In 2010 China surpassed Japan as the second largest economy in the world.  Goldman Sachs estimates that given current comparative growth rates, China will surpass the U.S. in nominal GDP by 2027.  As Justin Yifu Lin wrote in the Asia and the Pacific Mail (March 15, 2010), China's economic development has been "miraculous" since beginning its transition 30 years ago.  Like Nobel laureate Paul Krugman in commenting about the so-called "East Asian economic miracle," I hesitate to use the term "miraculous" for the simple reason that a miracle is an event or a phenomenon for which no human explanation can be given.  One has to look for supernatural reasons.  As Mr. Yifu Lin clearly explains in his article "China's Miracle Demystified," what China achieved over the last three decades has very natural causes.  If only countries like the Philippines and other aspiring emerging markets could learn these lessons, we can have equally spectacular achievements in such countries as Indonesia, Vietnam, Pakistan, Bangladesh, Cambodia and other developing countries in the next thirty years.

          Together with other members of the Makati Business Club that received "Notes from the MBC 001" which contained the article of Mr. Lin, let me share with the business community at large the answer to the first question "What was behind China's extraordinary performance?"  After the industrial revolution (which first happened in England during the period 1790 to 1830), sustained growth in any economy depended on continuous technological innovation as well as industrial diversification and upgrading.  For example, the first technological innovation happened in the textile and iron industry; followed by steel and chemicals; then there was the railroad revolution followed by the automobile era during the 1920s.  Then came the electronic decades of the 1960s and 1970s closely followed by the explosion in Information and Communication Technology (ICT) towards the end of the last century.  Today we are witnessing the most rapid technological changes in digital and internet technology together with biotechnology.  One thing is sure:  there will be endless improvements in technology that will enable human beings to meet the challenges posed by the "limits to growth" skeptics such as Al Gore and those petrified by "global warming."

          As Mr. Li recalls, quoting from economic historian Angus Maddison, before the 18th century, the average annual growth rate of per capita income in the West was only 0.05 percent for years.  That means it took 1,400 years for Europe's per capita income to double prior to the 18th century.  In the 19th century, it took about 70 years, and in the 20th century, 35 years.  I venture to speculate that in the 21st century, it will take twenty years or less.  If the right lessons are learned, this doubling of per capita income in one generation will happen in the BRIC countries followed by the Next Eleven, which include Vietnam, Indonesia and the Philippines, the VIP countries of Southeast Asia.  Especially with a focus on rural and agricultural development and the nurturing of small and medium-scale (SME) industries, this rapid growth in per capita income will lead to a swelling of the middle class households that can partly insulate these emerging markets from the ups and downs of the global economy.

          Both the experiences of the industrialized countries of the West and the Asian tigers showed that the industrial revolution sped the move away from an agrarian society where 85 to 90 percent of the labor force worked in traditional agriculture in which subsistence farming was the rule.  The move from agriculture to nonagricultural and manufacturing sectors was gradual but inexorable.  In the manufacturing sector, it was first very labor-intensive, and then became more capital-intensive as technology advanced.  Ultimately, the service sector dominated. Overall, the process was one of continuous structural change. As a late-comer to this modernization process in 1949, China had the advantage of backwardness, the same problem of the Philippines today that we can convert into an opportunity.  To innovate, China did not have to invent the technology or industry by doing R&D.  It could borrow technology, industries and institutions from the advanced countries with low risk and costs.  East Asian economies, including Japan and the four small dragons as well as China after the transition in 1979 under Deng Xiao Peng, all tapped into this advantage.   

          China has been so open to Foreign Direct Investments since 1979 that FDI flows have averaged $75 to $100 billion annually.  Like Japan at the beginning of the last century, China did not hesitate to borrow as much technology as possible from the more advanced countries.  But this borrowing process assumed a very important precondition.  The country must heavily invest in science and engineering education so that its absorptive capacity of borrowed technology will be high.  China can almost instantly replicate foreign technology in any branch of industry because they have a cadre of scientists and engineers that do reverse engineering.  The Philippines and some of the emerging markets wanting to follow the Chinese strategy must invest a great deal more in science and engineering education.

          In terms of industrial policy, there is much to learn from the failure of China before the transition in 1979.  Why did China fail before the transition in 1979?  The answer given by Mr. Li is as follows:  "China didn't tap into that potential until 1979 because it adopted a misguided modernization strategy.  Revolutionary leaders such as Mao Zedong and Zhou Enlai hoped to make China an advanced country immediately after the founding of the People's Republic of China in 1949.  They adopted a strategy to build up advanced capital- and technology-intensive industries even though China was an agrarian economy.  The government's priority industries went against China's comparative advantage.  The government needed to protect them by giving them monopoly positions and subsidizing them through various price distortions, including suppressed interest rates, over-valued exchange rates and so on.  The price distortions created shortages and the government was obliged to use administrative measures to mobilize and allocate resources directly to the non-viable firms in the priority industries.  Through these interventions the government was able to set up modern advanced industries, but the resources were misallocated and the incentives repressed.  Economic performance was very poor.  Haste made waste."

          It is uncanny that the failed industrial policy described above was exactly the same that our leaders followed for almost thirty years after we were granted independence in 1946.  No wonder we also failed miserably, acquiring the notoriety of being the sick man of Asia by the mid 1980s.  But all is not lost.  For more than a decade now, our leaders have been giving the due attention to rural and agricultural development and to tapping the advantages of a young labor force through labor-intensive industrialization.  What must be done in the next ten years is to significantly increase our investment in science and engineering education so we will have the human resources to borrow foreign technology intelligently and to make the transition to capital-intensive and high-value manufacturing as soon as possible.  For comments, my email address is bernardo.villegas@uap.asia.

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