Income Inequality and Economic Growth

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Chapter 1: Introduction

Economic growth is the result of abstention from current consumption. An economy produces a variety of commodities, and then income is generated through sales of products. The very same income is used to buy other products which generate income for other producers.

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The very same income is used to buy a variety of commodities. The producers decide what to produce depending on their individual preferences and the distribution of income, initial endowments. In general, commodity production creates income, which creates the demand for those very same commodities. The cycle of production, consumption, saving, and investment that constantly regenerates itself is as old as human civilisation. In some cases, savers and investors are exactly the same individuals, using their own funds; in other cases, they are not. (51, Ray) The income inequality occurs because people in an economy differ from each other in many ways that are relevant to their incomes. These differences can be in forms of human capital (education and health), in where people live, in their ownership of physical capital, in the particular skills they have, and even in their luck. As explained above, economic growth and income inequality have a huge influence on each other. That is why there have been extensive studies in income distribution and its effect on other economic variables. Income distribution has always been considered to be an important topic because it tells us how incomes are distributed among the members of a population and allows the government to determine tax policies for redistribution to decrease inequality, or to implement social policies to reduce poverty. However, there are many debates about how reliable data is because they mainly are collected through surveys and the sources of errors are numerous. Furthermore, the income distribution measure, income gini-coefficient, does have its disadvantage because the best fit line method is used when representing the Lorenz curve which is used to calculate gini-coefficient. As outliers are ignored when a best-fit line is illustrated, the population in extreme poverty will not be accounted in income inequality measure. Thus, the measure of inequality may not be as accurate as it is believed to be. Because of these data features, it is important to complement classical statistical procedures with robust ones. (Maria-pia, Victoria-Feser, 2000)

No concrete theory yet exists to explain the relationship between income inequality and economic growth. Most empirical research on income inequality and economic growth tends to focus on imperfect market, the politics of redistribution, the size of the market. Benabou (1996) and others argued that imperfect capital markets can slow the economic growth by increasing the level of inequality. The main input of economic growth is investment generated by savings or borrowing credits. A result of imperfect capital markets is that the poor credit applicants with high expected rate of return projects have limited access to credit compared with rich applicants with the lower profitable projects. Therefore, the imperfect capital markets create a higher level of inequality and limit both quantity and quality of investments, thereby lowering economic growth. As capital markets are more likely to be imperfect in developing countries, this theory implies that developing countries’ economic growth is affected greater by income inequality than developed countries. ‘Deininger and Squire find that land inequality reduces growth more in low income countries. However, the effects of income inequality on growth do not differ across high and low income countries. Moreover, contrary to the theory, Perotti (1996) finds that income inequality affects school enrolment more in rich countries than in poor countries.’ 143-144 I am particularly interested in how East Asian countries managed to develop so rapidly while maintaining low income inequality during late industrialisation. This is because compared with many orthodox economic theories and research based on many European and North American states during their industrialisation, what East Asian countries achieved is unprecedented. Furthermore, I believe that there are much more complicated reasons behind this unique achievement unlike the suggestions by 1993 World Bank Report, ‘East Asian Miracle.’ In this report, the neoclassical economists in the World Bank gave much credit to the new developing theories and state-intervened economies on the surface, but they managed to transform and relate the state-intervention and policies in East Asia to the orthodox economic theory, and concluded that the rapid economic growth in East Asia is the result of market friendly economies and well-operated macroeconomic policies. They are not completely wrong but I have found that the explanations are very vague and inaccurate. There is no consistency in their arguments because they are trying to explain state-oriented capitalism in terms of market-led capitalism. In addition, there is an obvious cultural factor. Johnson and few other economists and historians argue that cultural difference between in the East and in the West might play a crucial role in explaining the ‘East Asian Miracle. They argue that ‘Confucianism confers certain advantages over other traditions in the quest for economic development. Because Confucian beliefs place a high value on hard work, loyalty, respect for authority, and punctuality, these characteristics are thought to have facilitated the national consensus around high-speed economic growth in East Asian countries since the 1950s and 1960s.’ (Johnson, 1983:6-10; and the chapters by Lucien Pye, Gordon Redding, and Siu-lun Wong in Berger and Hsiao, 1988) I believe that an argument stated above can be a more influential factor of ‘East Asian Miracle’ than arguments based on the orthodox economic theory. Thus, in this paper, I aim to investigate not only orthodox economic theories behind the East Asian development but also focus more on political economic perspective during the late industrialisation periods in East Asian countries, especially in Republic of Korea (Korea hereafter) and Singapore. The political economic view of East Asian countries were taken rather lightly compared with theoretical economic analysis because there have been only few social-politic studies in East Asia and the presence of military regimes in many East Asian countries made it difficult for researchers to gather accurate information. The reason that I have chosen Korea and Singapore is that they both are in OECD countries, which makes it easier to collect more accurate and more quantity of data. Most of all, Korea and Singapore maintain the lowest income inequality level during the late industrialisation, but the income inequality level in two countries took a complete different direction after the Asian financial crisis in 1997/8. Singapore’s income inequality did get worsened but it still stayed at reasonably low level, whereas Korea’s income inequality level shoot up and still remains quite high at this point. This paper will contain five sections. They are; introduction; orthodox economic theory behind income inequality and economic growth; political economic section which will illustrate the policies employed in Korea and Singapore to develop rapidly while maintaining the income inequality level low with empirical evidences; the effect that Asian financial crisis had on Korea and Singapore, especially on two countries’ income inequality level; conclusion.

Chapter 2: Orthodox Economic theory

In this section, I shall discuss the orthodox economic growth theories and whether or not South Korea and Singapore followed neo-classical theory guidelines. To begin with, I will explain what causes income inequality and the consequence of it. I will especially focus on the spill-over effects of income inequality on economic growth.

The level of income inequality is one of the main economic concerns for economists as it is directly related to poverty and also has significant effect on economic growth: Assuming that the average level of income per capita maintains constant in a country, a higher degree of income inequality will mean that poor people are worse off. According to this observation with implication of Kuznets curve -the level of inequality rises until income per capita has surpassed a critical point- then in theory; economic growth can be bad for the population placed at the low end of income spectrum. ‘Specifically, growth’s effect of raising the average level of income may be counteracted by a widening of inequality as the poorest people fall farther below the average.’ (Weil, Economic Growth) The empirical study carried out by David Dollar and Aart Kraay shows how average GDP and the degree of inequality work together to determine the income of the poor. Mexico in 1989 and South Korea in 1988 had almost the same level of GDP per capita ($8,883 and $8,948) but because South Korea’s income distribution is so much more equal than Mexico’s, the average income of the poorest quintile in South Korea was twice as high as that in Mexico ($3,812 and $ 1,923). A similar effect is observed when comparing Taiwan and Mexico. This study illustrates that a country’s average level of GDP is the most influential factor of the incomes of the poor population. Thus, the empirical evidence suggests that poor people in a wealthy but unequal country are better off than poor people in a poor and egalitarian country. Dollar and Kraay assessed whether specific policies had different effects on the income of the poor versus overall income. Their key finding was that policies that affect growth for good or ill generally do not significantly affect the distribution of income. For example, rule of law and openness to trade raise overall income in a country and have positive but very minor effects on the share of income going to the lowest quintile. Similarly, a high rate of inflation and a high level of government consumption are bad for overall income and reduce the share of income going to the poor.372

The orthodox economic theory on income inequality and economic growth is that highly unequal distributions are necessary condition for generating rapid growth. In fact, in the 1960s and then again to a more limited extent in the 1980s and early 1990s with the dominance of free-market economic theory and policy, the explicit and implicit acceptance of this proposition by economists from both developed and underdeveloped countries tended to turn their collective and individual attentions away from problems of poverty and income distribution. If wide inequalities are a necessary condition of maximum growth and if, in the long run, maximum growth is a necessary condition of rising standards of living for all, through the natural passed-down processes of competition and mixed economic systems, it follows that direct concern with the alleviation of poverty would be self-defeating. Needless to say, such a viewpoint, correct or not, provided a psychological, if not conscious, rationalisation for the accumulation of wealth by powerful elite groups. The basic economic argument to justify large income inequalities was that high personal and corporate incomes were necessary conditions of saving, which made possible investment and economic growth through mechanism such as the Harrod-Domar model. If the rich save and invest significant proportions of their incomes, while poor spend all their income on consumption goods, and if GNP growth rates are directly related to the proportion of national income saved, then apparently an economy characterised by highly unequal distributions of income would save more and grow faster than one with a more equitable distribution of income. 182 Simon Kuznets hypothesis also states that in the early phase of economic growth, especially that are growing at an abnormal rate, growth is generally associated with high levels of inequality. First, to generate the high savings rate that is a prerequisite of rapid growth, income, it is assumed, must be concentrated in the hands of relatively rich, whose marginal propensity to save is relatively high. Second, Simon Kuznets has suggested that as the labour force shifts from low-productivity sectors to high-productivity sectors, aggregate inequality initially increases substantially, decreasing only later. Contrary to this conventional wisdom, in East Asia rapid economic growth has been associated with relatively low and declining levels of income inequality. Improved equity is not unique to East Asia. What is unique is the combination of rapid growth with modest (and, in a few high performers, dramatic) improvements in equity and reduction in absolute poverty. Analysis of the high performing Asian economies has focused on their rapid growth over the past decades. Isolated studies on the distributive qualities of growth in a few of these countries exist, but not of the growth-equity nexus for the group as a whole. (Adelman and Robinson, 1978) The indicators show that the Asian high performers have been unusually successful in distributing the benefits of growth widely. (The key to the Asian Miracle, Making Shared Growth Credible, Jose Edgardo Capos, Hilton L. Root, 1996)

The orthodox economic theory suggests that tax policies which directly affect saving rates will determine the economic growth rate depending on changes in the ratio of capital to labour. According to this theory, people’s incentives to save their income or wealth are influenced by the rate of returns to savings which effectively determines the income distribution. This theory would also imply that richer people are more encouraged to save their income or wealth in an economy with a regressive income tax. As a result of this, faster economic growth is achieved due to higher saving rates and thus higher level of investment driven by richer people. The rate of savings affects the long-run level of per capita income and, in many cases, the rate of growth of the economy. Thus the relationship between inequality and savings creates an additional channel through which inequality interacts with income and growth in income. The political force of the arguments presented here are also not to be taken lightly. The view that moderate or high inequalities in income distribution concentrate money in hands of those who are willing to save, accumulate, and invest, thereby boosting growth rate, has been used more than once to justify a hands-off approach by government in matters pertaining to redistributive taxation. However, there are opposing views as well, arguing that a certain degree of redistribution can actually enhance savings and push up growth rates. The effect of a reduction in income inequality on the rate of savings, and therefore in the rate of growth, is likely to be complex.

High economic inequality might retard economic growth by setting up political demands for redistribution. Now redistributing might take one of two broad forms. First, a policy might aim to redistribute existing wealth among the broader population. A good example of this is land reform. If land is held very unequally, the government may have the option to simply confiscate land from large landowners and redistribute the confiscated land among smaller peasants or landless labourers. Likewise, it is possible to have confiscatory taxes that transfer large quantities of nonland wealth to the government, which are then redistributed to the poor. It goes without saying that the creation and implementation of such policies require extraordinary political will, as well as the availability of data on which to base such policies. Elected government officials with large land holdings are not uncommon, and even if they were uncommon, large landowners often act as vote banks, which swing the votes of an entire village or even a group of villages. In such situations, the enactment of a comprehensive land reform that would alleviate inequality becomes a very difficult proposition indeed. Even if the political will did exist, there are the almost insuperable difficulties of implementation. To redistribute large quantities of wealth, for instance, it is necessary to know who has the wealth. There exist enormous quantities of wealth that are not even subject to taxes, simply because the information base required to implement such taxes is nonexistent. Even when wealth takes the form of land, which is arguably highly observable, it is difficult to implement ownership ceilings. As a large and powerful landowner, I could parcel out my holdings in the names of various members of my family, so that each parcel fell below the legally imposed ceiling.

Faced with these difficulties, most governments resort to redistributive policies that take an entirely different route: they tax increments to the shock of wealth, rather than the existing wealth base. Thus marginal rates of tax on high income purchase of various products, and business profits are taxed as well. These taxes, imposed as they are on the margin, tend to bring down the rate of investment and therefore the rate of economic growth.

Chapter 3: Political economic theory

In this section, I shall concentrate on three policies which were probably the main driving force behind rapid economic growth while maintaining low level of income inequality. They are Land Reform and Agricultural policy, Public-Housing policy and Education. These three political acts shaped up the main foundation in the early stage of economic development and because of this solid foundation; Korea and Singapore were able to achieve their current economic status in the international arena. Many people, in general, believe that industry, not agriculture, can only facilitate the economic growth and agriculture constrains the economic growth to some extent. I will attempt to argue that agriculture and industry are equally able to constrain or facilitate economic development, but that agriculture is perhaps more important in the earlier stages of development, while industry is possibly more important in the latter. In doing so, I attempt to emphasise the importance of land reform in the earlier phase of development and how South Korea and Singapore achieved it. Public-housing policy is rather more relevant to Singapore’s case than of South Korea. Today, over 85% of Singapore population resides in housing provided by the government since its public housing policy began in 1930’s. The initial quality of housing was poor, but the continuous revolutionary programme since 1960’s dramatically improved living conditions. The success of public housing policy, thus the positive spill-over effect of the programme on income inequality and economic growth will be discussed more in detail later on. High level of education, thus high quality of human capital in East Asia has always been on top of the list whenever the driving force of East Asian ‘Miracle’ was discussed. Thus, I will further investigate why the education is considered to be so much more important in East Asia compared to other developing countries and the effect education on income inequality and economic growth. However, most of all, the authoritarian political background of Korea and Singapore government must be stressed before the three policies are discussed. This is because without the complete control that President Park, Jung-Hee had in Korea and People’s Action Party had in Singapore, these policies would not have had its full effect.

Government intervention can determine four general areas of distribution of income. They are as follows;

  1. Functional distribution – the returns to labour, land, and capital as determined by factor prices, utilisation levels, and the consequent shares of national income that accrue to the owners of each factor.
  2. Size distribution- the functional income distribution of an economy translated into a size distribution by knowledge of how ownership and control over productive assets and labour skills are concentrated and distributed throughout the population. The distribution of these asset holdings and skill endowments ultimately determines the distribution of personal income.
  3. Moderating (reducing) the size distribution at the upper levels through progressive taxation of personal income and wealth. Such taxation increases government revenues and converts a market-and asset- determined level of personal income into a fiscally corrected ‘disposal’ personal income. An individual or family’s disposable income is the actual amount available for expenditure on goods and services and for saving.
  4. Moderating (increasing) the size distribution at the lower levels through public expenditures of tax revenues to raise the incomes of the poor either directly (e.g. by outright money transfer) or indirectly, through public employment creation or the provision of free or subsidised primary education and health care for both men and women. Such public policies raise the real income levels of the poor above their market-determined personal income levels. 189

A contribution which agriculture makes to economic development is known as factor contribution which is related to functional distribution. This can be divided into a further two contributions’ labour contribution and capital contribution. Labour contribution is defined as the phenomenon when agricultural productivity improves and surplus labour form the agricultural sector is released in to the industrial sector. Yao (2006) noted that in pre-reform China this was not so as labour could not be immediately transferred from one sector to another. In China’s case this resulted in depressed agricultural labour productivity and large underutilised human capital. In terms of capital contribution Thirlwall (2006) explains that capital contribution can be via voluntary investment in machinery or via involuntary contributions in the form of taxes.

One way in which agriculture may constrain economic development is through the product contribution of forward linkage effect, wherein the agriculture sector is responsible for providing raw material, capital and labour for the rest of the economy (Todaro, 2006, 819). Economic development is characterised by a substantial increase in demand for agricultural products, and if the expansion in food supplies (Johnston, 1961, 567) cannot meet demand, then economic growth will be stunted: there will be a significant rise in food prices, leading to pressure on wage rates, which could adversely affect industrial profits, investment and hence economic growth; it could also cause political discontent (Johnston, 1961, 573). This pressure on wage rates can have extremely adverse effects in undeveloped countries where food has a dominant position as a wage good. Structuralists would argue this was at least in part due to a growing population putting pressure on food supplies, coupled with supply inelasticities (Thirwall, 2006, 452). A reliance on exports may also develop. Growth of demand for food is particularly significant as high rates of population growth (1.5%-3%) characterise most of the world’s developing countries, as the decline in death rates, due to increased medical knowledge and application, is frequently much sharper than the fall in birth rates (Johnston, 1980, 572).

However, it is worth considering Engels’s law at this point, which states that the income elasticity for primary commodities is in elastic; the implication being that as individual’s, and a country’s income rise, they will spend proportionally less on these commodities (Thirwall, 2006, 550) and agriculture will become a less important component of economic development. Furthermore, the share of agriculture is GDP falls as per capita income increases; labour share also declines. Nevertheless, income elasticity for food tends to be considerably less elastic for developing countries in comparison with developed ones- 0.6 versus 0.2 or 0.2 Western Europe, the U.S and Canada (Johnston, 1961, 572), suggesting that at least in the short-run, or in the early stages of development, a lack of ability to provide product contribution could mean that agriculture is a main constraint to economic growth.

Engel’s law also has implications for the foreign exchange contribution argument: which states that a country which primarily exports primary commodities will automatically suffer a balance of payments deterioration if there is a growth in world income, vis-à-vis the balance of payments of a developed country largely exporting industrial goods (Thirwall, 2006, 550), as purported by the Singer-Prebisch thesis, whose import substitution industrialisation hypothesis advocates that developing countries replace imported industrial goods with their own domestically-produced versions. Furthermore, countries will have a heavy reliance on agricultural exports, particularly those which have a heavy reliance on one particular export, such as coffee, tea or fruits, are at the mercy of environmental factors within their own countries, as well as trade barriers and changes in taste, internationally. However, a long-run goal of diversifying from a reliance on one or two export crops can lessen this vulnerability (Johnston, 1961, 575). In addition, primary commodities typically are the greatest source of foreign exchange and foreign exchange is needed to fund development projects (Todaro, 2006, 69). It is also worth noting that some countries have a marked comparative advantage in agriculture and that in these, a reliance on agricultural exports does not necessarily constraining at all.

In some ways, agriculture is in fact an enabler of economic development as it can provide inter-sectoral transfers to faster growing industrial sectors, vis-à-vis labour or capital transfers. As non-industrial sectors grow, they will need an increased quantity of labour, and whilst the assumption of the Lewis two-sector model that labour supply is perfectly elastic can never be entirely true (due to, lack of transferable skills, or cultural factors, such as an unwillingness on the part of women to move away from their families), it is likely that during the earlier stages of development at least, labour will be drawn from the agricultural sector, as there will be fewer other sources (Johnston, 1961, 576). This loss of labour might in turn provide incentives for agricultural sectors to become more productive, though investment from some source will obviously be necessarily to enable this. However, empirical evidence would appear to suggest that capital, rather than labour is the main limiting factor to industrial growth, at least in the case of Japan, where taxes levied on the agricultural sector constituted 80% of the tax burden and were used to subsidise the creation of a merchant and shipbuilding industry, as well as investments in railways and education. (Johnston, 1961, 578) This evidentially, presents an example of agriculture enabling, not constraining economic development.

However, using agriculture in this way to provide capital for industrialisation inhibits the farming sector from aiding economic development in another way; namely through market contribution, otherwise known as the backward linkage effect, where the agricultural sector generates a demand for industrial products, such as fertilisers, insecticides, machinery, transportation and so on, positively impacting on the economy as a whole. In fact, in the early stages of development, the agricultural sector is likely to provide the largest market for industrial goods. Hence, if a country’s agricultural sector is very largely subsistence, as it is in many developing countries, with farmers able to afford very few of such capital inputs, then agriculture may indeed be the main constraint to economic development. (Thirwall, 2006) Thirwall in fact goes as far to say that, “a precondition for rapid industrial growth is a rapidly expanding agricultural sector” (2006)

Some economists, such as Hirschman, have argued that there are in fact higher linkage effects in the industrial, rather than the agricultural sector and in particular, that in many less developed countries, linkages are to be found within manufacturing industries, but not between industry and agriculture. According to Hirschman’ idea of Unbalanced Growth, the key to economic development is investment in a ‘leading’ sector, an industrial sector with high linkages, rather than in agriculture. A problem with this however, is the previously-mentioned inflation, due to lack of coordination between supply and demand. Propagating a single industry might indeed lead to the similar problems with lack of trade diversification that occur when primary commodities are the sole export.

As a consequence of land reform, Korea has enjoyed a reputation among countries as one with a relatively equitable income distribution (World Bank, 1983). In1945, when Korea was liberated from Japan and soon afterwards partitioned into South and North, about 80 per cent of the labour force in South Korea was engaged in agricultural and less than 3 per cent in the mining, manufacturing and construction sector. Under these circumstances, two land reforms in 1947 and 1949 meant the collapse of a traditional social order based on land, especially a rice-cultivating society, and the start of a new social order. Furthermore, the Korean War (1950-1953) had a profound impact on South Korean society, destroying existing capital stocks and levelling out the distribution of non-agricultural assets, and leaving the majority of Koreans in destitution. (Pg9 Korea housing) In a rather elaborate simulation-planning exercise, Irma Adelman and Sherman Robinson have investigated the interactive effects of various rural development programmes on income distribution and poverty South Korea. Land reform is one component. (Adelman and Robinson, 1978) Their objective was to determine what types of programmes would yield the largest impact over the medium term. They constructed a basic model of the Korean economy, taking great pains to calibrate it so that its predictions came close to actual outcomes over a predetermined period. In essence, the basic model was made to mimic the development of the Korean economy over a nine-year period, 1964 to 1972. The result is significant. First, among the individual programmes, land reform has the most favourable impact on income distribution. Second, land reform and the public works and small-scale industry programmes are much more effective in reducing poverty than are the other programmes. Third, promoting rural development, that is, implementing all the simulated programmes, leads to greater reductions in the incidence of poverty and income disparities than either of the two programmes taken individually or jointly. And fourth, without land reform, rural development programmes would be less successful at addressing both poverty and income inequality. (The key to the Asian Miracle, 55) Therefore, the inequality in landholdings is resulting in inequality in all spheres of economic activity, social and political life. The inequality in landownership is leading to inequality of other productive assets also. The inequality is further resulting in un-equal access to the much needed agricultural inputs like credit etc. (Krishna Rao, Growth and Inequality in Agriculture, 1991, 55)

Nevertheless, Alice Amsden argues that the reputation of Korea as a country with low income inequality might be due to false information for three reasons: (1) The value of real estate and other assets, which lends to appreciate with inflation, rose more rapidly in the 1970s than wages. Because this value is excluded from income and these assets tend to be owned by higher income earners, the treatment of such assets is likely to result in the understatement of inequality. (2) The equivalent of the United States’ Internal Revenue Service in Korea sometimes includes and sometimes excludes from the calculation of personal income, capital gains, rent, and interest payments. Such income is also taxed differently from wage income. (3) It was possible until 1988 to open bank accounts in Korea under an assumed name. Nevertheless, land reform did respond to the ancient cry for egalitarianism. When Korea was an overwhelmingly agrarian country, land reform undoubtedly contributed to greater equity in size distribution of income. In the late 1930s, 3% of all farm households had owned over two thirds of all land, whereas ten years later. Fewer than 7% of all households were landless (Ben et al, 1980). (Asia’s Next Giant, Amsden, 38) In addition, Korea has unusually high levels of aggregate economic concentration and of wage inequality by international standards. The process of measuring equality in Korea is vexed by institutional factors.

It is undeniable that the Korean state played a central role in the country’s economic development through its cunning use of state-created rents as an instrument for industrial development. Of course, such a result was only possible because the Korean state was a strong state which could discipline firms whenever necessary. It has often been suggested that the Korean state could become strong because the country’s historical development left a social structure with no powerful social classes to contest state power. (Ha Joon Jang, the East Asian development experience, 95) Another example of a significant state role in maintaining low income inequality is an agricultural pricing control. The typical price support programme consists in offering guaranteed procurement prices at which the government stands ready to buy food grain. The idea, of course, is to increase the marketed surplus of grain. At the same time, governments often are unwilling to pass on these prices to urban consumers, partly because these consumers are typically incensed by higher prices and partly because of the effect on the industrial wage. Thus price support programmes are usually accompanied by a subsidy to urban consumers: the procured food is sold at or below market prices by the government. Of course, someone has to pay for this subsidy, and it usually comes out of the government budget. An alternative option is to maintain an overvalued exchange rate. The overvaluation is kept in place by tariff or quota-based restrictions on imports. The implication of overvaluation is that the prices of exports are kept artificially low in terms of the domestic currency. If the country is a food exporter, this policy has the effect of discouraging food exports and shifting food sales into the domestic market. The policy has sufficient opacity about it-farmers may not be aware that the exchange rate is overvalued and reduces their export earnings- and it has the desired impact of making food available to urban consumers without a price rise. 369 Singapore government’s public housing policy played a major role in achieving rapid economic growth because public housing policy both directly and indirectly provided opportunities for foreign investments. Singapore government unlike Korean government focused on gathering funds from foreign investors because their belief was that the multinational companies are able to present an opportunity to open up world markets to Singapore; thus increasing Singapore’s reputation in the international arena as well as providing the sufficient skilled and relatively well-paid jobs for the population; and hence, to upgrade the economy quickly through value-added activities (Reference…). The multinational companies were not only attracted by the business environment and incentives in Singapore but also an opportunity to make greater profit presented by the People’s Action Party (PAP) policies. Two arguments are put forward by Castells, Goh and Kwok that public housing policy managed to keep the costs of operation for foreign investors. First, the public housing lowered the costs of living. The workers were able to rent house at relatively low prices, thus the wage rates in Singapore were not as high as other industrialising countries. With low wage rates, companies were not restricted to lowering quality of labour when employing workers to expand or set up businesses. The empirical example given by Castells et al illustrates this. Although real income increased during the early stage of industrialisation, public housing rentals set in 1960 (at as low as 15 Singapore dollar per month for one-room emergency flat) were not adjusted until 1979, and selling prices of public flats set in 1964 were not adjusted until 1974. In addition, the provision and development of package of relatively high standards of other human and social services, such as educational, health, recreational and other community facilities, in conjunction with public housing further subsidised the workers’ costs of living. (Reference) Second, public housing helped develop a complete network of urban infrastructure. State investments and subsidies into creating and improving industrial sites and services and other infrastructures such as railway system and roads around industrial sites reduced overhead and operating costs of the investing companies. Ssc The state investment also assisted the expansion of other industrial and commercial activities. This is another prime example of usage of forward/backward linkage effect. Singapore government not only managed to facilitate environments for investors but also provided bigger markets for domestic businesses that were at the early stage of expansion. Castells et al supports the second argument with an example of the Jurong Town Cooperation and the Housing Development Board (HDB). The Jurong Town Cooperation was established in 1968 as a spin-off from the Economic Development Board specifically to develop industrial sites and services, factories and living quarters for workers. However, the scope of the Cooperation was limited to assisting particularly the heavier industries and all industries within the industrial town of Jurong. Meanwhile, as the major landlord and developer in the republic, the Housing Development Board (HDB) was, in effect, largely responsible for the orderly coordination and development of almost the entire network of urban infrastructure and services, including the provision of sites and factories for light and non-polluting industries in the new towns. (Reference) Therefore, all these public-housing-led developments and services created a sophisticated level of social and urban services that formed the very basis of industrialisation and human capital productivity. These infrastructural investments subsidised a relatively high standard of living for the labour force. Moreover, the infrastructure supported the rapid growth of industrial and commercial activities that further enhanced Singapore’s image as a prospective investment locale, as well as an active business and financial centre, in the region. Public housing has also contributed to Singapore’s economic development in the area of capital formation. Funding for all the public construction by the HDB and other public development agencies came from the tremendous savings accumulated through the Central Provident Fund (CPF). 305

Besides economic regulation and government intervention on the supply side of economic development, Singapore also has a significant ‘sui generis’ welfare state. There are no welfare payments, and no unemployment insurance, although there is low unemployment, and the high rate of labour force participation and persistence of strong family ties enable the family structure to provide for most of the victims of economic recessions. The real extent of the welfare state in Singapore includes housing, health, and education. Primary education is almost universal and costs a low nominal fee. Secondary education is free and expanding rapidly. However, its provision is restricted to those children able to pass an examination at the end of primary school, a procedure that epitomises Singapore’s meritocratic system. University education remains the domain of meritocratic elite, clearly modelled after ‘Oxbridge’ pattern. Health care is of moderate to good quality and provided almost free for ‘class C’ people (low-income). Classes ‘B’ and ‘A’ have to pay higher fees, although since 1985 they have been able to use their CPF contributions to pay for hospital costs. However, people can decide that they are ‘class C’ and pay a normal fee, without account being taken of their income, provided that they accept the standard conditions of public health care, certainly lower than the technological level of Singapore. Yet the system clearly exceeds any other in the ASEAN region and in most of Asia in quality and affordability. In terms of housing, 85% of the population live in public housing at affordable prices. Although these high-density high –rise living quarters, they are well equipped with facilities, organised o the basis of self-sustaining new towns. Housing units are provided at a cost estimated to be as much as 40% lower than equivalent accommodation in the private sector. This is mainly because of the low cost of land purchased by the Housing Development Board, and the economies of scale achieved by a comprehensive programme that clears land, designs buildings, produces its own construction materials, contracts and supervises the builders, and manages and maintains the housing estates. The Housing and Development Board is actually the manager of Singapore’s everyday life. Government provision of collective consumption goods and services also includes open-air activities, cultural and recreational facilities, and institutional support for social life through the community centres that exist in most neighbourhoods and particularly in the new towns. By decisively intervening in the process of social consumption, the government provides the material basis for raising the standard of living in spite of low direct wages for the majority of the population (about 70% of Singaporean workers till earn less than $400 per month). In so doing, the state also shapes the pattern of social life and exercises its control and guidance of people, a matter with considerable policy implications. 188

The most important factor that facilitated the creation of the massive and comprehensive public housing programme in Singapore was the effective implementation and enforcement of the compulsory land-acquisition policies, based on eminent domain. This stringent land policy of compulsory land acquisition has limited land speculation during a period of tremendous economic growth, kept public development of sizable and more efficient satellite towns and housing estates. It has also contributed to the creation of a ‘captive’ demand market. Between 1961 and 1985, the HDB managed to clear almost $1200milion Singaporean dollar. This provides an idea of the extent of the ‘captive’ nature of the demand market.

The land-acquisition policy has served to redistribute wealth and resources in Singapore. Acquisition made at the expense of private landowners has enabled the government to assemble land for the development of the massive public housing programme, providing the opportunity for homeownership to almost the entire citizenry. Besides, ‘unless government assists in acquisition, clearance, resubdivision of land and planning, the private sector on its own will have great difficulty in obtaining choice sites for proper development, thereby giving indirect rise to urban sprawl’ (Head, Urban and Renewal Department, HDB, in Strits Times 18 April 1967) The Land Acquisition Ordinance was first passed in 1920 to empower the British Governor of Singapore to acquire private land for public purposes (Wong and Yeh, 1985, page 40). It was amended in 1946 and again in 1955 to give the government greater power to negotiate more comprehensive land acquisitions. These amendments helped to stabilise land prices and made possible the improvement of roads and the development of public housing and other public improvement projects. 267-268

On the contrary, housing in Korea was not an issue in political and social debate until at least early 1940s. The quality of housing was limited by the availability of materials and the skills of self-builders, but homelessness and housing tenure were unlikely to be a problem. After independence from Japan and partition in 1945 and the Korean War (1950-1953), the quality and quantity of housing was incredibly low. Although housing is an extremely important aspect of human life, it ranks below nourishment. Food, clothing, and therefore economic growth were more urgent and necessary requirements. Although housing was scarce and of a poor quality as a whole, the assumption of the government was that increased household income would be transferred into effective demands for new, decent housing, which builders would supply, increasing the number of households accommodated in decent houses. Given the constraints of defence expenditure, the housing sector had to be insulated from other investment for economic growth. This lack of money available for expenditure on housing by the government has constrained Korea to more negative means of coping with housing problems, such as regulations and controls, rather than positive means, such as direct supply or subsidies. The lack of resources also conditioned the public sector into closer collaboration with the market. The government adopted the private ownership solution mainly because there was no money available. As a means of keeping living costs and wages under control and raising labour productivity, the Korean government adopted food subsidies and mass investment in education, rather than subsidising housing like in Singapore. In 1969, for instance, the government launched the ‘dual grain price programme’, buying at higher prices from farmers and selling at lower prices to urban workers. At that time, those policies were more efficient given local circumstances. Until the 1970s, household expenditure on foods accounted for over 50 per cent of household income, while that on housing accounted for less than 15 per cent. (Economic Growth, Low Income and Housing in South Korea, Kim Woo-Jin, 1997, 106) Furthermore, the Korean government began to encourage urban renewals as a counter-measure against the economic downturn. Subsequently, general price inflation led by a real estate boom recorded the highest level in a decade. Land, office buildings and real estate in general were demanded not only for use but also for proving wealth. A large proportion of domestic savings was being switched from investment in industry to speculative investment in real estate. Moreover, government regulations over housing price and housing standards created conditions in which management of house builders focused increasingly on the speculative skills of buying land, selling at the right time, arranging favourable deals with subcontractors, and lobbying to change land use under the name of land banking. High inflation under the faltering economy led the government to give the highest priority in national policy to price stabilisation from 1879. In order to stabilise price increases, the government launched a tight monetary and fiscal policy. As a result of the policy, public-sector housing suppliers faced a serious scarcity of funds. With respect to the consumption side, demands for owner-occupation were declining because of deteriorating economic conditions, especially in moderate- and middle-income sectors. (Economic Growth, Low Income and Housing in South Korea, Kim Woo-Jin, 1997, 114)

Compared with PAP’s policy in Singapore, South Korean government took quite different methodology and approach to tackle the distribution and economic development issues. South Korean government chose to mainly control the food price in order to dampen the pressure of living costs and left the housing industry to the supply and demand of the market, whereas Singaporean government chose to subsidise in housing market in order to increase disposable income of those who are at low end of wage spectrum.


As I briefly mentioned in introduction, the cultural factor, especially the dominance of Confucianism, may be the only explanation behind the high level of education in East Asia. Confucius’ teaching background is evident in his emphasis on the power of education to bring about self-transformation. Confucius believed education helped people open their minds and realize their potential to become noble people in tune with the will of Heaven and in tune with other people. Education is so important to Confucianism that it is one of the primary methods used to reach a higher state of being. Confucius believed studying the liberal arts could create a better-rounded person, with each field of study helping to strengthen a specific aspect of personality. Education included study of six areas: poetry, to refine thought and expression; history, for understanding tradition and developing moral judgment; ritual, for understanding propriety; music, for inner transformation; politics, for social transformation; and cosmology, for achieving harmony with the sacred forces. (Confucianism 101, L.E. Terry, 2005) Based on these facts, the cultural factor cannot be neglected as a minor suggestion when explaining reasons for the high level of education and thus accumulation of human capital. There is a strong possibility that East Asian governments would have known that the accumulation of human capital is crucial for economic growth, but the investment figures of Korea and Singapore in education are unprecedented in any developing countries as well as any developed countries while they were in developing process.

Studies on the economics of education in both developed and developing nations formerly focused on the link among education, labour productivity, and output growth. This is not surprising in light of an objective of development during the 1950s and 1960s, the maximisation of aggregate rates of output growth. As a result impact of absolute poverty was largely neglected. Recent studies, however, have demonstrated that contrary to what might have been assumed, the educational systems of many developing nations sometimes act to increase rather than to decrease income inequalities.

The basic reason for this perverse effect of formal education on income distribution is the positive correlation between level of education and level of lifetime earnings. This correlation holds especially for workers who are able to complete secondary and university education where income differentials over workers who have completed only part or all of their primary education can be on the order of 300% to 800%. And as levels of earned income are clearly dependent on years of completed schooling, it follows that large income inequalities will be reinforced if students from the middle and upper income brackets are represented disproportionately in secondary and university enrolments. In short, it for financial or other reasons the poor are effectively denied access to secondary and higher educational opportunities, the educational system can actually perpetuate and even increase inequality in developing countries. Educational economist John Simmons gives the following sketch of how the poor are beginning to regard education:

Schooling, the poor quickly learn, in most countries, is an escape from poverty for only a few. The poor are the first to drop out because they need to work, the first to be pushed out because they fall asleep in class as one result of malnourishment, and the first to fail their French and English tests because upper income children have had better opportunities at home. The hope brought to village parents by the construction of the primary school fades. Enough schooling to secure steady, even menial job for their son, let alone for their daughter, seems just beyond their grasp. Before… any schooling would have done to achieve their aspiration. Now a primary school certificate is needed, and some are saying that even students with some secondary schooling cannot get a steady job; and they could never afford to send their son away to town for secondary schooling.

There are two fundamental economic reasons why one might suspect that many LECD educational systems inherently inegalitarian, in the sense that poor affluent students have less chance of completing any given educational cycle than more affluent students. First, the private costs of primary education (especially in view of the opportunity cost of a child’s labour to poor families) are higher for poor students than for more affluent students. Second, the expected benefits of primary education are lower for poor students. Together, the higher costs and lower expected benefits of education mean that a poor family’s rate of return from investment in a child’s education is lower than it is for other families. The poor are therefore more likely to drop out during the early years of schooling.

Korea and Singapore appear to beat this cycle and have industrialised rapidly because they have invested relatively heavily in education. Educational investments resulted in universal primary education and in widely available secondary education. In addition, the quality of schooling has improved more rapidly in the East Asian economies than in other middle-income economies; as fertility rates fell in the 1970’s, education spending per child rose sharply even as education expenditure as a percentage of GNP remained constant or, in some cases, declined. In Korea and Singapore, the school-age percentage of the population dropped by nearly half from 1965 to 1989. (East Asian Miracle, World Bank Report, 20) As argued by Young (1995) and Nelson and Pack (1999), coupled with factor accumulations in physical capital and labour force, an increase in human capital through improved educational levels accounts for the fast economic growth experienced by Korea. The proportion of the Korean workforce with a secondary education has tripled between the mid- 1960s and mid-1990s. This high level of education has enabled the labour force to absorb rapid changes in technology. Moreover, education has played a pivotal role in improving productivity in agriculture and industry within the Korean economy. (Asian Development Report) A well-educated work force, both white- and blue-collar, is a general property of late industrialisation, distinguishing it from earlier industrial change. (Alice Amsden, Asia’s Next Giant, 216) Clearly, late-industrialising countries tend to promote greater accessibility to education than was customary in earlier periods of industrial expansion. What is noteworthy here is the relative pre-eminence of Korea, by contemporary standards, in this area of social progress. Even among late-industrialising countries, Korea tends to excel in most indices of education, standardised for population size: secondary students as a percent of eligible secondary-age students, scientists and engineers per capita, and so on. Korea scores higher in most educational indicators than even Singapore, which adopted a high-skill growth strategy before Korea.

Nevertheless, there is also drawback of having many high educated workforces. Over 95% of eighteen-year-old children graduate from high schools, and more than 70% of them advance to higher education institutions. The result of this is that many employers consider an undergraduate degree as a minimum requirement and thus over half of undergraduates carry on their studying to further education level in order to make themselves more employable. This effectively creates further education costs that poor students cannot afford. Moreover, Korean society runs in culture of In-maek, which is alumni relations. The statics show that the students who graduated from Seoul University, Yonsei University and Korea University

Chapter 4: After Asian financial crisis

Explaining the Recent rise in income inequality (Weil,380) The technological advance is the main driving force in the recent rise in income inequality. As with other increases in technological progress, information technology increased the rate of return to certain characteristics of workers – most importantly education. Computers complemented the skills that educated workers already possessed, making such workers more productive, while doing little to raise the productivity of uneducated workers. In 1993, for example, 70% of workers with a college education used a computer in their jobs, while only 10% of workers with less than high school education did so. The new technology also created a fluid situation in which there was a high return to flexibility or entrepreneurial spirit.

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