TFP myths for East Asia's fast-growing economies …

       TFP myths for East Asia's fast-growing economies
                              by
                     Danny Tyson Quah
                      9 September 1997

A decade after the end of the Cold War, Soviet fear still stalks East
Asia. The bogeyman now, however, is not Communist conquest and
domination. Instead it is that East Asia may have unsuspectingly
always been like the Soviets already. East Asia and the Stalinist
Soviets both enjoyed high economic growth by putting to work more
labor and driving into the ground more steel and concrete. Just as
Soviet economic growth came to a crashing halt, so too will East
Asia's.
       Details differ but this, allegedly, is the dirty little secret of East
Asia's putative growth miracle. In this reckoning--most identified
with Paul Krugman's renowned 1993 Foreign Affairs article--East
Asian total factor productivity (TFP) growth has ranged from tiny to
non-existent. It is TFP growth that truly measures economic
success. It is TFP growth that shows how creative economies are,
beyond their merely building more factories and mobilizing more
labor. TFP is where it's at. East Asia never got it.
       Not unexpectedly, Krugman's challenge has provoked
considerable reaction, from researchers and policymakers alike. A
clarion call against complacency, it has had profound effect on East
Asian policy-making and public debate. Increasing public awareness
is always good.         If, however, hype has snowballed from
misunderstanding, and the challenge has unjustifiably raised doubts
and engendered second-guessing, then a disservice has been done.
       This article raises a warning on that second possibility. It
provides no fresh TFP numbers to quibble with those already
published by Krugman, Tsao, or Young (others like Sarel have
already); it proposes no silver-bullet strategy for pumping up TFP
(national boards have been set up, targeting x% TFP growth here,
y% there). Instead, this article seeks only to tell the story differently,
revealing in the process some lesser-known facts about TFP. It
argues that TFP can mislead as an indicator of economic success. It
points out that TFP myths are so pervasive that many worthwhile
programs are bound to "fail", if only by TFP criteria. It calls for
circumspection before writing off East Asia's economic miracle on
the test tablet of TFP measurement.
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"Or do you just want to keep making sugared water?"
To understand the model underlying TFP measurement, think of a
national economy as a factory producing some unnamed soft drink.
A big pounding machine draws in sugar, water, and a secret
ingredient A. Emerging from the roar and hiss of activity comes the
flow of output--a refreshing drink in the case of the factory, GDP in
that of the economy. Think of sugar and water as physical capital
and labor: these are the usual factor inputs. For a national economy,
A is TFP. How much output is produced depends on the
combination employed of factor inputs, including A.
      This sugar-water analogy illustrates the importance of getting
the factor mix right. If the sugar input pipes act up and start
pumping many times more sugar, while the water pipes continue
operating at original capacity, the output quickly becomes an
undrinkable mess. The situation is saved only by draining off some
of the sugar input, but then that excess sugar is wasted. A national
economy too needs the right factor mix. Simply throwing more
physical capital (sugar) at a fixed number of workers (water) wastes
that physical capital. Depending on circumstances, there is some
combination of factor inputs that is just right; deviating from that
optimal mix is wasteful and unproductive.
      Remember the secret ingredient A. Just adding only more
sugar and water, without simultaneously increasing A gives as
unpalatable a concoction as when the sugar pipes were acting up.
Sustained growth is possible only if all factor inputs and A ramp up
together.     Sure, without TFP growth (more A), things might
continue working in the short run: There might be spare A,
previously unused, lying about the factory floor, or the soft drink's
consumers don't immediately realize the flavor deterioration.
However, in the long run, attempting to raise production--through
increasing inputs of just sugar and water--without raising A is a dead
end. Likewise, economic growth without TFP improvement must
eventually slow down. Additional mobilization of capital and labor
alone will get us nowhere.
      This whimsical model of TFP tells the story over-simplistically.
It covers ground that many readers already know, done elsewhere in
more rigorous language besides. Its redeeming quality is that, unlike
other descriptions, it highlights the obscure quality of TFP A.
Outside observers, not themselves ladling A into the brew, never see
what A is. There might not even be any A, really. They know about
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A only indirectly--sugared water alone couldn't be this good. The
soft drink's proprietors know, of course, but they're not telling. The
situation for the national economy is worse: no statistician,
economist, scientist, or policy-maker ever physically handles TFP; no
ultimate proprietor can be found who knows for certain what
economy-wide TFP is. Instead, TFP is measured as a residual: TFP
growth is that growth in output left over after taking into account
growth in quality-adjusted inputs of capital and labor. In other
words, TFP is defined by what we cannot explain.
        This has not diminished TFP luster one iota. TFP has become
imbued with near-magical qualities: For countries, it is now
associated with, not just overall productivity of a nation's resources,
but with creativity and inventiveness. TFP might well be the killer
ingredient behind the economic success of nations.
        Conversely, however, what we think is TFP might be only
statistical error--from our not properly understanding the
engineering details of the soft drink factory or, indeed, of the
national economy.        Before committing national development
strategies to TFP growth, it seems useful to get a better grip on TFP.

Where does someone have to go for good TFP these days?
One obvious solution is to look elsewhere for TFP measurements.
Step back from East Asia, and consider the OECD economies.
From 1970 through 1987 the OECD country with highest TFP
growth was France. Indeed, average French TFP growth rate almost
doubled the US's. France is that country whose farmers, fishermen,
and transport workers, going on strike regular as clockwork, bring all
economic activity to a grinding halt. The French unemployment rate
today is more than double the UK's and six times Singapore's.
France is hardly the very model of a modern successful growth
economy.
      Over this same period and again across the OECD economies
over all industrial sectors, agriculture had the highest TFP growth.
Agriculture as the modern engine of growth? In which parallel
universe?
      Workers at the forefront of the computer-led New Industrial
Revolution know that information technology (IT) has improved
their productivity immensely. They know this, plain as day. These
workers, if anyone, are the front-liners ladling in A in our factory
metaphor, and in great gobs. IT investment as a fraction of total
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investment has risen from 7% in 1970 to over 40% in 1996. What
do TFP measurements show? Across the G7, TFP growth has
plummeted to an anemic 0.8% per year from its 3.3% average over
1960­1973.
      Maybe TFP isn't such a great measure of economic success.

TFP--who died and made it king?
Are there direct signs that East Asian growth will slow? These
economies are not crumbling with industrial decay. Singapore is the
world's largest producer of computer disk drives; S. Korea invests
heavily in semiconductor manufacturing; Malaysian entrepreneurs
envision constructing networks of satellites, digital television, and
telecommunications to link multimedia enterprises. All these
industries are critical pieces of a fast-growing IT-driven world.
       Consider, in particular, Singapore:           Hi-tech electronic
manufacturing comprises over 12% of GDP. Singapore's entire land
area is blanketed with cheap and advanced invisible
telecommunications links; its digital GSM telephony standard aligns
it with that technology's Western European originators. Smart card
usage is advanced beyond levels only now being experimented with
in the UK and Canada, with the US far behind and playing catch up.
Finance and business services comprise a third of GDP. Value-
added in IT in Singapore contributes more to GDP growth than in
the UK, and has a relative contribution almost two-thirds that in the
US. Singapore has in place all elements of the "weightless
economy", all essential ingredients for successfully riding the New
Industrial Revolution. Even in the outdated, pre-postmodern
international trade business of shipping physical molecules instead of
bytes of logic, Singapore's virtual port program has generated
dramatic improvements in turnaround efficiency, ranking it among
the top three worldwide.
       Be that as it may, shouldn't policy-makers go for growth by
aiming for higher savings, better education and skills in the labor
force, and greater imports of improved machines and human talent?
Sure they should, very sensibly, but not in the misguided view that
this will improve TFP growth. Remember, TFP is what remains after
accounting for contributions due to quality-adjusted factor inputs.
Thus, all these changes are just as likely to worsen measured TFP
growth or leave it unaltered as they are to increase it. If low TFP
growth is the disease, none of these proposals is a cure.
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      Microsoft has, over the last 20 years, been the single most
successful economic entity on this planet. It achieved growth rates
between 25% and 50% per year in the early 1990s. Microsoft's
domination continues, now not just in its market narrowly-defined
but in everything that every modern worker touches. Its products
soon will be on hundreds of low-orbiting satellites circling the Earth.
Microsoft achieved this success while hiring the smartest engineers,
the brightest managers, the most hard-working, geekiest
programmers. It spends unstintingly on the most advanced
computer hardware.        Microsoft attained superstar economic
performance through massive infusion of labor and capital. If
Microsoft's TFP growth were found to be low, what would we make
of it? Not much, I suspect. Why do we think differently when it
comes to the East Asian economies?
      Sure, countries are not firms, but the difference here is
meaningless. After all, TFP measurements are no more than
mechanical production function accounting--and production
functions apply to firms even better than they do to countries. Let's
acknowledge successes where they are, and let them get back to
doing what they do best. Growing.

Danny Tyson Quah is Professor of Economics at the London School of Economics, and
Director of the National Economic Performance programme at LSE's Centre for
Economic Performance. He wrote this comment while visiting the Monetary Authority of
Singapore. (http://econ.lse.ac.uk/~dquah/) (1685 words)