The second-tier or second-generation Southeast Asian high-performing Asian economies (HPAEs) of Malaysia, Thailand and Indonesia have been distinguished from the first-tier East Asian newly industrializing economies (NIEs) of Korea, Taiwan, Hong Kong and Singapore as well as Japan on a number of grounds, including the resource wealth of the former in contrast to the resource poverty of the latter. Southeast Asian resource wealth, it has been argued, made possible rapid economic growth on the basis of primary production, and thus weakened the imperative to industrialize. As much of this primary production was for export, such resource wealth also weakened the imperative to manufacture for export. Thus, resource wealth is seen by some as a ‘resource curse’, weakening the imperative to industrialize, especially for export. This argument is invoked to explain these second-tier Southeast Asian newly industrializing countries (NICs) later and slower industrialization (compared to Japan and the first-tier NIEs), as well as the allegedly lower emphasis on exports.

Thus, many observers — e.g. Jeffrey Sachs and his colleagues in the Emerging Asia study published by the Asian Development Bank (ADB 1997) — suggest that being a natural resource rich country is bad for growth. Curiously, the ADB study defines natural resource abundance in terms of the ratio of net primary product exports to GDP in 1971 without distinguishing extractive natural resources (especially minerals) from agricultural products. So-called Dutch Disease mainly involves the former, which tend to be very capital-intensive and only involve a small proportion of the population in the extraction of the resource. Consequently, the added income accrues to a few while the appreciation of the country’s currency affects the entire population.

Agricultural exports generally involve much more of the population, and increased income usually accrues to all producers, diffusing the adverse consequences of currency appreciation. The Southeast Asian high performing economies have been major agricultural exporters, thus offsetting the problems associated with the mineral exports of Malaysia and Indonesia, in sharp contrast to, say, Nigeria. Generally good macroeconomic management has also helped, especially to offset the tendency to indulge in expenditure on non-tradable.

Citing Lindauer and Valenchik (1994: 288-9), Intal (1997) has argued that the marginal labor productivity — and hence the opportunity cost of farm labor for manufacturing — is higher in land-abundant African economies compared to land-scarce Asian economies even though average labor productivity is usually higher in the latter. Hence, it is unlikely that the former will be able to compete with the latter in labor-intensive manufactures. The Malaysian experience suggests that such labor-scarce, land-abundant economies can only be competitive in skill-intensive, rather than unskilled labor-intensive manufactures, requiring considerable investments in human resource development.

Comparing wage rates to labor productivity in manufacturing for 1992, Intal (1997: Table 4) shows the high proportion of wages and salaries to value addition per worker in economies such as Hong Kong (0.51), India (0.39) and Singapore (0.34), compared to Malaysia (0.28), South Korea (0.26), Philippines (0.23), Sri Lanka (0.19), Thailand (0.15 in 1990) and Indonesia (0.14). This suggests that the low wages received by Indian workers, for instance, do not automatically translate into labor cost competitiveness. The situation in much of Africa suggests that, not unlike Indian labor, African labor may also not be competitive in wage/productivity terms.

The ‘tropical curse’ thesis has also been resurrected by the Asian Development Bank (ADB 1997). Surprisingly, the study seems to be oblivious to W.A. Lewis’ (1969, 1978) pioneering work on the economic condition of the tropics. Lewis (1978) showed that tropical exports grew faster than temperate zone exports during the last period of global liberalization from the end of the last century. While the tropics generally had more modest export bases than the temperate zone, it implies that the tropics were able to respond to export demand despite the disadvantages they faced. Lewis emphasized, however, that not all tropical countries were able to seize the opportunities from increased export demand. He suggests that the exports in greater demand were largely water-intensive; hence, only those areas with enough water to substantially increase their exports were able to take advantage of the new opportunities. The more arid tropical grassland areas thus could not benefit from the increased demand for tropical products. It is also important to note that Lewis observed that the terms of trade for tropical exports had deteriorated badly against temperate exports. This suggests that productivity gains in the tropics were largely lost to the worsening terms of trade, and the situation would have been even worse where few productivity gains were made.

Since the Southeast Asian newly industrializing countries and some other tropical countries have grown rapidly since the sixties, it is necessary to explain why countries in the tropics have fared so badly in the last few decades. It is not enough to simply attribute the tropical growth shortfall to ‘pests, diseases, typhoons and other natural calamities’, as the ADB study does, though such factors may not have been unimportant.

Against this background, this paper will show how the second-tier NICs successfully diversified the range of their primary exports and also developed processing capacities to increase retained value-added. As we will show, such diversification and development of resource-based industrialization did not always come easily, usually requiring government intervention to facilitate the process. Such a discussion implies that the Southeast Asian NICs went beyond static comparative advantages derived from natural resource endowments to develop new capabilities through learning, productivity growth, externalities and scale economies. Some Southeast Asian governments have captured and deployed resource rents to support policies enhancing new productive capabilities and capacities as well as international competitiveness, while some firms have invested their resource wealth to develop new internationally competitive capacities.

The story in Southeast Asia is quite varied, emphasizing the importance of careful and judicious targeting and organization to ensure the efficacy of public policy as well as private initiatives. Hence, we provide some detailed description of policy initiatives — including firm and industry level measures — used to encourage primary product diversification and processing. These include ‘functional’ interventions such as physical and social infrastructure support, including research and development (R&D) as well as training, as well as policies aimed at boosting private domestic investment including foreign direct investment (FDI), fiscal measures, subsidies, preferential credit, procurement policies, etc. We shall also show how export promotion and other policies were used to diversify exports, i.e. to promote non-traditional exports. Finally, some attention will be given to the role of primary sector institutional reform, particularly in designing, implementing and monitoring policies.

This paper proceeds in two stages. Because conventional wisdom exerts substantial influence on the way economic policy-making is viewed, our discussion departs from the conventional interpretation by offering an industrial policy interpretation of the three Southeast Asian governments’ economic diversification policies. The focus here is on demonstrating how deliberate government intervention was used to diversify the economies away from their previous dependence on a limited range of primary products they had long been producing for export. Such diversification included both broadening the range of primary products being produced as well as industrialization, including primary product processing — or resource-based industrialization — for export. The contention of this paper is that if these Southeast Asian governments had not intervened selectively and effectively to do this, they were less likely to have become high-performing economies or second-tier NICs.

Malaysia

The colonial Malayan economy grew rapidly from the late nineteenth century to become the single most profitable British colony. Access to agricultural land as well as to forest, mineral and other natural resources increasingly came under the control of the state during and since the colonial period. Peasant agricultural settlement from neighboring islands was encouraged by offering easy access to cultivable agricultural land. The colonial authorities generally allocated land and other natural resources to favor British investors, ostensibly because they were better financed. Favoring big British capital could have been efficient in so far as there may have been significant scale economies. However, this was certainly not the case in the tin industry during the nineteenth and early twentieth centuries before the advent of the dredge, or of the rubber economy during the colonial era (Jomo 1986).

Infrastructural development — in the form of roads, ports, railways, telecommunications, electricity and water supply — favored British interests. Colonial Malaya’s economic infrastructure (e.g. railways, roads, ports, utilities, etc.) was crucial for profitable private investment and generally more developed than in most other British colonies. Ethnic Malays remained largely marginal to the growing capitalist sector, with the elite integrated into the colonial state apparatus, and the masses remaining in the countryside as peasants. Instead, emerging business opportunities were mainly taken by some of the more urbanized and commercially better-connected Chinese. However, local businesses often found it more profitable to engage in production for export, commerce and usury.

The tin boom after the decline of Cornwall in the second half of the nineteenth century, and then, the decisive dominance of British dredging as well as the rubber boom — with the growth of the motor car industry from early this century — secured this position. In the half-decade after the end of the Second World War, colonial Malaya contributed more export earnings to the British Empire than any other part of the empire including Britain itself. However, tin mining, rubber plantations and international trade continued to be dominated by British-owned agencies in London after independence until they were bought back, mainly by Malaysian state-owned enterprises, between the mid-seventies and the mid-eighties. Some have since diversified considerably into real property development, financial services, and resource-based as well as import-substituting manufacturing, and also abroad.

Although the Malaysian economy has changed significantly since independence, the many existing differences reflecting uneven development can be traced to the crucial formative decades under colonial rule that shaped Malaysia’s economic structure. Helped by favorable commodity prices and some early success in import-substituting industrialization, the Malaysian economy sustained a high growth rate with low inflation until the early seventies. Malaysia’s export-led growth record in the last century has been quite impressive. During colonial times, Malaya was, by far, Britain’s most profitable colony, credited with providing much of the export earnings that financed British post-war reconstruction. Only a few industries were allowed to develop by the colonial authorities, who generally considered the colonies as suppliers of raw materials and importers of manufactured goods. Most industries then were set up to reduce transport costs of exported or imported goods, such as factories for refining tin-ore and bottling imported drinks. Local industries developed most when economic relations with the colonial powers were weak, e.g. during the Great Depression and the Japanese Occupation.

Table 1 Malaysia: Gross Domestic Product by Sector, 1960-95 (%)

____________________________________________________________________
	1960a	1970	1980	1990	1995
____________________________________________________________________
Agriculture	40	31	23	18	14
Mining	6	6	10	10	7
Manufacturing	9	13	20	26	33
Others	45	50	47	46	46
____________________________________________________________________
Total	100.0	100.0	100.0	100.0	100.0
____________________________________________________________________

Note: ^a Peninsular Malaysia only.

Sources: Alavi 1987: 14; Malaysia, Ministry of Finance, Economic Report, various issues.

Table 2 Malaysia: Export Structure, 1960-96 (%)

____________________________________________________________________
	1960	1965	1970	1975	1980	1985	1990	1994
____________________________________________________________________
Agriculture	66.1	54.5	59.5	52.8	43.6	32.7	22.3	14.2
Rubber	55.1	38.6	33.4	21.9	16.4	7.6	3.8	1.9
Timber	5.3	9.6	16.5	12.0	14.1	10.3	8.9	4.5
Palm Oil	2.0	3.1	5.3	15.4	10.3	11.8	6.2	5.8
Others	3.7	3.3	4.0	3.5	2.8	3.0	3.4	2.0
Mining	22.0	30.0	25.9	22.6	33.8	34.0	17.8	6.4
Tin	14.0	23.1	19.6	13.1	8.9	4.3	1.1	0.4
Petroleum	4.0	2.3	3.9	49.3	23.8	22.9	13.4	4.2
LNG	–	–	–	–	–	6.0	2.8	1.6
Others	4.2	4.6	2.4	0.2	1.1	0.8	0.5	0.3
Manufactures	8.5	12.2	11.9	21.4	21.6	32.1	59.3	78.2
Other Exports	3.2	3.3	3.0	3.2	1.0	1.2	0.6	1.2
____________________________________________________________________
Total	100.0	100.0	100.0	100.0	100.0	100.0	100.0	100.0
____________________________________________________________________

Sources: Bank Negara Malaysia, Annual Report, various issues.

Tables 1 and 2 illustrate some macroeconomic trends in the Malaysian economy in the post-colonial period, showing rapid growth as well as structural change (Table 1) and the rapidly changing composition of exports (Table 2). After independence in 1957, and especially during the sixties, the Malaysian economy diversified from the twin pillars of the colonial economy, i.e. rubber and tin. The Malaysian economy continued to experience rapid economic growth after independence. The average annual growth rate of the Gross Domestic Product (GDP) in Peninsular Malaysia was 5.8 percent during 1957-70 (Rao, 1976). Later, the GDP for the whole of Malaysia rose by an average of 6.9 percent per year between 1971 and 1990 (Malaysia, 1991) and by over eight percent annually from 1988 until 1996, i.e. before the regional financial crisis of mid-1997. Malaysia’s considerable export earnings ensured that it did not suffer from shortages of either savings or foreign exchange, contributing to investments, growth and structural change.

Primary commodity production continued to dominate the economy in the early years after independence. However, in view of colonial Malaya’s heavy dependence on rubber and tin export earnings, following sharp rubber price fluctuations during the 1950s and declining rubber prices in the 1960s, and in anticipation of the inevitable exhaustion of tin deposits, diversification of the economy after independence seemed imperative. However, economic diversification remained limited before the 1970s. Thus, despite the promotion of import-substituting industrialization and the uncertainties that over-dependence on tin and rubber production and exports posed for the economy, these commodities remained the mainstays of the country’s economy at the end of the 1960s. From 1951 to 1969, in spite of declining rubber exports due to falling prices, among other reasons, rubber and tin still accounted for almost 80 percent of Malaysia’s gross export earnings (Lim 1973: 122). However, continued dominance by foreign capital meant that the surplus generated was often channeled overseas.

In 1957, the primary sector (agriculture and mining) accounted for 45 percent of the GDP, the tertiary sector (services) for 44 percent, and the secondary sector (manufacturing and construction) for only 11 percent. By the late 1960s, there had been little structural change in the economy, both in terms of relative production shares as well as employment. Efforts were stepped up to diversify agricultural exports in the early 1970s. Oil palm and cocoa production, for example, were encouraged with crop-specific incentives, with Malaysia going on to become the world’s largest exporter of both agricultural products. Thus, Malaysia extended its colonial global pre-eminence in rubber, tin and pepper to palm oil, tropical hardwoods and cocoa, i.e. through diversification of primary sector production. In the mid-seventies, petroleum production — off the East Coast of Peninsular Malaysia — began providentially, as oil prices soared from 1973. Since the early eighties, petroleum gas production — almost exclusively for export to Japan — has come on stream, offering yet another primary commodity engine for the future growth of the Malaysian economy. Petroleum exports thus grew from the mid-seventies, while petroleum gas as well as cocoa production became increasingly significant from the early eighties. The openness of the Malaysian economy has also been sustained by Malaysia’s new industries since the late sixties, which have been largely export-oriented.

While biased and conservative, post-colonial rural development efforts contrasted with British colonial neglect, especially in the pre-war period. Initially, such government efforts were aimed at consolidating a politically loyal Malay yeoman peasantry for counter-insurgency purposes in the late colonial period and to capture the rural Malay vote after independence. Neither the colonial or post-colonial Malayan governments introduced reforms similar to the far-reaching redistributive land reforms which occurred in China, Vietnam and North Korea after communist-led revolutions, or the Cold War-inspired system-preserving redistributive land reforms of the late forties and early fifties in Japan, South Korea and Taiwan. Yet, in the face of a communist-led insurgency from the late forties, the colonial government initiated many reform measures in the early and mid-fifties, which were subsequently consolidated and elaborated upon by the post-colonial regime to consolidate its rural electoral base.

In 1951, the colonial government established the Rural Industrial Development Authority (RIDA) under the leadership of Onn Jaffar, the founding president of the United Malays National Organization (UMNO). Onn had left the party to form the multi-ethnic Independence of Malaya Party (IMP), apparently in response to a British condition for achieving independence. Later, various reforms were introduced to promote rural cooperatives and to limit rents charged for rice land tenancy as well as interest charged on credit loans. In the pre-war period, the government had restricted Malay land sales to non-Malays. It had also initiated research by the Rubber Research Institute (RRI) to enhance the agronomic, technical and other aspects of rubber production and use.

In 1952, the government established the Rubber Replanting Fund financed by a cess imposed on rubber exports. This facility was introduced in response to a recognition of widespread reluctance to replant less productive rubber trees owing to the tree removal and replanting costs involved as well as the opportunity costs due to the temporary loss of income. By providing replanting grants according to the area being replanted, the fund facilitated and encouraged replanting, thus also arresting declining productivity in rubber production. However, plantations and large small-holdings (defined as being less than a hundred acres in area) were better able to utilize the facility as they could better afford to allow particular areas to be replanted while working the rest of the planted area. For smaller small-holdings that did not have other land to continue working on, the opportunity costs seemed greater, resulting in much less replanting by such small-holders. In response, the government set up the Rubber Industry Smallholders Development Authority (RISDA), which has provided larger replanting grants to small-holders and facilitated replanting in other ways. The more recent demand for rubber wood as commercial timber has also encouraged replanting. However, many rubber small-holdings and other farms have been left idle since the eighties as the small-holders age and their children have secured employment outside the farm sector. As a consequence, productivity on small-holdings is now significantly lower than on plantations.

In 1956, the Federal Land Development Authority (Felda) was established to open up new agricultural land for cultivation by land-less settlers. Over the next three decades, Felda was to open up millions of acres of land in Peninsular Malaysia planted with rubber, oil palm and other crops. The management of these Felda land development schemes has changed considerably over time, involving various experiments ranging from simple supervision of small-holding operations to virtual plantation-style management of workers who are also settler-shareholders. Despite such variation in crop type, management and other conditions, as well as various controversies, Felda has successfully used public resources (land, capital) to significantly expand agricultural production to the advantage of the settlers and with some degree of public accountability. While the former might have been achieved through private investments alone, the consequences are likely to have been more inequitable and hence more likely to be politically destabilizing.

Since the early eighties, however, more emphasis has been given to the development of commercial agriculture — involving larger farms using more profitable, productivity-raising and cost-saving modern management methods — for export markets. While there has not been any spectacular increase in agricultural production in recent years, except for those due to technical advancements, there has been a significant relative as well as absolute decline in the agricultural labor force, although official statistics underestimate the presence of foreign labor, especially of undocumented workers.

Rents in Malaysia have been created and allocated in ways so as to encourage investments in new productive activities, which have accelerated the diversification of the economy from its colonial inheritance. Much of this has emphasized economic diversification, especially industrialization, initially on the basis of import substitution, then export promotion, and heavy industrialization as well. Another important goal of rent creation and deployment in Malaysia has been redistribution, especially along inter-ethnic lines, though the economic effects of redistributive state interventions have generally been quite different from those intended to enhance structural change and economic diversification, but also more varied.

The availability of natural resource rents — most notably from petroleum, natural (petroleum) gas, tin, timber and agricultural products — has been very significant for growth, exports, savings, investment, government revenue and fiscal capacity, allowing the government greater latitude and capacity than most other governments in the world. It is important to consider the nature and fate of different types of resource rents by comparing what has happened to those from petroleum and logging.

The Petroleum Development Act of 1974 has enabled the federal government to successfully capture much of the resource rents from petroleum and natural gas resources, providing a modest proportion to the governments of the states where the deposits are located. The PDA gave the federal authorities jurisdiction over petroleum resources, unlike other natural resources — including land, water, forests and minerals — which have been state government prerogatives under the post-colonial federal constitution. In the mid-seventies, petroleum production off the East Coast of Peninsular Malaysia began providentially, as oil prices soared after 1973. Although petroleum had long been extracted off Sarawak by Shell, Malaysia only became a net oil exporter from the mid-seventies. Since the early eighties, petroleum gas production — almost exclusively for export to Japan — has come on-stream. While petroleum royalties are shared with the state government concerned, the federal government controls Petronas as well as other petroleum revenues. Petronas is widely considered to be a well-run company, with a good international credit rating.

Petronas resources have been abused for various purposes, including salvaging the state-owned Bank Bumiputra on two occasions to save it from ‘going under’ and to buy into major real property construction projects of dubious commercial feasibility. These have done little to enhance productivity, but have instead served to prop up problematic government projects and to ‘save’ protected and non-tradable economic activities or international competitiveness. However, all this has only been possible because the company has been able to capture and retain petroleum rents reasonably well, in sharp contrast to the situation with logging.

In the case of timber, by contrast, almost nothing has been captured by the federal government and relatively little by the state governments, which control all land and natural resources other than petroleum and natural gas since the PDA. Timber rents have mainly been captured by powerful politicians, royalty and others who secure logging concessions, as well as their mainly ethnic Chinese logging operator partners and, frequently, Japanese sogososha financiers. It should not be forgotten that rent-seeking occurs in essentially oligopolistic environments, ensuring that rents are not all dissipated in the process due to political ‘entry barriers’ and that net gains are handsome enough to be very attractive. Such rents have not been restructured to reward productive and productivity enhancing investments until recently, when bans on log exports have encouraged investments in wood processing, with generally inefficient outcomes owing to the manner in which the incentives have been structured (Vincent and Hadi 1992).

The authorities do not tax either the timber concessionaires or the logging companies very much, certainly not even enough to cover the real costs of reforestation and for strict enforcement of logging and other related regulation. Timber companies hardly pay income tax, while the state governments collect a small royalty on the logs extracted, amounting to barely one percent of the timber price. Loggers minimize their tax liabilities by undervaluing both the type, nature and quality of the timber extracted, as well as their quantity, volumes or weights. Under-declaration of wood extracted and exported is common, while accounts are ‘fiddled’ or officials bribed to reduce tax and royalty liabilities and to maximize retained earnings. As the federal and state governments realize that timber revenues have been well below what they should be, tax rates have been raised, but often only to lead to further tax evasion.

With few taxes to pay, and poor enforcement by the authorities, the loggers seek to maximize short-term, rather than long-term returns, especially with the political uncertainties which threaten policy change and the security of their concessions. Having no stake in the forest's regeneration owing to the generally short-term nature of the logging concessions and the sub-contracting arrangements to the loggers by the concessionaires, the logging industry has been short-termist, and largely oblivious of the requirements of sustainable forestry practices. Much illegal logging — outside concession areas, of immature trees, etc. — occurs, while logging companies often disregard restrictions for selective felling in order to maximize profits in the short-term.

Logging’s contribution to Malaysian capital accumulation, investment and growth has been limited in other ways too. Under-declaration of timber production and exports has not only facilitated tax evasion, but also capital flight. Many of the beneficiaries have not even re-invested within the country, let alone in the areas from which the timber has been extracted. Not surprisingly, then, Malaysian logging companies have been among the most prominent of Malaysian companies investing abroad in the Southwest Pacific, Indochina, West Africa and northern South America. Thus, logging has exacerbated resource outflows, not only for the communities directly affected, but also for the national economy. Despite the considerable money made from logging, both state and federal governments get relatively little while they are obliged to bear some of the environmental and other costs of deforestation.

Despite some dissipation as well as rent capture by dubious rentiers unlikely to make productivity enhancing investments, such resource wealth and Malaysia’s relatively small population enabled the public sector to develop in the 1970s and early 1980s with a ‘soft budget constraint’. This not only allowed, but even encouraged various extravagances. Such fiscal irresponsibility seemed to increase with greater state intervention and the availability of enhanced oil revenues from the mid-1970s until the economic and political crises of the mid-1980s brought about greater fiscal discipline and harder public enterprise budget constraints, besides providing a rationale for privatization.

By East Asian standards, Malaysia has had one of the highest household savings rate, second only to Singapore. The main reason is a similar employees provident fund institution, requiring all workers and their employers to contribute the equivalent of between 20 to 30 percent of their wages to a fund which later becomes available upon retirement or for other designated purposes. This forced savings institution has also been important as an alternative to ‘pay as you go’ pension fund arrangements, which have become very burdensome and almost unsustainable in mature welfare states.

Malaysia’s manufacturing growth has been facilitated by both import-substitution (IS) and export-orientation (EO) industrialization policies. Both IS and EO industries have gained from protection and subsidies respectively, e.g. EO rents attracted foreign transnationals to invest in the processing of imported inputs for re-export. Various rents — offered in the form of financial (especially tax) incentives, low wages, good infrastructure, political stability and government support — have attracted risky lumpy investments in export processing, and even in some design activities since the 1980s. Like import substitution, export orientation has also involved distorting relative prices, contrary to the claims that export success has been due to laissez faire market policies.

Though Malaya was, by far, Britain’s most profitable colony, only a few industries were allowed to develop by the colonial authorities, who generally considered the colonies as suppliers of raw materials and importers of manufactured goods. During the colonial period, some such industries enjoyed ‘natural protection’ due to the nature of the raw materials produced (e.g. rubber latex requiring immediate processing near the point of extraction). Most industries then were set up to reduce transport costs of exported or imported goods, such as factories for smelting tin ore, processing smoked rubber sheets to reduce rubber’s natural liquid content and bottling imported drinks. Not surprisingly then, local industries developed most when economic relations with the colonial powers were weak, e.g. during the Great Depression and the Japanese Occupation.

Resource-based industrialization was the great hope for post-colonial Malaysia whose growth during the colonial period had been based on primary production. After independence, for example, it was expected that as the world’s largest natural rubber producer, Malaysia would be placed to become a significant producer and exporter of rubber manufactures such as car tires. Ironically, owing to the low natural rubber content and high synthetic rubber content of most car tires as well as the different effectiveness of industrial policies, South Korea (which does not produce any natural rubber or petroleum, from which synthetic rubber is made) — rather than Malaysia — emerged in the eighties as a major rubber tire producer and exporter.

Inexperienced Korean rubber tire manufacturers were initially protected on condition that they would export within a few years, which they did with great success. Having to export forced the tire manufacturers to quickly minimize costs, maximize scale economies and raise quality to international standards. In Malaysia, however, foreign tire manufacturers were granted protection to induce them to set up a plant to produce for the domestic market. While the government hoped that they would eventually export, it did nothing to require them to do so, although it offered attractive incentives and support facilities in the hope that they would do so. These transnational tire manufacturers eventually began exporting, but their achievement has been modest given the amount of protection they have enjoyed in terms of both the duration as well as the effective rate of protection. Exports were initially of tires with a high natural rubber content (e.g. aircraft tires), and have grown most since the ringgit depreciation in the second half of the eighties. The differences in the performances of the rubber tire industries in South Korea and Malaysia clearly reflect the consequences of appropriate and effective industrial policy measures.

As noted earlier, as part of its measures of agricultural diversification, post-colonial Malaysia promoted increased palm oil production from the sixties, especially in the face of lower, often depressed rubber prices. The nature of the crop and transport cost considerations required the domestic extraction of crude palm oil from the palm fruit before export. However, palm oil producers and other investors were unwilling to invest in palm oil refining capacity before the mid-seventies. Returns to such investments were not expected to be high enough to warrant them. Also, many importing countries imposed higher import duties on refined oil to protect their own refining capacities, effectively discouraging investments in such capacity abroad, including in Malaysia.

However, a higher export duty on crude palm oil exports introduced in Malaysia in the mid-seventies attracted massive investments in processing capacity, which soon led to very intense competition among refiners. This forced refiners to enhance their industrial and technological capabilities rapidly, enabling Malaysia to reach and then define the world technological frontier in palm oil refining within a decade. The rapid development of such capabilities was facilitated by the achievement of new economies of scale and scope (e.g. specialized palm oil — rather than generic vegetable oil — processing). In the face of new protectionist barriers erected by traditional importers who wished to promote the consumption of their own vegetable oils, the Malaysian government also did a great deal to promote palm oil exports to new markets. In some instances, the Malaysian authorities have even encouraged the potential importers to develop palm oil refining capacities in the importing countries, effectively committing them to future imports of the oil, presumably from Malaysia.

This story provides a splendid illustration of how government intervention — involving a temporary welfare loss for crude palm oil producers (due to the export duty equivalent which accrued to investing refiners instead) — led to considerable net welfare gains for all major segments of the palm oil industry, and significant gains in value-addition for the national economy. It also underscores the importance of a dynamic perspective on comparative advantage, instead of the static view associated with neoclassical international trade theory.

However, efforts to increase manufacturing value addition in Malaysia have not always been well considered. For example, bans on log exports have been imposed at various times in Peninsular Malaysia, Sabah and Sarawak with the ostensible intention of promoting wood-based manufacturing activities in Malaysia. While such activities have certainly grown, much of the existing capacity is quite inefficient and would not survive without the log export ban. More importantly, there is little evidence that most of these industries are ever going to become internationally competitive, meaning that they constitute a welfare loss, particularly for the timber producers who receive lower prices for their timber due to the market constraint imposed by the log export ban.

The government has become more selectively interventionist since the mid-eighties, even withdrawing in some areas in line with its commitment to economic liberalization, giving the overall impression of incoherent industrial policy. The period since the mid-1980s has also seen new efforts by the government to encourage technological deepening by foreign capital. Rents have been increasingly tied to the development of domestic production capabilities, rather than simply to investment and employment generation, as was the situation before the mid-1980s. Human resources, research and development, linkages, exports and technologically strategic manufactures all enjoy additional tax incentives.

Thailand

Between 1955 and 1988, per capita economic growth in Thailand averaged 3.9 percent per annum (Christensen et al., 1993: 2). Only four countries — Brazil, Malaysia, Taiwan, China, and South Korea — grew faster. High economic growth was accompanied by a rapid decline in the incidence of poverty, mild, but rising, income inequality, and substantial exports of both manufactures and primary commodities, including processed agricultural commodities. By 1985, the value of manufactured exports exceeded agricultural exports for the first time. Textile exports increased fourfold between 1983 and 1989; integrated circuits (ICs) exports doubled between 1985 and 1987, while exports of plastics and shoes more than doubled in 1988 alone. There was a similar boom in processed commodities. They had stagnated between 1981 and 1986, but grew rapidly after that, increasing by more than two and one-half times by 1993 (Tables 3 and 4). This export boom (largely based on foreign investment) contributed to an acceleration of growth to 6.4 percent per capita per annum between 1989 and 1992. This long-term development performance made Thailand one of the development success stories since 1960.

Table 3. Thailand: Changes in Production Structure, 1960-93
(GDP share in percentages, selected years)

____________________________________________________________________
	1961	1970	1980	1990	1993
____________________________________________________________________
Agriculture	39.8	27.0	20.0	13.6	11.8
Industry	18.7	24.4	30.1	37.8	40.8
Services	41.5	48.0	49.9	48.6	47.4
Manufacturing	12.6	16.0	21.7	27.8	31.1
____________________________________________________________________
Total	100.0	100.0	100.0	100.0	100.0
____________________________________________________________________

Sources: National Economic and Social Development Board and Bank of Thailand.

Throughout the 19th century, Thailand was a self-sufficient, semi-feudal economy (Bell 1970). With the imposition of the Bowring Treaty in 1855, the country began a century long process of integration with the West. The political crisis that accompanied the forced opening of the economy led the monarchy to turn to administrative reform and political change to preserve Thai independence. For the most part, reforms reinforced traditional institutions — the monarchy and Buddhism — and fostered the development of a centralized state, weak interest groups, and non-democratic politics (see Rock 1994).

Table 4. Thailand: Structure of Exports, 1981–1993 (percentage of total exports)

____________________________________________________________________
	1981	1985	1988	1990	1993
____________________________________________________________________
Agriculture
Rice	17	12	9	5	4
Tapioca	11	9	5	4	2
Total	48	38	26	17	12
Labor-intensive manufacturesa
Textiles and garments	10	14	16	16	14
Jewelry	3	4	6	6	4
Footwear	0	1	2	3	3
Total	15	21	29	31	27
Medium-high technology manufactures
Machinery and appliancesb	0	1	4	8	10
Electrical	0	1	2	6	7
Electrical circuitryc	4	4	7	6	8
Vehicles and parts	0	0	1	1	2
Total	5	7	15	22	30
Manufactures as percentage of total exports	36	49	66	75	80
____________________________________________________________________
Total Exports	100.0	100.0	100.0	100.0	100.0
____________________________________________________________________

Notes:
^a All ‘other’ categories (other agriculture, other labor-intensive, etc.) have been omitted.
^b Mainly computers and parts.
^c Mainly integrated circuits.
Sources: Thailand Development Research Institute (1994); Bank of Thailand.

By 1927, the outlines of the modern Thai political economy were set. The center (Bangkok) had molded a loosely integrated collection of semi-autonomous provinces into a nation-state by a triad of forces consisting of a highly centralized bureaucracy that invested in national defense and the transport system, a freed peasantry that expanded the area under cultivation, and Chinese traders and European exporters who facilitated the rice trade. Political legitimacy for this particular political economy rested on an aura of sacredness surrounding the monarchy, an elitist, hierarchical social structure in which superiors and subordinates were inter-linked in a set of reciprocal, but unequal relations, and the pervasive influence of Buddhism. Subsequent political developments — the formal establishment of parliamentary democracy in 1932, accommodation with Chinese ‘pariah’ entrepreneurs in the 1950s, and ceding of substantial control over economic policy to western-trained technocrats in the 1960s — reinforced the traditional pillars of political legitimacy and the tendency toward a centralized state, a weak political party system, and unstable democratic political institutions.

Industrial policy-making in Thailand has been spread across a wide array of agencies with limited technical capacity. At least seven agencies were responsible for industrial policy. Neo-liberals viewed these agencies as either deficient or irrelevant. The lead agency, the Board of Investment (BOI), offered lucrative fiscal incentives to promote investment. But, neo-liberals argued, it was understaffed, lacked clear promotion guidelines, and failed to hold promoted firms accountable for their performance. More often than not, promotions granted were ad hoc, and given with little understanding of their macroeconomic effects or of project viability. As noted above, the Ministry of Finance set tariffs and tax rates, but lacked the capacity to assess the impacts of changes in tariffs on industrial structure. The Ministry of Commerce (MOC) controlled the import and export of certain goods, including the ability to ban imports and exports of those goods, and operated an export services center. The Ministry of Industry (MOI) issued licenses to build factories, regulated business conduct and enforced zoning laws. Neither of these ministries had much technical strength. The Industrial Finance Corporation of Thailand (IFCT), a private development bank, lent long term to medium and large-scale enterprises. Its lending was small and irrelevant. Thailand’s national planning agency, the National Economic and Social Development Board (NESDB), set the broad direction for the economy but its role was only advisory and its technical capacity was limited. The Bank of Thailand determined credit policy. Although it was a key macro player, it had limited influence over sectoral policy.

Inadequate coordination between these agencies and overlapping jurisdiction contributed to the lack of coherent industrial policies. At least four agencies — the Board of Investment, the Ministry of Finance, the Ministry of Commerce, and the Ministry of Industry — controlled trade policy. Until 1990, attempts by the core macroeconomic ministries to rationalize trade policy along neo-liberal lines failed. No less than five departments in three ministries controlled access to numerous permits and licenses. Sometimes multiple offices were involved in obtaining a single permit. Efforts by BOI to facilitate the permit acquisition process through its Investment Services Center (ISC) were routinely blocked by departments or Ministries who refused to relinquish control over their prerogatives. As a result, BOI’s Investment Services Center was unable to serve as a one-stop shop and much of its work was limited to handling minor visa problems. Overlapping jurisdiction also meant that industries banned from expansion due to excess capacity by the Ministry of Industry had either been aggressively promoted by the Board of Investment (BOI) or grown due to the high tariffs under control of the Ministry of Finance (World Bank 1980b). And firms provided privileges by BOI often found those privileges undermined by the actions of other ministries. Neo-liberals argued that the fragmentation of industrial policy and its separation from macroeconomic policymaking served an important political function (Christensen et al., 1993: 21-24). It provided rich opportunities for the ‘big men’ in the bureaucratic polity to use sectoral policies to satisfy the demands of their supporters.

The standard interpretation of the Thai state seems to offer an internally consistent and powerful explanation of the irrelevance of Thai industrial policy. The focus on rent seeking ‘feudalization’ of government administration leads many observers to overlook important contrary evidence of highly effective, longstanding and significant selective distortions in agricultural markets. This causes them to miss equally important examples of successful selective interventions during first-stage import substitution industrialization (ISI) in the 1960s as well as with second stage ISI in the 1970s. It also contributes to a critical oversight of the systematic turning of the entire industrial policy machinery to promote non-traditional manufacturing exports and non-traditional agro-industrial exports during the 1980s.

An important part of the neo-liberal interpretation of Thai industrial policy rests on an assertion of low price distortions. While the exchange rate, the interest rate and the price of capital were kept close to their scarcity values, this was not true for agricultural prices, particularly rice prices, and, by implication, the price of labor. These distortions were systematic, sustained over time, and large. What was the purpose of the government’s rice price policy and how did it intervene in rice markets? Except for occasional rent-seeking, government intervention in rice markets was aimed at stabilizing rice prices at a low level. This was achieved through a variety of taxes, including a variable export tax, on rice. This policy had two important consequences. It facilitated substantial crop diversification (Panayotou 1989: 96-7). As shown below, this also contributed to the emergence of a large export-oriented agro-processing industry once the government began offering promotional privileges to large export-oriented agro-processors. This policy also enabled the government to take advantage of a large land frontier to manipulate the industrious, but politically docile peasantry by giving peasants access to land while taxing them heavily. As a result of the government’s systematic use of a variable export tax on rice for over thirty years, it was possible to extract resources from agriculture without impoverishing the peasantry and to build an indigenously owned commercial banking system and an import-substitution industrial base in Bangkok behind protective barriers.

In 1986, the government began promoting export oriented agro-industries (Manarungsan and Suwanjindar, 1992: 13). These industries were chosen for promotion because: all of their output was exportable; most of their raw materials were produced locally; they were labor-intensive; and they increased farmer incomes (Suehiro, 1992: 268). Since then, promotional privileges for export-oriented agro-processing industries have included import duty reduction on machinery imports; three-year income tax exemptions, extendible to seven years; exemption of import duties on raw or essential materials imports; exemptions of export taxes; exemptions of value added taxes on exports and on local goods used to produce exports; and reduced electricity changes, domestic air-cargo charges by Thai International, and rail charges if located in industrial estates in selective provinces (BOI 1996: 3-4, IEAT n.d.: 7). Agro-processing industries have also benefited from the extension of subsidized credit to farmers who participate in contract farming and outgrowing schemes (Pasuk and Baker, 1995: 60); from promotional privileges extended to general trading companies (Hewison, 1989: 145); from bilateral inter-governmental negotiations with importing countries, which have resulted in lower tariffs on imports; and from a government program designed to enhance the quality of agro-exports.

Although there are no definitive studies of the impact of promotional privileges on agro-processing industries and their exports, available evidence suggests that these programs probably did make a significant difference. For one, processed agricultural exports grew at an annual average rate of 33.75 percent between 1986 and 1993 (Table 4). Moreover, by the late 1980s, 15 of the largest 26 non-financial domestic business groups were exporting processed agricultural commodities (Suehiro, 1992: 269). For prepared meat exports, primarily chicken meat exports, growth was even more dramatic. Prepared meat exports were practically non-existent prior to 1976; by 1980, they equaled US$32.7 million; by 1985, they equaled US$63.5 million. Following heavy promotion by government, prepared meat exports increased eight-fold to US$434 million in 1993 (Table 4).

The experience of the Charoen Pokpahan (CP) Group is typical of the expansion experienced by Thailand’s agro-industries. The CP group got its start in 1921 as a trading company importing seeds and vegetables and exporting pigs and eggs. The company registered with the Thai government in 1951 and opened a feed mill in 1954. With this mill the company took the first steps toward vertical integration as the group not only sold seeds to farmers but also bought and processed farmers’ crops. In 1976, CP moved into poultry farming following an announcement by the Board of Investment that promotional privileges were available for this activity. Because of difficulties breeding local chicken, CP entered a joint venture with an American company, Arbor Acres. Arbor Acres provided and continues to provide CP with chicks. CP also established joint ventures with Japanese firms to market frozen chicken meat in Japan (Manarungsan and Suwanjindar 1992: 17). And it pioneered contract farming in Thailand, including guaranteeing loans to farmers from the commercial banks and from the Bank of Agriculture and Agricultural Cooperatives (Pasuk and Baker 1995: 60). By 1979, CP controlled 90 percent of poultry exports and 40 percent of the domestic animal feeds business. CP also used Board of Investment (BOI) privileges to establish its own trading company, CP Intertrade, and to establish plantations for growing mung beans and maize (Hewison 1989: 145).

Institutional changes within government and between government and the private sector provided a unique opportunity to reform industrial policy along neo-liberal lines. But efforts to do so were blocked by old patron-client ties between industrialists in the private sector and cabinet ministers in sectoral (line) ministries. In fact, the trade regime became more protectionist. Following this failure, the government turned its new found power to neo-statist micro (selective) interventions. Board of Investment (BOI) promotional privileges — including exemptions and/or reductions in import duties and business taxes on imported inputs, machinery, and equipment and exemptions from corporate income taxes — were extended to export projects, including those of direct foreign investors. This shift required changing the criteria for offering promotional privileges to foreign firms. The new criteria permitted majority foreign ownership for export-oriented firms and 100 percent foreign ownership for plants that exported all of their output. Foreign firms responded well to the BOI sponsored ‘contest’ as the average export propensity of foreign firms increased from 33 percent in 1984 to 50 percent by 1988 (World Bank 1993: 142). This was followed in 1985 by Japanese financing of a long term Export Industry Modernization Program (EIMP) through the International Finance Corporation of Thailand (IFCT) at highly subsidized interest rates. Starting in 1986, the Bank of Thailand’s (BOT) longstanding program of subsidies for working capital needs of agricultural exporters was re-oriented to meet the needs of exporters of manufactures. By 1988, exporters of manufactures were receiving more than one half (53 percent) of the BOT’s subsidized loans. The combination of rising effective rates of protection and countervailing export subsidies suggests that Thai trade policy during this period was closer to Korea’s during its early export expansion (1965-68) than it was to neo-liberal prescriptions.

If industrial policy was effective, Thailand’s industrial structure should differ significantly from expected international norms. One crude measure of this is the ratio of actual value added as a percent of GDP of a sector to predicted value added of that sector. If the ratio of actual value added to predicted value added equals one, industrial structure mirrors international norms. If it is greater or less than one, a sector deviates from international norms. By inference, deviations from international norms reflect, among other things, differences in factor endowments and the influence of industrial policy.

Given Thailand’s rich natural resource base and overwhelming comparative advantage in agriculture, one would expect the share of value added in agricultural processing industries to be significantly greater than one and to deviate most from international norms. Yet, the actual share of value added in food, beverage, and tobacco in Thailand in 1986 was only 34 percent of its expected share (Hewison 1989: 306). And this is the case despite the substantial success experienced by Thailand’s large-scale agro-processing industries. Moreover, Thailand’s overall manufacturing share of value added in GDP exhibits far greater deviation from international norms than that for any other HPAE, including Korea. In three of nine sub-sectors — textiles (3.33), wood and wood products (1.85), and metal products and machinery (1.82) — actual value added was between two and three times that predicted by international norms. Taken together, these outcomes suggest that Thai industrial policy almost certainly exerted significant influence on industrial structure.

Conservative macroeconomic policies, consistent selective interventions in agricultural markets, including markets for agro-industrial exports, successful industry and firm specific interventions during first stage and second stage import substitution industrialization, and the systematic turning of the industrial policy machinery to promote non-traditional manufacturing exports during the 1980s suggest that industrial policy in Thailand has been more coherent than neo-liberals admit.

Indonesia

Between 1965 and 1990, growth in income per capita in Indonesia averaged 4.5 percent per annum (World Bank 1992: 218). Only seven developing countries — China, Lesotho, Paraguay, Botswana, Korea, Singapore, and Hong Kong — grew faster. High economic growth was accompanied by a rapid decline in the incidence of poverty and low income inequality (Campos and Root 1996: 9-16). In addition to equitable and poverty reducing growth, Indonesia achieved food self-sufficiency (in rice by 1985), a rapid decline in the rate of population growth, and an equally impressive spread of basic education and literacy (Campos and Root 1996: 60).

These developments were accompanied by substantial industrialization and structural change. Agriculture’s share in GDP declined from 51 percent to 22 percent, while the share of manufactures in GDP rose from 8 percent to 20 percent (World Bank 1990: 222). Because overall growth was so rapid and growth in manufactures even more rapid (manufacturing output grew by more than 12 percent per year between 1965 and 1990), the manufacturing sector in 1990 was almost 45 times larger than it was in 1965 (World Bank 1992: 222). Although much of manufacturing was fostered under policies of import substitution, Indonesia also experienced substantial success in exporting manufactures. By 1993, manufactured exports reached US$21 billion and accounted for 53 percent of total exports (World Bank 1996: 216). Because of this, Indonesia has gone a long way toward diversifying its economy, including exports, away from oil and other primary products.

This long-term development performance has attracted considerable attention (World Bank 1993, Campos and Root 1996, Hill 1996a). Broad similarities across the developing world with Indonesia’s factor endowments (natural resources, physical capital and human capital) and with the character of its state (the state is neither ‘strong’ nor ‘hard’ in the Northeast Asian sense and is characterized by corruption, rent-seeking and patrimonial distribution networks) suggest that others in similar circumstances might have much to learn from Indonesia (Lindauer and Roemer 1993). The government’s relatively effective husbanding of the country’s natural resource riches to promote broad-based growth and economic diversification is also of interest. As experience elsewhere shows, this has not proved easy as all too often, natural resource riches may be a ‘curse’ (Auty 1990 and 1994, Gelb and Associates 1988) rather than a boon to development.

Table 5. Indonesia: Gross Domestic Product by Sector, 1965-90

____________________________________________________________________
	1965	1970	1980	1990
____________________________________________________________________
Agriculture	55.0	47.5	24.3	19.4
Manufacturing	8.5	10.9	13.4	19.4
Other Industry	6.5	8.9	29.7	22.1
Services, etc.	30.0	32.7	32.1	39.1
____________________________________________________________________

Sources: Central Bureau of Statistics (BPS) and World Bank staff estimates, reproduced in Bhattacharya and Pangestu (1993).

From the 19th century until independence in 1949, the Dutch colonial government systematically turned Indonesia into an export-oriented plantation enclave economy. Extraction of an agricultural surplus in estate crops for export was dependent on a triad of forces. Armed force and legal changes were used to coerce villagers to grow commercial crops and to allocate labor to state plantations (Robison 1986: 6). Indonesian Chinese merchants, who served as tax farmers and operators of state trading monopolies, facilitated extraction and transshipment of the agricultural surplus produced in the countryside. Over time, these merchants monopolized trade and petty commodity production. They also became a scorned ethnic minority. Export of primary estate crop commodities was handled by a small number of large European trading houses. By the early part of the 20th century, transformation of the Indonesian economy was complete. Much of Java had been turned into a virtual sugar plantation and the export-oriented plantation economy was extended to other crops (coffee, tin, rubber and petroleum) and other islands, most notably Sumatra (Robison 1986: 9).

Several crucial elements of Indonesia’s post-independence political economy — heavy, continuing and abiding government intervention in the micro-economy, the emergence and consolidation of patrimonial distributional networks between high ranking government officials and Sino-Indonesian businessmen, and the long term shift toward and consolidation of authoritarian politics — owe much of their legacy to elite reactions to the colonial period and the ‘ekonomi kolonial’. The fourth — a long standing commitment to macroeconomic stability — owes more to the failures of Sukarno’s ‘Guided Economy’ and to the small group of technocrats who have been advising the New Order government since 1966. More will be said about this later. Taken together, these four elements circumscribe the political economy of economic policy-making in the New Order and provide the basis for the neo-liberal contention that the New Order state lacks the capacity to successfully implement selective development policies.

Table 6 Indonesia: Major Manufactured Exports, 1980-93 (US$ million)

____________________________________________________________________
	1980	1985	1990	1993
____________________________________________________________________
Labor-intensive
Total	287	785	4,634	11,344
Major items
Clothing	98	339	1,646	3,502
Woven fabrics	43	227	1,132	2,247
Footwear	1	8	570	1,661
Electronics	94	77	204	1,382
Percentage of all manufactures	57	38	51	58
Resource-intensive
Total	119	992	3,324	5,364
Major items
Plywood	68	941	2,791	4,586
Percentage of all manufactures	24	49	37	28
Capital-intensive
Total	97	266	1,083	2,729
Percentage of all manufactures	19	13	12	14
Total, all manufactures	501	2,044	9,041	19,437
Three largest as percentage of total	52	74	61	53
Manufactures as percentage of total exports 2 11 35 53	2	11	35	53
____________________________________________________________________

Sources: BPS, Ekspor (Exports), Jakarta, various issues.

There is little doubt that the colonial experience bred a deep-seated mistrust of market forces, foreign investment, and the Sino-Indonesian business community (Gillis 1984, Timmer 1975, Hill 1996a). Because of this and due to the weakness of the indigenous Indonesian business community, political elites believed there was no alternative to the government playing a large role in the economy. Initially, state intervention took a variety of forms. In banking, the Dutch bank was turned into a central bank that provided subsidized credit to a small number of state owned development banks (MacIntyre 1993: 128). One of these channeled subsidized credit to industry. Another provided subsidized and administratively allocated credit to indigenous traders engaged in import and export. A third provided cheap credit to small and medium enterprises. Because of a perceived shortage in indigenous entrepreneurs, state banks also promoted state-owned enterprises in a wide range of industries — cement, textiles, glass, and automobile assembly. And the state administratively allocated highly lucrative import and commodity distribution licenses to indigenous entrepreneurs and regulated domestic and foreign investment.

Virtually all of these interventions transcended the Sukarno era and became more or less lasting characteristics of the New Order’s economic policies. State control of banks and the banking system, including administrative allocation of highly subsidized credit, lasted into the 1980s (MacIntyre 1993). State-owned industries in petrochemicals and steel were hallmarks of the New Order’s industrial deepening policies of the 1970s and of the high technology policies that continue to this day (McKendrick 1992, Auty 1990). State allocation of lucrative import and commodity distribution licenses were and are a hallmark of the New Order’s relationship with the Sino-Indonesian business community (World Bank 1989, Robison 1985: 302). And extensive regulation of both domestic and foreign investment lasted into the 1990s (World Bank 1989: 70). Because of this combination, the microeconomic policies of the New Order have been very dirigiste and, until recently, attempts to liberalize a highly regulated micro-economy along neo-liberal lines have not met with much success (Gillis 1984, World Bank 1989). The expansion and consolidation of patrimonial distributional networks between state actors and the Sino-Indonesian business community is another legacy of the colonial experience. This too was carried over from Sukarno’s Guided Democracy into Suharto’s New Order. These networks have their origin in the independence struggles of the 1940s when regional military commanders, who found their commands under-funded, developed close relationships with ethnic Chinese cukong entrepreneurs (Liddle 1991: 415) — Chinese businessmen who traded a share of their profits for political protection. By this mechanism, high-ranking military and political elites were able to provision their commands and enrich themselves and those in their political entourage.

The activities of Liem Sioe Liong, the head of Indonesia’s largest conglomerate, offers a prime example of how this system got started, subsequently expanded after independence, and was consolidated during the New Order. Liem provisioned the army during the struggle for independence (Sato 1993: 411). After independence, he consolidated relationships with the military by becoming a reliable supplier of goods to the army to then Lieutenant-Colonel Suharto in the Diponegoro Division in Central Java. Later, he parlayed his relationship with Suharto and the army into monopoly licenses for the import of cloves and for milling flour (Sato 1993: 411). Large monopoly trading profits earned from these licenses were subsequently invested in manufacturing, banking, cement, and substantial diversification.

The conventional interpretation of Indonesian economic development appears to offer an internally consistent and powerful explanation of the irrelevance of selective (micro) policies. But the focus on rent-seeking government at the micro (sectoral) level leads them to overstate the technocrats’ commitment to neoclassical liberalism and the bifurcation between macro and micro policy. It contributes to an underestimation of the government's commitment and ability, including that of the technocrats, to use income from natural resource riches, including oil, to diversify the economy by financing ‘full-set industrialization’ (Mihira and Sato, 1992). Because of this, neo-liberals miss substantial evidence that reveals rejection by the technocrats of a development strategy based on static comparative advantage in primary products, including oil. They also overlook important contrary evidence of the role of the technocrats in highly effective, long-standing, large and selective interventions in agricultural markets, particularly for rice. And they miss industry-specific examples of successful selective interventions during first and second-stage import substitution industrialization in the 1970s and in export promotion in the 1980s, including the establishment of resource based industries.

The intellectual predisposition of the technocrats may have been toward neo-classical microeconomic policies. Ideological hostility among political and intellectual elites to markets (‘free-fight liberalism’), foreign investment, and the Sino-Indonesian business community, puts technocrats proposing neo-classical solutions at a substantial disadvantage. Because of this, their proposals to liberalize the Indonesian micro-economy along neo-classical lines have been subject to substantial criticism. In addition, many of the micro agencies — most particularly, the Ministry of Industry, the Board of Investment (BKPM), Pertamina (the state-owned oil company), Bulog (the state food procurement agency) and the Ministry of Research and Technology — are in the hands of a group of so-called economic nationalists who favor state-led industrial development (MacIntyre 1993: 155). Some in this group have been influenced by the industrial development experiences of Japan, South Korea and Singapore, and favor using protection and financial subsidies to build indigenous industrial capabilities in targeted industries such as steel, fertilizers, petrochemicals, and aircraft. This group has had substantial support from Suharto who sees them as an "embodiment of his dream for more rapid progress toward an industrialized and more powerful Indonesia" (Liddle 1991: 418). Because of this, he favors them when resources permit.

Finally, it must be recognized that the combination of orthodox macro policies and interventionist micro policies serves an important political function. Macroeconomic stability facilitates overall economic growth and growth of the Sino-Indonesian business conglomerates that have come to dominate the landscape of the Indonesian economy. Because of cukongism, growth of the conglomerates provides the resources Suharto needs to maintain political support among key elites. It also provides ample opportunities for intra-elite rent-seeking. As Liddle (1991: 407) states, Suharto and the military seem to have realized that "the golden eggs provided by (macro stability) can be distributed to patrimonial clients without starving the goose." Or said another way, this particular configuration — separation of macro policy from micro policy-making, control of micro agencies by those favoring explicit and selective industrial policies, and use of selective policies for patrimonial ends — reflects President Suharto’s political calculus in which "the economists (are) the producers of wealth, the patrimonialists the distributors of it, and the nationalists the embodiment of (his) dream for more rapid progress toward an industrialized and more powerful Indonesia" (Liddle 1991: 419). Because of this, he favors them when resources permit.

What evidence is there that the desire to create a strong, integrated, diversified, industrialized, and outward oriented ‘ekonomi nasional’ actually affected the use of selective micro-policies and industrial and export outcomes? Several important micro policies are consistent with this interpretation. To begin with, technocratic intervention in agricultural markets, particularly the market for rice, has been significant, longstanding, and highly effective. It required substantial co-ordination with sectoral agencies, particularly the Ministry of Agriculture and Bulog, the food logistics agency. And it facilitated the building of a significant industrial base that ultimately became export-oriented.

Because the history of government policies toward rice is well known, only the outlines will be provided here (Timmer 1975, 1989, and 1993). Government interest in rice, most particularly in achieving self-sufficiency, is the consequence of a complex set of factors — President Suharto’s rural roots; recognition that increasing rural well-being is an effective antidote to agrarian radicalism; the macroeconomic consequences of importing large quantities of rice; the politically stabilizing effects of low and stable rice prices for urban (particularly civil servants and the military) consumers and for the pace of industrialization. For all these reasons, the government committed itself to achieving self sufficiency in rice (Glassburner 1978: 143). By 1985, this was achieved and it has been more or less sustained.

How was this done? The simple answer is by substantial intervention in markets: in markets for inputs (fertilizer, pesticides, and seeds); in credit markets; and in output markets. In each instance, the government and the technocrats in macro agencies deliberately distorted market prices. The objective of intervention in output markets was to stabilize the domestic price of rice around the world price (Timmer 1993: 152). In fact, domestic rice prices were kept roughly 15 percent below world prices (Gelb and Associates 1988: 219). What this meant in actual practice was stabilizing rice prices around a declining real world price of rice. Achieving this required substantial co-ordination across several macro and micro agencies including Bulog, the food logistics agency; BAPPENAS, the planning agency; the Ministry of Finance; the Ministry of Agriculture, the President’s Office; and EKUIN, the Co-ordinating Ministry for Economics, Finance, and Industry (Timmer 1993: 151). As Timmer states (1993: 158), the Ministry of Finance was the key organizer of an analytical process that resulted in the government setting floor and ceiling prices and controlling imports. This gave one of the key macro agencies substantial influence over one of the key sectoral, or micro agencies, Bulog. This effort has been highly successful (Timmer 1993). Because of it, stable price signals were communicated to farmers encouraging them (and others) to invest in marketed crops and agricultural marketing. Stable price signals also provided stability of real wages (rice is the primary wage good) and contributed to urban political stability (by provisioning cities with low and stable prices for rice). Both induced investment growth in industry (Timmer 1989).

But this was not the only intervention in rice markets. Because farmers had limited experience with commercial fertilizers and with high yielding seeds, the government subsidized both and subsidized credit to farmers so they could purchase these new inputs. These subsidies were used to overcome failures in information (farmers did not fully understand the impact of new seeds and fertilizer on yields) markets by significantly improving output to fertilizer price ratios (Booth 1989: 1243). Information failures were also addressed by an aggressive and publicly funded agricultural extension program (Hill 1996a: 129). Much of this was funded out of the revenue windfall that accompanied the oil price shocks of the 1970s. The government’s highly successful selective intervention in rice agriculture made it possible to finance an indigenously owned import-substitution industrial base behind protective barriers.

How has the government policy bias favoring a small number of firms bound together in large family-owned conglomerates affected the international competitiveness of Indonesian manufacturers? As experience elsewhere shows, large business groups can help developing countries acquire industrial competence, internalize external economies, overcome shortages of entrepreneurial talent, and increase exports of manufactures, but they can also lead to substantial economic inefficiency. While research in this area in Indonesia is sketchy, the experience of Indonesia’s most influential entrepreneur and his business group appears to be typical (Sato 1993, 1996). Liem Sioe Liong, founder of the Salim Group, began as an import/export merchant. As is well known, he has benefited greatly from close personal ties with the political elite, particularly the president.

The Salim Group’s early profits came from an import monopoly on cloves and preferential access to export quotas for coffee, rubber, cocoa and other primary products. The group’s growth strategy has been largely dependent on government policies. When the government began promoting import substitution industrialization (ISI), it too moved into IS industries. During first stage import substitution, Salim got into cotton spinning and weaving and flour milling; during second stage import substitution, it diversified into cement and steel (Sato 1993: 414, 417-421).

As government policy shifted in the 1980s to promote exports, the Salim group responded. The Salim Group’s response to the new export incentive system was impressive. Salim reduced investments in cement, liquidated investments in steel, and moved into export manufacture (sport shoes, toys, garments, and leather goods) and export oriented agri-business (pig and shrimp farming, fish and poultry farming, orchards, fresh fruit and vegetable cultivation, and oil palm and sugarcane plantations (Sato 1993: 423). Salim also moved overseas. The new industries in the Salim Group are notably distinct from past investments. Most importantly, they revolve around vertical integration from raw material production through processing to final product distribution and sales. Because of this, "the Salim Group is in the process of transforming itself from being Indonesia’s largest conglomerate to being a conglomerate that is making Indonesia the largest base of raw material production and processing, and whose business operations are now taking place across the broad expanses of Asia" (Sato 1996: 427).

But these are not the only examples of effective selective intervention. Other examples — the development of resource-based industries, particularly plywood manufacturing and liquefied natural gas (LNG), and aircraft manufacture — also deserve mention.

The Indonesian government banned log exports from the mid-eighties in order to support the nascent plywood industry. By 1992, APKINDO, the association of Indonesian plywood manufacturers controlled by Suharto confidante Bob Hassan, had succeeded in raising the quality of Indonesian plywood exports sufficiently in order to get into the heavily protected Japanese plywood market. Despite this achievement, there have been two major criticisms against the Indonesian government interventions in this regard. First, the ban on exports has forced loggers to accept lower prices for their logs from the plywood manufacturers. This represented a welfare loss for the loggers, ostensibly in favor of the plywood manufacturers. However, the latter’s inefficiency meant a corresponding welfare loss for Indonesia, involving an instance of value-enhancing, but welfare-reducing rent-seeking. Second, Bob Hassan’s self-serving control of APKINDO is also said to have caused the monopolist to become moribund, inhibiting the rapid development of industrial and marketing capabilities which could ensure greater value enhancement with minimal welfare loss through the development of a more dynamic and efficient plywood-manufacturing industry in Indonesia.

Promotion of LNG followed on the heels of the government’s expectation that windfall oil revenues could be used to accelerate the rate of growth of the non-oil economy. Because Indonesia’s supply of oil was limited and dwindling, government efforts focused, on among other industries, the development and export of liquefied natural gas (LNG). Development of this industry was based on negotiating long term production and revenue sharing contracts with multinational producers and equally long run sales contracts with buyers, primarily in Japan (Auty 1990: 168-170). To this end, the Indonesian government invested billions through Pertamina, the state-owned oil company, in LNG production (Auty 1990: 171). Little is known about the acquisition of technical competence by Indonesians in this industry. But based on performance to date, these investments have been little short of astonishing. LNG plants have run somewhere between 120 percent and 145 percent of capacity and earned healthy profits (Auty 1990: 170). And LNG exports rose from virtually nothing in 1978 to over US$4 billion in 1993 (Table 6). Because of this, it appears that Indonesia’s resource based industries, particularly on LNG, were low risk and relatively efficient (Auty 1990: 213).¹⁷

If industrial policy in Indonesia was effective, each of these — the composition of output, the structure of manufacturing, the composition of exports, and concentration of exports by commodity group — should deviate from international norms. Productivity growth in industry should also be high as Indonesian firms grow by learning, technological innovation or by catching up with international best practices (World Bank 1993: 304). Rock (1997: Appendix Tables 1, 2) has found that the manufacturing sector’s share of Indonesian GDP is almost 20 percent larger than expected; the share of manufactures in exports is almost 60 percent larger than expected; and the export concentration index is only about 60 percent of that expected for a country with Indonesia’s size, income per capita, resource endowment, and trade orientation. Varying the methodology and measures a little, he found that the manufacturing share of GDP to be significantly larger (1.28 times larger) than expected, as with the shares of several sub-sectors in manufacturing. This includes wood products (the actual share is 5.22 times larger than predicted) as well as petroleum refining and petroleum and coal products (the actual share is 2.86 times larger than expected).

The most dramatic transformation in the economy occurred in exports. In 1970, 93 percent of Indonesia’s exports consisted of unprocessed raw commodities, 5 percent were processed commodities, and the rest were manufactures. By 1993, the share of raw commodities in exports declined to 31 percent, processed commodities contributed 17 percent and manufactures 51 percent. Except for Thailand and Russia, where average incomes were three times Indonesia’s, this made Indonesia the largest exporter of manufactures among lower middle income countries (World Bank 1996: 216-217). Given Indonesia’s low income and its natural resource riches, it is hard to see how this transformation in exports could have occurred without substantial government intervention.

Concluding Remarks

Economic diversification has been considered an important component of the national economic development effort in Southeast Asia, at least since the fifties. This has involved diversification in the range of primary commodities produced as well as industrialization, including the processing of raw materials. Such diversification initiatives have often involved going beyond considerations of static comparative advantage. International specialization determined by such static comparative advantage considerations developed without any government interference, even during the colonial era. Most colonial authorities did not insist on a division of labor not justified by such considerations. Thus, for example, much raw material processing emerged under ‘natural protection’ — because of transport costs or physical characteristics — during the colonial period. However, new productive capabilities in which the economy concerned already enjoyed comparative advantage, could not develop in such circumstances. Only government intervention through industrial policy measures could create the necessary windows of opportunity for new capabilities to be developed, thus transforming an economy’s comparative advantage.

Although the colonial division of labor or specialization under imperial authority largely determined the composition of output and exports before independence in Indonesia and Malaysia, post-colonial governments deemed diversification necessary to reduce their dependence upon and vulnerability to external markets for their generally limited range of primary commodity exports. Hence, diversification involved either greater domestic or external/foreign orientation. Diversification could thus entail more diversified raw material production or more industrial production.

Southeast Asian HPAEs: Different Types of Diversification

Market Orientation

		Domestic	External
Nature Of New Output	Primary Production	Food Production, etc.	Cash Crop or Natural Resource
	Manufacturing	ISI	EOI

As the above table suggests, output diversification may involve various combinations. New production, especially for export, has often been encouraged by new discoveries (of minerals, deposits or crop suitability), market conditions (e.g. for timber, petroleum), technologies (e.g. new logging or mining technologies) and lower transportation costs (e.g. airfreight of electronic components). Nevertheless, while diversification may well have been facilitated by such new circumstances, most diversification would not have taken place without relevant government initiatives and encouragement. For example, government-sponsored research and extension has usually been crucial for crop diversification while government geological or mineral surveys and exploration has often led to new mining activity. Similarly, government subsidies, protection, incentives and other support have encouraged agricultural diversification and both import-substituting as well as export-oriented industrialization.

Policy Lessons

The diverse experiences of the second-generation or second-tier Southeast Asian HPAEs include some instances of failure where government interventions have probably involved continuing net welfare losses in the long-run with little likelihood of the emergence of internationally competitive industries or firms. However, this paper has focused on how government initiatives to diversify national economies have led to virtuous outcomes involving eventual net welfare gains or other national developmental goals (e.g. greater food security).

Government-promoted new agricultural development enabled the Malaysian economy to be less vulnerable to the vicissitudes of the external markets for the export pillars of the colonial economy, namely tin and rubber. By the eighties, Malaysia had become the world’s largest producer of palm oil, cocoa and pepper as it lost its leading positions in tin and then rubber. Also, by the eighties, export earnings from both petroleum and timber exceeded all other export items including manufactures. The paper also shows that the government has more effectively captured resource rents from petroleum and natural gas compared to timber.

Government intervention in Thailand supported the rice industry, but also stabilized rice prices at a low level, keeping wage costs low for the economy as a whole, generating a surplus for the government as well as private capital accumulation and investments and encouraging crop diversification. The government encouraged and supported investments in industries, including agro-processing, which have generally turned out to be internationally competitive quite soon, perhaps due to the relatively modest levels of protection and the greater degree of private sector influence and consultation. Nevertheless, government interventions have ensured that manufacturing growth has been greatly in excess of the level to be expected without such encouragement.

At least some of the resource rents from petroleum and LNG captured by the Indonesian government has been deployed to promote rice agriculture. By the mid-nineties, Indonesia had even become a net rice exporter, thus not only achieving rice self-sufficiency and greater food security, but also contributing to economic development more generally, as in the Thai economy, by keeping wage costs down and expanding the domestic market for import-substituting industrialization.

One important difference in East Asia has been the significant contribution of corporate or firm savings, mainly due to (family) corporate control characteristics, various tax features encouraging reinvestment, rather than disbursement of dividends and the high profitability of investments, due to government support, incentives, protection and regulation. The continued availability of such investment opportunities contributes to a virtuous cycle of accumulation and growth. However, unlike Northeast Asian (Japanese, South Korean and Taiwanese) companies, Southeast Asian firms’ industrial, technological and marketing capabilities have not enabled them to produce for export on their own. Instead, Southeast Asian manufactured exports have primarily come from subsidiaries or companies vertically linked to foreign trans-nationals that have relocated in the region to lower production costs or to overcome import restrictions. Hence, foreign direct investment has been far more important in Southeast Asia than in Northeast Asia, where the governments have been very selective to the point of being restrictive. Whereas much export-oriented manufacturing in Northeast Asia developed from import-substituting industries, such firms in Southeast Asia have been much less linked to the rest of the host economies creating the impression of new manufacturing export enclaves, not unlike the primary producing export enclaves from the colonial era.

The banking system and other lending institutions have also been less supportive of manufacturing, especially for export. In recent years, the Bretton Woods institutions have successfully promoted the expansion of stock markets in the region. For example, by mid-1997, the total market capitalization of stocks listed in the Kuala Lumpur Stock Exchange (KLSE) was more than four times annual national income. Yet, less than thirty percent of financing of new investments came through the stock market, while only slightly more than twenty percent came from bank lending and almost half came from the firms’ own resources, underscoring the significance of corporate savings for corporate investments and growth (Chin and Jomo 1996).

Perhaps given the colonial and subsequent experience with export-oriented primary-producing enclaves, Southeast Asia’s export-oriented industrialization strategy besides those industries involving domestic primary products (i.e. resource-based industries) has also been primarily of an enclave nature. But Southeast Asian governments have not just let static comparative advantage considerations and natural protection determine the nature of resource-based industrialization. They have gone well beyond that by actively developing new capabilities through various industrial policy initiatives.

They have provided an array of supportive policies and institutions to support such development. Many of the new institutions have successfully addressed collective action and information problems, e.g. in the areas of research and development, education, training and marketing. Some of the new institutions have involved civil society, which has ensured policy and institutional responsiveness as well as greater transparency and accountability, reducing the scope for abuse and waste. Although the regimes have often been quite authoritarian in style and method, they have also enjoyed considerable legitimacy by ensuring participation in shared growth, thus also enhancing the credibility of development initiatives, policy and institutions. For example, the export booms from the late eighties have been associated with greater concessions to and consultation with investors in the real economy.

Through agricultural and rural development ministries and other agencies, the governments have successfully introduced and promoted new crops, new crop varieties (e.g. new rice varieties as part of the Green Revolutions which have achieved rice self-sufficiency), new agricultural inputs (e.g. fertilizers, pesticides) and new techniques and practices which have enhanced productivity, yields and incomes. Government construction and provision of supporting infrastructure (e.g. irrigation, transport and communications infrastructure) as well as information (e.g. through agricultural extension, radio-broadcast agronomic advice, weather information and export crop prices) have also been important. Strong research and extension services have been important in promoting best agricultural practices. Adaptive research and development have been crucial for the successful promotion of the Green Revolution in rice farming, for example.

Intal (1997) has suggested that sub-Saharan Africa has lagged behind in terms of agricultural development since the sixties due to inadequacies in agricultural R&D and infrastructure, crop and agronomic considerations and macroeconomic conditions. He argues that higher temperate agricultural productivity has partly been due to long, sustained and larger investments in agricultural R&D, which temperate LDCs (e.g. Chile, Korea and Taiwan) have been better able to take advantage of. The tropical Green Revolution in rice farming since the sixties has mainly benefited irrigated farms in Southeast and South Asia, while drier agricultural practices in Africa have generally been left out.

However, the Malaysian, Indonesian and Thai success with tree crop agriculture offers some hope. The Malaysian experience, in particular, suggests that significant investments in tree crop agricultural R&D (e.g. in rubber, oil palm and cocoa) as well as rural infrastructure have made possible productivity gains in tree crop agriculture as well. The geographic specificities of agriculture imply that for imported agricultural varieties and technologies to be successfully adopted, there is a great need for effective adaptive investments in R&D and extension. Unfortunately, in their desire to industrialize, some governments have neglected agriculture, or worse still, subjected it to considerable negative policy bias.

Government provided and regulated credit facilities have also been very important for encouraging productive investments in new agricultural production as well as manufacturing. Finance ministries and central banks have stipulated minimal lending requirements to banks and other lending institutions, e.g. for manufacturing, small businesses or agriculture. Financial institutions have been encouraged through incentives, credit guarantees and even subsidies to lend to small businesses or farmers to whom they might otherwise not lend to. In some instances, the government has intervened directly (through government agencies) or indirectly (via ostensibly private and non-governmental institutions) to provide credit to ‘deserving’ activities deprived of adequate credit facilities

In the area of trade policy, the governments have introduced various incentives to increase value addition to exports of traditional primary products, as well as disincentives to discourage primary product exports and encourage investments to increase value addition. Market-based incentives have allowed more flexible implementation besides ensuring greater market responsiveness. Through government-sponsored or organized trade fairs, export promotion missions and bilateral government-to-government as well as private sector arrangements sponsored by governments, Southeast Asian governments have created new markets. This has been important, particularly in the face of exports facing new trade restrictions in traditional markets as well as potential trade barriers in new markets.

Where the quality of government performance has been high, as in Singapore, direct government intervention has generally been very effective and successful. This has been reflected in the effects of specific government regulations and their implementation and enforcement, as well as by the impressive performance of state-owned enterprises in the island republic. Where the likelihood of ‘state failure’ is higher, market forces as well as greater consultation with and accountability to civil society have served to discipline the state and the improve the quality and outcomes of government interventions. However, it is crucial to identify the sources and nature of state failures in determining whether market solutions are necessarily superior; the converse is also true. Other experiences, including those of Southeast Asia, offer important insights into what has happened in particular conditions, and considered correctly, can be useful guides in considering available options, but they should not be treated as inflexible determinants of what should be done in Africa or elsewhere.

References

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