to be viewed as furthering their
integration into the global market. ASEAN hoped regional integration would make it more
attractive for FDI and more competitive in the global marketplace.48 Before the Asian
financial crisis, it insisted that APEC exercised an open regionalism. The crisis has
significantly weakened the prestige and effectiveness of ASEAN. There is a growing sense
that ASEAN needs to hook up with bigger players outside, be it China or Japan or the United
States. There is a growing division within ASEAN. Indonesia is weakened. Impatient with
the pace of the ASEAN Free Trade Area, Singapore is striking its own bilateral FTAs.
Japan did not see many benefits in linking up with its Asian neighbors if it meant losing
access to North America and Western Europe. That is why Japan was interested in open
regionalism.49 Makoto Kuroda, a former Ministry of International Trade and Industry (MITI)
vice minister, commented in 1989 that although East Asia would integrate naturally, it should
not seek to build its own economic bloc to counter the creation of blocs in other parts of the
world because Asia would lose more by confronting the other groups. Rather, it should
promote a global free trade regime.50
Japan shifted its strategy in favor of regionalism in the late 1990s. The policy shift was
reflected in the 1999 white paper on trade by MITI. The report concluded that Japan was an
anomaly in the international trade system as most WTO members are involved in regional
trade arrangements and that regional FTAs can contribute to the global free trade regime.
While Japan had been active in the global financial system, it paid more attention to regional
financial initiatives in East Asia after 2000. Japan did not see this shift as choosing between
globalism and regionalism. Rather, Japan saw a stronger regional financial structure as
complementary to a strong global financial structure.51 This shift reflected Japan’s greater
interdependence on East Asia around the same time. Take Japan’s electronics industry, for
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example. Although Japan experienced a significant decline in the 1990s, its electronics
industry experienced a comeback after 2000 because of greater trade and investment in East
Asia. Unlike in the previous periods, Japanese electronics firms now are more dependent on
East Asia and increasingly play an equal role or even secondary role in some areas to other
East Asian firms.52
In yet another turn, Japan now does not really want to promote East Asia–only
regionalism. Rather, Japan wants to include Australia, New Zealand, and India in East Asian
economic regionalism. The main reason is that Japan sees its relations with the United States
as the most important and is increasingly concerned about being in a group where China
might dominate.
South Korea shifted in favor of East Asian regionalism around the same time as Japan
did. South Korea began its FTA negotiation with Chile in 1998 and concluded the trade deal
in 2002. South Korea then launched negotiations with various other partners, partly to keep
up with China and Japan.53 South Korea is interested in regional integration because it serves
its economic and political interests. Some South Koreans also feel that South Korea is in a
unique position to take the lead because it will not arouse suspicion of other Asian nations,
unlike China and Japan. Some non-Korean analysts endorse such a view of Korean centrality
in Northeast Asian integration.54
China is a relative latecomer in initiating regionalist projects. But the Chinese
increasingly feel that China should act as a great power and take the lead in regional
integration. Once China made the policy choice, it acted quickly. On November 25, 2000, at
the ASEAN Plus China Summit, Premier Zhu Rongji indicated interest in an FTA between
China and ASEAN. At the meeting, Zhu also expressed China’s wish for ASEAN Plus Three
to be the main channel for East Asian regional cooperation.55 China has a comparative
advantage compared with countries like the United States. U.S. negotiators need to include
the environment and labor conditions to win congressional approval, and they also need to
protect sensitive sectors at home. By contrast, China adopts a simpler strategy of lowering
tariffs without qualifying conditions.
Much of the drive for regionalism is defensive in nature. East Asia feels the pressure from
other regions’ regionalism as well as competitive pressure from within the region. With
China taking a lead in forming an FTA with ASEAN, Japan and South Korea also feel they
have to do something.56
POLITICAL ECONOMY OF REGIONALISM
There are political reasons for regionalism and regionalism has political consequences. How
does domestic politics explain regionalism? Obviously, domestic politics may get in the way
of regional cooperation if citizens in the countries involved do not trust each other and if
politicians utilize narrow-minded nationalism to advance their own political agenda. It has
been pointed out how East Asian domestic politics have hindered regional cooperation,
particularly in Northeast Asia.57
From a political economy perspective, like any other policy shift in foreign economic
policy, a country’s decision on regionalism has a distributive effect on domestic groups by
generating losers and winners. Losers will oppose the policy while winners will endorse it.
Thus, a country’s policy regarding regionalism is often consistent with the most powerful and
organized social groups. For example, South Korea’s politically sensitive sectors of
agriculture, forestry, and fishery worried about an FTA with Chile while the manufacturing
sector supported it. The reason was Chile’s perceived comparative advantage in agriculture,
forestry, and fisheries.58 By contrast, winners lobby for forming FTAs. As a case in point,
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Japan’s leading business group Japan Business Federation (Keidanren) promoted and was
heavily involved in the negotiations over EPAs both to advance Japanese companies’
business interests overseas and to force structural adjustment of uncompetitive firms at
home.59
Politicians select liberalization in certain areas to advance regionalism to balance their
needs to be reelected and to accommodate special interest groups.60 This dynamic is seen
more clearly in more democratic regimes, such as Japan and South Korea. Although it might
not be obvious to outsiders, the same dynamic works in less transparent governments such as
China as well. At the same time, consistent with earlier discussions of the developmental
state, East Asian governments also play an important role in shaping national interests,
including those regarding regionalism.
Domestic politics can be used to explain the rapid spread of regionalism. From a domestic
politics perspective, once a regional group is formed, the firms that export to the group
become more energized to lobby for entry into the arrangement, often tipping the political
balance in the country. The more countries join, the greater energies the exporting firms in
nonmember countries will try to persuade their governments to join. We thus see a domino
effect.61
More broadly, the expanding middle class in East Asia, created by rapid economic
growth, provides a social basis for regionalism. With similar professional background and
lifestyle, the middle class throughout the region constitutes an expanding regional consumer
market.62
At the same time, the need to form FTAs has had a strong impact on domestic politics in
East Asia. Competitive regionalist projects have forced the countries to do more to open up
trade. As a case in point, Japan now has political and strategic interests not to accommodate
its protectionist agricultural sector as much as it would otherwise. FTA negotiations have
transformed the Japanese policy debate and weakened public support for agricultural
protection. The Japanese business community has become more vocal against agricultural
protection policy. FTAs also expand Japanese agricultural exports even though they do not
nearly match agricultural imports at this point.63
Besides competition with Japan and other major trading powers, Chinese advocates for
regional integration openly see one benefit of regionalism as using “external power” to
further domestic reform.64 In the early 1990s, China had the highest level of tariffs among the
APEC countries, which meant that it had to make greater adjustment. China was willing to do
so because it was trying to join the WTO, which also required it to reduce tariffs.
CONCLUSION
Building on discussion in the previous chapters, this chapter suggests that regionalization has
increased in recent decades, but East Asian companies have not been trading more with each
other against their best interests just to promote regionalization. The United States and the
European Union remain active participants in East Asian economy. At the same time,
although there is little bias embedded in growing regional integration, the fact that East Asian
nations have become more interdependent with each other provides an important rationale for
them to institutionalize regional cooperation.
East Asian regionalism is characterized by East Asian enthusiasm and limited
institutionalization. East Asian regional integration began as open regionalism and is now
moving toward formal institutions. Economically, it makes sense to have a regional grouping
because strong regional links already exist, because other regions have already built regional
groups, and because a regional group does not necessarily impede a global free trade regime.
291

Politically, it has been difficult to establish East Asian regionalism because of strong
domestic resistance, particularly in leading countries like Japan, because the United States
does not want to be excluded, and because China and Japan have a tense political
relationship. At the same time, competition between major powers like China and Japan also
serves to push forward trade liberalization as they need to present better terms to trading
partners than they would have otherwise.
If successful, East Asian regionalism would help create a three-pillar world economy. It
would give East Asia greater negotiating power, although that might also mean greater
difficulties in global coordination. Regionalism would necessarily affect regional distribution
of power. China might be the initial winner, but Japan and other countries would also have
their shot in this ongoing game. A more compelling regionalism might help to further reform
domestic political economy, but a weaker version of regional institution in place of a stronger
global institution would delay the process of reform.

SUGGESTED READINGS

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Bowles, Paul. “Asia’s Post-Crisis Regionalism: Bringing the State Back In, Keeping the
(United) States Out.” Review of International Political Economy 9, no. 2 (May 2002):
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Dieter, Heribert, and Richard Higgott. “Exploring Alternative Theories of Economic
Regionalism: From Trade to Finance in Asian Co-operation?” Review of International
Political Economy 10, no. 3 (August 2003): 430–454.
Friedman, Edward, and Sung Chull Kim, eds. Regional Cooperation and Its Enemies in
Northeast Asia: The Impact of Domestic Forces (London: Routlege, 2006).
Haas, Ernst B. The Uniting of Europe: Political, Social, and Economic Forces 1950–1957
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NOTES

1. Benedict Anderson, Imagined Communities: Reflections on the Origins and Spread of
Nationalism (London: Verso, 1983).
2. Andrew Hurrell, “Regionalism in Theoretical Perspective,” in Regionalism in World
Politics: Regional Organization and International Order, ed. Louise Fawcett and Andrew
Hurrell (New York: Oxford University Press, 1995), 37–73.
3. For discussion of regionalism and regionalization, see Edward D. Mansfield and Helen V.
Milner, “The Political Economy of Regionalism: An Overview,” in The Political
Economy of Regionalism, ed. Edward D. Mansfield and Helen V. Milner (New York:
Columbia University Press, 1997), 3–4; Samuel S. Kim, “Regionalization and
Regionalism in East Asia,” Journal of East Asian Studies 4, no. 1 (January–April 2004):
40–41.
4. Naoko Munakata, Transforming East Asia: The Evolution of Regional Economic
Integration (Washington, D.C.: Brookings Institution Press and Tokyo: Research Institute
of Economy, Trade and Industry, 2006), 37–61.
5. Ronald I. McKinnon with Gunther Schnabl, “Synchronized Business Cycles in East Asia
and Fluctuation in the Yen/Dollar Exchange Rate,” in Exchange Rates Under the East
Asian Dollar Standard: Living with Conflicted Virtue, ed. Ronald I. McKinnon
(Cambridge: MIT Press, 2005), 53–76.
6. Richard Stubbs, “Asia-Pacific Regionalization and the Global Economy: A Third Form of
Capitalism,” Asian Survey 35, no. 9 (September 1995): 785–797.
7. T. J. Pempel, “Introduction: Emerging Webs of Regional Connectedness,” in Remapping
East Asia: The Construction of a Region, ed. T. J. Pempel (Ithaca, N.Y.: Cornell
University Press, 2005), 1–28; Paul Evans, “Between Regionalism and Regionalization:
Policy Networks and the Nascent East Asian Institutional Identity,” in Remapping East
Asia, 195–215.
8. For comparative studies of regionalism, see Jamie De Melo and Arvind Panagariya, eds.,
New Dimensions in Regional Integration (Cambridge: Cambridge University Press,
1993); Mansfield and Milner, eds., The Political Economy of Regionalism (New York:
Columbia University Press, 1997).
9. C. Fred Bergsten, “Open Regionalism,” World Economy 20, no. 5 (1997): 545–565; and
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C. Fred Bergsten, ed., Whither APEC? The Progress to Date and Agenda for the Future
(Washington, D.C.: Institute for International Economics, 1997).
10. John Ravenhill, “APEC Adrift: Implications for Economic Regionalism in Asia and the
Pacific,” Pacific Review 13, no. 2 (2000): 319–333. For a discussion of broader criticism
of several countries, see Okamoto, Trade Liberalization and APEC.
11. Ravenhill, “APEC and the WTO.”
12. Miles Kahler, “Legalization as Strategy: The Asia-Pacific Case,” in Legalization and
World Politics, ed. Judith L. Goldstein, Miles Kahler, Robert O. Keohane, and Anne-
Marie Slaughter (Cambridge: MIT Press, 2001), 165–187.
13. Paul Bowles and Brian MacLean, “Understanding Trade Bloc Formation: The Case of the
ASEAN Free Trade Area,” Review of International Political Economy 3, no. 2 (Summer
1996): 319–348.
14. Richard Higgott and Richard Stubbs, “Competing Conceptions of Economic
Regionalism: APEC Versus EAEC in the Asia Pacific,” Review of International Political
Economy 2, no. 3 (Summer 1995): 516–535.
15. Paul Bowles, “Asia’s Post-Crisis Regionalism: Bringing the State Back In, Keeping the
(United) States Out,” Review of International Political Economy 9, no. 2 (May 2002):
244–270.
16. Heribert Dieter and Richard Higgott, “Exploring Alternative Theories of Economic
Regionalism: From Trade to Finance in Asian Co-operation?” Review of International
Political Economy 10, no. 3 (August 2003): 430–454.
17. Kim, “Regionalization and Regionalism in East Asia.”
18. David Shambaugh, ed., Power Shift: China and Asia’s New Dynamic (Berkeley:
University of California Press, 2006).
19. Lincoln, East Asian Economic Regionalism.
20. Peter J. Katzenstein, A World of Regions: Asia and Europe in the American Imperium
(Ithaca, N.Y.: Cornell University Press, 2005).
21. Yomiuri shimbun, August 24, 2006,
www.yomiuri.co.jp/atmoney/news/20060824ib25.htm.
22. Munakata, Transforming East Asia, 15.
23. Wilfred J. Ethier, “The New Regionalism,” The Economic Journal 108, no. 449 (July
1998): 1149.
24. Naya, Asian Development Experience, 97–101.
25. Jeffrey D. Lewis and Sherman Robinson, “Partners or Predators? The Impact of Regional
Trade Liberalization on Indonesia,” Policy Research Working Paper No. 1626, Country
Operations Division, World Bank, Washington, D.C., July 1996.
26. Anne O. Krueger, “Are Preferential Trading Arrangements Trade Liberalizing or
Protectionist?” Journal of Economic Perspectives 13, no. 4 (Autumn 1999): 105–124;
Arvind Panagariya, “Preferential Trade Liberalization: The Traditional Theory and New
Developments,” Journal of Economic Literature 38, no. 2 (June 2000): 287–331.
27. Jacob Viner, The Customs Union Issue (New York: Carnegie Endowment for
International Peace, 1950); Bela Balassa, The Theory of Economic Integration
(Homewood, Ill.: Richard Irwin, 1961); Jagdish Bhagwati, “Regionalism and
Multilateralism: An Overview,” in New Dimensions in Regional Integration (see note 8),
22–51; Philip I. Levy, “A Political-Economic Analysis of Free Trade Agreements,”
American Economic Review 87, no. 4 (September 1997): 506–519.
28. Wilfred J. Ethier, “Regionalism in a Multilateral World,” Journal of Political Economy
106, no. 6 (December 1998), 1214–1245.
29. Bowles and MacLean, “Understanding Trade Bloc Formation,” 324.
30. Mansfield and Milner, “Political Economy of Regionalism,” 1–19.
294

http://www.yomiuri.co.jp/atmoney/news/20060824ib25.htm

31. Ernst B. Haas, The Uniting of Europe: Political, Social, and Economic Forces 1950–1957
(Stanford: Stanford University Press, 1958), 16.
32. David Mitrany, A Working Peace System (Chicago: Quadrangle Books, 1966).
33. Joseph Nye, Peace in Parts: Integration and Conflict in Regional Organization (Boston:
Little, Brown, 1971).
34. Stephen D. Krasner, ed., International Regimes (Ithaca, N.Y.: Cornell University Press,
1983); Robert O. Keohane, After Hegemony: Cooperation and Discord in the World
Political Economy (Princeton: Princeton University Press, 1984) and International
Institutions and State Power: Essays in International Relations Theory (Boulder:
Westview Press, 1989).
35. Joseph M. Grieco, “Systemic Sources of Variation in Regional Institutionalization in
Western Europe, East Asia, and the Americas,” in The Political Economy of Regionalism
(see note 3), 164–187.
36. Joanne Gowa, Allies, Adversaries, and International Trade (Princeton: Princeton
University Press, 1994).
37. Grieco, “Systemic Sources of Variation in Regional Institutionalization.”
38. Gilbert Rozman, Northeast Asia’s Stunted Regionalism: Bilateral Distrust in the Shadow
of Globalization (Cambridge: Cambridge University Press, 2004).
39. Bowles, “Asia’s Post-Crisis Regionalism.”
40. Alexander Wendt, Social Theory of International Politics (New York: Cambridge
University Press, 1999).
41. Kim, “Regionalization and Regionalism in East Asia,” 44–47.
42. David Leheny, “A Narrow Place to Cross Swords: Soft Power and the Politics of
Japanese Popular Culture in East Asia,” in Beyond Japan: The Dynamics of East Asian
Regionalism, ed. Peter J. Katzenstein and Takashi Shiraishi (Ithaca, N.Y.: Cornell
University Press, 2006), 211–233.
43. For a broad discussion of how globalization has affected East Asia, see Samuel S. Kim,
ed., East Asia and Globalization (Lanham, Md.: Rowman and Littlefield, 2000).
44. Ngai-Ling Sum, “The NICs and Competing Strategies of East Asian Regionalism,” in
Regionalism and World Order, ed. Andrew Gamble and Anthony Payne (New York: St.
Martin’s Press, 1996), 207–245.
45. Carl J. Green, “APEC and Trans-Pacific Dispute Management,” Law and Policy in
International Business 26, no. 3 (1995): 719–734.
46. Kahler, “Legalization as Strategy.”
47. Ravenhill, “APEC Adrift.”
48. Suthiphand Chirathivat, “The ASEAN Perspective on East Asian-Wide Regionalism,” in
New East Asian Regionalism: Causes, Progress, and Country Perspectives, ed. Charles
Harvie, Fukunari Kimura, and Hyun-Hoon Lee (Northampton, Mass.: Edward Elgar,
2005), 151.
49. For Japan’s interest in open regionalism, see Kozo Kato’s chapter in Peter Katzenstein,
Natasha Hamilton-Hart, Kozo Kato, and Ming Yue, Asian Regionalism (Ithaca, N.Y.:
Cornell University East Asia Program, 2000).
50. Cited in Charles Smith, “Protectionist Fear Over Trade Blocs,” Far Eastern Economic
Review, June 8, 1989, 68.
51. Natasha Hamilton-Hart, “Creating a Regional Arena: Financial Sector Reconstruction,
Globalization, and Region-Making,” in Beyond Japan (see note 42), 108–129.
52. Dieter Ernst, “Searching for a New Role in East Asian Regionalization—Japanese
Production Networks in the Electronics Industry,” in Beyond Japan (see note 42), 161–
187.
53. Chan-Hyun Sohn and Hyun-Hoon Lee, “Korea’s Perspectives on East Asian
295

Regionalism,” in New East Asian Regionalism (see note 48), 171–212.
54. Charles K. Armstrong, Gilbert Rozman, Samuel S. Kim, and Stephen Kotkin, eds., Korea
at the Center: Dynamics of Regionalism in Northeast Asia (Armonk, N.Y.: M. E. Sharpe,
2006).
55. Hu Zhaoliang, “Dongya hezuo de xianzhuang yu weilai” [The present and future of East
Asian cooperation], Guoji wenti yanjiu [Journal of International Studies] 1 (2002): 21–25.
Hu is a senior Chinese diplomat.
56. Stephan Haggard, “The Balance of Power, Globalization, and Democracy: International
Relations Theory in Northeast Asia,” Journal of East Asian Studies 4, no. 1 (January–
April 2004): 1–38.
57. Rozman, Northeast Asia’s Stunted Regionalism; Edward Friedman and Sung Chull Kim,
eds., Regional Cooperation and Its Enemies in Northeast Asia: The Impact of Domestic
Forces (London: Routlege, 2006).
58. Sohn and Lee, “Korea’s Perspectives on East Asian Regionalism,” 181.
59. Hidetaka Yoshimatsu, “Japan’s Keidanren and Free Trade Agreements: Societal Interests
and Trade Policy,” Asian Survey 45, no. 2 (March/April 2005): 258–278.
60. Helen Milner, “Industries, Governments, and Regional Trade Blocs,” in The Political
Economy of Regionalism (see note 3), 77–106.
61. Richard E. Baldwin, “A Domino Theory of Regionalism,” in Trading Blocs: Alternative
Approaches to Analyzing Preferential Trade Agreements, ed. Jagdish Bhagwati, Pravin
Krishna, and Arvind Panagariya (Cambridge: MIT Press, 1999), 479–502.
62. Takashi Shiraishi, “The Third Wave: Southeast Asia and Middle-Class Formation in the
Making of a Region,” in Beyond Japan (see note 42), 237–271.
63. Munakata, Transforming East Asia, 143–144.
64. Feng Zhaokui, “Zouxiang dongya ziyou maoyiqu zhi lu” [The path to East Asian free
trade area], Shijie jingji yu zhengzhi [World Economics and International Politics] 3
(2002): 21–26.
296

INDEX

Note: f refers to figures and t to tables.

ABF. See Asian Bond Fund
ABMI. See Asian Bond Markets Initiative
ACU. See Asian Currency Unit
ADB. See Asian Development Bank
AMCs. See Asset management companies
AMF. See Asian Monetary Fund
Amsden, Alice, 146
Anderson, Benedict, 358
Anti-Fascist People’s Freedom League (Burma), 42
APEC. See Asia-Pacific Economic Cooperation
Aquino, Benigno, 41
Aquino, Corazon, 41
Arroyo, Gloria Macapagal, 41
ASEAN. See Association of Southeast Asian Nations; specific countries
ASEAN Four, 35, 242
See also specific countries
ASEAN Free Trade Area (AFTA), 263–265, 362, 371
ASEAN Plus China Summit, 372
ASEAN Plus Three, 363, 365
Asia-Europe Meeting (ASEM), 308
Asian Bond Fund (ABF), 308–309
Asian Bond Markets Initiative (ABMI), 308
Asian Currency Unit (ACU), 345
Asian Development Bank (ADB), 149, 186, 187t, 345
Asian financial crisis (1997), 171–198
background of, 171–177
developmental state economics and, 149
explanations for, 177–186
crony capitalism, 184–186
economic policies, 181–184
speculative capital, 177–181, 179t, 180f
impact of, 188–190
management of, 186–188
political economy of, 190–191
Asian Monetary Fund (AMF), 308
Asian tigers, 30–34
See also specific countries
Asia-Pacific Economic Cooperation (APEC), 47, 263, 360–362
Asset management companies (AMCs, China), 300
Association of Southeast Asian Nations (ASEAN)
297

free trade agreements and, 362, 364, 371
regional integration and, 153
regionalism and, 362
Vietnam joins, 46
Aung San Suu Kyi, 42–43
Australia, 365
Automobile production, 200, 203, 222

Bangkok International Bank Facility, 299
Banking systems, 282–286
Bank Negara, 294
Bank of Korea, 342
Bank of Taiwan, 293
Bank of Thailand, 216
Barisan Nasional (National Front, Malaysia), 36
Bernanke, Ben, 304
Bernard, Mitchell, 152
BIBF. See Bangkok International Bank Facility
Big Mac index, 325
Blaut, James, 85
Bolshevik Revolution, 113
Bond markets, 289–291, 290t
Borrus, Michael, 210
Bowie, Alasdair, 40
Brand names, 220, 221t, 222, 223
Braudel, Fernand, 79
Bretton Woods system, 296, 326, 339–340
British East India Company, 102, 110
Broadband penetration, 139
Buddhism, 75, 76
Bull, Hedley, 60
Burma. See Myanmar
Burmese Communist Party, 42
Burney Treaty (1826), 110
Business cycles, 359

Cambodia
economic and political development in, 25t, 26
invasion by Vietnam, 46
national system of, 47–48
regional integration and, 153
as transitional economy, 3
Cambodian People’s Party (CPP), 43, 48
Canada and regional integration, 360
Capital
accumulation, 137, 278–282, 278f, 279t, 281t, 282f, 283t
domestic mobilization of, 291–295
Capital-intensive production, 199, 200
Capitalism
corruption and. See Crony capitalism
298

economic miracle and, 139–141
imperialism and, 100
regional development and, 79, 359
Central Provident Fund (Singapore), 215–216, 292, 294
CEPT. See Common Effective Preferential Tariff
Chaebol, 176, 221–222
Chang-Tai Hsieh, 138
Chatichai Choonhaven, 38
Chavalit Youngchaiyudh, 173, 191
Chen Shui-bian, 33
Chiang Ching-kuo, 32, 33, 227
Chiang Kai-shek, 32
Chiang Mai Initiative, 308, 363
Chile, 365, 372
China
Asian financial crisis and, 177, 181, 189
banking system in, 285, 312
nonperforming loans and, 286, 286t, 300
British trade with, 102–103
capital
accumulation and, 278f, 279t, 280, 281t, 282, 282f, 283t
domestic mobilization of, 295
capitalism and, 139, 141
communism in, 43, 113–114, 121
Cultural Revolution in, 7, 44
currency system of, 69
current account surplus by, 305t, 306, 307f
economic and political development in, 3, 8, 24–26, 25t, 159
exchange rate policies of, 325, 327–329t, 331–336, 336f
financial markets in, 287, 288t, 289
politics and, 311
reform of, 299–300
foreign direct investment and, 201, 207–209, 219, 220, 303
free-trade agreements and, 363–365
Great Leap Forward and, 43, 148
historical world order of, 61–65
IMF voting share of, 339–340
imperialism, responses to, 107, 111, 118
industrialization in, 202–203, 217, 223, 243, 244f
merchandise trade and, 239, 241f, 242
monetary systems and domestic policy, 349
silver standard and, 69–70
nationalism in, 113
national system and economic modernization, 22, 43–45
Portugal and, 101
postwar economic growth, 132–133, 133–134t, 135f
regional integration and, 153, 359, 370, 372, 374
regionalization of, 212, 347
Spain and, 101
technology exports, 244–245, 245f
299

trade
disputes, 260
liberalization in, 255t, 256
surpluses by, 246f, 247, 247f
system of, 65–70
as U.S. rival, 157
WTO membership of, 256, 261
China-Japan Tianjin Treaty (1885), 104
China’s National Offshore Oil Corporation (CNOOC), 209
Chinese Communist Party (CPP), 43, 113–114, 121
Chinese State Statistics Bureau, 138
Chuan Leekpai, 38
Chulalongkorn, King, 103
Chun Doo Hwan, 31
CNOOC. See China’s National Offshore Oil Corporation
Colonialism. See Imperialism
Commercial banks, 285
Common Effective Preferential Tariff (CEPT), 264
Communalism, 35
Communism
imperialism and, 112–114
transitional political economies and, 43
U.S. hegemony and, 154
Companies in East Asia, 220–224
Comparative political economy (CPE), defined, 9
Confucianism
Chinese political development and, 63, 64, 71
communism and, 113
in Korea, 74
regional development and, 80
trade systems in China and, 65
in Vietnam, 109
Constructivist theories of regionalism, 370
Corden, W. Max, 182
Corruption perceptions index survey, 34
CPE. See Comparative political economy
CPNs. See Cross-border production networks
CPP. See Cambodian People’s Party; Chinese Communist Party
Crony capitalism
Asian financial crisis and, 184–186
in Philippines, 40, 147–148
in South Korea, 31
Cross-border capital flows, 301–304
Cross-border production networks (CPNs), 210
Crouch, Harold, 24, 159
Cultural Revolution (China), 7, 44
Cumings, Bruce, 151
Currency system
China and, 69
exchange rates. See Exchange rates
300

monetary union and, 343–345
regionalism and, 362–363
regionalization of, 343–347
swap agreements and, 363
Current account balances, 304–306, 305t

D’Albuquerque, Alfonso, 101
Debt financing and Asian financial crisis, 184, 185t
Democratic People’s Republic of Korea (DPRK). See North Korea
Democratic Progressive Party (DPP, Taiwan), 33
Democratic Republic of Vietnam. See Vietnam
Democratization and political economy, 11, 159
Deng Xiaoping, 7, 43–44, 203, 242
Deregulation and speculative capital, 179
Developmental state model, 23, 145–148, 149
Diamond, Jared, 78
Dirty float, 339
Dodge, Joseph, 330
Dollar, David, 257
Dollar standard, 340–343, 342 f
DPP. See Democratic Progressive Party
DPRK (Democratic People’s Republic of Korea). See North Korea
Drake, Francis, 102
Dutch East India Company, 101, 105

Early Voluntary Sector Liberalization (EVSL), 263, 361
East Asian Economic Caucus (EAEC), 362
East Asian Vision Group, 363
East Asia Study Group, 365
Economic development
See also Economic miracle
capital accumulation and, 137
equity and, 132–137
global historical comparison, 80, 81–82t, 83, 84t
growth factors, 150–151
industrialization and, 139
political impact of, 158–160
political regime vs., 11
regional integration and, 153–154, 158
regional perspective of, 151–154
technology and, 137
U.S. influence on East Asian, 154–158
Economic Expansion Incentives Act (1967, Singapore), 254
Economic miracle, 131–169
debate on, 137–139
explanations for, 141–151
neoclassical economics and, 141–145
postwar transformation, 131–141
structural changes in, 139, 140t
Economic partnership agreements (EPAs), 363–365
301

Electronics industry, 201, 372
Embedded autonomy, 23
Embedded mercantilism, 27–28
EMEAP. See Executives Meeting of East Asia and Pacific Central Banks and Monetary
Authorities
Emerging Asia: Changes and Challenges (ADB), 149
Eminent Person’s Group, 361
England. See Great Britain
EPAs. See Economic partnership agreements
Equity markets. See Stock markets
Ernst, Dieter, 210
Estrada, Joseph, 41, 344–345, 363
Europe
See also European Union; specific countries
global economic development and, 80, 81–82t, 83, 84t
IMF donations by, 188
Japanese foreign direct investment in, 209
models of world history based on, 78–79
monetary system crisis (1992–1993) in, 172, 184
political development in, 72
European Union (EU)
See also specific countries
dollar standard and, 341
institutional regionalism in, 361
monetary union of, 344
regionalism and, 362
regional trade interdependence in, 248
shipbuilding in, 200
Euysung Kim, 138
Evans, Peter, 23
EVSL. See Early Voluntary Sector Liberalization
Exchange rates, 323–355
See also Currency system
Asian financial crisis and, 172–174, 173f, 176, 180
impossible trinity and, 182, 335
international monetary regime and, 337–339
national policies, history of, 323–337, 327–329t
pegged vs. floating, 181–183, 330–334
regionalism and, 362–363
regionalization and, 359
swap agreements and, 363
Thailand and Asian financial crisis, 172
Executives Meeting of East Asia and Pacific Central Banks and Monetary Authorities
(EMEAP), 309
Export-free zones, 255
Export-led strategies, 252–254
Exports
East Asian share of, 238–239, 239 t
global comparisons, 239, 240t
growth rates in, 180, 180f, 184, 241–242, 242f
302

manufacture vs. merchandise, 243–244, 244f
manufacturing and, 203
merchandise, 237–238, 238f
Export-transferring strategies, 248

Family-based capitalism, 359
Fertility rate and regional development, 78
Feudalist system, 75
Fields, Gary, 143
Finance, 277–321
banking systems, 282–286
bond markets, 289–291
capital accumulation, 278–282
cross-border capital flows, 301–304
domestic capital mobilization, 291–295
equity markets, 287–289
financial markets, 286–291
global savings glut, 304–307
liberalization of, 295–301
policies on, 291–301
political development and, 309–312
regionalism in, 307–309
Financial Reform Act (1993, Japan), 297
Financial Services Agency (Japan), 297
Fischer, Stanley, 189
Flying geese formation, 151–153, 154
Foreign aid
from Great Britain, 302
to Indonesia, 39
from Japan, 156
from Soviet Union, 302
from United States, 302
Foreign direct investment (FDI)
Asian financial crisis and, 189
to China, 201
from East Asia, 207–210
in East Asia, 204, 205–206t, 208t
industrialization and, 204–207
Japan and, 29, 243
policies on, 218–220
regionalization and, 358
to Southeast Asia, 202
from Taiwan, 201
Foreign Joint Venture Law (1984, North Korea), 153–154
Foreign reserves
exchange rate policies and, 325–326, 337
national holdings of, 337, 338t
U.S. securities held as, 306
France, 102–105, 109–110
Free trade agreements (FTAs)
303

See also specific agreements
regionalism and, 263–265, 361, 363–364
regional trade interdependence and, 248–249
Free trade zones, 254
See also ASEAN Free Trade Area (AFTA)
Front Uni National pour un Cambodge Independent, Neutre, Pacifique, et Cooperatif
(FUNCINPEC), 48
FTAs. See Free trade agreements
Fumimaro, Konoe, 119
FUNCINPEC. See United National Front for an Independent, Neutral, Peaceful, and
Cooperative Cambodia
Functionalist approach to regional integration, 367–369

G5. See Group of Five
Gallagher, Mary, 45
GDP. See Gross domestic product
General Agreement on Tariffs and Trade (GATT), 256, 260–261
General trading companies (GTCs), 252
Geographical definition of East Asia, 3–4
Ghosn, Carlos, 221
Gilley, Bruce, 45
Gini coefficient, 132–133, 137
Globalization vs. regionalization, 359
Global savings glut, 304–307
Goh Chok Tong, 34
Gold Standard–British Sterling hegemony, 339–340
Golkar Party (Indonesia), 39
Gorbachev, Mikhail, 8, 44–45
Great Britain
foreign aid from, 302
imperialism in East Asia by, 102–105, 110
Industrial Revolution in, 83
Malaysia and, 35
Greater East Asia Co-Prosperity Sphere, 119, 357
Great Famine (China), 43, 132
Great Leap Forward (China), 43, 148
Gross domestic product (GDP)
Asian financial crisis and, 174, 174f
China reporting of, 138
gross domestic savings as share of, 278–282, 278f, 278t
historical measures, 84t
merchandise trade as share of, 239–241, 241f
Group of Five (G5), 332
GTCs. See General trading companies
Guided Democracy (Indonesia), 38
Haas, Ernst, 367, 368
Hae-jong Chun, 67
Haggard, Stephan, 138, 146, 190, 210
Han Dynasty, 63
Hang Seng index and Asian financial crisis, 176
304

Hawke, Bob, 361
Hideyoshi, 62
High-performing Asian economies (HPAEs), 132
High-technology industries. See Technology
Hinduism, 76
Historical institutionalism approach to political economy, 7–8
Holland and imperialism, 101–105
Hong Kong
Asian financial crisis and, 176
banking system in, 284
British imperialism in, 102–103
capital accumulation and, 278f, 279t, 280
current account surplus by, 305t, 306, 307f
developmental state economics and, 146
economic growth, postwar, 132–133, 133–134t, 135f
exchange rate policies of, 327–329t, 330, 333–334
export-led strategies, 253
financial markets in, 287
foreign direct investment and, 207–209, 218–219
industrialization in, 200, 201, 216
merchandise trade and, 239, 241f
as newly industrialized economy, 3
political impact of economic growth in, 159
regional integration and, 153
regionalization and, 359
trade
disputes, 259
expansion in, 238, 238f
liberalization in, 255, 255t
HPAEs. See High-performing Asian economies
Hsinchu Science-Based Industrial Park (Taiwan), 215
Hu Jintao, 8
Hun Sen, 48
Huntington, Samuel, 11, 40, 159
Hurrel, Andrew, 358

IBM. See International Business Machines Corp.
IBRA. See Indonesian Bank Restructuring Agency
Ibraham, Anwar, 174
IMF. See International Monetary Fund
Imperialism, 99–129
East Asian responses to, 105–110, 121
Japanese, 114–122
history of, 116–120
legacies of, 120–122
Western, 100–114
history of, 100–105
legacies of, 110–114
Import-substitution strategies, 76, 154, 249–251
Impossible trinity, 182, 335
305

Income distribution, 132–133, 137
Indonesia
Asian financial crisis and, 173, 174–175
banking system in, 285
nonperforming loans and, 286, 286t
capital accumulation and, 278f, 279t, 280
communism in, 113–114
economic and political development in, 25t, 26
exchange rate policies of, 334
financial reform in, 299
Hinduism in, 77
imperialism in, 101, 120
import-substitution strategies and, 251
industrialization in, 202, 217
merchandise trade and, 239–241, 241f
Muslims in, 77
national system of, 38–39
political regime and economics in, 11
regionalization and, 359
trade
expansion in, 238, 238f
liberalization in, 255, 255t
Indonesian Bank Restructuring Agency (IBRA), 299
Indonesian Communist Party (PKI), 38, 114, 268
Industrial clusters, 204
Industrial Master Plan (Malaysia), 216
Industrial Revolution in Western Europe, 59, 78, 83
Industrial sector. See Manufacturing
Institutional political economy, 5–9
International Business Machines Corp. (IBM), 209
International Monetary Fund (IMF)
Asian financial crisis and, 186, 187, 187t, 188
Bretton Woods system and, 339
currency swap agreements and, 363
exchange rate policies and, 326
Indonesia and, 175
Philippines and, 174
Thailand and, 172
U.S. influence on, 4
Washington consensus economics and, 144
International political economy (IPE), defined, 1, 9
International production networks (IPNs), 210
International regime theory of regional integration, 368
Investment-led strategy, 28
IPE. See International political economy
IPNs. See International production networks
Islamism, 76, 285

Japan
APEC and, 361
306

Asian financial crisis and, 180
banking system in, 284
capital
accumulation in, 278–280, 278f, 278t
domestic mobilization of, 292
Chinese world order and, 62
companies in, 220
currency swap agreements and, 363
current account surplus by, 305t, 306, 307f
developmental state economics and, 145–146
dollar standard and, 341–343, 342f
domestic policy in, 226, 267
economic and political development in, 24, 25t, 28
postwar growth, 132–133, 133–134t, 135f
economic partnership agreements and, 363–365
embedded mercantilism in, 27–28
exchange rate policies of, 326–333, 327–329t, 333f, 336–337, 336f
export-led strategies, 252
financial markets in, 287, 288t, 289, 290t, 291
reform of, 296–297
flying geese formation and, 151–153
foreign direct investment and, 207–209, 218, 219–220, 243
free trade agreements and, 363
IMF donations by, 188
imperialism and, 103, 106, 107, 109, 114–122
import-substitution strategies and, 250
industrialization in, 199–200, 214
as mature market democracy, 3
merchandise trade and, 239, 241f
monetary regionalization and, 345–347
nationalism in, 113
national system of, 26–29
political development in, 74–76
Portugal and, 101
protectionism by, 262
regional integration and, 153, 359, 370, 372, 374
regionalization of production and, 211–212
silver exports to China, 70
technology and, 139
trade
during Chinese world order by, 68–69
disputes, 259
expansion in, 238, 238f
surpluses by, 245–247, 246f, 247f
United States and, 154–157
Japan Business Federation, 373
Japanese Central Bank, 343
Japan Export-Import Bank, 219
Japan-Korea Treaty of Kangwha (1876), 104
Japan Post, 292, 297, 311
307

Japan Socialist Party (JSP), 27
Jiaqing, Emperor, 101
Johnson, Chalmers, 145, 146, 148
Joint venture laws, 153–154, 219
Jong-il Kim, 137
JSP. See Japan Socialist Party
Junichiro, Koizumi, 297
Jurong Town Corporation, 215

Kaname, Akamatsu, 151
Kang Youwei, 108
Karen National Union (Burma), 42
Keiretsu system, 220–221, 284
Kennedy, Paul, 224–225
Keohane, Robert O., 368
Kim Dae Jung, 31, 191, 365
Kim Il Sung, 47
Kim Jong Il, 47
Kim Young Sam, 31
KMT. See Kuomintang government
Koguryo, 62, 73
Koizumi, Junichiro, 29, 218, 311, 342–343
Kojima, 219–220
Korea
See also North Korea; South Korea
Chinese world order and, 62
imperialism, responses to, 106, 107, 109, 120
nationalism in, 113
national system and economic modernization, 22–23
political development in, 73–74
tributary relations and, 67
Korean Monetary Authority, 331
Korean War, 154, 156
Krugman, Paul, 137, 184
Kuala Lumpur Stock Exchange, 289, 311
Kubilai Khan, 63
Kuomintang (KMT) government, 22, 32–33
See also Taiwan
Kuroda, Makoto, 371
Kwantung Leased Territory, 116

Labor-intensive production, 199, 200, 203
Labuan International Offshore Financial Centre, 285, 298
Lall, Sanjaya, 149
Land reform, 79, 80, 155
Laos
economic and political development in, 25t, 26
regional integration and, 153
as transitional economy, 3
Lau, Lawrence, 137
308

LDP. See Liberal Democratic Party
Le Duan, 46
Lee, Chung H., 145
Lee Hsien Loong, 34
Lee Kuan Yew, 33–34, 153
Lee Tenghui, 33
Legalism and Chinese political development, 64, 71
Lenovo Group Ltd., 209
Levi, Margaret, 10
Liang Qichao, 108
Liberal Democratic Party (LDP, Japan), 27, 311
Liberal market economies, 23
Life expectancy and regional development, 79
Lindberg, Leon, 368
Lipset, Martin, 11, 159
Little, Ian M. D., 143
Liu Shaoqi, 43–44
Long-Term Capital Management, 177
Long-Term Credit Bank (LTCB), 297
Long Yongtu, 258

Maastricht Treaty (1992), 361
Macau, 101
MacIntyre, Andrew, 153, 190–191
Magellan, Ferdinand, 101
Mahathir Mohamad
Asian financial crisis and, 174, 186
industrialization and, 216, 225
monetary integration and, 344–345
regional integration and, 153
trade agreements and, 264, 362
Malaysia
Asian financial crisis and, 173, 174
banking system in, 285
nonperforming loans and, 286, 286t
capital
accumulation and, 278f, 279t, 280, 282
domestic mobilization of, 294
currency swap agreements and, 363
current account surplus by, 305t, 306, 307f
economic and political development in, 11, 24, 25t, 26, 159
postwar growth, 132–133, 133–134t, 135f
economic partnership agreements and, 364
export-led strategies, 252, 254
financial markets in, 287, 288t, 289
financial reform in, 298, 311
foreign direct investment in, 207
import-substitution strategies and, 251
industrialization in, 202, 216, 225–226, 243, 244f
merchandise trade and, 241, 241f
309

Muslims in, 77
national system of, 35–37
regional integration and, 153
regionalization and, 359
trade
expansion in, 238, 238f
liberalization in, 255t, 256
United States and, 156
Malaysian Chinese Association (MCA), 35
Malaysian Indian Congress (MIC), 35
Manchus, 62, 72–73, 105
Mansfield, Edward, 367
Manufacturing, 199–236
companies in East Asia and, 220–224
domestic policy and, 224–227
exports, 243–244, 244f
foreign direct investment and, 204–207, 218–220
globalization of, 211
industrialization of East Asia and, 199–204
political influence on, 213–220
regionalization of, 210–213
Mao Zedong, 22, 43–44, 121, 202
Maps
China in Qing Dynasty (1644–1911), 106
Japanese imperialism (1895–1941), 117
political East Asia, 3
Silk Road trade route, 68
Western imperialism to 1910, 104
Marcos, Ferdinand, 40, 147–148, 159
Maritime Silk Road, 68
Maritime trade. See Trade
Market Average Exchange Rate System, 334
Marshall, Alfred, 5
Marxism, 113
Masayoshi, Hotta, 115
MCA. See Malaysian Chinese Association
McKinnon, Ronald I., 139, 143, 296, 341, 345
Meiji Restoration, 114–115, 117
Mercantilism, embedded, 27–28
Merchandise exports. See Exports
METI. See Ministry of Economy, Trade, and Industry
Mexico
economic partnership agreements and, 365
peso crisis (1994–1995), 172, 184
regional integration and, 360
MFN. See Most-favored-nation treaty clause
MIC. See Malaysian Indian Congress
Mill, John Stuart, 5
Milner, Helen, 367
Ming Dynasty, 64, 71, 72
310

Ministry of Economy, Trade, and Industry (METI, Japan), 366
Ministry of Finance and Bank of Japan (MOF-BOJ), 337
Ministry of International Trade and Industry (MITI, Japan), 145, 371
Minxin Pei, 45
Mitrany, David, 368
Miyazawa Initiative, 188, 346
MOF-BOJ. See Ministry of Finance and Bank of Japan
Monetary relations. See Currency system; Exchange rates
Monetary union, 343–345
Mongols, 62, 63
Moore, Mike, 261
Morley, James, 24, 159
Most-favored-nation (MFN) treaty clause, 103, 361
Multi-Fiber Agreement, 267
Multiple Currency Basket Peg System, 334
Munakata, Naoko, 366
Mundell, Robert, 182, 312, 335, 344
Muslims. See Islamism
Myanmar
British imperialism in, 110
Buddhism in, 77
economic and political development in, 25t, 26
imperialism by, 106
Japanese imperialism in, 120
national system of, 35, 41–43
Myrdal, Gunnar, 142

NAFTA. See North American Free Trade Agreement
National Front (Malaysia), 36
Nationalism and imperialism, 112–114, 121, 369, 371
Nationalist Party (Taiwan). See Kuomintang (KMT) government; Taiwan
National League for Democracy (Burma), 42–43
National Savings Bank (Malaysia), 294
National systems, 21–57
of Asian Tigers, 30–34
in Cambodia, 47–48
in China, 43–45
economic change and politics, 24, 25t
emulation of, 24
global comparisons, 22–23
in Indonesia, 38–39
in Japan, 26–29
in Malaysia, 35–37
in Myanmar, 35, 41–43
in North Korea, 46–47
overview of, 21–26
in Philippines, 39–41
in Singapore, 33–34
in Southeast Asia, 34–43
in South Korea, 30–32
311

in Taiwan, 32–33
transitional, 43–48
in Vietnam, 46
Naughton, Barry, 153
Naya, Seiji, 138, 145
Neoclassical economics, 141–145
Neo-functionalist approach to regional integration, 367–369
Netherlands and imperialism, 102–105
New Economic Policy (Malaysia), 36
New Economic Program (U.S.), 332
Ne Win, 42
Newly industrialized economies (NIEs), 3, 201–202, 204
New Zealand, 365
Nguyen Anh, 109
Nixon, Richard, 332
Noguchi, Yukio, 293
Noland, Marcus, 149, 214, 218
Nominal exchange rate, 325
Nonperforming loans (NPLs), 286, 286t
North, Douglass, 11, 79
North American Free Trade Agreement (NAFTA), 248, 360, 361, 362
North Korea
communism in, 113–114
economic and political development in, 25t, 26
industrialization in, 202
national system of, 46–47
nuclear testing by, 47
regional integration and, 153–154
as transitional economy, 3
NPLs. See Nonperforming loans
Nye, Joseph S., 368

Official development assistance (ODA), 259
Oligarchy in Philippines, 40
Olson, Mancur, 11, 145
One-party dominant system, 32–33
Open regionalism, 360–362, 371
Opium War, 102, 105, 107
Optimal currency area (OCA) theory, 344
Organization for Economic Cooperation and Development (OECD), 361

Pacific Basin Economic Council (PBEC), 360
Pacific Economic Cooperation Council (PECC), 360
Pacific Trade and Development Conference (PAFTAD), 360
Pack, Howard, 149, 214, 218
Panics, financial, 178–179
PAP. See People’s Action Party
Park Chung Hee, 30–31, 47, 146, 159, 253
Parliamentary democracy, 42
Partai Komunis Indonesia (PKI), 38, 114, 268
312

PBEC. See Pacific Basin Economic Council
PECC. See Pacific Economic Cooperation Council
Pempel, T.J., 27, 29
Pension plans, 292
People’s Action Party (PAP, Singapore), 33–34
People’s Republic of China (PRC). See China
Perkins, Dwight, 73, 139
Perry, Matthew C., 103, 114
Perusahaan Otomobil Nasional (Proton), 216
Petri, Peter, 151
Philippines
Asian financial crisis and, 173–174
capital
accumulation of, 278f, 279t, 280
domestic mobilization of, 295
developmental state economics and, 147
economic and political development in, 25t, 26
economic partnership agreements and, 364
exchange rate policies of, 327–329t, 331
financial markets in, 287, 288t
reform of, 298
foreign direct investment in, 219
imperialism in, 101, 103, 120
import-substitution strategies and, 251
industrialization in, 202, 243, 244 f
land reform in, 155
merchandise trade and, 241, 241f
monetary systems and domestic policy, 348
Muslims in, 77
national system of, 39–41
nonperforming loans and, 286, 286t
trade
expansion in, 238, 238f
liberalization in, 255t, 256
PKI. See Indonesian Communist Party
Plaza Accords of 1985, 26, 28, 156, 332
Political development
in China, 70–73
domestic policies, 224–227, 265–268
economic development and, 10, 24, 25t, 158–160
finance and, 309–312
manufacturing and, 213–220
monetary systems and, 348–349
power and, 8–9
Political regimes and economic development, 11
Pol Pot regime, 48
Pomeranz, 85
Population g rowth and regional development, 80
Portugal and imperialism, 100–101, 114
Power and political institutions, 8–9
313

PRC. See China
Prebisch, Raul, 142
Principles of Economics (Marshall), 5
Product cycle theory, 152
Production. See Manufacturing
Property rights and regional development, 79, 80
See also Land reform
Protectionism, 262
Proton. See Perusahaan Otomobil Nasional
Purchasing power parity (PPP), 325

Qianlong, Emperor, 66, 72
Qing Dynasty, 62, 63, 64, 71, 105

Rajin-Sonbong Economic and Trade Zone, 219
Ramos, Fidel, 41, 173–174
Rational choice approach to political economy, 6–7
Ravenhill, John, 152
Rawski, Thomas, 138
Real effective exchange rate (REER), 334, 336f
Real exchange rate, 325
Realist theories of regionalism, 369
Regional integration
of financial markets, 307–309
functionalist and neo-functionalist approaches to, 367–369
international regime theory of, 368
monetary system and, 345–347, 362–363
role in economic miracle, 153–154
of trade, 358
United States and, 158
Regionalism, 357–380
constructivist explanations for, 370
defined, 358
in East Asia, 360–366
economic theories of, 366–367
free trade agreements and, 363–365
history of, 360–362
monetary cooperation and, 362–363
plus vs. minus regionalism, 365–366
political economy theories of, 367–372
political influences on, 373–374
realist explanations for, 369
strategic explanations for, 370–372
Regionalization
defined, 358
in East Asia, 358–360
of monetary system, 343–347
of production, 210–213
Regional trade agreements (RTAs), 258, 264–265, 367, 371
Regulations for Maritime and Overland Trade between China and Korean subjects (1882),
314

104
Reid, Anthony, 77, 101
Rhee Syngman, 30
Rodrik, Dani, 257
Roh Tae Woo, 31
Roland-Holst, David, 211
Roubini, Nouriel, 182
RTAs. See Regional trade agreements
Russia
Asian financial crisis and, 177
communism and, 113
imperialism in East Asia by, 102–105
Ryutaro, Hashimoto, 297

Sachs, Jeffrey, 178
Samuelson, Paul, 142
Savings
accumulation in East Asia, 304–307
as share of GDP, 278–282, 278f, 278t
Scheineman, Lawrence, 368
Schmitter, Philippe, 368
Scitovksy, Tibor, 143
Scott, Maurice, 143
Setser, Brad, 182
Shang Dynasty, 70
Shanghai Stock Exchange, 289
Shareholder capitalism, 359
Shariah principles, 285
Shaw, Edward S., 296
Shenzhen Stock Exchange, 289
Shihuangdi, Emperor, 64
Shimonoseki Treaty (1895), 108
Shipbuilding industry, 200, 203
Sh in, Yoshida, 115
Sieishisai, Aizawa, 115
Silk Road, 67–68
Silla Dynasty, 73–74
Silver standard, 69–70
Singapore
banking system in, 284
capital
accumulation and, 278f, 279t, 280, 281t, 282, 282f, 283t
domestic mobilization of, 292, 294
current account surplus by, 305t, 306, 307 f
economic and political development in, 24, 25t, 159
postwar growth, 132–133, 133–134t, 135f
economic partnership agreements and, 364
exchange rate policies of, 327–329t, 331
export-led strategies, 254
financial markets in, 287
315

foreign direct investment and, 207, 219, 303
free trade agreements and, 363, 365
imperialism in, 103
import-substitution strategies and, 250
industrialization in, 200, 201, 215–216
merchandise trade and, 239, 241f
national system of, 33–34
as newly industrialized economy, 3
trade
expansion in, 238, 238f
liberalization in, 255, 255 t
Sino-Japanese War (1894–1895), 108, 117
Smith, Adam, 5
Socialism, 43
Socialist Republic of Vietnam. See Vietnam
Socially embedded economies, 23
Solow, Robert, 142
Southeast Asia
See also specific countries
foreign direct investment to, 202
national systems of, 34–43
political development in, 76–78
South Korea
Asian financial crisis and, 176
banking system in, 284
capital
accumulation and, 278f, 279t, 280, 281t, 282f, 283t
domestic mobilization of, 293
companies in, 221–222
currency swap agreements and, 363
current account surplus by, 305t, 306, 307f
democratization in, 11
developmental state economics and, 145–146, 147
dollar standard and, 342–343
domestic policy in, 267
economic and political development in, 25t, 26, 158–159
postwar growth, 132–133, 133–134t, 135f
exchange rate policies of, 327–329t, 330–331, 334
export-led strategies, 253
financial markets in, 287, 288t
reform of, 297–298
foreign direct investment in, 207, 218, 303
free trade agreements and, 363, 365
import-substitution strategies and, 154, 250
industrialization in, 200, 214
land reform in, 155
merchandise trade and, 241, 241f
national system of, 30–32
as newly industrialized economy, 3
regional integration and, 153, 372
316

regionalization and, 359
technology and, 139
trade
disputes, 260
liberalization in, 255t, 256
surpluses by, 246f, 247, 247f
Sovereignty and imperialism, 100, 110–111
Soviet Union, 302
See also Russia
Spain and imperialism, 101–105
Spanish America and silver standard, 69–70
Spanish-American War of 1898, 103
Speculative capital and Asian financial crisis, 177–181, 179t
Spice Route, 68
Stakeholder capitalism, 359
State-Owned Asset Supervision and Administration Commission (China), 217
State Peace and Development Council, 42
Stiglitz, Joseph, 187
Stock Exchange of Singapore, 289
Stock markets, 176, 287–289
Strategic theories of regionalism, 370–372
Suharto, 38–39, 146, 175, 190
Sukarno, 38
Summers, Lawrence, 304
Supachai Panitchpakdi, 261
Susilo Bambang Yudhoyono, 39
Swan, Trevor, 142
Swap agreements, 363

Taika Reform, 74–75
Taiwan
Asian financial crisis and, 175
banking system in, 285
capital
accumulation and, 278f, 279t, 280, 281t, 282f, 283t
domestic mobilization of, 293
companies in, 222
current account surplus by, 305t, 306, 307f
democratization in, 11
domestic policy in, 226, 267
Dutch trade with, 101
economic and political development in
developmental state and, 145–146, 147
postwar growth, 132–133, 133–134t, 135f
exchange rate policies of, 327–329t, 330
export-led strategies, 252
financial reform in, 298
foreign direct investment and, 207–209, 219, 303
imperialism in, 117
import-substitution strategies and, 154, 250
317

industrialization in, 200–201, 215, 243–244
Japanese imperialism in, 120
land reform in, 155
national system and economic modernization, 22
national system of, 32–33
as newly industrialized economy, 3
political impact of economic growth in, 158–159
regional integration and, 153
regionalization and, 359
trade
disputes, 260
expansion in, 238, 238f
surpluses by, 246f, 247, 247 f
Takeshi, Hameshita, 69
Tang Dynasty, 62
Taoism, 71
Tariffs, 254–256, 255t
Taxation and Chinese political development, 71–72
Technology
economic growth and, 137, 139
exports, 244–245, 245f
imperialism and, 109
industrialization and, 199, 203–204
nationalism and, 113
Thailand
Asian financial crisis and, 172, 174
banking system in, 285
nonperforming loans and, 286, 286t
Buddhism in, 77
capital accumulation and, 278f, 279t, 280
currency swap agreements and, 363
economic and political development in, 25t, 26
exchange rate policies in, 183
financial markets in, 287, 288t
reform of, 299
foreign direct investment in, 207
imperialism, responses to, 110
industrialization in, 202, 216–217, 243, 244f
merchandise trade and, 241, 241f
Muslims in, 77
regionalization and, 359
trade
liberalization in, 255t, 256
with United States, 156
Thai Rak Thai Party, 38
Thaksin Shinawatra, 38
Thomas, Robert, 11, 79
Tokugawa, Japan
See also Japan
Chinese world order and, 62
318

imperialism and, 101–102, 150
import substitution in, 76
political development and, 75
trade during Chinese world order by, 69
Toshihiro, Nikai, 365–366
Total factor productivity (TFP), 137
Toyotomi, Hideyoshi, 106
Trade, 237–276
Chinese world order and, 65–70
disputes, 258–263
domestic policy and, 265–268
exchange rates, impact on, 69–70
expansion of, 237–243
exports. See Exports
imperialism and expansion of, 111
import-substitution strategies, 249–251
liberalization of, 254–258, 361
maritime, 77, 238–239
regional integration of, 358, 359, 368, 374
regional interdependence of, 248–249, 263–265
retaliatory policies, 156–157
structural changes in, 243–245
surpluses, 245–248, 246f
Trade Act (1974, U.S.), 259
Trade diversion theory, 367
Transparency International, 34
Treaties
See also specific agreements
compared to tributary relationships, 103
imperialism and trade, 102–105, 114
nationalism and, 112
Treaty of Kangwha (1876), 116
Treaty of Yandabo (1826), 110
Treaty port system, 102–103, 111
Tribute relations, 64–66, 103

Unger, Danny, 40
United Malays National Organization (UMNO), 35–36
United National Front for an Independent, Neutral, Peaceful, and Cooperative Cambodia
(FUNCINPEC), 48
United Nations Conference on Trade and Development, 184
United States
Asian financial crisis and, 177
current account balances for, 305t, 306, 307f
dollar standard and, 340–343
East Asian economic development and, 154–158
exchange rate policies, influence on, 326, 330
financial system safeguards against panics, 178–179
foreign aid from, 302
free trade agreements and, 363, 365
319

IMF, influence on, 188, 340
imperialism in East Asia by, 102–105
Japanese foreign direct investment in, 209
Japanese imperialism in, 118
military presence in East Asia, 4
regional integration and, 360, 370
regionalism and, 361
trade
deficits in, 245–247, 246f, 247f
disputes, 258–260
retaliation by, 156–157
Washington consensus economics and, 144
United States Trade Representative (USTR), 259
Unocal Corp., 209

Vasco da Gama, 100
VER. See Voluntary export restraint
Vernon, Raymond, 152
Vietnam
capital accumulation and, 278f, 279t, 280
capitalism in, 141
Chinese world order and, 62
economic and political development in, 25t, 26
postwar economic growth, 132–133, 133–134t, 135f
exchange rate policies of, 327–329t, 332, 334–335
foreign direct investment in, 219
imperialism and, 46, 106, 109–110
joins World Trade Organization, 47, 257
manufacture vs. merchandise exports, 243, 244f
national system of, 46
political development in, 76
regional integration and, 153
as transitional economy, 3
Vietnamese Communist Party, 46
Vietnam War, 154, 156
Viner, Jacob, 367
Vogel, Ezra, 26
Vogel, Steven, 29
Voluntary export restraint (VER), 259

Wade, Robert, 146, 178, 188
Wallerstein, Immanuel, 85
War and political economy development, 85
Washington consensus economics, 144, 149
Weber, Max, 79
Western Europe
Industrial Revolution and, 59, 78, 83
regional integration and, 359, 360
rise of, 83–86
Westphalian system, 59, 111
320

Williamson, John, 144
A Working Peace System (Mitrany), 368
World Bank
Asian financial crisis and, 186, 187 t
foreign aid from, 302
IMF reform and, 340
Japan and, 148
U.S. influence on, 4
Washington consensus economics and, 144
World order, 59–97
Asian historical models of, 79–83
comparative political studies of, 70–78
Eurocentric historical models of, 78–79
imperialism and, 100
international order, 60–65
wealth measures, 80, 81–82t, 83, 84 t
World Trade Organization (WTO)
China membership in, 256, 347
East Asia and, 260–261
regionalism and, 361
Vietnam joins, 47, 141, 257
Wudi, Emperor, 64

Xia Dyansty, 70
Xiongnu empire, 64

Yanagihara, Toru, 149
Yan Fu, 108
Yangban, 74
Yi Dynasty, 74
Ying-shih Yu, 66
Yoshimitsu, Ashikaga, 62
Yosuke, Matsuoka, 119
Young, Alwyn, 137
Yuan Dynasty, 62

Zaibatsu, 117, 220
Zen Buddhism, 75
Zheng Chenggong, 105
Zheng He, 63
Zhou Dynasty, 70
Zhu Rongji, 300, 372
321

Title
Copyright
Dedication
Contents
Tables, Figures, and Maps
Preface
PART I: INTRODUCTION
1. Introduction
What Is East Asia?
The Political Economy Approach
Defining Political Economy
Institutions
Comparative Political Economy and International Political Economy
The State and the Market
Economic Growth Versus Political Regime
Power of Ideas
Design of the Book
Suggested Readings
Notes
2. The East Asian National Systems of Political Economy
The Political Economy Systems of East Asia: An Overview
The Japanese System of Political Economy
The Embedded Mercantilism
Structural Reform
The Political Economy Systems of the Asian Tigers
South Korea
Taiwan
Singapore
The Political Economy Systems of Southeast Asia
Malaysia
Thailand
Indonesia
The Philippines
Burma/Myanmar
The Transitional Political Economies
China
Vietnam
North Korea
Cambodia
Conclusion
Suggested Readings
Notes

PART II: THE RISE AND FALL OF EAST ASIA
3. The Chinese World Order
World Orders
International Order
The Chinese World Order
Political Economy of East Asian Trade
Comparative Political Economy
China
Korea
Japan
Southeast Asia
Beyond European Models of World History
Eurocentric Models of World History
New Scholarship on World History
Why Did the West Rise?
Conclusion
Suggested Readings
Notes
4. Modern Imperialism
Western Imperialism
Imperialism
History of Western Domination in East Asia
East Asian Responses to Western Domination
Legacies of Western Colonialism
Japanese Imperialism
Japanese Response to Western Imperialism
History of Japanese Imperialism
Legacies of Japanese Imperialism
Conclusion
Suggested Readings
Notes
5. The East Asian Miracle
Postwar Transformation of East Asian Political Economy
Rapid Economic Growth with Equity
Was There a Miracle?
Structural Change
March to Capitalism
Explaining the East Asian Miracle
Neoclassical Economics
The Developmental State Approach
The East Asian Challenge
What Exactly Explains the East Asian Miracle?
A Regional Perspective of East Asian Political Economy
Flying Geese Formation
Regional Integration and Learning
The United States and East Asian Political Economy
The U.S. Hegemony
Managing Rivals
The United States and East Asian Regionalism
The Political Economy of Growth
Conclusion
Suggested Readings
Notes
6. The Asian Financial Crisis
Tracing the Crisis
Explaining the Crisis
Speculative Capital
Unsustainable Economic Policies
Crony Capitalism
Managing the Crisis
The Consequences of the Crisis
The Political Economy of the Crisis
Conclusion
Suggested Readings
Notes

PART III: ISSUES OF EAST ASIAN POLITICAL ECONOMY
7. The Political Economy of East Asian Production
The “Factory” of the World
East Asian Industrialization
Foreign Direct Investment in East Asia
The Investors of the World
Regionalization of Production
The East Asian State and Production
Picking the Winners
Foreign Direct Investment Policies
East Asian Companies
Domestic Political Economy of Production
Conclusion
Suggested Readings
Notes
8. The Political Economy of East Asian Trade
Trade Patterns in East Asia
Rapid Expansion in Trade
Structural Change in Trade
Surplus with the World
Greater Regional Trade Interdependence
East Asian Trade Strategies
Import Substitution
Export Promotion
Trade Liberalization
Facing the World
Managing Trade Disputes
Global Rules, Asian Plays
East Asian Trade Regionalism
Domestic Political Economy of Trade
Conclusion
Suggested Readings
Notes
9. The Political Economy of East Asian Finance
East Asian Finance
East Asian Capital Accumulation
East Asian Banking
Shallow Financial Markets
East Asian Financial Policies
Mobilizing Domestic Capital
Financial Liberalization
East Asia in Global Finance
Cross-Border Capital Flows
Global Saving Glut
East Asian Financial Regionalism
East Asian Political Economy of Finance
Conclusion
Suggested Readings
Notes
10. The Political Economy of East Asian Monetary Relations
East Asian Exchange Rate Policy
Exchange Rate Policies
East Asian Exchange Rate Policies Through the Early 1970s
From the Early 1970s to the 1997 Financial Crisis
Postcrisis East Asian Exchange Rate Regimes
East Asia in the Global Monetary System
International Monetary Regime
East Asia and the Bretton Woods System
The Dollar Standard
East Asian Regional Monetary System
Monetary Union
A Yen Bloc
The Yuan’s Arrival
East Asian Political Economy of Money
Conclusion
Suggested Readings
Notes
11. The Political Economy of East Asian Regionalism
Defining Regionalization and Regionalism
East Asian Regionalization
East Asian Regionalism
Open Regionalism
The New East Asian Regionalism
“East Asia Plus” Versus “East Asia Minus” Regionalism
Theories of Regionalism
Economic Theories of Regionalism
Political Economy Theories of Regionalism
Political Economy of Regionalism
Conclusion
Suggested Readings
Notes

Index

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