We Study Billionaires - The Investor’s Podcast Network - TIP152: How Asia Works with Joe Studwell (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. In 2014, Bill Gates made a post on his blog about a book that he found so compelling that he made his entire agricultural team at the Gates Foundation read it. So the name of the book is How Asia Works, and this is by Joe Studwell. In the book, Joe walks the reader through the financial history of countries like Taiwan, South Korea, China, and many others. After baselining the history of these various countries, he then talks about what they did to achieve such great success and growth. Luckily, we reached out to Joe about coming on the show, and he said yes. So we are really excited to share this interview with you today. How Asia Works is the best book I read in 2017.

Starting point is 00:00:42 I always wonder why Japan could become one of the wealthiest countries in the world in just a few decades, and essentially why some countries are rich while others are poor. What I like about this episode is not only Joe's insightful an explanation of this, but the simple realization that economic growth is not about fixed inputs, like natural resources. It's human-driven. In this episode, we're excited to share with you why. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. All right. So how's everyone doing out there? And like we said in the introduction, we have Joe Studwell

Starting point is 00:01:34 with us, and we are really, really excited to be talking about this book. In fact, Stig had read this book two times because it was so good. We're talking to Joe about his book, How Asia Works. This book was rated as Best Book of the Year by an economist. And a highly readable and important book by the Financial Times is a quote that they put out there. So, Joe, thank you so much for taking time out of your busy day to talk to Stig and us about your book. I'm very happy to be here on the podcast. Well, we're thrilled to have you, Joe.

Starting point is 00:02:04 So Stig, go ahead and take away the first question that we have for Joe. The first question is something economists and financial journalists have tried to answer multiple times over the years. And it's both very simple, but I guess also extremely complex. So the question is this, why are some countries rich while others are poor? But for me, and if I might add, Bill Gates, there's no better explanation provided than the one that you give in your book. So, I don't know if you like this term, but I call it the three-step formula. Could you please explain to us, how does it work?

Starting point is 00:02:43 We can begin, we can go all the way back very briefly and say, well, what was the industrial revolution, the original industrial revolution in the UK? And if we look at that in growth terms, that was only just over 2% growth per annum, but we call it a revolution because prior to that, economic growth wasn't really a phenomenon. The point I made in how Asia works is that after the Second World War, all of these things take and go up another notch. And what happens, first of all, is we see in agriculture something that we've never seen before, which was that in Japan and Taiwan and Korea and in China, although China moved away from this system and then came back to it, what we saw in all of

Starting point is 00:03:29 those places was land reform. And by land reform, we mean that governments took available agricultural land, they split it up between the farming population and they gave everybody a piece of land. And so everybody was engaged in the capitalist game, if you like, everybody had a bit of capital, a bit of land. And household farming was supported with big investments in the provision of infrastructure and the provision of fertilizer and everything else you need. And also what agronomists call it extension, which essentially means teaching you how to grow things. And they showed that in agriculture, unlike in manufacturing, when you have a lot of poor people, so wage rates are very low, that you can actually turn agriculture very efficiently into a kind

Starting point is 00:04:17 of form of gardening. You can make it incredibly labor intensive and you can have higher yields than you're actually able to achieve on large farm. And East Asia pioneered this. It had never been done before. And then on top of that, they over-emphasized the role of manufacturing because this was the best way to take people out of the agricultural economy. When you've got low-sueled people coming out of farming, it's a lot easier to train them to work in factories than it is to train them for service jobs because so much of what needs to be done is embedded within machinery. And then the final thing that they did was that they used finance to support small. more scale household farming and manufacturing.

Starting point is 00:05:01 When they did those three things, they were able to move on from what the US and Germany had achieved in growing at 5 to 6% a year and moved to growing an average 10% a year. And as you know, China, the latest example, has grown at 10%, an average 10% a year for the last 30 years. So that's a rather long answer. So that might be a long answer, but a really great answer, Joe. Just to sum up here, so the first of the three steps, that's land reforms. The second step is manufacturing. And finally, the third step is all about how the financial industry can support the agriculture and manufacturing industries. So as we move on, we'll talk about each of these three

Starting point is 00:05:46 segments. So, Stig, you're exactly right. So my first question that I have here for you, Joe, is relating to the farming and the agricultural piece. So I would like to talk more about the key role that it played into this development over in Asia. One of the many reasons why this is the first step is because developing countries have this abundance of farm labor and a shortage of capital. Why is it that countries like Korea and Japan managed to get high yields out of their lands and their laborers, whereas other Asian countries have struggled to do the same? Well, fundamentally, the land reform, and of course that's politically very difficult to do.

Starting point is 00:06:20 the end of the Second World War, the US had a big problem because the communists were winning in China. Socialist parties were also strong in Japan and in Korea. Of course, the US occupied Japan until 1952, so it could tell the Japanese to do whatever it wanted them to do. And in the winter of 45-46, the US government instructed the Japanese emperor to instruct his government to, to pursue a very comprehensive land reform program. Now, interestingly, the Japanese had actually in the 1870s done a land reform program themselves, but it had not had limitations on people's ability to buy and sell the land, and a lot of landlords had managed to re-aggregate large farms or larger farms than they would have with equal distribution.

Starting point is 00:07:14 And that had kind of unwound the impact of that in the course of the Great Depression, Japan very hard. One of the reasons that Japan not going ahead of any other East Asian country was they had a land reform in the 1870s. So the Americans then made them have a much more comprehensive one after the Second World War. And the U.S. military opposed doing the same thing in Korea. The U.S. military was occupying South Korea, was opposed to doing the same thing. But then when the Korean War started with the invasion by the North Koreans and the involvement of the Chinese, and then the end of that, the U.S. government decided we've got to do the same thing in Korea to stabilize support for our allies in South Korea.

Starting point is 00:07:53 And at the same time, they said, well, if we're doing it in South Korea, we might as well do it in Taiwan as well. So these land reforms occurred in all of these places. And the communists in China won the civil war telling everybody that they were doing the same thing, that the land reform which occurred in China, which was actually much more violent because Mao saw it as a class struggle as well as a simple economic solution. The Chinese did that, but from the mid-50s, they started to do that. to collectivize because Mao's view was that private ownership of land was the root of capitalism.

Starting point is 00:08:26 So it didn't produce the positive result in China until Deng Xiaoping comes in in 78, and the Communist Party accepts the return to household farming, the same kind of high-yield household farming. But all of these places, it worked for the reason that I pointed to earlier, that agriculture, when you have a lot of poor people, is not like manufacturing. In manufacturing, you always get returns to scale. So bigger factory, lower unit costs. I mean, it's pretty much always the case. In agriculture, when you have a lot of poor people,

Starting point is 00:08:58 and you turn agriculture into a kind of vegetable gardening operation, it becomes very responsive to labor intensity because you apply water just to the plants, fertilize it, just to the plants, you use vertical trellising. I mean, you guys lived in Korea. You must have seen, you know, when they're using the plastic and the vertical trellis.

Starting point is 00:09:19 I mean, there's no room to drive a tractor through those fields because the land is being used so intensively. And this is what they realized in these countries is that actually if you've got the labor available, then rather than having these people sitting around doing nothing, being an economic dead weight, you want to get them out on the land and just produce more and more food. And in producing more food, they then got this fantastic. income distribution, which was very evenly spread in society. So everybody was creating demand for basic things, household goods and producer goods, a bit of cement, a bit of glass,

Starting point is 00:09:58 you know, to improve my home. And these were all manufactured products that you could make domestically with quite low levels of technology. And so it was just a sort of usable kind of demand story as well. Oddly enough, it should be very intelligible to Americans because in the United States, of course, the US was split between a household farming story in the northern states where under the Homestead Act, you could go and get your 20 acres or whatever it was and farm it. I mean, the US is just much more land abundant, it's what people had more, but it was still labour-intense family farming in the 19th century. And the southern US was plantation agriculture, which was much lower yields, but very much favoured by the people who own

Starting point is 00:10:42 the plantations because it produced large profits for small numbers of people. Well, of course, the Civil War meant that the Northern States won out. And it was the agricultural economy of the Northern States that was much more conducive to the industrialization of the US. So, yeah, it's a story that's not unconnected with what we've seen elsewhere in the world, but it was just applied in a much more rigorous and aggressive way in East Asia. And it meant that these countries could grow at 10% a year. Let's take a quick break and hear from day sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every

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Starting point is 00:15:03 Sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. Really interesting point here, Joe. And I would really like to stress how we have seen the policies in effect before, but not to the same magnitude because they haven't been implemented with the same conviction.

Starting point is 00:15:33 Now, I would like to talk about Japan specifically because even though that Korea and Taiwan have done really well since the Second World War, Japan's done better. Why is that the case? I mean, you've got to go back to the world in the 1860s. And of course, the American Navy turned up in Japan in the 1860s with great big battleships. And the Japanese didn't react in the way that the Chinese did to the arrival of the Europeans by just saying, look, we've got 5,000 years of history or very inferior, a bunch of people go away. The Japanese looked at this and said, geez, you know, this is actually. quite scary. What are we going to do? We need to figure out how to get ourselves the same kind of

Starting point is 00:16:17 military capabilities that these people have. And so the Japanese did what the Chinese later did and the Koreans later did and the Taiwanese did, which is to say, well, this is a soluble problem. We really need to catch up with them. And so all we've got to understand really is what they did and how we can apply it to our society here. And so in the major, era, a small group of political leaders. I mean, they traveled to Europe, they traveled to the United States, they visited huge numbers of factories, talked with anyone in government who would talk with them, Bismarck, for instance, in Germany they visited. And they put together this plan, which involved the first comprehensive land reform program, I guess, that had been initiated

Starting point is 00:17:06 by a developing country government, unless you don't include the first comprehensive land reform program, I guess, that had been initiated, the US Homestead Act, which you could say was a form of land reform as well, instituted by Americans. They copied laws and regulations, wholesale, and they figured out what they needed to do. And so they were the breakout state in East Asia because they saw development as a soluble problem. So, Joe, in the West, we might sometimes underestimate the importance of manufacturing because the economy here is predominantly service-based.

Starting point is 00:17:39 However, for developing countries, this is a crucial step that you talk about in the book. The manufacturing in Korea took off from the early 60s to the mid-70s and went from as little as 9% to 27% of the GDP. So an important reason that you explain in your book is that the government conducted reforms for export-oriented growth. Could you explain to us how credit could drive exports and also how the credit expansion backfired decades later? In Korea, Park Chung-hee very aggressively made interest rates offered by banks significantly lower when they were given to firms that were exporting. Okay, so how did he know that they were exporting or how could he prove that they exported? Well, the loans were given against the letters of credit. So exporting firms use letters of credit to finance their working capital needs.

Starting point is 00:18:32 So you can actually prove, you know, there's actually a paper trail that shows. those that these firms are exporting when you provide the credit to them. And the credit was so cheap in Korea because of a relatively high inflation rate that it was negative in real terms for a very long time. So effectively, so long as you could raise your prices and you would be able to do this if your quality was good enough because your prices were determined by international prices, you were being paid to borrow money in effect in Korea. And this was very, very effective at increasing foreign exchange earnings.

Starting point is 00:19:05 And then the foreign exchange earnings were taken and they were used to buy equipment in more complex and more demanding industrial sector. In other countries that succeeded, there were variations on this theme, but they really were just variations on the theme. The Japanese used a private banking system, but they used a central bank which did a lot of what is called in banking, re-discounting. So that means that if you're a commercial bank, if you make a certain type of loan that conforms, with government objectives as stipulated by the central bank, you take that loan to the central bank and they will rediscount it. And that means that they will give you additional credit up to 100% of the value of the loan against that. Now, of course, it increases the money supply and so there's some inflationary pressure, but so long as you keep this targeted on particular

Starting point is 00:19:57 objectives and they would most obviously do it for exports, then the inflationary implications didn't prove to be too serious. In the longer run, of course, this tends, whereas at the beginning all these countries run current account deficits and trade deficits, there's a tendency in the long run for countries that follow this type of strategy to get stuck in perennial trade surpluses. In China, you've noticed, I'm sure, you know, huge trade surpluses. Japan still has big trade surplus, so it tends to kind of lock that in. The problem is that, you know, when that strategy is served as purpose, as we know, there's a lot of half dependency in life. And so countries tend to get sort of stuck on forms of behavior. So when you say that they're getting stuck

Starting point is 00:20:47 on that behavior of this trade surplus, is that through the manipulation at the central bank? Or how would you describe that? How would you say that that's happening? Well, it's different in different countries, you know, Germany does not provide the same level of banking support to its manufacturers as he did in the past, but the structure of the German banking system is nonetheless highly supportive to its manufacturing economy, far more so than the banking system, for instance, in the UK. So it's a number of things, you know, it doesn't remain as egregious as it is at the part of the development period, but these policies, you know, they create institutional arrangements that last for a long time.

Starting point is 00:21:31 So now we're talking about financial policies and how even though the spark growth and are good for a number of reasons also has severe drawbacks. Now, next I'd like to talk about the Philippines because as much as it's been interesting talking about the Northeast Asian countries that have done really well over the past 60 or 70 years, it's also really interesting to look at what we can learn from the countries that haven't performed. And I think the Philippines might be the best example, because in just less than half a century, the Philippines went from being twice as rich as Korea to 11 times as poor. What went wrong? Well, everything went wrong. I mean, the Philippines had everything

Starting point is 00:22:16 going for it. I mean, you're absolutely right. They had the best educated workforce in East Asia as well. So, of course, agriculture went wrong. They never implemented any of their land reform programs. They retain a kind of semi-fudal plantation-type agriculture at low yield. They failed to implement any kind of domestic manufacturing strategy. And in terms of the financial sector, the political elite just has looted the financial system for its own benefit for the last 50 years, to the point. where the Philippines ended up as East Asia's number one IMF junkie,

Starting point is 00:22:58 you know, more IMF programs than anyone else in the region. And so the Philippines is really a lesson about, you know, it's entirely a human matter development. It's within human hands. And you can have all the advantages that the Philippines had. I mean, the Philippines had more agricultural land per person, more fertile agricultural land, a better educated labor force,

Starting point is 00:23:21 a more developed education system, thanks to the U.S., and a much more sophisticated financial system. And it took all of those advantages and through them all away. All right, Joe. So in the U.S. and in the U.K., they've been supporting economic reforms in Taiwan and Korea and Japan, but not in Southeast Asia. Do you think this is a coincidence and how much of the progress that you're seeing in Asia do you attribute to Western influence and why? Well, all of the success or a lot of the success in Japan and Taiwan, South Korea, you know, really does have to be credited to the Truman administration in terms of the Truman administration support for land reform and the Truman administration support for aid in developing manufacturing capabilities and they have a very different type to the aid that the U.S. has supplied since the 50s. I mean, in the late 40s, the U.S. was willing to provide machinery. and information without the money to pay for it, without always compelling countries to buy American

Starting point is 00:24:23 goods. You know, the objective was simply to make these economies work and become more successful and taking a looser view that so long as countries become rich, the US will always be successful at trading around the world. And so it's in our interest to have more wealthy, stable economies. So the US deserves enormous credit for the success of the Japanese and South Korea and Taiwanese economies. In Southeast Asia, things were very different, and why they were different is there was political change in the United States in the 1950s that meant that a group of people who had supported change in Japan, Taiwan, and Korea

Starting point is 00:25:05 were pushed out of government and political jobs and university jobs in the 50s. They were regarded as left wing, and there was a lot of political appetite. there was also a stabilization of the Cold War frontier, which meant that there was less existential pressure on the US to do radical things than there was at the end of the Second World War when Washington was really worried that it could actually lose a large part of East Asia to communist control. And then again, of course, in Southeast Asia where there had been colonies and although the US was not a major colonial power, with the exception of the Philippines, all around Southeast Asia, the US had much.

Starting point is 00:25:45 much more vested corporate interests than it had in Japan and Korea. And of course, when you've got your own vested commercial interests at stake, your capacity to make open-minded political decisions about how to help other countries as perhaps not as great. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up. And customers now expect proof of security. just to do business.

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Starting point is 00:29:51 So, Joe, I can help but think, how can we apply a three-step formula in developing countries today? I think that one of the stories of development is that once you row too far in the wrong direction, it is very hard to row back. This is the problem in Latin America. So we've seen in the last decade the rise of left-wing governments in Latin America that have said they're committed to radical change. But actually, I mean, if you look at a government like Lula's in Brazil, they weren't able to

Starting point is 00:30:27 fundamentally change the approach to agriculture. It's very, very hard at this point to make a fundamental change in that way in Brazil, although they could do a lot to support small farmers. But they didn't do that. They didn't really get an industrial policy in place. What they did was to implement essentially a welfare program to support the poor. We've seen similar things in Venezuela, but the problem is that you put a welfare program in place, just giving money to poor people. Once you hit a macroeconomic shock, as has happened in Venezuela with the oil price and in Brazil with a broader commodity correction, you don't have the money to pay the welfare any longer. Durable economic development, durable change is about giving people the capacity to look after themselves. But I just don't

Starting point is 00:31:18 know how there's going to be any fundamental change in. South America or indeed in Southeast Asia now. I just think that those are going to be parts of the world where countries are going to develop much, much slower. And instead of taking 50 years, it's going to take two or 300 years to change. In Africa, there is a greater potential, I think. One possibly is Ghana, which has been very badly run in the past, but now seems to have a more focused developmental government. The other is Rwanda, which following the genocide in the 90s, has had a leadership which is very, very focused on trying to emulate East Asian development, although they're very engaged with the Singaporean government.

Starting point is 00:31:58 They want to, I mean, it's a small country in the middle of a lot of other countries, and they see that more as a sort of potential way forward for them. But the most important one is Ethiopia, which is a country of 100 million people. It's the second most populous country in Africa. And Ethiopia now has been growing at about 11% a year for over a decade. They're very engaged at an economic commercial level with China because China is able to offer them credits for various things that they need and machinery at a better price than other countries. And they're very engaged at an intellectual level with the Japanese and the Korea. They're doing all of the right stuff.

Starting point is 00:32:40 They are bending their financial system to support our objectives. And as I say, they've been doing over 10% for over a decade already. So I think within the next few years, they will very much come onto the radar. They're not there yet, mainly because as with China, when I first went to China, the GDP but cap was $300 in 1991. It's now 9,000. So Ethiopia has been growing 10% a year, but it was so poor that it's still only, I think, about $700 or $800.

Starting point is 00:33:12 So that's happening. And, yeah, as I say, I'm not excited about anything. in Southeast Asia. I was in Myanmar last year. I don't think Myanmar is going to surprise us on the upside, I'm afraid. I think that Latin America is just going to be a slow burn development story. But I think we're going to see things in Africa that will really surprise people. However, it's going to be a very mixed story. So, Joe, I got the last question here. And having gone through your book, there is so much research that was done. I can't even imagine the number of books that you had to read and individuals that you had to connect with

Starting point is 00:33:50 in order to write this book. But that's why we've got this question for you. So if you could pick one book to recommend to our audience about economic history, what book would you recommend that they read? My favorite book about economic history. Well, I think the normal one, the normal one that people recommend is perhaps the Heilbronner book, which is called worldly philosophers, which is about the history of economic thought. But I'm I like a book that came out in, I think, 1982, and it was by a guy called AK Dasgupta, who actually is the father of the guy who's the head of the economics department at Cambridge at the moment. And the book is called epochs of economic history.

Starting point is 00:34:34 And I really like it because it shows better than any other book how economic theory has it's evolved over the last two or three hundred years. has always been utterly rooted in the time in which it's been made. That's a kind of a counterintuitive thing because everybody's led to believe that economics is a science in the way that the natural sciences are a science. Economics is an effort to use some of the positive things in a scientific approach in understanding human life, which cannot be subjected to laboratory analysis

Starting point is 00:35:09 in the way that the manner in which chemicals interact or whatever can. Well, Joe, we cannot thank you enough for coming on the show today. For everybody out there listening, the name of Joe's book is how Asia works. This is all about the success and failure in the world's most dynamic region. And, I mean, you talk about some heavy hitters endorsing this book. You got billionaires like Bill Gates. In fact, Bill had his staff at his foundation read this book. So this was a forced reading.

Starting point is 00:35:39 that Bill put out to all of his employees that they were to read this book so that they understood how important the message is inside. Stig and I can absolutely attest to how incredible this book is and how eye-opening it is to help developing country to emerge into success and to a wealthier being for their citizens. So, Joe, we thank you so much for coming on the show and we appreciate your time. All right. Thank you for having me. That was all that Preston and I had for this week's episode of The Ammasters podcast. We see each other again next week. Thanks for listening to TIP.

Starting point is 00:36:14 To access the show notes, courses or forums, go to the investorspodcast.com. To get your questions played on the show, go to asktheinvestors.com and win a free subscription to any of our courses on TIP Academy. This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP network. Written permission must be granted before syndication. or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP152: How Asia Works with Joe Studwell (Business Podcast)

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