The Decline of a Japan-led Model of the East Asian Economy Andrew MacIntyre & Barry Naughton* Revised October 15, 2002 * We thank Peter Drysdale, Ross Garnaut, Stephan Haggard and T.J. Pempel for very helpful critiques of earlier drafts of this paper, and Pablo Pinto for research assistance. Andrew MacIntyre is Director of the Asia-Pacific School of Economics and Government at the Australian National University, and Barry Naughton is Professor in the Graduate School of International Relations and Pacific Studies at the University of California, San Diego. 1 The dynamism of the Asian economies since the 1950s not only implies rapid growth, it also implies continuous change in the economic relations among East Asian countries. In this paper we map the changing interests of three key East Asian countries with respect to the main economic issues, and explore the way in which those perceived interests shape what those countries have sought to achieve from regional economic cooperation. Specifically, we focus on the interaction between changes within national political economies and changes in the wider regional economy, and the effect these two variables have on had on government-to-government economic cooperation in Asia. Our aim is to describe and explain what we see as a basic shift in the pattern of economic and economic cooperation in East Asia. The established wisdom about both economic integration in East Asia and government-to-government economic cooperation has been informed by the wave of literature produced in the 1990s that sought to make sense of the remarkable developments in the region in the early part of that decade and the latter part of the preceding decade. In this paper we attempt to make sense of the many important changes at both the national and regional levels since that time, the consequences of which are now beginning to become more clearly apparent. To highlight these changes, we develop a simplifying framework in which East Asian economic interactions are divided into two periods: the first, from about 1985 to about 1994, we characterize as the period of the flying goose model and of “open regionalism”, or APEC-style consensual cooperation among governments. The second period, from about 1994 through the present, we characterize as a period of instability in economic hierarchies and economic relations. The new period reflects the emergence of competing inter-regional production complexes (Japan-centered vs. greater China). The result has been great difficulty in converging on patterns of regional cooperation that are seen to be mutually beneficial by the countries involved. We develop and illustrate this argument by focusing on the behavior of three Asian countries: Japan, China, and Indonesia. We use these countries not simply because they are the biggest. We use them because, together, they capture much of the essential dynamics of regional economic cooperation across East Asia. In broad terms, we can 2 think of Japan, followed by South Korea, Taiwan, Hong Kong, and Singapore as representing capital- and technology-rich political economies, which potentially form the nodes of high-level economic development. China represents the most important of the dynamic middle-tier economies whose rapid growth is disrupting traditional economic relationships.2 The cross-border production networks that link China and Taiwan, as well as Singapore and Malaysia, are creating dynamic economic regions that are closing the gap with Japan. Indonesia shares with Thailand, the Philippines, and Malaysia many characteristics as resource- and labor-rich political economies. During our first period from the mid-80s to the early-90s – the period of more hierarchical regional economic relations – the rough characterizations of economies in the previous paragraph captures much of the fundamental character of Asia’s political economy. Subsequently, however, as the hierarchical regional structure increasingly breaks down, this becomes a less satisfactory taxonomy. But this gets us to the heart of the paper: the changing dynamics of the Asian regional economy and the implications of this for attempts by national governments to build regional economic cooperation. The paper is organized in two main sections, corresponding to the two periods we seek to contrast. And then, for each period, we present five short sub-sections: the overall economic environment, country sections for Indonesia, China and Japan, and the implications for international cooperation. IA. The Economic Setting in the 1985-1994 Period The year 1985 marks a convenient starting point for the acceleration of integration in East Asia. The Plaza Accord of that year, and the currency realignments that followed in its wake, were key short-term drivers of change. Currency realignments crystallized the economic changes that had been building over the previous couple decades. By the early 1980s, the remarkable success of Japan had been followed by that of the “four small dragons” (Korea, Taiwan, Hong Kong and Singapore) in pursuing export oriented industrialization. The success of that development strategy created huge export 3 surpluses, which in turn created irresistible upward pressure on the currencies of Japan and some of the dragons. Thus, currency realignments were simultaneously consequences of an existing development outcomes, and causes of further changes in the economic strategy of other East Asian actors. In the short run, again, currency realignment made production in Japan, Korea and Taiwan much more costly, and encouraged firms in those countries to relocate production to less developed parts of Asia. But the receptivity of those other countries was greatly enhanced by three factors. First was the demonstration effect. Countries such as China and Indonesia saw the success of Taiwan and Korea first hand, and observed the development gap open up between them. The second exogenous factor influencing receptivity was the collapse in raw material prices that began in the early 1980s and culminated in the rapid decline in petroleum prices in 1986. This convinced oil exporters like Indonesia and China—but also agricultural material exporters such as Malaysia and Thailand—that there was no real future with commodity-based export development. Third, the success of the Japanese economy, combined with the appreciation of the Japanese currency, meant that Japanese capital and technology was available to the rest of Asia. We use the familiar “flying goose” label to describe this period. The key factors that make the label applicable are the following: 1: There was perceived to be a clear hierarchy of economic development in East Asia at this time. Japan was unambiguously the economic leader, in all respects. Korea and Taiwan were unambiguously second, with Singapore and Hong Kong close behind technologically, and bringing superior commercial resources. Malaysia and Thailand came next, and China and Indonesia followed. Potential entrants waited outside the door: Vietnam most importantly. 2: Japan was seen to be the key source of both capital and technology. Japanese investment came both through foreign direct investment [FDI] and through bank lending. Japanese technology made its FDI especially attractive. Japanese corporate networks 2 In addition, China shares with Vietnam, Cambodia, and Laos characteristics of transitioning socialist regimes 4 would integrate firms in other East Asian economies, providing rapid institutional and managerial learning, in addition to “hard” technology transfer. 3: Significant aspects of the Japanese economic policy were seen to be not only successful, but also replicable. Protection of some domestic economic sectors was not seen to be an obstacle to export-driven growth. So long as selective trade promotion effectively targeted emerging export sectors—and stable macroeconomic policies provided a predictable, low inflation environment—countries could gradually emerge into the world economy without the political and economic disruption of across-the-board liberalization. Like any simple metaphor, the flying goose model falls short of a comprehensive description of the complex Asian reality. It papers over important differences among the various categories or cohorts of developing East Asian economies. For instance, there is important variance in terms of the significance of agriculture and extractive industries, the character of protectionism, the extent of openness to foreign investment, and the basic political economies of foreign economic policy (Bernard & Ravenhill, 1995; MacIntyre, 1994; Hill, 1993; Jomo, 1997). But our purpose is not to talk a out differing development models around the region. Further, the flying goose metaphor (and, indeed, the very notion of “an East Asian economy”) clearly does not come to grips with the glaring fact the United States was a critical part of the underlying economic equation. None of this is in dispute. To be clear, we invoke the flying geese image not to describe the model of economic development in any particular country or to characterize the totality of international economic relations across the greater Pacific, but to capture the perceived nature of economic relations among East Asian countries. For our purposes the utility of the model is that it captures the notion of an hierarchical pattern of economic development across Asia, in which it appeared national economies could interact without fundamental conflict of economic interests. Japan was the key driver and would stay on top, but the