Abstract: This paper aims to review the economic policies adopted by high-income economies after the growth miracle period, mainly from the perspectives of aggregate demand management, structural reform and social welfare. In terms of aggregate demand management, expansionary monetary and fiscal policies are the standard policy tools for dealing with insufficient endogenous market demand. In terms of structural reform, economic policies need to be adjusted, and it is critical to have the market play the major role in resource allocation. As for social welfare policy, the strategy is not to simply increase social welfare spending but also make timely adjustment and address new problems effectively.
After the Second World War, mankind created an unprecedented miracle of high-speed economic growth.
The growth miracle mainly occurred in Europe and East Asia, mostly owing to successful industrialization. However, the miracle could not last forever. A per capita GDP of US$10,000 (in 1990 constant PPP prices) marks a watershed in the development of an economy, from which it faces greater pressure to reform and innovate, more difficulties in coping with new challenges through traditional policy recipe for sustaining rapid growth, and various acute economic and social problems.
In terms of purchasing power parity, China’s per capita income surpassed US$10,000 around 2012. In terms of nominal dollar values, China is expected to become a high-income country around 2022. Since 2012, China’s economic growth has continued to slow down. With consumption replacing investment and export as the main driver of demand and the service sector outperforming the industrial sector as the main contributor of new employment and added value, the growth engine has shifted, posing many new problems and challenges to China’s economic development.
A review of the economic policies adopted by high-income economies after the growth miracle might provide valuable lessons for China. To this end, the paper studies the cases of European economies like Germany, France, and Italy as well as East Asian economies like Japan, Taiwan of China, and South Korea to investigate the challenges they encountered after the end of the growth miracle and their coping strategies.
I. MAJOR EUROPEAN ECONOMIES
Germany, France, Italy, and other Western European economies experienced a golden period of rapid growth during the 1950s and '60s. After that, their growth miracles ended with the emergence of triple shocks of the structural transformation of the economy, the collapse of the Bretton Woods system, and the oil crisis. Factors like industrial transformation and excessive high growth rate of real wages led to massive unemployment in the coal, steel, textile, and automobile sectors.
1. Aggregate demand management
While dealing with unemployment, the governments of these countries found rising inflation to be the bigger threat. Following the end of the growth miracle, these economies first encountered problems of rising unemployment rate and downward pressure on economic growth. In response, the governments adopted stimulus policies such as interest rate cuts and public sector investment, which allowed the economies to recover to some extent. But subsequently, inflation put a greater strain on aggregate demand management, forcing these countries to take fiscal austerity policies that lasted for many years. It was not until the mid-1980s that inflation fell back to low levels.
Both fiscal and monetary policies had limited room for maneuver. The increased commitment to strengthening social welfare and building public facilities during the high-growth period of the 1960s and the economic slowdown in the 1970s widened the gap between government revenues and expenditures, restraining the fiscal space to ease the unemployment pressure by increasing spending. After the breakdown of the Bretton Woods system, Europe introduced a floating exchange rate arrangement known as the “Snake”, which was later replaced by European Monetary System (EMS). Such arrangements stabilized exchange rates among European countries but also undermined each country’s ability to leverage monetary policies to rein in inflationary or unemployment pressures.
The structural policies adopted by European governments under political pressure to protect traditional sectors and workers are the root cause of stagflation. These policies undermined the market mechanism and reduced efficiency on the supply side. Adding the oil price shock to the inflationary pressure, the aggregate demand management policies had to tighten, which drove the economy into deeper stagnation. A more important mechanism is the “wage-price” spiral caused by the practice of pegging wages to prices, making it difficult to get rid of high-inflation expectations. Only by slashing aggregate demand and sacrificing output can inflation be anchored.
2. Structural reform
In the 1970s, to deal with the unexpected pressures of high unemployment and economic recession, most European countries resorted to state power to overcome the difficulty. As a result, the crisis strengthened the public sectors of these European countries. The following measures were taken: nationalization or support for corporate mergers and reorganizations, pegging inflation to wages, requiring employers not to lay off surplus workers through wage subsidies, expelling foreign labor, controlling prices, and limiting the import of foreign goods.
However, these measures were not effective in relieving unemployment pressure and overcoming economic depression. Unemployment rate did turn around briefly but increased immediately afterwards. The inflationary pressure became more prominent and economic recession was not alleviated.
In the 1980s, neoliberalism became the mainstream school of thought. In Britain, “Thatcherism” held sway. In France, then-president Francois Mitterrand called for an American-style modernization of France. “Thatcherism” consists of a package of policies and ideas: tax cuts, free markets, free enterprises, privatization of the industrial and service sectors, patriotism, individualism, etc. Privatization brought considerable revenues to the British government and reduced its spending. Yet total government spending as a percentage of GDP did not fall accordingly, mainly because the government spent more on unemployment benefits.
3. Social welfare
After the Second World War, European countries continued to expand the social safety net, with the aim to build “cradle-to-grave” nanny states. In the 1970s, these countries started to check the growth of welfare spending to various degrees. Under the influence of neoliberalism, countries like France, Britain, and Germany adopted tax cuts and promoted the privatization of state-owned enterprises. Although Europe promoted privatization in the 1980s, the public sector actually expanded. From 1974 to 1990, employment in the public service sector generally increased, from 13% to 15% in Germany, 13.4% to 15.5% in Italy, and 22.2% to 30.5% in Denmark. Most employment was concentrated in education, health care, and finance in the tertiary sector.
The social welfare system secured the basic livelihood of ordinary people during the 1970s recession, which distinguished this recession from previous ones. Despite its inherent flaws, social welfare system has become an integral part of modern society. Anthony Giddens argued that no welfare system is meant to run perfectly once implemented, rather, a robust one must be flexible enough to adapt to changing realities.
II. JAPAN
Similar to Germany and France, the Japanese economy also encountered triple shocks, namely, the structural transformation of the economy, the collapse of the Bretton Woods system, and the oil crisis, after the high-growth period of the 1950s and 1960s. The number of unemployed people rose from 735,000 in 1972 to 850,000 in 1974 and peaked at 1.13 million in 1975. Most of the job losses occurred in traditional manufacturing industries such as textiles. In the 1980s, Japan’s growth and unemployment pressures eased while the US-Japan trade frictions intensified, posing a new challenge on how to balance the economy.
1. Aggregate demand management
Japan’s policies to manage aggregate demand in the 1970s and '80s basically dealt with two types of contexts:
The first context is the high-inflation period between 1973 and 1975, during which curbing inflation was the priority. The Japanese government tightened both monetary and fiscal policies, sharply reducing the growth of fiscal spending from a double-digit rate to -11.8% in 1974 and raising the average loan rate from 6.7% in 1972 to 9.4% in 1974. As a result, the inflation rate and economic growth dropped sharply.
The second context is the huge appreciation pressure of the yen, imbalance of international payments, rapid accumulation of foreign exchange reserves, and the discontent of the international society, especially the US, with Japan’s large trade surplus. The periods of 1971-1973, 1975-1978, and 1985-1987 all fall into this category.
In this context, Japan preferred loose monetary policy to expand domestic spending and reduce capital inflow in order to ease the appreciation pressure of the yen and international payments imbalance. The fiscal policy was also relatively proactive, on the one hand to boost domestic spending and reduce the negative impact of appreciated currency on aggregate demand, and on the other hand to achieve long-term goals regarding economic restructuring and social welfare.
2. Structural reform
Since the 1970s, Japan had rolled out a series of structural reform policies to ease the pressure brought by the phase-out of traditional industries and support industrial transformation.
Japan’s response to the pressure of phasing out traditional industries shows two features: first, regardless of industry, it only coped with macroeconomic recession with time-limited measures; second, it intended to help enterprises withdraw labor, capital and other production factors from the old industries and redirect them into the new ones.
In the 1980s, following OECD’s proposal for a proactive industrial restructuring policy, Japan attached more importance to free competition and the principles of market economy. In the 1970s, the Japanese government started to adopt policies to support the transition from labor- and energy-intensive industries to technology-intensive ones. In 1980, Japan put forward strategies such as building itself into a "nation based on science and technology" and decided to develop applied microelectronics and computer technology as the path to realize the goal. In addition, Japanese foreign direct investment alleviated the pressures of Japan’s domestic overcapacity and its trade frictions with other countries. Since the 1970s, Japanese overseas investment has surged, with various support from the Japanese government.
During the 1970s and '80s, the Japanese government intervened less in the economy and shifted towards a “small government”. In the 1970s, the Japanese government still maintained a strong influence on economic operation, mainly through policy measures including various regulatory policies and control over credit allocation. In the 1980s, Japan experienced a wave of corporate privatization. Meanwhile, financial liberalization pushed forward the marketization of the Japanese financial system, but also brought about many challenges. Financial liberalization intensified competition in the financial sector and reduced credit quotas in a low interest rate environment. Japanese scholars believe that the excessive and unfair competition in the financial sector is the main cause of the subsequent financial crisis.
3. Social welfare
In 1950, the Yoshida Shigeru administration established the policy framework for post-war Japan’s social security system that consisted of four institutional dimensions, i.e., social insurance, government assistance, public health care, and social welfare. By 1961, Japan had basically set up a universal social security system pillared on social insurance, which was mainly financed by social insurance premiums paid by Japanese people and supplemented by government subsidies, and invested in infrastructure to ensure returns. In the 1970s, despite economic slowdown and declining fiscal revenue, the Japanese government raised debt to support spending on social welfare. In 1973, the proportion of medical insurance paid by the government rose from 50% to 70%, a level that has been maintained till today. The transfer payments of the Japanese government for low-income households include minimum subsistence allowance, housing subsidy, medical subsidy, and education subsidy. These systems, coupled with universal health care and old-age insurance system, have helped Japan realize relative income equality.
III. TAIWAN OF CHINA AND SOUTH KOREA
The high-growth period in Taiwan and South Korea came to an end in the late 1980s and mid-1990s, respectively. Since then, economic growth has continued to slow down. For Taiwan, it faced the challenges of industrial transformation and upgrading as well as how to improve its international competitiveness. For South Korea, its challenges were tougher, including overreliance on heavy industries, severe corruption, dominance of chaebols in the economy, sluggish development of SMEs, and speculative heat in the real estate sector versus deficient investment in the industrial sector.
1. Aggregate demand management
After the end of the growth miracle, the main challenge for Taiwan’s aggregate demand management was insufficient demand. Against the backdrop of a significant economic downturn in 1985, Taiwan decided to run a budget deficit, transitioning from a balanced budget to functional budget. But overall, Taiwan’s fiscal expansion was modest with a relatively low level of debt-to-GDP ratio among developed economies. The monetary authority continued to lower interest rates to stimulate the economy. The average interbank market lending rates dropped from 6.8% in the 1980s to 6.1% in the 1990s, and to 0.89% in the first 20 years of the 21st century. Despite the declining interest rates and government debt expansion, inflation is still decreasing while unemployment rate is hard to be reduced, so insufficient aggregate demand remains a great challenge.
Following the end of the growth miracle, South Korea fell into recession during the 1997 Asian financial crisis but otherwise has maintained a relatively stable economic operation. Although the mean inflation rate went downward and unemployment remained stable, the labor market was still under pressure with an increasing share of informal employment. The main task for South Korea’s aggregate demand management was to boost domestic demand. Therefore, the average unsecured lending rate continued to drop from 12.6% in the 1990s to 1.9% between 2010 and 2020, while the government debt-to-GDP ratio increased from 13.2% in the early 1990s to 41.9% in 2020.
2. Structural reform
Faced with trade protectionism in developed regions while competing with products from South Korea, Singapore, Hong Kong, and China’s mainland, Taiwan started to pursue the three goals of liberalization, internationalization, and institutionalization. Measures adopted include: liberalizing interest rates and loosening foreign currency controls, promoting trade liberalization and relaxing import and export controls, as well as importing technologies and capitals. South Korea began a new round of market-oriented reforms, including abandoning five-year economic planning and reducing government intervention in industry development; liberalizing interest rate and exchange rate, strengthening financial regulation, and ending the government’s economic guidance through banks; allowing zombie conglomerates to file for bankruptcy; promoting chaebols reform and the privatization of SOEs; enforcing competition policies and avoiding concentration of economic power; and implementing policies to promote science and technology development.
In addition, Taiwan and South Korea encouraged foreign investment, which resulted in a significant increase in the amount of foreign direct investment. At the request and under the influence of the United States in the 1980s, Taiwan and South Korea both adopted floating exchange rates and liberalized interest rates, which over time did reflect the price of capital, promote competition among financial institutions and optimize resource allocation. Financial deregulation, on the other hand, has caused instability in the financial markets.
3. Social welfare
During rapid economic growth, Taiwan and South Korea did not considerably boost social welfare spending, and the social security system primarily covered workers. Several factors prompted increased spending on social welfare protection after their growth miracles. To begin with, job opportunities diminished, the income distribution gap grew, and poverty levels rose. In 1996, only 3.1% of Korean households lived in absolute poverty, but by 2003, the percentage had risen to 10.4%. Second, pension insurance could not keep up with an aging population. Third, as more women enter the job market, the family's social security function was reduced. According to Jin Yuanming, the post-industrial society will face new difficulties that would necessitate changes in the social welfare system.
Ⅳ. CONCLUSIONS AND TAKEAWAYS
1. Aggregate demand management
The key challenge emerged after the end of the economic growth miracle was a lack of market demand. Ex post unemployment and inflation rates are insufficient to determine whether there was a spontaneous market demand deficit.
If the government uses an active monetary policy and an expansionary fiscal policy to compensate for the demand deficit, demand, employment, and inflation can all be maintained at agreeable levels. If productivity fails to improve or energy prices grow on the supply side, high inflation and high unemployment can occur simultaneously.
The lack of demand is caused by decreased credit demand from non-financial firms, which in turn is a result of changes in the industrial structure. When economies reach the pinnacle of industrialization, credit is in high demand in capital-intensive industries like steel, energy, and chemicals, where extensive investment leads to rapid productivity gains and economic expansion. When the demand for products from these industries reaches saturation, investment and loans to non-financial enterprises both slow down. If other industries do not fill the credit growth gap, the economy will confront a lack of spontaneous market demand.
Expansionary monetary and fiscal policies are the standard policy tools for dealing with insufficient spontaneous market demand. However, in practice, the strategy may stray from aggregate demand management plans, putting monetary and fiscal policy under pressure. One popular argument is that income inequality weakens consumption and thus lead to insufficient overall demand, to which the respond should be to subsidize low-income groups and raise the minimum wage. France yielded little success by massively subsidizing low-income groups and hiking the minimum wage. This method didn’t considerably increase aggregate demand, nor did it reduce the pressures of unemployment and economic downturn.
In comparison to France, Germany, and other European countries, Japan maintained a high degree of economic dynamism in the 1970s and 1980s, and sustaining a decent level of aggregate demand was central to this success. Japan was able to utilize its monetary policy tools more proactively to respond to spontaneous market demand deficiency after it stopped pegging to the US dollar. Japan's fiscal policy was very active. The considerable increase in the government debt-to-GDP ratio after 1970 did not jeopardize the credit of the Japanese government or cause inflation. The fundamental reason for this is that Japan's fiscal expansion was primarily intended to compensate for spontaneous demand deficiency, and aggregate demand growth after accounting for government fiscal spending expansion did not exceed supply capacity or result in inflation. According to Japanese academics, excessive personal savings were absorbed by government bonds for public investment to maximize resource utilization.
2. Structural reform
Most governments in Europe and East Asia intervened in economic operations during the growth miracle, using measures including but not limited to economic development plans, credit rationing and financial controls, controls on enterprises in upstream industrial sector through SOEs or other industrial policies, industrial investment incentives, and trade barriers.
With the end of the miracle and investment-driven growth, the government's magic formula of subsidizing investment and the industrial sector through financial regulation and industrial policy no longer works, and it has resulted in a slew of negative consequences, including inefficient resource allocation, overcapacity, zombie businesses, and pollution.
Economic policies must be adjusted. As the economy becomes more complicated, it is critical to enable the market to guide resource allocation. Fair market competition, anti-monopoly, cutting and removing subsidies, opening up to the outside world, particularly in trade and investment, and supporting basic research and education are all priorities for policies. Since the 1980s, Germany, France, Italy, Japan, Taiwan of China, and South Korea all made similar decisions. These policy changes aided the expansion of knowledge- and technology-intensive economies, helping them to remain within the high-income rank.
3. Social welfare
Welfare state is an inevitable choice of high-income economies.
After the growth miracle, a country would see a number of new features of the economy. First, unemployment rate rises in steps, or the proportion of informal employment increases sharply, just like what has happened in South Korea; second, income distribution becomes increasingly polarized with rising proportion of poor people; The third is an increase in the labor force participation rate of women and the decline in the average family size, which would weaken the function of traditional families in caring for children and the elderly. The fourth is an aging population. These new features put forward new requirements for social welfare policy.
The strategy to meet the new challenges is not simply to increase social welfare spending. Excessive increase in social welfare spending has been criticized a lot, with side effects including excessive reliance on welfare, loss of work motivation, and waste of resources, etc. In order to deal with the new problems in the post-industrial era, and respond to the criticism of traditional welfare policies, European scholars put forward a new strategy of social welfare policy, namely, the social investment strategy. This strategy no longer emphasizes achieving equality through income distribution, but focuses on increasing work opportunities for and improving working ability of low-income groups through investment in human capital and provision of education and training. For example, the UK has reduced cash subsidies for youth and unemployed groups, and increased vocational training and lifelong education. The UK, Singapore and Canada, among other countries, have set up child development accounts to support children's education. A women-friendly policy would include three core elements, namely, affordable childcare, paid childcare leave, and sick child leave.
The article was an abridged version of the NFR working paper titled “Economic Policies after the Growth Miracle”. The paper was first published on International Economic Review (Issue 2, 2022). It is translated by CF40 and has not been reviewed by the authors. The views expressed herein are the authors’ own and do not represent those of CF40 or other organizations.
