INTRODUCTION

Before the outbreak of the Asian financial crisis in 1997 East Asian economies were widely praised for their rapid growth, and their development strategies were held up as models for other countries. A famous study by the World Bank coined the term "East Asian Miracle."¹ It sparked a wave of research on the determinants of this miracle and the possibility of replicating it in other parts of the world. Although there remained some controversial issues, the East Asian Miracle literature had soon reached broad consensus on the main causes of East Asia's economic success. Rapid growth was explained by a strong export orientation, high savings rates, and sound macroeconomic policies underpinned by a solid institutional framework.

1. World Bank (1993).

In the wake of the crisis, there has been a marked shift in popular sentiment. The former miracle is now often perceived as a myth, and it has become common to blame government institutions for the crisis.²

2. The term myth is often also associated with another debate: that on the contribution of total factor productivity (TFP) to East Asian growth. Paul Krugman (1994) popularized this debate as well as the phrase "myth of the East Asian Miracle" in an article that suggested that the East Asian countries could not continue growing at the same speed as they had in the past. His argument was based on Alwyn Young's (1992, 1994) study of how East Asian countries had been growing: mainly by accumulating more factors of production, rather than by increasing productivity in their use. The subject has given rise to a new field of research on the effects of TFP growth in East Asian countries. What is important to note is that the term myth in this literature is not used to refer to the origin of a sudden crisis but rather to the sources of long-term growth. In fact Krugman himself has rejected the claim that he had predicted the Asian crisis.

What used to be defined positively as "cooperation between the private and public sectors" has been transformed into "crony capitalism" - a vicious mix of corruption, nepotism, and government meddling. Countries that were thought to have sound management of their economic policies are now perceived as having mismanaged exchange rates and provided guarantees for reckless banks that continued to borrow excessively.

Such extreme comments - suggesting that there never really was an economic miracle, that it was always a myth - are certainly exaggerated. That most of the East Asian countries now find themselves in a deep financial crisis does not erase the fact that their gross domestic product per capita had previously grown at rates of more than 5 per cent over more than two decades. The miracle was real, and so were the reductions in poverty and the improvements in living conditions that came with it.

What role did governments play in engineering this miracle? Three kinds of answers have been offered to this question. The first emphasizes industrial policies, the second "Asian capitalism" and "Asian values," and the third an institutional framework favorable to private sector activity. The first two explanations remain controversial, to say the least. The last one is the subject of this book.

Regarding the first answer, there is no question that governments, at least in North East Asian countries, did not follow the model of a passive or minimalist state but rather intervened heavily in their nations' economies and played a very active role in promoting exports and supporting specific industries. What remains controversial is how effective these industrial policies were. Supporters of such policies point to the successful export industries (for instance the Korean shipbuilding industry) that developed under massive government support and protection. East Asian governments, so they claim, have mostly been successful in picking "winners," providing them with time-bound protection and strong incentives to become competitive, while routinely cutting off "losers" from further support. The counterclaim is that government incentives, especially the ones directed at promoting exports, merely counterbalanced the disincentive effects of protective import policies. The net incentive effect, according to this view, was more or less what a free market would have provided. In other words, industrial policies may not have hurt growth, but they did not promote it either - perhaps East Asian countries would have grown even faster had governments not intervened so heavily. The supporters of this last claim find new ammunition in the recent financial troubles, seeing them as the proof of a large-scale misallocation of resources in the banking system, in the form of bad loans, that has finally come to light. Certainly the final verdict in the debate on the role of industrial policies in East Asia has yet to be rendered. Indeed it is likely that the question will never be completely settled, because either position is difficult to prove in the absence of a counterfactual.

The second, even more controversial, proposition is that East Asia's growth was due to unique Asian values and that governments promoted a special kind of capitalism. Obviously there is no commonly agreed-upon definition of "Asian values" or "Asian capitalism." The idea of a uniquely Asian variety of capitalism is sometimes linked with the industrial policy debate, in the sense that governments are called to play an active, supportive, paternal role in guiding the economy and society in general. The catch phrase "Asian values" is shorthand for the notion that Asian people are devoted to hard work, cultivate strong family ties, and have a preference for working in and with tightly knit networks. It is clear that these propositions are highly controversial - mainly because it is not at all obvious that such values are specific only to Asia. Authoritarian and paternalistic states are certainly not unique to East Asia. Close family ties and business relations within extended families are common in many developing countries. And it has often been pointed out that the Confucian values that are now considered a key to East Asian development were widely seen back in the 1950s as the main obstacle to that same development.

This brings us to the last answer regarding government's role in promoting growth: the proposition that East Asian governments provided a favorable institutional framework within which the private sector was able to develop. What is meant by a favorable institutional framework? The East Asian Miracle report suggested two characteristics: (1) East Asian governments had very close ties with business, were receptive to its problems, and developed policies in cooperation with the private sector. (2) East Asian bureaucrats were competent, independent, and highly motivated. Three further qualities of a favorable institutional framework have been proposed by the broader literature that was sparked by the renewed interest in the determinants of growth: (3) the role of secure property and contract rights (or, more generally, the rule of law), (4) the harmful impact of high levels of corruption on growth, and (5) the negative effect of political instability.

These are the five qualities of the institutional framework that will be analyzed in this book in an attempt to answer the question of whether better institutional performance can explain higher levels of growth. Most of the evidence presented to date in support of this claim has been informal or based on country studies. An important reason for this approach were the inherent difficulties in quantifying such factors as the nature of ties between business communities and governments, the effectiveness of bureaucracies, and the prevalence of corruption. However, better data have recently become available, making a more systematic analysis possible.

The plan of the book is as follows: Chapter 1 reviews the literature that links growth and institutions and provides the conceptual framework for the analysis. Drawing on the research surrounding the East Asian Miracle study as well as the broader literature on institutions and growth, five qualities of a favorable institutional framework are identified and discussed.

Chapter 2 presents the data and the empirical setup. In order to quantify the quality of government performance, data from a large number of indicators of institutional quality were collected. The indicators either are based on surveys of local entrepreneurs or of international experts or were collected by professional risk assessment firms, academic researchers, or the World Bank. It is clear that measuring the quality of institutions consistently across countries is not easy. Every class of indicators has advantages and disadvantages, and these are also discussed in this chapter; however, the aim is to provide more confidence in the results by using measures of institutional quality from various sources.

Chapter 3 proceeds to test the indicators of institutional quality in growth regressions. Overall this analysis provides support for the claim that differences in the quality of the institutional framework can explain differences in levels of growth. However, there are some interesting qualifications to this finding. For instance, it appears that close cooperation between the public and private sectors is not so tightly associated with differences in growth as the East Asian Miracle literature has led us to believe. On the other hand, efficient and motivated bureaucracies do seem to be associated with high levels of growth. The strongest growth effects, though, appear to be fostered by the most basic qualities of a sound institutional framework, namely law and order, and security of property and contract rights.

Chapter 4 takes a closer look at the quality of institutions in East Asian countries and compares them with those in the rest of the world. Scorecards with more than 30 indicators of institutional quality are presented for Thailand, Malaysia, South Korea, Singapore, and Hong Kong. They show that Hong Kong and Singapore indeed had extremely favorable institutional conditions. Both countries rank in the very top of the worldwide comparison. The picture is more murky for Malaysia and South Korea. Their overall institutional performance is more in line with India's than with that of more advanced countries. And in most dimensions institutional conditions in Thailand were even worse. This finding leads to the conclusion that the East Asian Miracle literature may have been too positive - or at least not well enough differentiated - in its praise of institutional conditions in East Asia.

Chapter 5 is dedicated to the causes and consequences of corruption. The motivation for focusing on the issue of corruption is twofold: It has come to be seen as one of the largest obstacles to development, and it is also viewed as one of the triggers of the Asian financial crisis. This chapter first reviews some existing evidence on the negative economic effects of corruption and then, with the benefit of new data, tests for different possible determinants. The findings suggest that corruption can be controlled through liberalization, that is, through a reduction in the opportunities for corrupt payments, better incentives within the bureaucracy, and more external controls on the bureaucracy.

Regarding the question of whether corruption may have triggered the crisis, I find no supporting evidence for this hypothesis. Although levels of corruption had indeed been very high in some East Asian countries - notably Thailand and Indonesia - they had been so for a long time before the crisis. The degree of corruption had not increased over the years preceding the crisis; on the contrary, in most East Asian countries corruption had instead been declining.

The inspiration for this book was studies I conducted as a visiting scholar at the United Nations University in Tokyo in 1997 and 1998. Tokyo was then one of the focal points of the debate surrounding the lessons to be drawn from the East Asian experience. Japanese scholars have been among the most active in this debate because many of them disagreed with the analysis as initially presented by the World Bank.

I had also worked at the World Bank as a member of the team that prepared the World Development Report 1997. This report was a general reassessment of the role governments should play in the development process. Trying to understand the role of governments in the East Asian experience had been one of the central research topics for the team (although this subject was not discussed at length in the report itself). In the process of preparing the report we conducted a worldwide survey and collected a new data set on institutional conditions. Unfortunately the survey had only very poor coverage of the East Asian countries. Therefore, together with Aymo Brunetti of the University of Basel, I expanded the data set for East Asia. This extended data set opened up the possibility of taking a new look at the empirical evidence on the role of governments in the East Asian experience.³

3. This extended data set, the WDR+ survey, can be downloaded from the Internet at www.unibas.ch/wwz/wifor/survey.

The book is addressed to two types of readers. One is the academic audience, interested in the topics of growth, development, institutions, and corruption. The second is the broader audience of observers and commentators interested in the experience of the East Asian economies. In an effort to satisfy both types of readers, all formal results are also presented in summary tables and are discussed in a non-technical manner.

I am grateful to many people for helpful comments and continued support, but I owe special thanks to my husband Filippo di Mauro and to Aymo Brunetti, Alberto Alesina, Silvio Borner, Guy Pfeffermann, and Julius Court.