Which of the following is a supply-side fiscal policy that could stimulate economic growth

3.1.6 Discussion of supply-side policies

In recent times, supply-side policies have been strongly influenced by international trade agreements as well as general principles of public management that discourage direct industry subsidization. Targeting infant, strategic, dynamic, or even laggard and failing industries risks being seen as an industry specific subsidy. A consequence is that policies aiming to support risk taking as an activity associated with innovation, to provide a stronger foundation in scientific and technological knowledge for innovation, and attempting to “signal” the value of a new technology or line of research-related innovation have become the prevalent instruments for supply-side technology policy.

The supply-side policies discussed in this section relate directly to the innovation “performer” which is viewed as a firm and therefore is directly linked to the traditional rationales for technology policy of market failure or underperformance. Assuming that firms are profit-seeking leads directly to the conclusion that policies should provide incentives favoring higher levels of investment and activity related to innovation. In the case of signaling-related policies, traditional assumptions are augmented with the theory asymmetric information—the idea that good ideas may simply not be known and therefore need to be signaled or demonstrated to potential users.

Transformational Change or Trickle up Economics

Most people agree that Reaganomics meant low tax rates, strong defense, and a strong dollar. The defeat of the Evil Empire was another major plank of Reaganomics. On domestic spending, Reaganomics did not say much. The Gramm–Rudman–Hollings law defined that the Reagan administration limited spending and remained true to conservative principles. While critics derided the supply-side policies, the lower tax rates delivered the goods. In contrast, President Obama pretty much campaigned on a reversal of Reagan’s economic principles. President Obama is quite fond of talking about the failed policies of the past. Perhaps incorrectly, former President Bush’s economic policies are linked to those of President Reagan. Thus, it seems reasonable to conclude that a repudiation of the Bush administration led to a repudiation of the Reagan policies. This phenomenon is quite common during political turning points. The perfect example of this is the former Soviet Union satellites. Once they freed themselves, they made a 180 degree turn in economic policies moving away from collectivist, redistributionist, and dirigiste policies to free market economics. During the 2008 election cycle, the market debacle led many to question free market capitalism and endorse a greater degree of regulation and government control of the economy, an environment perfect for President Obama’s economic views and philosophy.

But were proponents of the Obama administration correct when they attributed the financial crisis to the failures of low tax rates and free market capitalism? What if the administration was wrong in its linking of Bush policies to Reaganomics? In the process of repealing the Bush policies, were Reaganomics components also eliminated? Here we need to give credit and high marks to the Clinton administration, which started going down the path of more government intervention and when defeated at the midterm election, it changed paths and delivered the economic goods. Contrasting that behavior with that of President Bush, we get a much different perspective. Some say that President Bush was stubborn and a big spender. In many ways, the same and more can be said about President Obama. Not only was he a big spender, he was also a big redistributionist and regulator. The budget deficit and other budget considerations did limit the magnitude of the changes President Obama had in mind after suffering a defeat at the midterms. But unlike President Clinton, President Obama doubled down on his policies. The president intensified trickle up economic policies to achieve its objectives faster.

Put together, the different figures suggest that if one is to select an administration for comparison based on the level of the unemployment rate at the beginning of the term and the improvement in the index at the end of the years in office, then the Reagan administration should be the one to compare if one adheres to President Obama’s view that they inherited the worst economy since the Great Depression. The Obama administration experienced a slower improvement in the real economy or Misery Index than the Reagan years, while both experienced significant improvements in the stock returns. The question is what accounts for the differences in Misery Index and the similarity in stock returns ranking? Can the fiscal and monetary policy mix explain these rankings? The next few paragraphs give it a try.

If President Obama was a transformational candidate, as some of his supporters believed that he was, his election this could be a turning point not seen since the election of FDR. Especially if the Trump administration turns out to be infective in reversing many of the Obama policies. It is quite possible that we have seen the end in low tax rates for decades to come. Table 42.3 lends support to this view. The crash of 1929 led to a reversal of many of the policies enacted earlier in the decade. We passed incredibly protectionist legislation such as Smoot-Hawley, as well as reversed the Mellon tax rate cuts as a new democratic administration initiated a secular trend of tax rate increases that continued under both Democratic and Republican administrations. Interestingly, it was a Democratic administration, that of JFK, who reversed the secular trend.

Table 42.3. Top Tax Rates

In spite of a prolonged economic downturn, the FDR administration remained popular and was able to implement its agenda and FDR became a transformational figure. We now know that some of the policies enacted at the time were responsible for prolonging the economic malaise. Amity Shlaes’ book provides an interesting account of the period consistent with our interpretation [1]. Yet FDR’s popularity remained very high. We attribute this in large part to FDR’s ability of successfully, and perhaps unfairly, blaming the economic failures on the policies of his predecessor. The story here is that as President Bush’s personal popularity was hurt, if Obama could shift the blame of any economic malaise to the Bush administration, then he could continue implementing his agenda even as the economy recovered slowly. Yet there is one important point that we need to make. While there is a great difference in the Misery Index performance of the various administrations, the Obama economic performance—as far as the Misery Index was concerned—was either above average or its improvement was slightly below average. On the stock return front, the performance was well above average. So, if people vote their pocket, there was really no compelling reason to change the top of the ticket. Viewed from this perspective, his reelection was consistent with the economic performance delivered by his administration.

An important issue to discuss is the explanation of the differences in results produced by the Reagan and Obama administrations in the context of the economic policy mix pursued by the two administrations. On the fiscal policy side, the differences could not be greater. Regulations and the top marginal tax rates declined during the Reagan administration, while the Obama administration increased the top marginal tax rates (Table 42.3), as well as significantly increasing the regulatory burden. Given our views that the economic agents respond to incentives, we would expect the lower tax rate and lower regulations to unleash the “animal spirits,” hence an increase in economic activity is to be expected once the tax rate cuts take effect. The experience of the Reagan administration is consistent with this view. In contrast, even if one assumes that the economy has a tendency toward equilibrium in the aftermath of an adverse shock and thus it would tend to recover; higher tax rates and regulations would slow down the recovery process. Again, this interpretation is consistent with the Obama’s slow recovery.

Next let’s tackle the valuation and the stock market returns using a simple valuation model that capitalizes the earnings of the economy. The slow recovery implies also a slow rate of increase in corporate profits and, as such, it cannot account for the above average rate of stock market appreciation, which is the above average stock returns. This process of elimination leaves a declining discount factor as the one possible source for a higher valuation. So, the entity that controls the discount factor is in effect the dominant player in the increase in valuation and the higher rate of return and that player is none other than the Federal Reserve. If we are correct that the Fed—and not fiscal policy—is responsible in large part for the above average stock returns during the Obama administration, then this result is quite different than during the Reagan period. The Fed, under the leadership of Paul Volcker, changed its operating procedure and switched to a price rule. As the inflation rate was declining, the nominal interest rate topped 15.84% and the real interest rate rose to double digit levels. The discount factor unambiguously increased during the early years of the Reagan administration, yet valuation increased. This means that the denominator of the valuation formula, that is, earnings and its future earnings expectations, increased by an amount larger than the increase in the discount factor. This is a very different explanation for the increase in valuation than the case of the Obama administration, where we contend that the source was a decline in the discount factor.

Additional evidence in favor of our hypothesis is that for three of the four administrations that faced a better than 10% unemployment rate during their term in office, the small-caps outperformed the larger capitalization stocks. The exception being the Reagan administration. The common elements of the three administrations—FDR, Carter, and Obama—is either the top tax rates increased or the regulatory burden increased. In the past we have argued that the smaller-caps are more adept at inflation hedging, tax avoidance, and regulatory skirting than their large-cap counterparts. For that reason, we argue that in an environment of rising tax rates and an increased regulatory burden, the smaller-cap stocks would outperform. We also know that of the four administrations, only one reduced tax rates and the regulatory burden. It is during this administration that the large cap outperformed as expected (Table 42.1).

Our interpretation of the data suggests that the Obama administration owes a portion of its above average stock market performance to the Fed. But the data also shows that while the Fed may take credit for the valuation increase, its policy failed to generate a normal recovery. Given that we attribute the slow recovery to the fiscal policy side of the equation, we end up with the traditional monetarist conclusion regarding the assignment of policy instruments. Monetary policy should be focused on price stability, while fiscal policy should be focused on the real economy. Interjecting the Fed on the real economy does not add much. In fact, we believe that the expansion of the Fed portfolio has resulted in a policy that has reduced the bank credit creation and that, in turn, contributed to the slow recovery.

Supply Policies

Many government education policies operate not through increasing education demand but instead by improving the supply. Most supply-side policies take two forms: (1) increasing the quantity of schooling services offered and (2) increasing the quality of schooling services. The former involves building more schools and/or increasing the capacity of existing schools.

Building new schools reduces households' distance to the nearest school. Long distances reduce enrolment. Some regard distance as particularly harmful to girls' schooling (Foster and Rosenzweig, 2004; Bommier and Lambert, 2000). Filmer (2004) argues that decreasing distance to schools increases enrolment, but not by much. Duflo (2001), using a natural experiment, showed that building new schools increased years of schooling in Indonesia by about 0.15 years.

Another quantity policy is hiring more teachers to increase existing schools' capacity. In French-speaking West Africa, several countries have recently hired additional teachers, but on different terms. Contract teachers have short-term renewable contracts, receive little training, and are paid much less than permanent, civil service teachers. Senegal, Mali, and Niger have hired thousands of such teachers, permitting large enrolment increases. For example, Mali hired 11 400 contract teachers between 1992 and 2004; between 1998 and 2002 they constituted 86% of newly hired primary and secondary teachers. PASEC (2004) estimates that this allowed 100 000 additional pupils to be enrolled, a 5% increase.

The impact of contract teachers on education outcomes is widely debated, but few reliable evaluations exist. Results using PASEC data suggest that contract teachers raise student learning as much as regular teachers do (Sy, 2007). Theoretically, the impact is ambiguous. Lower wages could reduce incentives, but worries of losing one's job due to underperformance may offset this. Yet, designing performance-based teacher contracts is difficult. Glewwe et al. (2003) implemented a randomized trial in Kenya to assess the impact of awarding teachers prizes based on student learning. They found little impact of incentives on learning.

Consider next policies to increase education quality (increasing learning per year enrolled). Additional teachers may raise school quality as well as quantity. Banerjee et al. (2007) conducted a randomized evaluation of a program that hired young educated women from the community to teach basic literacy and numeracy skills to children falling behind in India's government schools. The program was very effective, increasing test scores by 0.14 standard deviations after 1 year, and 0.28 after 2 years. Similar results were found in Chile by Chay et al. (2005).

Increased enrolment from reduced tuition or other policies increases class size, which may reduce learning. Angrist and Lavy (1999) exploited an Israeli natural experiment arising from strict application of a rule that class size should not exceed 40 (which is low by sub-Saharan Africa's standards) to investigate how class size affects learning. They found that smaller classes improve learning; having ten fewer students increased reading scores by 2.5 points (the average score was 72, with a standard deviation of 8). Urquiola (2006) finds similar results for Bolivia.

Another way to improve education quality is to provide material inputs. Two randomized trials, one that provided textbooks and another that supplied flipcharts, were conducted in Kenya. Surprisingly, neither textbooks nor flipcharts increased learning, except that textbooks raised learning among the best students (Glewwe et al., 2004, 2007). In India, Banerjee et al. (2005) conducted a randomized evaluation of computer-assisted education. Fourth graders were given 2 h of computer time per week to play games that reinforced mathematics skills. The program increased math scores by 0.47 standard deviations after 2 years. These results persisted for at least 1 year after students finished the program.

Domestic Strategy

Domestically, the strategy should aim to boost the economy’s competitiveness and capacity-building through instituting and applying “supply-side” policies. On the issue of capacity-building, the policies could aim to promote applied technology in consumer products. Promoting new areas of comparative advantage could in turn enrich competitiveness. Resources should be geared more to industries that are employment-promoting than to financial businesses and activities that often involve speculation. In conjunction with industrial expansion there needs to be infrastructure promotion and expansion. For example, transport infrastructure with high-speed trains should be energy-saving and reduce road traffic. Investment in the environment could minimize waste and maximize the redeployment of materials. These examples of infrastructure development would require large funds, but their favorable prospects in the future should be able to repay the borrowed loans. Thus, one possibility is to issue treasury bonds that are geared specifically to funding long-term infrastructure projects. This would be a more useful and productive alternative than to issue bonds to cover debts.

Another area of improvement in many industrialized countries could be the revitalization and rejuvenation of run-down cities and regions. Previous industrial development was often based on the development and success of a single industry, such as the motor car industry in one city and coal mining in another. The decline of these “mono-industry” cities and regions provide good potential for economic capacity expansion, as the cost of redevelopment should be low, and new industries could be set up depending on market forces and supply of inputs. Consortiums could be established so that new investments could create jobs, industries, and output.

At the macroeconomic level, weak deflation may be a good policy choice as that should attract investment. To boost investment, both fiscal and monetary policies could be more effective. A cut in tax, combined with a rise in interest rates, could work effectively, as one produces investment incentive, while the other encourages high productivity projects to emerge. A cut in profit tax and salary tax does not mean lower government revenue. It could be the reverse if the tax cut led to an increase in businesses and employment, leading to higher government revenues in the next round. The revised interest rate policy should be used to steer long-term growth in the real economy, rather than to cater for such short-term goals as inflation and speculation. A stable and high interest rate policy does not mean to hurt investment, but to ensure that funds are geared to high-return investments. The combination of these domestic policies can produce multiple results. The combination of a tax cut and issue of treasury bonds to boost infrastructure development would definitely stimulate investment in the private sector and increase overall employment. A high interest rate may not hurt the issue of bonds if the future returns of the project are economically viable and could generate the ability to repay. Infrastructure projects normally are expensive to build, but will become more expensive as time passes. The important consideration is whether the infrastructure project will generate long-term gains for the community.

There is a need to get away from political considerations as much as possible when it comes to economic policy decisions. Instead of aiming at “equality,” the policy should aim at job opportunities and output creation. Instead of aiming at taxing the very few rich, the policy shall encourage the rich to invest more at home, so that more jobs can be created. Economic self-strengthening means policy reorientation to boost “supply-side” factors, and separate unnecessary politics from pure economic decisions. Most industrialized countries have reached a mature stage of political democracy, but it is the economy that should be given a chance to improve and grow. The battle of equality should be based on productivity and opportunity, and not simply on pecuniary differences. Wage improvement should be based on economic sustainability and potential for capacity expansion. Although labor unions and wage bargaining were politically oriented in the early stage of capitalism, contemporary developments in labor relationships in industrialized countries has gone much further.

In addition to government agencies, nongovernment organizations have provided services to alleviate people’s hardship through professional and voluntary works that attend to needs which are not politically oriented. Civic society is playing an increasing role in closing various social and economic gaps. The outdated “dichotomy” between employers and laborers should be reconsidered economically from the point of mutual need and interests, rather than the power of one over the other politically. The ultimate goal in any economy is to build a bigger economic pie so that there is more to share, rather than to argue over how the pie will be shared. With improvements in the civic economy, there are new criteria for deciding how the pie should be shared. Although wage is a direct criterion, the quality of labor and work environment should be considered as alternative criteria. Intrapersonal development in income and output should be more relevant than interpersonal differences.

In a nutshell, there should be efforts to reenergize the domestic economy by reducing the size and volume of redistribution, while at the same time promoting real economic activities through fiscal and monetary policies. Capacity and capability building policies could be enhanced through technology and rejuvenating run-down cities. Allowing the economic game that generates “relative” outcome to have a bigger role, and creating jobs and employment will promote individuals’ economic welfare, and when individuals are occupied “economically,” they will be interested more in attaining upward mobility than concentrating on the extent of inequality interpersonally. Industrialized countries should engage in policies that will look into the potential of their own economies, rather than “punish” the minority of “able individuals.” The intention is to enable society to have more “able individuals” than to encourage more “dependent individuals” that rely on assistance. The prosocialist policies in many industrialized countries have gone too far, both in coverage and in substance, to the extent of crippling competitiveness, dismantling capacity, and promoting dependence.

Abstract

The economies in East Asia have been considered as “show case” economies since the 1970s, because of their use of neoclassical approaches and the adoption of supply-side policies. Beginning with the discussion on the “take and give” behavior in economics, this chapter outlines the few major causes of growth and development based on the political economy framework that are different from other studies. The Asian financial crisis has been the most dramatic incident in Asia, as it served both as a shock and wake up call for the need to restructure. Each of the three East Asian economies of Singapore, South Korea, and Taiwan are faced with new challenges. The three sections provide a discussion on each of these three economies, and suggestions are made to ensure their survival and expansion. The situation in Asia has rapidly been challenged by the rise of China, and economic expansion takes place in conjunction with political uncertainty.

VII Why Supply-Side Economics is Preferred

Individuals and firms in a capitalist economy will exercise their endowment to the best possible extent. There is a multiplying effect, as one aspect of growth leads to other aspects of growth, and the individual’s growth at the microeconomic level would aggregate to form overall growth at the macroeconomic level. With income and profit earnings made, individuals would consume in order to improve their welfare, utility, and satisfaction. Since the ability to consume would depend on the ability to earn, it follows that production must come before consumption. Although an individual can dis-save by borrowing, the amount of loans borrowed also depend on the future earning ability of the individual. The spirit of Say’s Law that “supply creates its own demand” implies that individuals have to supply their endowment in order to gain the market returns, from which consumption can be made.

In contemporary economics, Say’s Law is discussed within the context of “supply-side” economics (Canto et al., 1983; Feldstein, 1986; Helliwell, 1986; Marshall and Arestis, 1989; Lucas, 1990). By using simple supply and demand curves, David Harper has given a simple explanation of “supply-side” economics in the website of Investopedia. The simple argument is that situations of “over” or “under” production cannot last long as variation in inventory and prices will eventually remove any excesses or shortages. Supply-side economics argues that demand is irrelevant, as consumers will respond to the price set by the suppliers. The three pillars that formed the backbone of supply-side economics include: (1) a low marginal tax rate that does not impose unnecessary disincentives to businesses and workers; (2) a small government with least intervention that allows maximum economic freedom; and (3) a prudent monetary policy that would not create excessive liquidity and inflation.

As summarized in Wikipedia, there have been heated debates on the effectiveness of supply-side economics, especially in the context of “Reaganomics” and that the tax rate cut had not been growth generating in the United States under the leadership of two Republican Presidents, Ronald Reagan and George Bush (Krugman, 1994). However, there can be a number of economic instruments under the framework of supply-side economics, and tax reduction is just one of the instruments. Other concerns included the stage of the business cycle in which tax reduction was instituted, and promotion in research and development. Indeed, supply-side economics shall be regarded more as a long-term policy direction which both individuals and government institutions should adopt, rather than as a short-term instrument in alleviating economic hardship.

The importance of supply-side economics can crucially be discussed in two situations. One relates to the situation of a growing economy, and the other relates to the situation of a crisis economy, though the mechanisms could be similar in both situations. Beginning from an early phase of a growing economy, income is expected to remain low, but the relevant question is how to utilize resources for production-oriented activities. Individual endowments will become the first and primary consideration; namely how individuals can produce some output from their own endowment, which can be a combination of skill, capital, knowledge, and information. Such usage of individual endowment in producing output shall be the first action in the “supply chain.” One production activity will lead to another activity, either horizontally or vertically, as the production process requires other inputs. This shall generate a “supply-side multiplier” where the supply of one good will lead to the supply of another good.

In an economic or financial crisis where the economy is faced with sudden shocks due to a financial collapse that has ruined numerous economic activities, the sharp economic downfall would lead to economic shrinkages. Low economic expectation and pessimism would delay economic revival. Aggregate demand will fall, inventory starts to build up, and business will find it harder to survive. However, economic slowdown creates excess capacity, and producers could face a lower cost of production. Business cycles come and go, and expectation that changes over time can be nurtured or nourished. Economic scenes are always dynamic. A low expectation today can be changed through productive activities and become more favorable tomorrow. The low expectation and low demand can be temporary and revive when sufficient individuals make use of their endowment productively in improving their personal wellbeing.

The solution to a financial crisis is to rebuild economic confidence and expectation. By making use of the falling cost of production, creative, innovative, and adventurous individual producers would hire workers for new production and create new supply. The low demand could be temporary as more workers are hired, and sooner or later the increase in individual spending would lead to an increase in aggregate demand. Indeed, it is possible that the faster the increase in supply, the quicker it would lead to demand revival.

Supply-side economics is preferred, because supply is first in a chain of economic activities. Once supplied, the goods and services would then be demanded in the market. Market forces will eliminate unsuccessful and uncompetitive supply when there is insufficient demand. In the process of supply, jobs are generated due to the need for production inputs, and employment gives rise to wage payments. Workers would then use the wage for consumption, thereby giving rise to demand. On the contrary, “demand-side” economics is important only when individuals have sufficient earnings to consume. The ability to consume depends on the ability to earn, the possibility to earn depends on employment opportunities and job security, employment depends on productive activities, and production ultimately relates to the ability to supply.

Supply is a more fundamental economic element than demand, as supply is related to production, through which demand takes place as a result of more goods and services being made available in the market, and as a result of more employment that increases workers’ purchasing power. Many have argued that the root of “demand-side” economics can be found in the Keynesian school of thought (Keynes, 1926, 1937Keynes, 1926Keynes, 1937). After the end of the Second World War when the United Kingdom and other European countries were in economic recession, Keynes advocated for a fiscal solution by increasing government intervention through public expenditure as a main instrument in reviving the recessed postwar economy. It has some truth in it as some government expenditure is better than no expenditure in times of economic depression. The public sector is often thought to serve as a cushion against economic recession, because unlike workers in the private sector who may suffer a reduction in wage as the economy recesses, employees in the public sector tend to have a stable wage. The two arguments against Keynes were that government expenditure can have a “crowding-out” effect, in that the more government spent, especially in investment, the less the private sector would invest, thereby limiting the economic potential in the private sector. Second, a considerable amount of government expenditure could have ended up in welfare provision that had boosted demand, but since there was no parallel increase in output, the rise in demand resulting from welfare expenditure would either boost inflation that lowered the purchasing power, hurting those who are not receiving welfare assistance, or resulting in higher imports and a trade imbalance.

Demand-side economics can best be regarded as a short-term strategy. Immediately after a major crisis, the “ultra-low” economic expectation would need stimulus in order to avoid further hardship. The government can then exercise its fiscal ability by making short-term spending. Once the imminence of the economic crisis was over, demand-led economic strategy should give way to supply-led economic strategies. It is true that supply-led strategies tend to take time to materialize, as business decisions and productive activities would take time to execute, but ultimately it is the rise in physical output that can see more goods available in the market. The increase in goods’ supply would help to lower inflation and promote purchasing power. In short, supply-side economics produces a “virtuous circle” of economic activities.

The difference between “demand-side” economics and “supply-side” economics is whether a quick short-term impulse is needed to deal with an economic shock or the desire to build up a long lasting capacity enlargement that can lead to economic revival and expansion in the long run. Short-term impulse policies are usually immediate expenditure that does alleviate some economic hardship, but it can also generate inequity to nonrecipients of welfare if the short-term expenditure produces inflationary pressures. By building up long-term economic capacity, the benefits will be available and open to all. The supply-side economic strategy turns out to be the superior choice, especially when a supply-multiplier can be generated.

Cutting tax is a popular instrument used in supply-side economics. A lower tax would stimulate businesses, the increase in subsequent investment would be productive, and the increase in output and employment would eventually promote growth and lift the economy from recession and crisis. However, the positive impact of cutting tax could depend on a number of factors. With a lower tax, investment would take time to materialize, and supply would take time to produce. The delay could differ among businesses and industries. Second, it also depends on what kind of investment a lower tax would stimulate, as some investments may not be output-oriented, or even speculative in nature. Third, the sustainability of the tax cut can be another factor. Investment, which often involves long-term activity, may not consider a tax cut favorable if the expectation was that the cuts were meant to be short-lived and would be revived in due course. In short, the short-term impact of a tax cut might not be obvious, as it is the consistency of a low tax regime, not the fluctuation of tax rate, that counts. A low tax rate should be seen more as a fiscal infrastructure that constantly promotes investment than as an instrument that influences business cycles.

3.2 NSI as a framework for new industrial policies

NSI-approaches have, not surprisingly given their historical origin, a strong industrial policy tradition. The erosion of popularity of traditional industrial policy in the 1970s had much to do with the bad press such policies were getting both in terms of the many failures of such policies in restructuring successfully heavy industry sectors such as coal mining and steel, which made the policy-designed aid support schemes seem incapable of bringing about improvements, and, second, with the strong resistance by those workers losing their jobs as a direct consequence of the structural industrial adjustment policies put in place. It was also at that time that Ronald Reagan and Margaret Thatcher began their terms in office with a strong emphasis on supply-side economics and less room for the government to intervene.

The political awareness of having to shift industrial policy from its negative, job-reducing image toward a more dynamic, sun rise image was of course very much inspired by the success of Japan in rapidly catching up in many industrial sectors from motor vehicles to semiconductors in the 1970s and really 1980s. At the political level, the US–Japanese semiconductor trade agreement, providing breeding space to the US industry, became one of the clearest examples of a new form of strategic industrial/trade policy with major long-term implications for the competitiveness of the US semiconductor industry. In Europe too, this strategic nature of industrial policy was used.

What the debate about “strategic” industry and trade policy in the 1980s brought to the forefront is that, in contrast to previous literature, once the continuous nature of technological change was taken into account, various dynamic increasing returns and cumulative features would take place across sectors (e.g., Dosi et al., 1990). Insofar as the actual process of production in firms, regions, or countries was closely associated with the existence of technological capabilities in such firms, regions, or countries, mechanisms leading to specialization in production did also have a clear and significant dynamic counterpart in that they would also lead to specialization in technological skills and capabilities. The potential for dynamic technological specialization would, in other words, be very much different between technologies and sectors. It would ultimately closely depend on the systemic interactions between technologies and sectors along the lines highlighted by Pavitt (1984), and the first sector-based evidence studies on innovation of the late 1970s and early 1980s. The identification and support of “strategic” technologies or sectors, even though not justified on the basis of static allocative efficiency, could then well be justified from a dynamic, innovation system perspective in terms of long-term output and productivity growth.

5 Conclusions

Education occurs over the life cycle, not just in formal schooling. A focus on formal schooling alone is likely to miss important options for improving education of individuals, both before they initiate their schooling and after they complete their schooling. Investments in education should be viewed as occurring within a dynamic life-cycle perspective in the presence of unobserved heterogeneities, state variables that reflect the education to any particular point in the life cycle, and expectations regarding further developments, including future returns to education. Educational outcomes are determined by a combination of household demand decisions and educational supply provider decisions, with implications for educational product markets and educational input markets.

There have been a number of recent studies that have improved our knowledge of inputs and incentives relating to education within particular contexts. These studies have exploited a range of techniques to establish the counterfactual, from natural policy experiments to controlled experiments to propensity score matching to fixed-effects/instrumental variable estimates to structural models. There are a number of both demand-side policies (e.g., conditional in-kind and cash transfers, educational vouchers) and supply-side policies (monitoring and creating incentives for reducing teacher absences, expanding supply, possibly more individualized education) that appear to have some positive at least short-run impacts in particular contexts that are discussed in some detail in this chapter. But the limited number of studies of direct responses to incentives that are designed to directly influence particular behaviors reinforces that entities respond to incentives in pursuit of their own objectives, which is not necessarily how policy makers or academics thought they would or should, so that ongoing monitoring and evaluation is essential.

And, there also are a number of other possibly important gaps in the literature. There is a need to undertake further research on what appear to be promising educational interventions to see how robust they are to scaling up and to different contexts, explore the relevance of expectations on incentives for investments in education, investigate longer-run effects rather than just effects over a year or two since effects may be cumulative or dissipate over time, direct attention to education other than just schooling—particularly postschooling learning, investigate market and aggregate effects, exploit the insights of economic modeling, develop evidence on efficiency and distributional policy motives, and go beyond impact estimates and governmental budgetary estimates to calculate economic benefit-cost estimates for possible policy interventions. Just as there are not likely to be “magic bullet” interventions that improve education at all levels in all developing country contexts, there is not a “magic bullet” research strategy for evaluating the alternatives. More controlled experiments with longer follow-ups in varying contexts, though with well-known limitations, would be desirable for evaluating many specific proposed interventions. But use of nonexperimental data with other means of establishing controls and of structural models to explore counterfactual experiments, with careful and explicit attention to the assumptions being made and their probable implications, also is likely to add importantly to our knowledge of inputs and incentives related to education and development.

II Laissez-Faire Policies

The economics adopted by the British colonial government were to keep things simple, meaning that Hong Kong citizens were allowed to conduct their own businesses and the government was “hands-off” in business activities, involved only when necessary. Hong Kong began as a “free port” between mainland China and overseas countries. Immigrants were free to enter, while British types of institutions were gradually introduced, including the rule of law and a business-friendly fiscal policy. The big British businesses were dominant, but local businesses also flourished. The enterprising immigrants formed a key component in the development of Hong Kong. Appropriate infrastructure and public utilities had been developed as the pace of urbanization and population expanded.

The role of the laissez-faire government was to monitor and ensure efficiency. Fiscal consistency and certainty had over the years become an advantage. The growth-led nature of economic development would focus on “supply-side” economics. The high degree of domestic “preparedness” was important in the political economy in Hong Kong. Other laissez-faire practices included the duality in the supply of such public goods as schools, hospitals, and medical centers, housing provision, media, and transportation. The combined economic forces of “supply-side” economics and “duality in supply” produced promising scenarios for foreign investment. Economic opportunities expanded exponentially, and mutual positive-sum outcomes were realized, as both foreign and local businesses benefitted from their activities in Hong Kong.

The high degree of stability in Hong Kong contrasted with the periodic instability in mainland China, resulting in a continuous inflow of enterprising immigrants who came to look for opportunities and alternatives. It was only after the 1960s that border control was instituted as the population in Hong Kong expanded, but there were still periodic floods of immigrants from mainland China. In many ways, the stability and “supply-driven” nature of economic development in Hong Kong was shown to be a better alternative to development in mainland China at various historical periods. Thus, Hong Kong had been serving as a shelter for mainland refugees whenever mainland China was faced with crises and difficulties. This, in itself, would make the enterprising immigrants to act, behave, and conduct activities differently from people in mainland China. The opportunities and alternatives that Hong Kong offered eventually created differences between Hong Kong and mainland China.

The only period when the British colonial government lost control of Hong Kong was the “3 years and 8 months” during the Japanese occupation from December 25, 1941, to the end of the Second World War. The establishment of the communist regime in China in 1949, and the subsequent trade embargo by the western world, had put an end to the reexport trade of Hong Kong. Instead, the migration of Chinese capital to Hong Kong paved the way for industrialization, with labor-intensive manufacturing from the 1950s. Hong Kong also attracted much foreign investment after the end of the Second World War, as world demand for light manufacturing increased. Thus, Hong Kong’s exports increased gradually and labor-intensive manufacturing included wigs, toys, transistor radio, textiles and clothing, plastic flowers, and related products. Electronics production became popular after the 1980s.

In much of the 1950s and 1960s, the colonial government was reluctant to introduce welfare-related policies, arguing that improvements in “supply-side” factors should be the more appropriate prerequisites for development in Hong Kong. Other than the rule of law, the colonial government also introduced professional institutions from Britain so that local students could follow the practice and standards that existed in the United Kingdom. The establishment of the Independent Commission Against Corruption (ICAC) on February 15, 1974, was a milestone in lifting Hong Kong to a fully fledged civic society where privileges, vested interests, cronyism, and “backdoor” activities were replaced by transparency, fairness, and equity before the law. Beginning from the mid-1960s, the Hong Kong colonial government began to modernize Hong Kong. Massive “supply-side” developments turned Hong Kong into a modern metropolitan economy. Examples included the construction of industrial towns for low-cost labor supply for industrial plants, urbanization and creation of new towns in the New Territories to cater for the growing population, provision of public housing for low income families and the “sandwich” class, construction of cross-harbor tunnels and underground railways, reclamation of land for residential purposes, and expansion of public health provisions and postsecondary educational institutions.

Laissez-faire noninterventionism based on capitalist market principles, popularly known as “positive noninterventionism,” was the approach adopted by the colonial government in the 1970s, although the provision of water, land use, and road and park construction were entirely controlled by the government. The Hong Kong experience showed that there were numerous advantages in laissez-faire economic principles, typically in the form of a private-led economy, macroeconomic stability and fiscal certainty, indirect support through “supply-side” channels, coupled with a hard-working, enterprising, and disciplined labor force; opportunities and chances of upward mobility were the major outcome of these advantages.

However, there were inadequacies. For example, technological advancement had not been a major concern. Government spending on research and development activities was minimal. Foreign investment related to industrial production either concentrated in labor-intensive manufacturing, or brought along with their own technology. The local businesses comprised mainly small- and medium-sized enterprises (SMEs) which did not promote technology. Nonetheless, the laissez-faire nature permitted Hong Kong to achieve a high level of development, and the flexibility and ability to move along with the international economic community remained the cutting-edge of the Hong Kong economy. Nonetheless, Hong Kong over the decades had developed brand names in several lines of consumer products, especially in clothing, food processing, and beverage industries. Despite the lack in technological advancement, growth in Hong Kong proceeded favorably, diversifying into such areas as finance and business services.

As the British sinologists’ strategy was to ensure Hong Kong’s economic supremacy over the socialist economy in mainland China, the advance economy would serve as a “cushion” for Hong Kong in its post-1997 years. As Hong Kong people were keen on making “money” and economic progress, rising incomes and growth would serve to pacify the political demand for democratic changes. This could be a misunderstanding on the part of the sinologists. Hong Kong had all along been an immigrant city, and many held a “siege mentality” as certainty and stability was not guaranteed. As such, amassing wealth and assets were seen as an “insurance” policy and a source of security and reliance. Should they eventually have to emigrate to another destination as a result of political uncertainty, their economic survival would be assured.

2.1.2 The Consequent Rise in Profitability did not Lead to the Warranted Investment Push

Evidence supports the proposition that the post-1980 period offered a viable environment for expanding the profitability of global capital. For example, Orhangazi (2008) supported his theories of financialization of the US economy using his calculation of the profit rate in nonfinancial corporations over the postwar era. Orhangazi reported a secular decline of the profit rates of the nonfinancial corporations after the second half of the 1980s. After an extended period of restructuring during the 1980s, under the supply-side economics of Ronald Reagan and Paul Volcker, the profitability was observed to rise. Orhangazi’s findings were also supported by the work of Duménil and Lévy (2001, 2004). In their analysis of the profitability of capital in the United States and Europe, they reported the behavior of the rate of profit (as measured by the ratio of net product minus total cost of labor) to the value of the stock of physical capital. Their data corroborated Orhangazi’s findings with even more pronounced tendencies. As clearly shown in Fig. 2.3, the post-1980 patterns of profitability revealed a breakthrough for private capital returns in United States and Europe.

What is hidden beneath the path of aggregate profitability in Fig. 2.3 is the financialization of the patterns of accumulation. To fully account for the divergent patterns of finance over industrial profitability, Fig. 2.4A and B shows yet another aspect: it was actually the rise of financial returns that increased aggregate profitability. As stagnation of industrial profit rates deepened, the rise of financial profit opportunities compensated for such losses. Financialization was then the major response of capital in its quest for expansion, profits, and further expansion.

It was at this juncture that the introduction of debt instruments under post-1980 financialization enabled the middle classes to become a component of final demand. During a period of falling incomes, newly created debt instruments helped the American (and other economies) working class to become part of the consumerist culture. As the level of private savings to the gross domestic product fell to negative ratios, household debts rapidly accumulated. Therefore financialization was opportune, not only in terms of compensating the loss of industrial profitability, but also for expanding the consumption power for middle-income households that would have otherwise experienced significant income losses.

Data from the Bank of Settlements revealed that nongovernmental corporate debt accumulation has been the driving force behind this episode. Accordingly, nonfinancial corporate debt in the developing emerging market economies rose from USD 9 trillion in 2008 to USD 25 trillion in 2015, almost doubling as a ratio to GDP from 57% to 104% (Table 2.2). Taking data from selected economies in Table 2.2, the basic message is that investment expenditures have been on a declining trend in comparison to both aggregate returns to capital (profits) and the installed levels of capital stock. The most rapid declines were observed in countries, such as Korea, Turkey, and Russia; however, no country has displayed an opposing (positive) trend. The third and fourth column blocks in Table 2.2 reveal that accumulated debt has fallen against total sales, but has risen against fixed assets.

Another characteristic of the debt problem has been the positive correlation between the rise of household debt and income concentration at the upper scale. Data on US household debt reveals that (as a ratio to GDP) it rose from 75% in the early 1980s to in excess of 130% by the end of 2010. As a parallel development, a rise in the income share of the richest 5% of the population was observed from 22% to 34% (Fig. 2.5).

These observations lead us to propose that, on the one hand, indebtedness enabled the maintenance of effective demand despite falling incomes and declining productivity; however, it also led to the expansion of casino capitalism as new financial instruments were created and the global financial markets turned into a melting soup.

Meanwhile, the advent of financialization led to the short-term and highly-volatile expansion of hot finance. With the ascendance of finance over industry, loanable funds were provided for the expansion of lucrative products of speculative finance. Investment expenditures on fixed capital also stagnated and formed the basis for the faltering productivity gains and expanding structural unemployment. Increasing poverty levels, worsening income distribution, and intensification of social exclusion and social violence were the unavoidable outcomes as deindustrialization became a real threat to the viable future of the global economy.