Chapter 5 Prospect for New Market
As it has shown in chapter 4, Krugman (1994a, 1994b) points out that Asian rapid growth has been achieved through an astonishing mobilisation of resources and that the input driven growth is certain to slow down. Indeed, a recent comparative econometrics study by Kim and Lau (1996) on sources of economic growth in newly industrialising East Asian countries does not reject the hypothesis that the phenomenal post-war growth in those economies has been realised simply by continual increase in capital inputs.
However, we should notice that Krugman assumes the rapid growth of both USSR and Asian NIEs were achieved by input resources. In other words, input driven growth contributes to development up to the certain level of market saturation with high speed. It is true that technology innovation does not have upper limit, theoretically, while input-driven come to the end of the limitation of physical market saturation, therefore technology innovation is superior to market enlargement. However, it does not make sense that market enlargement is insignificant. Additionally, even if there is a limitation of physical saturation in a market, it may give little influence for LDCs, because it is the last stage of development when the physical saturation slows down development. So far as the first stage or the middle stage of development is concerned, involved markets are enormous like infinity. Consequently, there are no reasons to deny both the input driven development process and the development in USSR and Asian NIEs, because they demonstrate the possibilities to realise rapid development without technology innovation, though it has a limitation.
Thus, the enlargement of economic scale is not insignificant. Rather, it turns out to be profit prospect to stimulate entrepreneurship. This chapter will discuss that new market possibility gives incentive by offering some rational reasons and examples. 5.2 explains the significance of market security by relating coordination problem to economy of scale. It will be clarified that there is natural coordination problem caused by industrial characters, and that it requires arbitrary coordination in order to keep sound competition. Then, 5.3 introduces current understandings of ISI and EOI. They involve inconsistency inside. Indeed, the best account for the difference between them can be found in the concept of "profit prospect signal by market security". Lastly, 5.4 reassesses current trade liberalisation policy and redefine the kernel of successful trade policy.
5.2 Economy of Scale, Ordered Competition and Market Security
As mentioned in chapter 3, "new combination" related to the discovery and introduction of "new market/segment" influences industrial structure and it gives new additional profit to the undertaker. Accordingly, when there is a signal telling a prospect of new market/segment, enterprises will make effort to realise the possibility to real profit. Then, if the signal is recognised by the plural enterprises, there comes a reinforced competition.
However, there is a case in which undesirable situation would come, if the number of competitors is more than a certain level. It often comes at the industry characterised by economy of scale. Any industrial technologies characterised by strong increasing returns to scale, like steel or petrochemical, need large minimum production scale, therefore, it is more efficient to keep an oligopoly market by small number of large size enterprises, than to maintain a perfect market by large number of small enterprises. This coordination problem is to be solved by arbitrary method, because there is no evidence that natural situation should result in desirable oligopoly.
On the other hand, some significant technologies for machinery industrial development, like automobile, consumer durable foods, are characterised by mass production. At the same time, those technologies require both equipment investment and production commence itself through technology transfer process. In short, that technology transference needs for receiving enterprises to commerce mass production coincidentally. Therefore the minimum running scale becomes necessary condition, and bottleneck.
Again, facing market size is not unlimited. Potential market size is defined by national population, nations’ purchase competence or real income level. Except for India and China, most of LDCs do not have sufficient potential markets. Consequently, there is much justice in an attempt to restrict the number of competitors in such industry, as Lau (1996: 43) describes "Potential size of the domestic market also makes a big difference. The size of the domestic markets, relative to the minimum-efficient-scale plant, determines the nature of and the potential social benefits, if any, from any government intervention and/or coordination. Note _ for example, if the potential domestic market is not large enough, then the protection granted to an infant industry may have to become permanent, unless it becomes export oriented and internationally competitive." Indeed, MITI in Japan has been worried about inefficiency due to excess competition and tend to form ordered competition through competitor restriction. It is an important fact to stress that to restrict competitors’ number turns to increase the profit prospect and to give incentive to enterprises. If there is no restriction but large number of competitors, each enterprise feel strong uncertainty to be aggressive, for the lack of enough prospect for the market of necessary size.
In the same context, it is rationalised to secure the domestic market for indigenous enterprises in order to utilise them in the best of limited market. Moreover, because indigenous enterprises in LDCs do not have enough competitiveness, they cannot explore foreign market. It means that foreign market does not attract incentive for the local enterprises. Only when oneself and others recognise their competitiveness as sufficient in comparison with international level, foreign market can give incentives, but when the competitiveness is under a certain level, they cannot be aggressive. Then, it can be attractive for indigenous enterprises to secure the domestic market only for them. In short, to exclude TNCs negates fears and alleviate uncertainties for profit prospects. International market involves many strong TNCs, whose advantages are obvious, while secured market involves only indigenous enterprises with the same capabilities. It is obvious that secured domestic market has high profit prospects.
Securing domestic market entails that the government purchase is opened for only domestic industry. This is explained by the same reasoning. If government buys some goods with high quality, low price and large amount from TNC, infant indigenous enterprises cannot compete with it, and not be fostered. As regard to government purchase from domestic enterprises, Porter (1990: 651) justifies it as follows: "Government has the ability to encourage early or sophisticated demand in a variety of other ways that promotes the upgrading of industry. Such programs lead a nation’s buyers to become early purchasers of advanced new products and services and encourage firms to innovate in order to be able to supply them. Just as important, however, is that such programs reduce the risk perceived by firms that demand will fail to materialise. Explicit or implicit assurance of suture demand encourage investment both in R&D and efficient scale productive assets." It may worth pointing out that those secured markets are possible to contain a keener competition than the international market.
The profit prospects related to "new market/segment" are provoked from industrial development of related sector, because "there may be benefits generated by simultaneous expansion of all industries, so that one industry’s additional supply will be taken up as another industry’s additional demand and altogether the additional earnings of the workers will increase the aggregate final demand" (Lau: 52). In turn, the structure that the incomes generated by the new economic activities creates in turn provides the demand for the goods produced, which gives incentive as well as concerned product or raw material market. In fact, the whole industrial trend can indicate a signal of development, to activates enterprises, as Lau (1996: 52) explains with an example: "It is not possible for manufacturers in Hong Kong to get rich by relying of sales to one another and their own workers only; the domestic market is simply too small. This is not true of Chine. Such "bootstrap" strategy that does not work for much smaller economies may actually work in China. However, in order for those so-called coordination externalities to be realised, all industries must share the common knowledge or belief that a simultaneous expansion will be forthcoming. This is a coordination problem __ for example, the announcement or formulation of a money supply may provide the signal. Announced economic growth and money supply targets can also serve as coordinating signals, to the extent that they are credible. More concretely, consider how the Chinese economy emerged from its recession of 1989-91. Publicity about Deng Xiao-Ping’s visit to southern China in early 1992, as well as statements attributed to him, provided precisely the signal for the convergence of public expectations of a resumption of economic expansion, simulating the subsequent boom that continuous today. In fact, Deng’s southern visit coordinated not only China but also Hong Kong and Taiwan, which stepped up their direct investments in China in response." Indeed, not only Chinese enterprises but also Hong Kong and Taiwanese enterprises invested to southern China due to the Deng’s southern visit. In this way, government signalling may attract FDI as well.
Thus, for enterprises, the potential size, growth rate or characters of its structure of the indigenous market influence incentives for enterprises. However, those factors are not always desirable for effective industrial development. Rather, there often arise coordination problems.
5.3 Import Substitute Industrialisation and Export Oriented Industrialisation
Generally, ISI has been assessed as "failure" by neoclassical school. The main reasons were thus, ①the goods produced in protected market had higher price than international price, ②import protection spoiled domestic industries, ③distorted exchange rate resulted in resource misallocation, ④favourable finance caused financial depression, ⑤the lack of competition obstruct technology development.
Then, neoclassical school argued that trade liberalisation including privatisation and the abolition of import protection should be taken. In turn, open policy was supposed to realise internationalised competition and Pareto optimum with appropriate resource allocation.
However, this idea has been changed. Recently, most studies recognise that the effective combination of ISI and EOI is desirable. Kirkpatrick, Lee and Nixson (1984: 200) demonstrate the combination as one of significant element of the strategy for development: "ISI and EOI strategies should not be treated as mutually exclusive alternatives. In practice, elements of both strategies should be employed, and the relative importance of each strategy is likely to alter over time. The appropriate balance between ISI and EOI policy measures will be determined by, inter alia, an economy’s level of industrialisation, its size and resource endowments and its overall development objectives. Government involvement, through planning and other measures, in industrial sector activities is likely to be needed to ensure that the appropriate combination of EOI- and ISI-based industrial development is achieved." Then, the question here is what elements are necessary for both strategies. Lall (1993b) indicates an answer related to technology absorption. That is, under protection, indigenous enterprises can accumulate learning process. On the other hand, he suggests repealing protections gradually in order to face international competition, because international competition pressure can provide advanced technology absorption.
However, it seems not appropriate to analyse that successful regime is composed by the combination of ISI and EOI, because Hong Kong had a very short ISI period whereas Japan succeeded in high economic growth by only ISI. In other words, there is wide range from null to full, therefore it should be null to emphasis the combination of ISI and EOI. The core of all questions is how to explain the common secret of success in Hong Kong and Japan. Especially, the fact that Japan has achieved industrialisation only ISI with high effective rates of protection (ERPs) while south American countries have not succeeded in it by same ISI strategy, requires another answer than import protection, i.e., "why ISI failed but EOI successes?"
As one on the problematic aspect of ISI, Watanabe (1986: 193) points out the size of domestic potential market. "There are several problems concerning to ISI, but one of the most significant issue is related to the domestic market size. Except China, India, Pakistan, and Indonesia, basically most Asian countries do not have large number of population. Low average income and the inequality of income distribution causes large Gini coefficient. ISI tries to secure the domestic market for domestic enterprises instead of import sector, but the secured market (= ready market) is not enough. It is true that we can expect rapid development growth up to the ready market saturation, but the potentiality is determined by the national purchase ability." This argument accords with the discussion above. As mentioned, the size of market influences enterprise behaviour. Therefore if the policy maintains closed market strategy in spite of saturation, the enterprises will lose incentive owing the lack of new market. This explanation does not conflict to the fact that both Hong Kong had a very short ISI period while Japan had practically only ISI period. The ready market in Hong Kong was very small and saturated soon, while Japanese ready market had a large potentiality that graded up domestic market competition. Consequently, for Japanese enterprises, domestic market was the first issue but foreign market was the second one, as Itoh and Kiyono (1986: 148) describe: "During heavy chemical industry development process, first was to increase the production for domestic demand, then, second was to orientate export sector. The reason enabling industrial development by domestic production development is found in the large domestic market. The import protection policy and direct investment inflow regulation were to help the development based on domestic market." To echo neoclassical school, Japan could accumulate sufficient learning effect, without international market. The development based on domestic market results in low trade dependency (see table 2).
Now, let us turn to the common elements between successful ISI and recommended EOI. The point is that the existence of apparent new market prospect activates entrepreneurship. The reason for the failure of ISI should be attributed not to import protection but to dwarfishness of the ready market. Conversely, some countries with large potential market, like China or India, are capable of achieving rapid industrialisation at beginning stage, by the secured market to signal new market prospect to indigenous enterprises, in a closed market. That is, open policy attracts strong TNCs into the market, and they may wither the indigenous entrepreneurship.
According to this logic, the policy change from ISI to EOI equals to the change of the location signalled as profit prospect, and it depends on the relation between the potential market size and the competitiveness of enterprises. There are two conditions to open its market. One is when the domestic market gets saturation. The saturation means that any additional profit cannot be expected and cannot attract incentives. The other is when the indigenous enterprises get competitiveness enough to compete in the international market with advanced TNCs. The common element is to show new market prospects.
Additionally, we should notice that the policy change from ISI to EOI does not accompany with the repeal of governmental support. Indeed, most of the successful export push strategies are followed by several strong government supports, like favourable treatment, direct or indirect subsidies, diplomacy method, or even import protection. These supports worked both to increase profit prospect and to decrease uncertainty to newly enter foreign market. Without those supports, in another word, perfect liberalisation would cause to reduce incentive and rise uncertainty. In this respect, it is not appropriate to treat EOI as same category of trade liberalisation, because EOI does not necessarily go with the protection relief.
Generally speaking, the argument that LDCs should open its domestic market to international market with repeal of governmental intervention has some rationalised reasons as below:
To those opinions, it is possible to reply from the profit prospect view. Firstly, as to the inefficiency caused by protections, some protections do not necessarily follow inefficiency. (In the following chapter, I shall be examining the protection issues in detail.) Japanese high ERPs shows a typical example of non-inefficient protection. On the contrary, the domestic market distributed to the domestic enterprises may stimulate internal competitions. Additionally, proper resource allocation may cause an undesirable result due to multiple equilibrium problems in some cases. On the other hand, domestic market may keep not less competition pressure than the world market, because the level of competition pressure is defined not by the scale but by density and the incentives. Even concerning the technology information, it may be transferred through not only market competition, but also academic meetings, industrial network or governmental sector. In fact, through post war, MITI administered almost every advanced technology to be imported. Thus, the government can give both incentives for competition and technology information by its industrial strategies. In other words, to administrate the market competition, in order to keep competitiveness, may be justified obviously.
To sum up, the following points have been clarified in the chapter.
This chapter concludes that protections, regulations or government interventions may cause better result than that if they were not, in some cases. However, there are strong objections against government intervention, especially "rents", which is supposed to make inefficiencies. The following chapter will deal with "rents" problems.
