The Middle Income Trap
Implications for Industrialization
Strategies in East Asia and Africa

Three Policy Discussion Papers by

Kenichi Ohno

C GRIPS Development Forum

Contact:
GRIPS Development Forum
National Graduate Institute for Policy Studies
7-22-1 Roppongi, Minato-ku, Tokyo 106-8677 Japan
Phone: +81-3-6439-6337
Fax:+81-3-6439-6010

Email: forum@grips.ac.jp
URL:

http://www.grips.ac.jp/forum-e/

Publication of this volume was supported by the Japan International Cooperation Agency (JICA).

Preface
The four discussion papers contained in this volume were drafted in thecourse of the year 2008. While targeting different audiences, they all evolvearound the same principal message which I have harbored for years. The
message is that latecomer countries may reach an intermediate level ofdevelopment by macroeconomic stabilization, institution-building, and opening up and liberalizing the national economy, but to go beyond middle
income the government must launch more active industrial strategies withtenacity and dexterity. In other words, while private sector dynamism iscertainly needed for economic development, letting it loose alone will not
attain the economic performance comparable to Japan, Taiwan or South
Korea. This is the truth that does not change even in the early 21st century
when the policy space for protection is severely limited in comparison withthe 1960s, 70s or 80s when the aforementioned economies were rapidly
industrializing. But this volume argues that effective policy actions are still
possible without violating any WTO rules or other international commitments of our age.
The first chapter, written for the research project organized by Professor
Linda Yueh of Oxford University, is addressed to the middle income countries in East Asia, especially Malaysia and Thailand, that actually face therisk of being trapped in middle income. The second chapter, drafted jointlywith Izumi Ohno for the Initiative for Policy Dialogue (IPD) African Task
Force organized by Professor Joseph Stiglitz of Columbia University, discusses the transferability of the East Asian experience to the African soil.
The third chapter, prepared for the Institute of Southeast Asian Studies(ISEAS) Conference on Vietnam held in Singapore, warns Vietnamese policy
makers of future risks and offers practical suggestions to avoid the identified problems. Based on that, the fourth chapter is a concrete policy proposal that hopes to stimulate action-oriented industrial policy formulation in
Vietnam with the cooperation of the Japanese government and businesses.

None of these drafts have been formally published. The first three are to
be properly reviewed, edited, and published in due course. The last was initially intended to be an internal document. Nonetheless, the author wishes tobind them together as a collection of discussion papers for the review andcriticism of interested readers.
Since the four chapters are variations on the same theme, there will be alarge amount of duplication in text, data and diagrams for which I apologize
in advance. In particular, the graph that shows different speeds of catchingup (Figure 2 in Chs.1 and 3; Figure 1 in Ch.2), prepared by Dr. Le Quoc Hoiof the Vietnam Development Forum (VDF), was the source of inspirationthat drove me to produce these papers. I am grateful to Dr. Hoi, and I
would like to also thank Ms. Yayoi Kikkawa and Ms. Azko Hayashida of the
GRIPS Development Forum (GDF) for collecting additional data and compiling this volume.

Hanoi, January 2009
The Author

Contents

Preface

Acronyms and Abbreviations

Chapter 1

Overcoming the Middle Income Trap
The Challenge for East Asian High Performers ………………1

Chapter 2

Dynamic Capacity Development
What Africa Can Learn from Industrial Policy Formulationin East Asia(with Izumi Ohno) ………………………………………………31

Chapter 3

Avoiding the Middle Income Trap
Renovating Industrial Policy Formulation in Vietnam………61

Chapter 4

Vietnam-Japan Monozukuri Partnership for
Supporting Industries
For Leveling Up Vietnam s Competitivenessin the Age of Deepening Integration …………………………89

About the Author ………………………………………………………………107

Acronyms and Abbreviations
ADB
ADLI
AFTA
ASEAN
ASMED
BOI
BUILD
CGF
CPRGS
EPU
FDI
FTA
GNI
GRIPS
GTZ
HRV
IBRD
ICOR
IDA
ILP
IMF
IMP2
IPD
4J
JBIC
JETRO
JICA
MATRADE
MDG
MFEZ
MIDA
MITI
MNC

Asian Development Bank
Agriculture Development Led Industrialization
ASEAN Free Trade Area
Association of South East Asian Nations
Agency for SME Development
Board of Investment
BOI Unit for Industrial Linkage Development
Credit Guarantee Fund
Comprehensive Poverty Reduction and Growth Strategy
Economic Planning Unit
Foreign Direct Investment
Free Trade Agreement
Gross National Income
National Graduate Institute for Policy Studies
German Technical Cooperation
Hausmann, Rodrik and Velasco
International Bank for Reconstruction and Development
Incremental Capital Output Ratio
International Development Association
Industrial Linkage Program
International Monetary Fund
Second Industrial Master Plan
Initiative for Policy Dialogue
Japanese Embassy, JICA, JBIC, JETROJapan Bank for International Cooperation
Japan External Trade Organization
Japan International Cooperation Agency
Malaysia External Trade Development Corporation
Millennium Development Goals
Multi Facility Economic Zones
Malaysian Industrial Development Authority
Ministry of International Trade and Industry
Multi National Company

MOET
MOF
MOI
MOIT
MOLISA
MOST
MPC
MPI
MTEF
NEDA
NESDB
NEU
NSDP
ODA
OECD
PMRC
PRSC
PSD
QCD
SME
SMEFP3
SMIDEC
SOE
TAC
TFP
TVET
UNIDO
USAID
VDF
VDP
VCCI
VJCC
VJJI2
WGI
WTO
WW2

Ministry of Education and Training
Ministry of Finance
Ministry of Industry
Ministry of Industry and Trade
Ministry of Labour, Invalids and Social Affairs
Ministry of Science and Technology
Malaysia Productivity Corporation
Ministry of Planning and Investment
Medium Term Expenditure Framework
National Economic Development Authority
National Economic and Social Development Board
National Economics University
National Supplier Development Program
Official Development Assistance
Organization for Economic Co-operation and Development
Prime Minister's Research Commission
Poverty Reduction Support Credit
Private Sector Development
Quality, Cost and Delivery
Small and Medium Sized Enterprise
JBIC two-step loan program
Small and Medium Industry Development Corporation
State Owned EnterpriseTechnical Assistance Center
Total Factor Productivity
Technical and Vocational Education and Training
United Nations Industrial Development Organization
United States Agency for International Development
Vietnam Development Forum
Vendor Development ProgrammeVietnam Chamber of Commerce and Industry
Vietnam - Japan Human Resources Cooperation Center
Vietnam-Japan Joint Initiative Phase 2
Worldwide Governance Indicators
World Trade Organization
World War IIChapter 1
Overcoming the Middle Income Trap
The Challenge for East Asian High Performers

East Asia has attained high growth on average, but good performance is not uniform acrosscountries. While the middle income economies in East Asia, such as Malaysia and Thailand, participate actively in the region’s production network, they have not risen to the status of advanced economies such as Taiwan and South Korea, where foreign dependence intechnology and management has long been overcome and internal industrial capability
now reaches a global level. Differences in industrial performance cannot be attributed tothe early start of the latter group since both groups have spent about the same amount oftime in industrialization. Liberalization and external integration can bring middle income,but aiming higher requires building of industrial skill, supporting industries and efficientlogistics. This in turn hinges on government leadership beyond the Washington Consensus
and strong private sector dynamism, two factors that are not easily amenable to externalmanipulation.

This paper discusses issues that ought to be of central concern to anumber of the so-called high performing economies in East Asia, a group ofcountries that participate in East Asian growth dynamism and have alreadyachieved middle income levels. The topic is related to the competitiveness ofthe manufacturing sector in economies that receive a large amount of FDI andhave formed a sufficiently large base for producing and exporting manufactured
products. The challenges analyzed here are quite different from and pertinent toa much higher development level than those faced by typical low income countries in Sub-Saharan Africa and other regions, where enticing investors to form
an initial industrial base is the main policy objective. East Asia’s middle
income economies, with an aspiration to join the ranks of highly advanced
countries, must overcome the barriers that keep them in the middle stage ofdevelopment.

1

Kenichi Ohno

1. High versus middle performers
East Asia’s economic development has been quite remarkable, buthigh performance has not been uniform across countries. Figure 1 shows a wide
range of achievements in governance and economic development in East Asiawith a strong positive correlation between the two measures (0.90)1. In analyzing East Asia and drawing lessons for other regions, most studies examine only
successful economies for an obvious reason that excellence is more interesting
to talk about and disseminate than failure. This winners’ bias tends to hide the

Figure 1. East Asia: Governance and Income
Governance, WGI2005

600
Sin

Hkg

S Kor

Jpn
Twn

500
400

Mal
Mong Thai

300

VN
200
E Timor

Phil
China

Camb

100
0
100

Bru

1000

Indo
PNG
Lao
N Kor
Mya
10000

100000Per Capita income ($PPP2004, log scale)
Sources: Compiled from World Bank, Worldwide Governance Indicators, Sep. 2006; and World
Bank, World Development Indicators, 2006. Unofficial income data from various
sources are used for countries without World Bank income data.
Note: Worldwide Governance Indicators (WGI) consist of six dimensions (voice andaccountability, political stability, government effectiveness, regulatory quality, rule of law,
control of corruption) with each carrying 0 to 100 points. The vertical value in thisdiagram simply adds these points for each country or area.

1

2

It should be added immediately that correlation does not necessarily imply causality, either fromincome to governance or vice versa. More information and analysis are needed to argue causality. See also Khan (2008).

Overcoming the Middle Income Trap

fact that East Asia also contains poor countries that are struggling to take off
economically, just as in the rest of the developing world.
In reality, only a subset of economies belonging to this region has
achieved or is achieving economic miracles. Japan, Singapore, and Hong Kong
have already reached high income and life style comparable to the richest countries in the West. Taiwan and South Korea are very near that level. Malaysia,
Thailand, China, and Vietnam, although in different development stages, are in
the process of catching up. These nine economies are full participants of theEast Asian production network. On the other hand, Indonesia and the Philippines are participants in the regional dynamism, but their performance andfuture prospects are more precarious2. Moreover, a number of economies lie
outside the East Asian production network for various reasons. Cambodia,
Laos, Mongolia, Papua New Guinea, and East Timor are struggling for politicalstability or economic take-off, or both. At present, Myanmar and North Korea
are political outcasts for which no meaningful growth strategy can be discussed.
Finally, Brunei is a small oil-rich country that does not join East Asia’s flying
geese formation.
More importantly for the purpose of this paper, East Asian growth
performance has differed significantly in depth and speed even among countries
that are considered “successful.” There should be a clear distinction among Taiwan and South Korea (high achievers), Malaysia and Thailand (moderateachievers), and Indonesia and the Philippines (low achievers). They are often
collectively praised for good economic performance, but the first group is far
ahead of the second or the third in terms of income and industrial capability3.
Figure 2 shows per capita real income of selected East Asian economies relative to the United States level. Until the mid 1960s, these economies(except Japan) showed no clear sign of catching up. However, Taiwan and
Korea, which started from equally low levels, took off in the late 1960s andhave improved income dramatically. In comparison, the catching up of Malay2

3

In late 2006, Thailand also faced political and economic difficulties following the ousting offormer Prime Minister Thaksin Shinawatra. However, it should be noted that Thailand has
grown fairly consistently in the past despite many political crises and changes in government.
Without denying the possibility of a non-manufacturing sector such as agriculture, mining, commerce, tourism and finance becoming a growth engine, this paper focuses on the analysis of the
manufacturing sector.

3

Kenichi Ohno

Figure 2. Different Speed of Catching Up(Percent of US real income)

100%
Japan
80%

TaiwanS. Korea

60%

Malaysia
Thailand40%

Indonesia
20%

2005

2000

1995

1990

1985

1980

1975

1970

1965

1960

Vietnam
1955

1950

0%

Philippines

Sources: Angus Maddison, The World Economy: A Millennium Perspective, OECD
Development Centre, 2001; the Central Bank of the Republic of China; and IMF
International Financial Statistics (for updating 1998-2006).
Note: Per capita real income relative to US as measured by the 1990 international GearyKhamis dollars.

sia and Thailand looks less impressive, and Indonesia and the Philippines failed
to improve their relative positions vis-à-vis the US. Clearly, divergent performance comes from different speed of catching up rather than delayed starts4.
ASEAN4 are taking much longer to reach the industrial capability that Taiwan
and Korea had achieved in the 1980s and 90s.
South Korea was a divided, war-torn, and US aid-dependent country
in the late 1950s. Most observers regarded it as a hopeless basket case until
1961 when Army General Park Chung-hee seized power. By the late 1980s,
South Korea had a formidable industrial base that could produce high-quality
electronic and machinery products with well-recognized brand names thatencroached the global market. It joined the OECD, a club of advanced industrial countries, in 1996. The industrial development of Taiwan, an island once
famous for rice, sugar, and bananas, was initiated by the Kuomintang govern-

4

4

Except Vietnam where wars and socialist planning prevented economic growth until the late1980s. Vietnam began to take-off and integrate into the global economy in the early 1990s.

Overcoming the Middle Income Trap

ment which fled from Mainland China in 1949. By the 1980s, Taiwan was aleading producer of electronic products in the world with strong SMEs backed
by international commercial networks. Through active outward FDI, South
Korea and Taiwan are now creators of global industrial structure, no longer
dependent on foreign managers or engineers for progress.
The important point is that it took Taiwan and South Korea only
about three decades to move up from a poor agricultural economy to a global
industrial power. Their capacity to absorb technology was exceptionally high.
When South Korea built its first integrated steel mill in the 1970s or modern
automobile factory in the 1980s, assisting Japanese engineers were no longer
needed after a few years.
Compared with these achievements, the industrial capability of
Malaysia and Thailand looks less impressive, although it still shines by thestandard of average developing countries. As with Taiwan and South Korea,
ASEAN4 started industrialization in the 1960s with an aim of ending monoculture and diversifying economic structure into manufacturing. As with Taiwan
and South Korea, they first tried import substitution but later shifted to exportorientation. Their long-term macroeconomic records have been good despite
shocks such as the recession in the early 1980s and the financial crisis in 199798. But they all have failed to graduate from heavy reliance on foreign management and technology in manufacturing.
While the electronics industry in Malaysia and the automobile industry in Thailand have grown remarkably in terms of volume, high-tech materials,
key components and important processes such as design and marketing are still
supplied mainly by FDI firms or through direct imports. As a result, locals only
assemble or produce “easy” parts while most value continues to be created andcaptured by foreigners5. FDI is still courted and foreign general directors still
stay. After four decades of industrialization, the lack of discipline and skills ofworkers and the shortages of top and middle managers are still at issue. These
problems were overcome long ago in Taiwan and South Korea.
5

In the case of the Thai automobile industry, which boasts the largest cluster of that industry in
ASEAN, roughly 30% of parts are imported, 45% are supplied by FDI firms, and only about
25%, consisting of relatively simple parts, are produced by local firms. This information is provided by the Nomura Research Institute in 2004 as quoted in Mori and Ohno (2005), p.117.

5

Kenichi Ohno

We ask why ASEAN4 have not performed as brilliantly as Taiwan
and South Korea, and whether and how emerging industrial powers such as
China and Vietnam can avoid the same problem. These questions may soundtoo harsh on ASEAN4 since assessment of country performance depends critically on the comparator. The glass may be half empty and half full at the sametime. But it is quite certain that East Asia’s middle performers, with a strong
aspiration for industrial excellence in the global value and supply chains, would
prefer to be judged by the standard of best achievers rather than by the attainment of the Millennium Development Goals6.
The difference between East Asia’s first-, second-, and third-tiereconomies is sometimes explained by historical or cultural factors such as colonial past and the prevalence of Confucius value. Without denying such explanations entirely, however, this paper highlights policy as a key shaping factor thatcan even partially modify these initial conditions.

2. The East Asian competitive ladders
East Asian growth was attained through the very existence of the East
Asian region as an arena for economic interaction among its members. One byone, countries in different development stages initiated economic growth byparticipating in the dynamic production network spanned by private firms.
Linked by trade and investment, international division of labor with clear orderand structure has emerged in the region. Industrialization has proceeded
through geographic spreading on the one hand and structural deepening withineach country on the other. The term flying geese referred to these systematic
supply-side developments. To understand this mechanism, evaluating the policies of individual countries, as done in the World Bank’s East Asian Miracle
report (World Bank, 1993), is not enough. It is necessary to analyze East Asia
as a whole, with its production structure, intra-regional trade, investment flows,
and technology transfer.
6

6

The Millennium Development Goals set forth by the United Nations Group for low income
countries consist of the following eight targets: poverty reduction, universal primary education,
gender equality, reduction of child mortality, maternal health, combating infectious diseases,
environmental sustainability, and global partnership.

Overcoming the Middle Income Trap

For countries in East Asia, development was—and still is—tantamount to jumping into this regional production network and becoming one crucial dynamic link in it. Each country is under constant competitive pressure
from the countries moving ahead of it as well as behind it, which compels it tocontinuously climb the ladders of development. What drove them were thedesire for material well-being and the pursuit of national pride in the context of
this regional competition, not policy matrices introduced by international organizations.
Industries are constantly passed from the first-tier countries to thenext and down the line. Since this industrial passing occurs mainly through
FDI, countries wishing to strengthen their positions court FDI vigorously.
Japanese corporations have been the chief architect of the East Asian production network, together with EU and US multinationals. The extensive businessnetworks of Taiwan, Hong Kong, and overseas Chinese as well as bold businessmoves by Korean chaebols have also invigorated this region. Since the 1990s,
the emergence of China as producer and investor has become the new importantfactor. No other developing region has experienced such an organic and dynamic interdependence as East Asia. This fact must be taken into account when thereplicability of East Asian experiences in other regions is considered.
Figure 3 illustrates the four steps that East Asia’s competing economies must take to catch up with the forerunners. Industrialization of developing
countries usually starts with the arrival of FDI companies in substantial number.
In Stage 1, simple production such as contract manufacturing of garment andfootwear, food processing, and manual assembly of electronic parts are established under foreign dominance. Virtually all inputs are imported from abroadand value-creating processes such as management, R&D, production of raw
materials and key components, logistics, and marketing are performed by foreigners.

7

Kenichi Ohno

Figure 3. Breaking the “Glass Ceiling” in Manufacturing

Internalizing
technology
FDI absorption

STAGE ONE
Simplemanufacturing
under foreign
guidance

Vietnam

STAGE TWO
Have supporting
industries, but still
under foreign
guidance

Creativity

STAGE FOUR

STAGE THREE

Full capability ininnovation andproduct design as
global leader

Technology &management
mastered, canproduce highquality goods

Japan, US, EU

Korea, Taiwan

Thailand, Malaysia
Glass ceiling for
ASEAN countries(middle income trap)

In Stage 2, as contract manufacturing and machinery assembly reacha critical mass, domestic supporting industries7 start to develop. Over time,
most parts and components except the most difficult are produced by either FDI
or local suppliers in the country. However, production is still highly dependent
on foreign technology and management. The competitive firms and factories
continue to be directed by foreign managers. In Stage 3, technology and management capability are internalized, localization expands from physical inputs
to human resources, and foreign dependency is significantly reduced. The country becomes an exporter of high-quality manufactured products and vigorously
invests to build production bases abroad. Finally, in Stage 4, capability to create
new products and lead global industrial markets is achieved through innovation.
Climbing up this ladder is extremely difficult for most developing
countries. A large number of low income countries which receive too little FDI
in manufacturing remain entirely out of the picture. Even in East Asia whereindustrialization is said to be quite successful, only Taiwan and Korea havereached Stage 3. Within ASEAN4, there is no country that has broken the barri-

78

The term supporting industries refers to a layer of production establishments that supply partsand components to assembly-type manufacturing industries. The term was first used officiallyby Japan’s White Paper on Economic Cooperation in the mid 1980s (MITI, 1985). They are also
called subcontractors, ancillary industries (mostly in India), and vendors (often used in
Malaysia). See Nguyen Thi Xuan Thuy (2007) for more on definition.

Overcoming the Middle Income Trap

er between Stage 2 and 3. It is as if there is an invisible glass ceiling preventing
ASEAN countries to go up8. For a latecomer country such as Vietnam, theimmediate goal is to rise from Stage 1 to 2 by absorbing as much FDI as possible, but it is also well advised to simultaneously prepare for the next move from
Stage 2 to 3. Measures required for this will be discussed in the next section.
The glass ceiling for ASEAN can be generalized as the middle
income trap, a phenomenon which can occur in any part of the world. A large
number of Latin American countries, which attained “high income” as early asin the 19th century, are such examples. The middle income trap, at the per capita income level of thousands of dollars, is an entirely different problem from thelow income trap of Sub Saharan Africa and others, at the per capita income
level below one thousand dollars.

3. Internal capability for manufacturing
What are the key requirements for middle performers to climb to thehigher level in manufacturing? To answer this question, misleading notions,which may collectively be called the high-tech myth, should be dismissed first.
Many developing countries officially promote IT, bio-tech, nano-tech,and other high-tech sounding activities as a means to leapfrog to a higher levelof income and technology. The extreme popularity of such a strategy among
low and middle income countries is surprising and even alarming. Operatingmachinery that embodies high technology is easy. But developing and commercializing such technology from scratch, which generates great value, is extremely difficult. This is possible only by a country at the summit of an industrial
pyramid having large bases of R&D, human resource, production technology,
and effective policy. Using internet and creating a new generation of OS should
not be confused.

8

Within ASEAN, Singapore and Brunei have achieved high income through non-manufacturingindustries (high-value services and oil and gas, respectively) and therefore do not belong to thispicture. Figure 3 covers manufacturing only, especially assembly-type manufacturing such as
electronics, automobiles and other types of machinery which has played a key role in East
Asia’s economic dynamism.

9

Kenichi Ohno

Another common mistake is to identify the level of technology withthe product. For example, it is said that computers and mobile phones are hightech but jeans and frozen shrimp are low-tech. However, this view ignores thefact that electronic gadgets are produced in a long value chain that stretchesfrom innovation in fundamental technology to product and software development, production of raw materials and key components, procurement of nonkey inputs, assembly, marketing and advertisement, sales, and post-sale services. Whatever the product, what developing countries are asked to do initially is
to fill the lowest segment of such a value chain, namely, labor-intensive assembly under foreign directives. In this sense, stitching jeans and putting electronicparts together are essentially the same type of industrial activity, requiring thesame kind of workers and paying similar wages. In many cases, exporting farm
products and seafood under strict hygienic standards of the EU, US and Japanese markets is far more “high-tech” than assembling computers, a task which
can be done at any computer shop.
When these popular but often misleading slogans of high-tech promotion are stripped away, what are the requirements that elevate domestic manufacturing capability from Stage 1 and 2 to 3? The East Asian experiences, especially those of Taiwan, South Korea and ASEAN4 countries, show that they areindustrial human resource, supporting industries, and logistics, the three factorsthat are mutually enhancing. These may not sound as exciting as computer science or DNA engineering, but they can raise the competitiveness of a large
number of manufactured products regardless of product cycles. This is the realization that many East Asian countries come to after flirting with unreachable“high-tech” goals for a few decades.
Industrial human resource
The importance of human resource in development is well recognized, but for industrial competitiveness general promotion is not enough. Highliteracy and universal primary education are certainly necessary but not sufficient for competing fiercely in the global market. Technical and vocational education and training (TVET) must be integrated with the nation’s industrial positioning strategy with specific goals and time tables. For each type of required
industrial human resource-business leaders, engineers and production man-

10

Overcoming the Middle Income Trapagers, and workers—realistic targets must be set, action plans and monitoringmechanisms must be installed, and necessary funding must be secured including external assistance. While many national and international programs for
upgrading industrial human resources exist in East Asia9, the speed of levelingup differs significantly across countries.
In East Asia, a number of common difficulties have emerged inindustrial human resource development such as:● Ambiguity of national industrial goals, required industrial humanresources, and action plans to produce such human resource.
● Popularity of computer science, finance, business administration and for-eign language as preferred subjects among students and the correspondinglack of interest in engineering and industrial technical training.
● Short-termism and materialism of workers who prefer higher salaries andlarger benefits today rather than striving for higher technical competency
in the long run, generating high incidents of job hopping which discourages firm-based training.
● Difficulty in designing incentive structure and promotion mechanisms

within factories and in national labor and technology markets to encourage
and reward learning and excellence.
● Lack of enthusiasm on the part of indigenous enterprises to improve skills

and technology and conduct aggressive marketing to become business
partners of foreign companies.
● Difficulty in matching the demand and supply of industrial labor, andaligning school curriculums to the specific needs of manufacturing firmsthat will employ graduates.

9

In Vietnam, for example, the following externally assisted programs were operative in 2007:
Technical Assistance Center (Japan International Cooperation Agency); Japan-Vietnam Cooperation Center (JICA); quality control, factory management, kaizen, management technology(JICA); SME and IT promotion (Japan Bank for International Cooperation), overseas technicaltraining (Japan Overseas Development Corporation); supporting industry seminars (Japan
External Trade Organization); training for industrial park workers and TVET (Singapore);industrial vocational training (Germany); SME development (Asian Development Bank);
national and provincial SME support infrastructure (Italy, Finland); and SME promotion andResearch and Training Center (Australia). This list is not comprehensive, and each programoften has multiple phases and carries several or more action components.

11

Kenichi Ohno

To solve these problems and supply high-quality managers and workers in sufficient quantity, a comprehensive and sustained policy effort isrequired. However, part of the difficulties may arise from ingrained national
characters which policy can address only indirectly (see the final section).
Supporting industries
Supporting industries are multiple layers of domestic manufacturing
establishments that produce parts and components for machinery assemblers
such as electronics, automobiles, and motorcycles (see footnote 7). Since thelargest value (typically 80-90%) of mechanical products comes from parts andcomponents while labor-intensive assembly adds relatively little value (typically 5-10%), international competitiveness requires easy and stable access to suppliers of parts and components that can offer QCD10. Industrial human resourceand supporting industries are the two sides of the same coin, the one emphasizing human capability and the other pointing to the supply of needed physicalinputs.
Among East Asian “miracle” countries, Japan and Taiwan are particularly well equipped with strong supporting industries. In most developing
countries, however, supporting industries are either nonexistent or very weak,
which has negative impacts on FDI attraction, building of industrial clusters,
and technology transfer. In fact, the term supporting industries (or susono
sangyo in Japanese) was created by Japanese firms to point out the absence ofsuch industrial activities in Southeast Asia when Japanese FDI inflows to that
region greatly increased in the 1980s (MITI, 1985).
For the governments of developing countries, properly understanding
the concept and significance of supporting industries is already a challenge. At
first, highest value components—engines for automobiles and motorcycles,
optical devices for DVDs and hard disks, compressors for air-conditioners andrefrigerators, and so on-are often targeted for domestic production for several
years until the country realizes that they are too difficult to produce without
heavy foreign help. What FDI manufacturers expect from low to middle income
1012

Quality, Cost and Delivery (zero defects, low cost, and on-time delivery). QCD is recognized by
Japanese manufacturing firms as the general source of competitiveness as well as the criteria for
selecting business partners and subcontractors.

Overcoming the Middle Income Trap

countries is not the production of key components but the provision of bulky,common, and low-tech inputs that satisfy QCD.
More specifically, what assembly-type FDI manufacturers desperately need is a critical mass of reliable domestic producers (this includes bothindigenous and FDI firms) that can perform basic production processes such aspressing, casting, forging, molding, machining, plating, and heat treatment on
metals, plastic, rubber and other industrial materials at zero defects and low costwith prompt delivery. These processes are generic and can support different
assembly-type industries and products, be it automobiles, motorcycles, industrial and construction machinery, electronics, or home appliances. Among suchprocesses, by far the most crucial task is the production and maintenance ofdies and molds for metal and plastic processing. These are the most common
responses in surveys conducted on FDI manufacturers in Southeast Asia
(Ichikawa 2005; VDF 2007). To perform these processes at variable quality iseasy; the only requirement for that is the purchase of relevant equipment. But todo them at the level required by demanding FDI assemblers is extremely hard.
This difference determines whether or not the supplier can become part of the
global value chain, and that is what ASEAN4 countries, by and large, fail toattain after many decades of trying.
One way to promote industrial human resource and supporting industries is to develop SMEs in particular and the private sector in general. Amongaid donors, SME promotion and private sector development (PSD) are popularinterventions. However, these policies usually have two overlapping purposes:
generation of jobs and income (for poverty reduction) and improving technology and productivity (for competitiveness). For the former, a broad segment ofprivate enterprises should be targeted without discrimination; for the latter, only
those firms that are making realistic effort to be globally competitive should be
supported with appropriate selection criteria and monitoring mechanisms.
While both purposes are loadable, we prefer not to mix them in our analysis.
Our argument is focused on bolstering competitiveness and overcoming the
middle income trap.

13

Kenichi Ohno

Logistics
Logistics—moving things—includes both hardware such as transport
and telecom infrastructure and software such as distribution systems, tax andcustoms procedures and a reliable legal framework. Together they create anefficient business environment that can reduce the cost of doing business. In
terms of QCD, good logistics enables manufacturers to achieve the quick delivery of both inputs and finished products, the reduction of time and transport
costs, and the shortening of production lead-time. These are essential conditions
for attracting investors, especially those firms that produce high-value products
in response to rapidly changing customer demands such as mobile phones, digital cameras, and fashion garment.
The Toyota production system featuring just-in-time manufacturingaims at raising productivity and reducing cost by eliminating wasteful movements and the inventory of intermediate inputs. Through trial-and-error, Toyota
introduced such techniques as kanban (index cards), heijunka (productionsmoothing) and jidoka (automation with human intelligence) over the years andminimized all sorts of muda (waste) in production. While Toyota’s method is

Figure 4. Sea Transportation Cost to Tokyo
Freight cost in USD (40-foot container)

Hanoi

1500

Bangkok
HCMC Jakarta

1000

ShanghaiSingapore
TaipeiNew Delhi
Seoul
Hong Kong
K. Lumpur

500

Beiling

0
0

2000

4000

6000

Straight distance from Tokyo (km)Source: JETRO, “The 15th Survey of Investment-related Cost Comparison in Major Cities andRegions in Asia,” March 2005.
Note: Sea transport cost from the city via the nearest port to Yokohama Port (adjacent toTokyo) as of November 2004.

14

Overcoming the Middle Income Trap

the most advanced in Japan, other Japanese manufacturing firms with global
operation also attempt to achieve a smooth flow of production by reducing
waste and unnecessary waiting. However, this cannot be realized unless efficient logistic support is available.
To deliver products quickly and on-time without fail requires not only
short distance, but reliable transport infrastructure such as ports, roads, air links
and cargo handling facilities as well as improvements in collection, delivery,
sorting, loading and unloading; reasonable tax and customs procedures; andsupporting functions such as finance, insurance, storage and trucking.
Figure 4 illustrates shipping costs of 40-foot container from various
Asian cities to Tokyo. It is clear that distance alone cannot explain the transportation cost of each location. Despite relatively large distance, freight costs
from Singapore, Kuala Lumpur, Jakarta and New Delhi are similar to thosefrom much closer cities such as Shanghai and Taipei. Hanoi has the highest
freight cost among all these cities, and Bangkok and Ho Chi Minh City are notvery competitive either.
Hanoi’s high transportation cost reflects many inefficiencies such as
the lack of deep sea ports and modern container berths, lopsided cargo traffic(inbound freight is larger than outbound), uncertainty in taxation and customs
clearance, and traffic congestion and restriction in urban areas. This seriously
impedes Northern Vietnam’s ability to integrate effectively into the regional
production network-something that the Vietnamese government should seriously worry about.
Solving these basics—industrial human resource, supporting industries, and logistics—is key to improving the country’s standing in global industrial competition. That in turn permits the country to break through the middle
income trap and move to the higher level of income and technology. Below,
two viewpoints are offered to address these problems in slightly different
angles.
Manufacturing++ and industrial clusters
Manufacturing plus plus and cluster based industrial development are
two related concepts in Malaysia’s Second Industrial Master Plan (IMP2) 19962005 which concisely stated what this country hoped to do to bolster competi-

15Kenichi Ohno

Figure 5. Manufacturing ++ Strategy of Malaysia
Valuecreation

R&D Product Assembly & Distribution Marketing
design production

Source: Economic Planning Unit of the Prime Minister’s Department, Malaysia (edited).

tiveness (Ohno, 2006). They also point to a fairly general strategy for middle
income countries to climb up to Stage 3. Manufacturing plus plus expresses a
two dimensional desire to (i) expand along the value chain to encompass higher
value-added activities; and (ii) uplift the whole value chain by raising productivity (Figure 5). Since Malaysia started industrialization as a conventional
assembler, which was the lowest point in the value chain, it wanted to master
R&D, design, product development, distribution, marketing, and so on horizontally, and improve the skills of all these activities vertically.
Cluster-based industrial development broadens the concept of industry. An industrial cluster is defined as “an agglomeration of inter-linked or
related activities comprising industries, suppliers, critical supporting businessservices, requisite infrastructure and institutions” (IMP2, p.23). In other words,
it is a collection of supporting industries and services as well as hard and soft
infrastructure that surround any particular industrial activity. IMP2 selected
eight industrial clusters to be strengthened: electronics and electricals, textiles
and apparel, chemicals, resource-based industries, food processing, transportation equipment, materials, and machinery.

16

Overcoming the Middle Income Trap

Thus, the policy intention of IMP2 was very clear 11. However,whether Malaysia could make significant progress along these lines during
1996-2005 is another matter. Among the monitoring criteria, investment targets
were surpassed but other targets, more directly related to the broadening andraising of value chains, did not produce remarkable results. Problems in industrial human resources and supporting industries continued to persist, and the
Malaysian automobile industry, one of the most protected sectors of Malaysia,
was reeling from limited domestic demand and severe global competition. Partof the reason for less-than-expected performance was undoubtedly the Asianfinancial crisis in 1997-98 whose negative impacts were however dissipated by
2005. Another reason seems to have been the generality of goals; it was very
difficult to simultaneously improve scope and productivity of eight industrial
clusters which represent virtually all manufacturing activities of this country.
Finally, despite fairly active policy support, responses of the local private sector
appeared to have been weak. This last issue will be taken up again in the lastsection.
Integral manufacturing versus copy production
The importance of building human and non-human capacity in manufacturing can also be highlighted from the perspective of business architecture.
Takahiro Fujimoto and his research team at the University of Tokyo haveadvanced a business architecture theory to explain the fundamental differencesamong manufacturing industries of major economies, such as the United States,
Japan and China (Fujimoto, 2004, Fujimoto and Shintaku, 2005, Ohno andFujimoto, 2006). According to this theory, there are two basic architectural
types in manufacturing: modular and integral. In modular architecture, themodality of interaction among components is standardized for easy assembly.
For example, desktop computers are a typical modular product in which globally common components from various companies can be freely combined, be it

11

The clarity of analysis in government documents such as this is relatively rare. In the case of
Malaysia’s IMP2, the fact that the background paper was prepared by a researcher at the
Malaysian Institute of Economic Research, a reputable think tank, gave IMP2 a lucid academic
style. By contrast, IMP3 covering 2006-2020 was drafted in a more “usual” fashion with eachchapter written by different groups without a common structure imposed from above.

17

Kenichi Ohno

Figure 6. Modular versus Integral Manufacturing
Modular manufacturing Integral manufacturingPartsinterface

Parts are common and canbe used for any model

Each product has uniqueparts, specifically designed

MeritsQuick results and flexibility

Endless pursuit of quality

Demerits

No differentiation,excess
entry, low profit, lack of R&D

Much energy and time toachieve results

Openness, quick decision
Institutional
requirements making, flexible outsourcing

Long-term relations, building
internal skills & knowledge

Performance

Time

Time

Source: author’s summary from Fujimoto (2004), Fujimoto and Shintaku (2005), and Ohno andFujimoto (2006).

Korean, Taiwanese, or Thai. By contrast, in integral architecture, the complexity of interaction among components is happily accepted, and improvements areachieved through numerous trials and errors involving an assembler and a large
number of component producers. For example, automobiles must be manufactured with integral architecture if multiple objectives such as power, comfort,style, safety, environment, low cost, and fuel efficiency are to be attained simultaneously. Generally speaking, modular architecture is suitable for obtaining
quick results at low cost while integral architecture is appropriate for the pursuitof ever-higher product quality in the long run (Figure 6).
Correspondence between products and business architecture is not
fixed; it evolves dynamically with the business strategy of each firm or country,
technical progress, and consumer tastes. For instance, a motorcycle can be produced as an integral product (as in Japan) or a modular product (as in China)
with different product quality and targeted customers. In addition, businessarchitecture often has structural layers in which, for example, modularization
may proceed in final assembly while integration may deepen in components.

18

Overcoming the Middle Income Trap

Japan is a country of integral architecture, intensely interested in efficient factory operation and product integrity. By contrast, the United States
excels in modularization and is good at slicing the supply chain of a productinto appropriate elements, standardizing them, and making profits by the novelty of combination. China is also a country of modular architecture, but its comparative advantage lies in labor-intensive modular products rather than knowledge-intensive modular products as in the case of the US. Fujimoto considers
China to be a country of quasi-modularity since its manufacturing features mass
production of products with copied design and technology rather than original
innovation (Fujimoto and Shintaku, 2005).
In general, there is no absolute superiority of either business architecture. At advanced stages of economic development, two business architectures
co-exist and complement each other. Which architecture is more suitabledepends heavily on each product as well as the strategy of each manufacturer.
However, producers in developing countries usually start with (sometimes illegal) copy production of established products with low to medium quality andlow prices. This is expectable because they are initially in possession of little
capital and technology. Such copycats are often collectively trapped in thevicious circle of too many entries, too low prices, and too little profit for investing in higher technology-a situation which Fujimoto dubs as technological lockin. This is a very common problem among indigenous industries in developing
countries (Sonobe and Otsuka, 2006). To break free from this trap and raiseoverall productivity, a small number of innovative entrepreneurs who adopt
new management, technology and marketing must lead the way, with less efficient producers exiting the scene. In Japan, Taiwan and South Korea, there
were business innovators in sufficient number, at least in the past, whichenabled these countries to proceed to the next level of industrialization. However, innovators are far scarcer in developing countries where the situation of low
quality and low price persists.
From the perspective of business architecture theory, developing
countries may start from, but should not stay forever at, the stage of copy production based on simple modular manufacturing with little value-added. To create value, there are two ways ahead: a move toward integral manufacturing,which is far more difficult but eventually rewarding; and perfecting modular

19

Kenichi Ohno

manufacturing by becoming a master of new combination of what other countries produce. The first path builds a strong manufacturing country while thesecond leads to a mercantile or service-oriented economy such as Hong Kongand Singapore.
If the first path is chosen, what needs to be done is fairly clear. To
become a country of integral manufacturing requires ability to operate factories
efficiently; maintain, adjust and repair machines; design parts; produce precision dies and molds; supply highly skilled industrial Meisters and workers, andso on, which we have already summarized as industrial human resource andsupporting industries. Doubling effort to master integral manufacturing will
propel middle income countries from simple assembly by foreign orders to participation as indispensable players in the global manufacturing network. Fujimoto (2006) regards Vietnam and Thailand as prime candidates for becoming
producers of labor-intensive integral architecture goods.

4. Determinants of greater successLet us now return to the initial question: why do some countries succeed in breaking away from the middle income trap in manufacturing while others fail (or take a very long time to overcome it)? A policy package of liberalization and global integration combined with the provision of physical infrastructure and a modern legal framework can push up a country to the middle
income level, but climbing higher seems to require more. It is hypothesized that
aggressively capturing the most lucrative segments of the value chain, rather
than passively filling foreign orders, requires two conditions: high policy capability and private sector dynamism. In other words, high income cannot be
attained in a country where policy intervention does not go beyond the Washington Consensus or where the private sector fails to respond strongly to suchpolicy intervention.
Policy capability (or good leadership)
The lack of information about appropriate policy is a possible causeof economic stagnation, but it may not be the only one. Policy makers in developing countries are already immersed in such advice from academics and20

Overcoming the Middle Income Trap

donors and can seek more if they want to. In many instances, the problem is not
the shortage of ideas but inability to prioritize and implement them effectively
under the political and social constraints of a particular country in question.
This calls for the existence of an outstanding person who leads and decides,
evokes awe and respect, galvanizes government and population, manages troubles and oppositions, and takes responsibility for the nation’s fate.
Leadership in the narrow sense means the top political leader—thepresident or the prime minister, whichever the case may be. In a broader sense,
leadership also includes the entire government at the command of the top
leader. When viewed this way, leadership can be understood as a public sector
capability to consistently produce, implement and adjust necessary policies. In
the past experience of East Asia, conditions for an effective developmental stateincluded a good leader, a group of elite technocrats who concretize and carryout the policies of the leader, a clear national vision and ideology that affirm
growth, and political legitimacy through delivering prosperity (Watanabe, 1995,
Ohno, 2008). Among these, a good leader is primary since other elements canbe created by such a leader if they do not already exist. The importance of hav-

Figure 7. Key Relations in Development Policy Making

LeaderCentralgovernment①④

Non-government
stakeholders
Businesses, NGOs/NPOs, people②
Ministries, departments
and other state organs⑤
Donors andInternationalorganizations③
Local governments

Source: “The Framework and Players: An Overview,” online course in Policy Design and
Implementation in Developing Countries, National Graduate Institute for Policy
Studies, Tokyo, 2008.

21

Kenichi Ohno

ing a wise (economically literate) and decisive leader for development canhardly be overemphasized. However, the economic, social and political backgrounds from which such leaders are likely to emerge are not yet well understood. If the policy capability of Japan, Taiwan and South Korea has been thedecisive cause of their economic success, how can that be taught and transferred to other countries?
The top leader (and his or her government) in a developing country
must manage five key relations as indicated in Figure 7: (i) leader-central government; (ii) coordination among central ministries and agencies; (iii) centrallocal government; (iv) government-private sector; and (v) government-donors.
The most effective way of managing these relations is case-dependent and also
hinges on the initial conditions of each country.
For example, in formulating industrial strategies, Japan and South
Korea in their fast growing periods adopted the super-ministry model, in which
one organization (the Ministry of International Trade and Industry and the Economic Planning Board, respectively) with strong and broad authority orchestrated the entire industrial policy process. Malaysia drafts industrial master plans in
the multiple layer model which consists of the minister-level committee, thesteering committee and technical resource groups. Thailand under Thaksin Shinawatra (2001-2006), in what may be called the central coordination model,
assigned newly created institutes, such as the Thai Automotive Institute and theElectrical and Electronics Institute, to coordinate among businesses, government and experts to draft policies and conduct supportive activities.
All of these policy formulation models worked reasonably well to
produce results on each occasion, but they are not suitable for all countries at all
times. Matching these models with country-specific situations is crucial. The
same can be said about central-local government relations, working withdonors, and government-business cooperation. In many latecomer countries
including Vietnam, Laos and Cambodia, a workable model for conducting consistent industrial policies is not yet in place. These countries must build theirown models that reflect both local circumstances and international experiences.
In the international aid community, there is no consensus on the proper scope of government leadership required in a developing country, a factreflected in the broad range of views from the big push to the Washington Con-

22

Overcoming the Middle Income Trap

sensus. The desired style of leadership, from a strong state to decentralization,
has also failed to converge. In recent years, controversy over leadership hastaken the form of governance debate.
The dominant view interprets good governance as the government
capability to promote market efficiency, and emphasizes such factors as low
corruption, democratic accountability, administrative efficiency, transparency
in business environment, and the rule of law. Delivering good governance inthis sense is considered imperative in releasing the true power of markets whose
dynamism is not in question. The Worldwide Governance Indicator of theWorld Bank, which was used to draw Figure 1 above, measures performance inmarket-enhancing governance in individual countries. However, the current
good governance agenda, which is uniform, broad and derived from the realityof advanced Western countries, is criticized as being unrealistic or too difficult
to achieve in developing countries. The fact that East Asian high performers did
not score any higher than others in governance indicators at the beginning or
middle of their rapid growth periods casts serious doubt on the desirability ofconcentrating development effort on improving market-enhancing governance(Khan 2008).
Two proposals for ameliorating these problems include growthenhancing governance and growth diagnostics. Growth-enhancing governance,
as presented by Khan (2008), argues that the extensive requirements of thegood governance agenda are unattainable in low income countries because of
low productivity and structural problems inherent in their economies. The
weakness in property rights and the prevalence of corruption and rent-seeking
are not the results of greed of particular individuals but natural phenomena thatsustain economic activities in a society where efficient market solutions are
impossible. Instead of trying to eliminate them prior to economic take-off,
Khan suggests that the government manage incentives and opportunities in sucha way that these non-market transfers—bribery, patron-client politics, and soon—are directed toward increasing investment, upgrading technology, andmaintaining political stability which together foster productive capitalism,
rather than toward waste and self-enrichment of the few. Whether the government has this ability, which he calls growth-enhancing governance capability,
determines the economic fate of a developing country between catching up and23

Kenichi Ohno

stagnation.
Growth diagnostics is proposed by Hausmann, Rodrik and Velasco(2005, 2006) as a way to design country-specific growth strategies with clear
priorities. The main objective is to identify a few most binding constraints on
economic activities in the local context, whose process can be summarized as adecision tree. They start by asking what keeps growth low: is it inadequate
returns to investment, inadequate private appropriability of the returns, or inadequate access to finance? If it is the first case, then they ask if it is due to poor
geography, shortages of complementary factors of production such as humanresource or infrastructure, or the lack of access to imported technology, and soon. For each of the possibilities, one can trace down the decision tree to discover the most fundamental cause for that country. The authors hope to produce a
useful manual for policy makers that encompasses all existing development
strategies as special cases. Inspired by this approach, the World Bank and theBritish Department for International Development have already begun to conduct such diagnostics in a number of countries.
Both growth-enhancing governance and growth diagnostics reject the
one-size-fits-all approach of the Washington Consensus and emphasize theimportance of country specificity, which can be considered progress. However,by and large, they still remain too general to be immediately useful for policy
makers. As noted earlier, the core problem in the reality of developing countries
may not be informational but operational. Senior officials are usually wellinformed about the barriers to growth in their countries. They need to know
more than the necessity of investment, productivity and political stability, or adecision tree that helps them discover bad infrastructure, low human capital or
the lack of domestic saving.
This brings us back to the question of how good policy can be conveyed to others. Analysis of the content and organization of effective leadership, such as above, is useful, but East Asia’s success was also built on something emotional rather than just cool calculation. Japanese officials and academics (and some of their East Asian colleagues) are poor communicators of developmental ideas. What they practice in East Asia is quite impressive but theycannot put it into words which can be understood by all. This is partly due to
deficiency in language and presentation skills, but there seems to be a more fun-24

Overcoming the Middle Income Trap

damental reason for incommunicability. Perhaps some critical knowledge cannot be expressed in writing.
The epistemological difference between the logical West and theexperiential East is well recognized. This difference also permeates in the economic discourse as seen in the quest for generalization in the West versus sharing individual experiences in the East (Murakami, 1992). In a similar spirit,
Yanagihara (1992) distinguishes the framework approach of Western development economics and the ingredients approach of Eastern developmental practice. The Eastern teaching of art and sport as well as manufacturing relies on
doing without reasoning, learning by doing, stealing the master’s technique by
the eye, sharpening intuition, and the like. Textbooks and manuals are certainly
useful, especially for beginners and outsiders, but when analysis comes to thefinal obstacle specific to the country in question, decision trees and policy
matrices are unlikely to tell us how that should be broken. The original way to
overcome the middle income trap must be invented by each country.
Private sector dynamism
Difference in national character is a sensitive matter that should betreated carefully. Many choose to presume that all people are equal and can
respond equally to good business environment regardless of nationality. This
leads to the conviction that any failure of development relative to initial conditions must be blamed on the government and its policies. While this view ispolitically correct, it is not very convincing economically12. It is almost impossible to explain why some countries attain high income quickly while others arestuck at the middle income level without reference to difference in private sector capability in responding to national visions, business opportunities, and policy reforms.

12

A Western economist with limited knowledge of East Asia strongly protested to the notion that
Thai workers were less diligent than Korean workers even under the same management.
However, this observation is supported by the majority of general directors of multinational corporations operating in East Asia and corroborated in, for instance, the 19 consecutive years ofsurvey on Japanese manufacturing firms conducted by the Japan Bank for International Cooperation (2008) and 21 similar annual surveys since 1987 by Japan External Trade Organization(2008).

25

Kenichi Ohno

Good policy may bring a country up to middle income, but that alone
may not be sufficient to attain high income. While the assertion that every person should have equal rights and opportunities is broadly acceptable, it is anentirely different matter to argue that all people are equipped with the sameability to play football, compose music, or produce cars. We must start with thepremise that different people are good at different things.
As noted earlier, Malaysia and Thailand have come a long way to
improve economic administration and deliver good policy to their people. In
many aspects, including morale, professionalism, reform mindset, academic
achievements and presentation skills, central government officials in thesecountries are superior to their Japanese counterparts. Despite this, these countries continue to rely heavily on Japanese MNCs, overseas Chinese, Koreanchaebols and other foreigners mainly because their domestic businesses lackdynamism.
Following the 1969 racial riot, Malaysia abandoned laissez-faire economic management and introduced ethnicity-based affirmative action in favorof Bumiputra (indigenous Malays) against other ethnic groups, especially urbanrich Chinese. The New Economic Policy of 1970 imposed comprehensive rules
in allocating public positions, business management, workforce, and otherincentives to Bumiputra. With the coming of power of Dr. Mahathir in 1981,
and under the recessionary pressure of the early 1980s, aggressive industrial
policy was introduced. Look East Policy and heavy industrialization, including
the automobile industry, were initiated. With the help of the yen appreciation
starting in 1985, Malaysia succeeded in absorbing a large number of manufacturing FDI and turning itself into the world’s major electronics exporter. However, heavy industrialization based on self-help was less successful. In 1986,
policy emphasis shifted back partly from social equity to wealth creation. There
was a gradual easing of Bumiputra policy, and more pro-market, outward-looking measures were adopted.
Strong measures favoring ethnic Malays may have maintained social
harmony but they did not succeed in sending Malay firms to the global market.
Proton, Malaysia’s heavily supported national car company established in 1983,
did produce popular vehicles for the protected domestic market, but it did not
become competitive enough for export. As tariffs and trade restrictions are lift-26

Overcoming the Middle Income Trap

ed and global competition accelerates, Proton now desperately needs strategic
alliance with one of the big-name foreign producers for survival. At the sametime, Malaysia continues to receive foreign technical assistance to level up its
local supporting industries. The contrast with the South Korean automobile
industry is striking. Koreans also faced a small domestic market and received
strong policy support and foreign technical assistance initially, but was soonable to export its products. In 1975, Hyundai Pony, the first-Korean developedcar, was produced. In 1986, Hyundai entered the US market with Excel and set
the record of selling the largest number of cars (126,000) in the first year of
business in the US. Koreans are now recognized as one of the few truly independent automobile producers in the world. Dr. Mahathir’s lament on the lackluster performance of Malay businesses which received generous support for
years is understandable (Mahathir, 2001).
National characters embedded in history and social structure are slow
to change, but they are not immutable. The only thing that can be said generallyis that both genes and effort matter, a maxim that is equally applicable to art,sports, or manufacturing. About a century ago, a survey of factory workers inJapan found that Japanese workers were lazy, unskillful and unspecialized witha low propensity to save and high inclination to job hopping (Ministry of Agriculture and Commerce, 1901). To accumulate skills and retain workers, Japanese large manufacturing firms began to introduce new incentives and promotion
mechanisms in the 1910s. The transformation of footloose workers into loyal
and responsible workers was further carried out during the war years (1937-45).
After WW2, Japanese had turned into hard workers with high saving propensity
and lifetime dedication to their companies.
This means that, at the middle income level, policy must go much
deeper than just providing infrastructure or unleashing the power of markets if
the country wants to obtain higher income through manufacturing. What isrequired is the transformation of people’s aspiration and value in a country
where relaxed attitude toward production and services rules. There is no need to
succumb to economic determinism, but patience is required to change national
characters.

27

Kenichi Ohno

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Chapter 2
Dynamic Capacity Development
What Africa Can Learn from Industrial Policy Formulation in East Asia

The essence of East Asian development experience should be sought in the methodology
of policy formulation rather than individual policy measures whose applicability differs
greatly across countries. East Asia approaches development as a joint process of politicaland economic factors where leadership and nationalism matter as much as technicalities.
Policy formulation in East Asia is characterized by real-sector pragmatism, goal orientation, and aspiration for building the country’s unique strength rather than removing general
negatives. The problem of weak policy capability is overcome through focused hands-on
endeavor to achieve concrete objectives, which we call dynamic capacity development,
rather than trying to improve governance scores generally vis-à-vis the global standard.
These features are sharply distinct from the dominant development thinking of Western
donors which emphasize good governance and an early adoption of policies and institutions that copy international best practices. Examples of dynamic capacity development arepresented, and four entry points for bringing this methodology to Africa are suggested.

1. Introduction
Transferability of East Asian experience to Sub-Saharan Africa is a
popular topic in development economics, but investigation into this matter
needs to go deep to be useful for policy makers. An ad hoc introduction of what
an East Asian country did in the past, without analyzing its social context ortransferability to other societies, is hardly informative. Similarly, general refutation that Africa is different from East Asia and thus cannot adopt what the latter
did is not very constructive.
Diversity of ecology, history, and social and economic structure iscommon to any region including East Asia and Sub-Saharan Africa. In view ofthis intra-regional diversity, it is futile to come up with one or a few concrete
policy lessons from East Asia or to offer one or a few concrete policy recommendations to all economies in Sub-Saharan Africa. The lessons from East Asia

31

Kenichi Ohnoshould not take the form of a small number of generally applicable policy packages. At the minimum, various policy experiences in East Asia should be construed as raw materials from which a development strategy unique to eachcountry is built with selectivity and modification.
However, East Asian experience should not be reduced to mere policy references. If that is the case, references should be sought throughout theworld as there is no reason to confine the search to East Asia. What is striking
in East Asia is not the similarity of development policies within the region—
which does not really exist—but the methodology by which individually unique
but equally effective policies are designed and implemented. This methodology,
in a broad sense, includes not only technicalities of policy making procedureand organization but also the way non-economic factors such as passion,nationalism and the sense of pride and humiliation are strategically mobilized
under strong leadership to serve as driving forces of catch-up industrialization.
This, more than anything else, is the aspect of East Asian policy formulationthat is highly distinct from the mainstream development trends dominated by
European donors and international organizations.
This paper aims to extract the methodological essence of East Asianpolicy formulation in its ideal form for policy practitioners in the rest of theworld who is seriously interested in what East Asia did in the past. The next
section stresses the diversity of East Asian experiences which include both miracles and disasters as well as “high performing economies” with significantly
different speeds of catching up. Section 3 makes a general point that the lack ofconsideration of interaction between politics and economics has been a major
cause of development policy failure. Section 4 presents the key ingredients ofindustrial policy formulation in East Asia with some examples of such policy
making from the past and present. Finally, section 5 addresses the question of
how Japan, a donor with rich experience in assisting East Asian countries into
graduation from aid, can make a meaningful contribution to African development. Four entry points are suggested.

2. Diversity of East Asian experiences
East Asia is a region that draws awe and admiration from other devel-32

Dynamic Capacity Development

oping regions. The region works as if it were a big factory with individual
economies competing to become more effective machines in it. One by one,countries in different stages of development initiate economic growth by participating in the production network spanned by private firms. Linked by trade andinvestment, an international division of labor with clear order and structure has
emerged. Industrialization has proceeded through geographic spreading on the
one hand and structural deepening within each country on the other. The term
flying geese refers to these systematic supply-side developments. In this sense,the very existence of the East Asian region provides an arena for economic
interaction among its members. There is no other developing region that hasestablished such an organic intra-regional dynamism as East Asia (Ohno,
2008a).
Despite its success on average, the most striking feature of East Asia
is diversity. It has been noted earlier that each region is diverse. East Asia,
together with Africa, is a region that exhibits greater diversity than Europe,
Latin America, or the Former Soviet Union in terms of country size, income
level, religion, and so on (Table 1). It contains societies boasting the world’s
highest income and advanced democracy as well as the world’s most oppressive
regimes with horrendous economic mismanagement. The population size also
ranges from giant China (over 1.3 billion) to tiny Brunei (0.4 million). All thethree major religions of the world are strongly represented in the region.
Because of this diversity, the average picture of East Asia is highly misleading.
In this regard, the fact that not all East Asian countries are theparagon of high economic performance deserves special mention. The region
contains both economic miracles and disasters. There are both participants andnon-participants in the East Asian production network. When researchers
extract lessons from East Asia, they almost invariably look at experiences in a
subset of economies with relatively good performance. The winners’ bias isquite understandable because success is far more interesting to analyze andreport than failure. But meaningful research can also be conducted by explaining the gap between the winners and the losers in East Asia and their causes.
Even among the so-called “high performing economies” of East Asia
(World Bank 1993), degrees of success vary considerably. In this regard, there
should be a clear distinction among high achievers such as Taiwan and South

33

Kenichi Ohno

Table 1. Comparison of Regional Diversity(a) Population (million, 2005)

East Asia
AfricaFormer Soviet Union
EuropeLatin America

No. ofcountries
17
47
15
27
22

Mean
122.8
19
18.9
18.7
24.9

Coef. ofvariation
2.52
1.28
1.93
1.20
1.70

(b) Per capita income (USD adjusted for purchasing power, 2005)

East Asia
AfricaFormer Soviet Union
EuropeLatin America

No. ofcountries
17
47
15
27
22

Mean
11,5903,000
7,454
23,970
7,342

Coef. ofvariation
1.07
1.17
0.79
0.45
0.55

(c) Most practiced religion (number of countries)

East Asia
AfricaFormer Soviet Union
EuropeLatin America

No. ofChristianity
countries
17
2
47
24
15
9
27
25
22
22

Islam

Buddhism

2
15
6
2
0

11
0
0
0
0

Animism &Shamanism
2
7
0
0
0

Other
0
1
0
0
0

Note: The coefficient of variation is standard deviation divided by mean.
Sources: World Bank, World Development Indicators, 2005 (population and income);
United States Central Intelligence Agency, The World Fact Book, 2009 (religion).

Korea, middle achievers such as Malaysia and Thailand, and low achievers
such as Indonesia and the Philippines. The first group is far ahead of the secondor the third in terms of income and industrial capability. Figure 1 shows per
capita real income of selected East Asian economies relative to the UnitedStates level. Until the mid 1960s, these economies (except Japan) showed noclear sign of catching up. However, Taiwan and Korea, which started fromequally low levels, took off in the late 1960s and have improved income dramatically. In comparison, the catching up of Malaysia and Thailand looks lessimpressive, and Indonesia and the Philippines failed to improve their positions
vis-à-vis the United States. Divergent performance comes from different speedsof catching up rather than delayed starts (except Vietnam where wars andsocialist planning prevented economic take-off until the early 1990s). ASEAN4
are taking much longer to reach the industrial capability that Taiwan and Korea

34

Dynamic Capacity Development

Figure 1. Different Speeds of Catching Up(Percent of US real income)

100%
Japan
80%

TaiwanS. Korea

60%

Malaysia
Thailand40%

Indonesia
20%

2005

2000

1995

1990

1985

1980

1975

1970

1965

1960

Vietnam
1955

1950

0%

Philippines

Sources: Angus Maddison, The World Economy: A Millennium Perspective, OECD
Development Centre, 2001; the Central Bank of the Republic of China; and IMF
International Financial Statistics (for updating 1998-2006).
Note: Per capita real income relative to the United States as measured by the 1990
international Geary-Khamis dollars.

had achieved in the 1980s and 90s. The image of flying geese in perfect formation with all birds flying at the same speed is not quite right. In addition, there
are economies which are not even on our radar screen—those that continue tostruggle at the bottom of income ladders such as Cambodia, Laos, Myanmar,
North Korea and East Timor.
Different income performance closely reflects different industrial
capability. Income rises greatly only when difficult processes in the value chain
are internalized. Figure 2 illustrates four typical steps in climbing the ladders ofindustrialization in East Asia. The pre-industrialization stage is characterized bya very low income, limited integration through trade and investment, and heavy
reliance on extractive industries, monoculture exports, subsistence agriculture
or foreign aid (stage zero). Economic take-off starts with the arrival of a sufficient mass of manufacturing FDI firms that perform simple assembly or processing of export-oriented light industry products such as garment, footwear,
and foodstuff. Electronic products and components can also be assembled inthis way. In this early stage, design, technology, production and marketing are

35

Kenichi Ohno

all directed by foreigners, key materials and parts are imported, and the country
contributes only unskilled labor and industrial land (stage 1).
In the following stage, as FDI accumulates and production expands,
the domestic supply of parts and components begins to increase. This is realized
partly by the inflow of FDI suppliers and partly by the emergence of local suppliers. As this occurs, assembly firms become more competitive and a virtuous
circle between assemblers and suppliers sets in. The industry grows quantitatively through the internal supply of physical inputs. Internal value creation
rises moderately, but production basically remains under foreign management
and guidance (stage 2). The next challenge is to internalize skill and knowledge
by accumulating industrial human capital. Locals must replace foreigners in allareas of production including management, technology, design, parts and components, factory operation, logistics, quality control, and marketing. As foreigndependence is reduced, internal value rises dramatically (stage 3). In the final
stage, the country acquires the capability to create new products and lead global
market trends (stage 4).
However, progress is not guaranteed for all. A large number of countries that receive too little manufacturing FDI stay at stage zero13. Even after
reaching the first stage, climbing up the ladders becomes increasingly difficult.
Another group of countries are stuck in the second stage because they fail to
upgrade human capital. It is noteworthy that none of the ASEAN countries,
including Thailand and Malaysia, has succeeded in breaking through the invisible “glass ceiling” in manufacturing between the second and the third stage. In
Latin America, many countries remain middle income even though they had
achieved relatively high income as early as in the 19th century. This phenomenon can be collectively called the middle income trap. The shortage in internal
capability, especially private sector dynamism and policy formulation capacity,is the cause of this divergent performance.
Another important fact is that policy content and industrial outcome
also differed significantly among economies that have reached middle to high13

36

Low-income countries may receive FDI in mining, telecom, power, tourism, or property development. While such projects are lucrative for investors and can generate jobs for the poor andprovide basic infrastructure for the nation, these alone cannot put the country on a dynamic pathof structural transformation as manufacturing does.

Dynamic Capacity Development

Figure 2. Stages of Catch-up Industrialization

Technology
absorption
Agglomeration

STAGE ONE
Simplemanufacturing
under foreign
guidance

Vietnam

STAGE TWO
Have supporting
industries, but still
under foreign
guidance

Creativity

STAGE FOUR

STAGE THREE

Full capability ininnovation andproduct design as
global leader

Technology &management
mastered, canproduce highquality goods

Japan, US, EU

Korea, Taiwan

Thailand, Malaysia
Glass ceiling for
ASEAN countries(Middle income trap)

stages. With respect to government intervention, Korea and Singapore had verystrong states while Hong Kong consistently pursued laissez-faire policy. Taiwan, Malaysia and Thailand stayed in the middle of this scale. In mobilizing
foreign savings, Japan did not avail itself to FDI or foreign loans, Korea accepted foreign loans but not FDI, whereas China and ASEAN4 vigorously courted
FDI as the main engine of growth before opening the capital account. With
respect to the manufacturing sector, heavy industry promotion was successful inJapan and Korea but not so in Malaysia and Indonesia. Most latecomers specialized in labor-intensive manufacturing industries such as electronics, garment, footwear and food processing, but city economies of Hong Kong and Singapore achieved high income through finance, commerce and other high-value
services. It is impossible to extract one development model from such diverse
experiences.
The final point about East Asia is that most countries initially had low
capabilities just as in the rest of the developing world. Competitiveness was
weak in the private sector and governance was wanting in the public sector. In
the early 20th century, an official report found that Japanese workers were lazy,
unskilled and only half as productive as American workers, and that they neversaved and hardly remained in one factory to accumulate skill and experience(Ministry of Agriculture and Commerce, 1901). Until 1960, South Korea wasconsidered a basket case with inept and corrupt officials, heavy dependence on

37

Kenichi Ohno

US aid for survival, and no prospect for profitable investment in comparison
with the resource-rich North (World Bank, 1993; Kim and Leipziger, 1993). In
1959, the World Bank report on Thailand pointed to the severe shortage oftrained manpower, managers and administrators as well as the sheer absence ofplanning in public investment (World Bank, 1959). These are familiar scenes indeveloping countries, but many East Asian economies have by now overcome
these problems. Clearly, capabilities were built in the process of industrialization; they were not prepared ex ante as the precondition for growth.

3. Interaction of politics and economics
Development is a political as well as an economic process. It succeeds only when both aspects are fully taken into consideration, especially thecomplex interaction between the two, and appropriate visions, strategies andaction plans are fleshed out and executed. Here, the politics of development
refers broadly to what can be done under the political landscape of the country
as well as the administrative capacity of the government, whereas the economics of development refers to what should be done in terms of policy content tomove the economy to a higher level given its initial conditions. The one isabout the feasibility of development policy and the other is about its desirability.
Not all feasible policies are desirable and not all desirable policies arefeasible. To be effective, a policy maker at any level or in any organizationmust rack his brains for a narrow and delicate set of actions that satisfy bothfeasibility and desirability. Because all countries are different in both aspects,
no one-size-fits-all solution can apply. Since the first best from the viewpoint of
economics is often impossible from the viewpoint of politics, compromisesmust be made and a detour may have to be taken. Policy making is a very complex game, and any advice that looks only at one aspect is easy to formulate but
certain to fail. While this general point may be too obvious to anyone, it must
be stressed that the lack of consideration of this obvious fact constitutes a major
cause of failure in development policy advice.
While the government is directly responsible for designing and implementing development policies, the weight of foreign advice cannot be ignored

38

Dynamic Capacity Development

in latecomer countries. Depending on what they say, foreign advisors from aid
organizations or academic institutions can contribute significantly to the country’s welfare or bring misery and despair to its people. Although there is noneed to explicitly state the political and administrative constraints of a developing country, foreign advisers are well advised to take them fully into consideration when they draft any report. Some advisers seem to believe that their job isto find an economically sound solution while implementation is the problem of
the host government. But if the advice is meant to be practical rather than academic, the fact is that policy advice not based on (implicit) feasibility analysis
can hardly be implemented regardless of whether proposed actions are a few ormany, or whether they are globally common or tailor-made to a particular country.
From this perspective, the shortcomings of the traditional IMF conditionalities and World Bank policy matrices are clear enough and need no further
elaboration. By now, few economists defend an international organization that
imposes a long list of common policies on countries struggling with macroeconomic crisis or popular discontent.
The argument for good governance suffers from the same problem.
The advocates of this view regard the inadequacy of governing institutions as
the main source of poor policies. They extract desirable attributes of growthfriendly governments from the advanced West and evaluate and rank developing countries by these criteria. For instance, the World Bank’s Worldwide Governance Indicators (WGI) consist of six scales: voice and accountability, political stability, government effectiveness, regulatory quality, rule of law, and control of corruption. Member countries are given grade points ranging from 0 to
100 on each of these scales. This approach is criticized from various angles
including the confusion of causality between growth and governance, theimpossibility—and even non—necessity of attaining good governance in lowincome countries, the need for a smaller or different set of institutional targets
to start with, and the absence of empirical evidence that good governance isnecessary for growth (Grindle, 2004; Khan, 2008; Shimomura, 2005). On thelast point, it should be recalled that high performing economies in East Asia
generally had poor records in public-sector efficiency, transparency or cleanliness at the beginning or even during their high growth periods. From the view-

39

Kenichi Ohno

point of interaction of politics and economics, however, the most fundamental
shortfall of the good governance drive is the total lack of analysis on the political and administrative feasibility of Western-style governing principles in thesocio-political context of the country in question.
Growth diagnostics, which is supposed to overcome the problems
associated with the long and universal policy menu of the Washington Consensus, is subject to similar criticism. This research program was proposed by three
economists associated with Harvard University (Hausmann, Rodrik and Velasco, 2005) to discover a small number of most binding constraints to growth ineach country. It proposes a logic tree (the HRV tree) that instructs researchers
to look systematically for such binding constraints and also serves as a checklist—albeit a rather simple one. The HRV tree assumes that boosting private
investment is the key to growth, which can be thwarted by either low return or
high financing cost. For each case, the inquiry continues by asking the reason
why it occurs. The idea that policy advice should be simple and geared to thesituation of each country is commendable. This research program has alreadyproduced a large number of country growth diagnostics at Harvard University,
the World Bank, the Inter-American Development Bank, the Asian Development Bank, and the British Department for International Development. However, it must be pointed out that growth diagnostics writes prescriptions only fromthe economic side. When political and administrative constraints are added, it ishighly doubtful that a small number of economic problems identified to be mostbinding in a particular country are the correct entry point for reform. Sometimes
it is more effective not to tackle the greatest constraint head-on, and instead
work on peripheral issues first to gain political support and administrative competence for a bolder action later. There may also be other sophisticated scenarios for improving the chance of success. It must therefore be concluded that theanalytical scope of growth diagnostics is too narrow. Policy sequence whichworks in real world requires far deeper thinking than just following down the
HRV tree.
How should we cope with the nexus of politics and economics indevelopment with the understanding that the two are inseparable? One obvious
suggestion, at least for academicians, is to conduct inter-disciplinary research.
However, the producing a book with economists and political scientists analyz-

40Dynamic Capacity Development

ing development independently and without intellectual cross-fertilization hardly helps. Each discipline is deeply entrenched in its methodology which is
scarcely mutable. Operationally meaningful results cannot be had simply byinviting them into the same conference room.
The World Bank’s World Development Report in 1997 proposed a
strategy which may be dubbed as policy-capability matching (World Bank,
1997)14. It acknowledged that some policies, such as selective industrial policy,
were inherently more difficult and required far more information and policy
skill than others, such as providing universal primary education or a level playing field for all businesses. It argued that countries with already advanced institutions might try difficult policies but those without them should first build
institutional capabilities in three areas: (i) effective rules and restraints, (ii)greater competitive pressure, and (iii) increased citizen voice and partnership.
The latter group should content themselves with easy policies (or “fundamentals”) for now and leave difficult ones for later when their institutions were
upgraded. This advice can be useful in preventing developing countries fromover-reaching themselves, but it shares the same weakness as the good governance approach. It is based on the belief that institutions and capabilities can beenhanced generally and more or less independently from the particular development path that the country has chosen to tread. But such unfocused effort at
capacity development is difficult to rally politically and too broad to implementadministratively. There should be an alternative and more concentrated way tostrengthen capability that appeals to the political constituencies as well as thehearts of the general public.
What East Asia’s successful economies practiced was quite different
from any of the above. Starting from an incompetent and often corrupt government, a leader rose to take over power, either legally or illegally, to establish a
new government with the sole purpose of achieving rapid economic development to maintain national unity or defend the nation from external threats. Such

14

The exact phrase used in the report was the two-part strategy of “matching the state’s role to its
capability” and “raising state capability by reinvigorating public institutions.” The latter included the five “fundamental tasks” of (i) establishing the foundation of law; (ii) nondistortionary
policy environment including macroeconomic stability; (iii) social services and infrastructure;(iv) protecting the vulnerable; and (v) protecting the environment (World Bank, 1997, pp.3-4).

41

Kenichi Ohnoa leader often launched the political regime of authoritarian developmentalism
where he himself became the prime driving force of development. He wasbacked by a technocrat team to concretize his vision, national ideology that glorified material advancement, unwavering belief in upgrading technology andcompetitiveness, popular support for rising living standards, and political legitimacy based on industrial results rather than democratic procedure (Ohno,
2008a; Watanabe, 1995). Military-like discipline ruled to largely wipe out corruption and nepotism. In this process, politics and economics were deeply intertwined. Leaders had no illusion that politics and economics could be practiced
separately or solved independently from each other. Social scientists have a lotof catching up to do to analyze what these policy practitioners actually did.
East Asian economies raised policy capability through hands-on
efforts to attain concrete goals rather than trying to improve governance generally and aimlessly. Organizations were created or restructured, and officials andadvisors were mobilized or re-assigned, to execute specific tasks required by
the five-year plan, the master plan for a priority industry, or the blueprint for a
new industrial zone. This approach had several advantages such as concentrating limited human and financial resources on truly needed areas, clear criteria
for monitoring and assessing performance, flexible reshuffling of resources in
response to initial results or changing circumstances, and the cumulative prideand sense of achievement that emerge as specific targets were realized one byone. We shall call this approach dynamic capacity development. The next section will explain it more in detail with some concrete examples.

4. Industrial policy formulation in East Asia
There are three inter-related features of industrial policy formulationin East Asia that are quite distinct from the dominant development thinking.
Dynamic capacity development takes place in the process of designing andimplementing policies that satisfy these conditions. They are (i) real-sector orientation; (ii) goal orientation under the multiple policy layers of visions, strategies and action plans; and (iii) enhancement of unique strength instead of
removing general negatives. These features are explained below.

42

Dynamic Capacity Development

Real-sector pragmatism
Yanagihara (1992) distinguishes the “framework approach” practiced
by Western aid donors and the “ingredients approach” adopted by the Japanese
government in its development aid strategy. The framework approach emphasizes the rules of the game according to which the private sector acts and policy
makers make decisions while leaving the actual outcome of the game to individual matches and players. In this approach, the functioning of markets, theprinciple of official intervention, budget and public investment frameworks,
empowerment and participation, monitoring mechanisms, administrative efficiency and accountability, and the like, receive great attention. Aid harmonization and general budget support are clearly couched in this tradition. In contrast,
the ingredients approach takes deep interest in how individual players are doingin the field and the outcome of each game. It examines the state of technology,
factors of production, demand trends, product mixes, industrial structure, marketing and logistic efficiency, and the like, in the concrete context of individual
sectors and regions of the country in question. Matching crop species with particular soil or training factory inspectors for kaizen and efficient use of equipment are considered to be crucial for successful development15. Similarly, thetechnical specification of roads and bridges to be built, the lot size and administrative supports in an industrial zone, and other details which are normally left
to consultants and contractors are the proper concern of Japanese aid officials.
Both approaches are indispensable and should be highly complementary since general frameworks need to be filled with concrete contents. Yet, thetwo approaches are not well integrated in reality. Japan feels uncomfortablewith the explosion of new aid rules, tools and meetings set up by European
donors while the latter do not look kindly on “selfish” donors who refuse to participate in aid harmonization or do so only unwillingly. Europeans should
broaden the scope of aid to embrace more concrete ingredients while the Japan15

Kikuchi (2008) reports that the same goal of boosting the competitiveness of Tunisian industries
was approached in two different ways. The EU’s Industrial Modernization Project aimed toassist acquisition of ISO certification while Japan’s Study on the Master Plan for Quality andProductivity Improvement tried to level up the operation of 30 companies in electronic assembly and food processing by dispatching experts with experience in factory management andtraining the Tunisian trainers. A senior manager of the EU project described this difference asready-made versus order-made.

43

Kenichi Ohno

ese side needs to effectively communicate what it has been doing and become
part of the broader aid framework.
Goal orientation
In high performing economies in East Asia, industrial policy has usually taken a goal-targeting form. The top government leader proclaims a longterm national vision which shows a direction without specifying details. To
realize this, appropriate government organizations are created or designated todraft ambitious but feasible strategies and execute concrete action plans. Strategies and action plans may be revised as circumstances change, but the longterm vision remains intact. Working backwards from broad goals to phased
strategies and concrete action plans, while making necessary adjustments andaccumulating experience and confidence along the way, has been the hallmark
of East Asian development planning. This is in sharp contrast to the call for
wide-ranging reforms without specific real-sector targets such as those of IMF
conditionalities, World Bank policy matrices, good governance drive, and otherinstitutional reform agenda.
Japan in the 1960s had the goal of doubling income within the decadeas well as competing effectively with Western multinationals as trade barriers
were lifted under the GATT Kennedy Round commitments. The Ministry ofInternational Trade and Industry (MITI) together with the Japan Development
Bank coordinated and assisted private efforts in improving productivity. Taiwan
in the 1980s launched high-tech industry promotion to replace the heavy industry drive of the 1970s. Priority areas were designated, a science and technology
industrial park was created in Hsinchu, FDI marketing was conducted, andmeasures were introduced to support R&D and financing of eligible companies.
More examples are given below.
Enhancing unique strength rather than removing general negatives
Instead of comparing countries across the board to rank them or findfaults with individual countries relative to the global norm, the East Asian
approach is to identify the future potential (dynamic comparative advantage)
unique to each country. Limited resources are poured into this area to realizethat potential rather than scattered across many unrelated programs. The devel-

44Dynamic Capacity Development

opment strategy of a land-locked country with rich mineral resources should beentirely different from that of a country with long coastal lines and excellent
seaports. A society with nomad population cannot tread the same path as adensely populated agricultural society. Unique potential for each country should
be identified, and main policy effort must be directed to removing barriers toattain that potential (Secretariat of the Stocktaking Work, 2008).
As noted in section 2, domestic capability of a latecomer country is
initially very weak. Corruption and rent seeking are rampant. However, Khan
(2008) contends that it is not only difficult but even undesirable to eradicate
these “evils” in an economy where market-enhancing rules and institutions areseverely underdeveloped. In such an economy, commerce, production, andinvestment are carried out with the help of these non-market activities and theirsudden removal (by strict policing and punishment, for example) would bringthe economy to a halt. According to Khan, what is required is to design policies
and incentives so that these non-market activities are channeled towards learning, productive investment, and political and social stability. Khan calls thiscapability growth-enhancing governance.
Foreign investors do not expect a latecomer country to become aninvestors’ paradise overnight. They know that inefficiencies and irregularities
are part and parcel of a developing country. What they really need is a few specific guarantees that are crucial to their investments and not an overall reform.
Masaki Miyaji, a JICA expert with extensive business experience in Africa,
asks each African country to declare its “charm point,” an (untapped) advantage
unique to that country that would attract investors. Then the government should
defend that advantage by all means to realize the promised returns. After all,there is no need for a country to improve on all fronts before launching a
growth strategy.
When a country clearly understands its real-sector potential and isequipped with a policy system of vision, strategies and action plans to attain it,
it is not difficult to know where to start building capability. Action plans must
be implemented, and specific problems arising in this process must be solved asa matter of highest priority. Weak coordination among concerned ministries,
gaps in budgeting and execution, delays in land procurement and resettlement,
training of officers in charge, and devising incentives to curb brain drain are

45

Kenichi Ohno

some of the issues that may be encountered. Capacity is created where it isneeded through solving such problems one by one, rather than by a general
campaign to eradicate corruption or promote administrative efficiency. Dynamic capacity development is a natural consequence of the East Asian policy making characterized by real-sector pragmatism, goal orientation and the pursuit ofunique strength.
More Examples
Generally speaking, East Asian countries are good practitioners ofdevelopment but they are not very good at explaining their achievements orarticulating their differences from the Western way. There are numerous development policies worthy of study in the region, but few are known to the rest of
the world. Four stories from Japan, China, Malaysia and Thailand are added
below to illustrate East Asian policies which are individually different yet share
the three common features stated above.
Japan in the late 19th century was a backward agricultural country
just out of the feudal system. Trade with the West was resumed in 1858 andimports of British cotton products surged. Under the strong competitive pressure from the Western powers, the Meiji government promoted industrialization
for yunyu boatsu (import substitution). One of the key policy targets was toestablish a cotton spinning industry to replace imported cotton yarn withdomestic production. State-owned enterprises were set up in the 1870s but they
did not succeed economically. The reasons for the failure included the lack of
capital, small capacity, use of water power which was constrained by locationand operation hours, and the general lack of expertise. The turning point camewhen private Osaka Spinning Company was established in 1883 by the strong
leadership of Eiichi Shibusawa, a super business coordinator and former MOF
official16. Shibusawa was determined to build a factory that overcame thedefects of the previous SOEs. Innovations were made in production scale
16

46

Shibusawa mobilized capital, technology and human resources for setting up companies but
never assumed general directorship. He delegated the running of the company to others andwent on to establish over 500 companies, numerous economic institutions such as the stock
exchange and the chamber of commerce, and non-economic organizations such as hospitals anduniversities. Unlike Yataro Iwasaki who founded the Mitsubishi group, Shibusawa did not form
his own zaibatsu.

Dynamic Capacity Development(10,500 spindles instead of 2,000), the use of steam engines for 24 hour operation, adoption of the Ring spinning machine rather than the traditional Mule,and the use of low-cost Chinese cotton instead of domestic one. Osaka Spinning
was a joint stock company subscribed by big merchants and former samurai
lords who were personally persuaded by Shibusawa to invest. For working capital, loans from the First National Bank, where Shibusawa was the president,
were made available. But what contributed most to Osaka Spinning’s performance was the recruitment of Takeo Yamanobe, a young engineer who was persuaded and then financially supported by Shibusawa to study the cotton industry in the United Kingdom. Equipped with the latest technology and pragmatic
knowledge, Yamanobe could lead the company into instant success in the firstyear of operation. This had a powerful demonstration effect. Soon, several spinning factories modeled after Osaka Spinning were established. By the early
20th century, Japan overtook the United Kingdom to become the top textile
exporter in the world and the City of Osaka, where many textile mills werelocated, was called the “Manchester of the Orient.” Without Shibusawa’s endless passion and meticulous attention on details, this feat could not have beenachieved (Ohno, 2006b).
Deng Xiaoping, who held power in China during 1978-1997, was avery pragmatic leader penchant for material progress in sharp contrast to Mao
Tsetung who ruled during 1949-1976 with political ideology and radicalism
which brought chaos and misery to the Chinese people. This leadership switch
completely changed the economic landscape of China. Under Deng, agriculturalliberalization and gradual international integration became the two pillars of“reform and opening” policy17. His method was to try everything, even capitalist mechanisms and foreign elements, to increase production, then continue if itworks and adjust or abandon if it does not. Many of his dictums, such as “Itdoes not matter whether the cat is white [SOEs] or black [FDI or private] aslong as it catches mice [increases output],” “My invention is staying away fromdebates,” “Poverty is not socialism,” and “Even try the stock market and see,”17

Though SOE reform was also attempted, it met with limited success. Township and village
enterprises became another source of Chinese dynamism in much of the 1980s and 90s, but they
emerged more or less spontaneously and cannot be regarded as the direct outcome of Deng’s
industrial drive.

47

Kenichi Ohno

exemplify his unwavering pragmatism. The greatest engine of the Chinese
economy introduced by Deng was the attraction of FDI into special economic
zones and economic development zones along the eastern and southern coast.
FDI flows, initially timid and cautious, turned into a tsunami in the 1990s. The
event that precipitated this inflow was a series of pep talk Deng gave in Shanghai and Southern China in early 1992. Strong reaffirmation of “reform andopening” policy by the supreme leader reinvigorated investors’ psychology, andChina started to grow at double digits ever since. Deng also denied egalitarianism, the hallmark of socialism, and encouraged the pursuit of wealth by those
who were able and let all others follow later. This idea was highly effective inremoving the stigma of materialism and accelerating growth but also created ahuge gap in income and wealth by the early 21st century.
In Malaysia, Vision 2020, an aspiration to become a “fully developed
country” by 2020 set by former Prime Minister Dr. Mahathir in 1991, remains
the overarching goal. The Economic Planning Unit (EPU) of the Department of
the Prime Minister directs national effort to concretize this vision under a system of overlapping policy documents and cascading organizations (Figure 3).
Dr. Mahathir mentioned nine general challenges without further elaboration.
They are national unity, confidence, democracy, moral and ethics, tolerance,
science and technology, caring culture, economic justice, and prosperity. To
achieve this, Malaysia drafts multiple layers of policy documents such as industrial master plans (MITI), Outline Perspective Plans (EPU), and Malaysia Plans(i.e., five-year plans, EPU). Under MITI, special agencies such as MIDA (FDI
policy), SMIDEC (SME promotion), MATRADE (trade), and MPC (productivity) have been established. Although this policy structure may sound quite complex, the Malaysian government manages it surprisingly well without being
bogged down in bureaucracy. In terms of industrial policy framework, Malaysia
has reached a level where no significant improvements are possible 18. If
Malaysian industries still fail to emerge strongly, the blame should be on thedearth of local private dynamism rather than the shortage of policy sophistica18

48

In 2006, a policy research mission from Vietnam asked the representative of the Japan External
Trade Organization (JETRO) in Kuala Lumpur to list main constraints for foreign investors in
Malaysia. He paused, and replied that he could think of none as far as policies and institutions
were concerned.

Dynamic Capacity Development

Figure 3. Malaysia: Overlapping Policy Structure
Malaya Plans
1
2

NEP
1MP 2MP 3MP 4MP 5MP 6MP 7MP 8MP 9MP

OPP2

OPP1
MP: Malaysia Plan
OPP: Outline Perspective Plan
IMP: Industrial Master Plan
NEP: New Economic Policy

IMP1

OPP3
IMP2

EPU
(OPP4)
IMP3

EPU
MITI

Vision 2020 (1991-2020)tion (Ohno, 2006a).
The entire working of the government of Thailand changed in 2001
when Thaksin Shinawatra came to power. Previously, most Thai governments
were weak and uncoordinated. But Prime Minister Thaksin was strong andwanted to run the country as if it were a private company. He determined general directions and ordered related ministries and organizations to work out thedetails and implement actions. This top-down decision making affected theentire scope of policy making. The role of economic ministries changed frombuilding policies from bottom up to concretizing pre-determined policy orientation. Many officials positively evaluated this change. Previously, Thai ministries did not talk to each other and their policies were often at cross purposes.
Under Thaksin, policies became more integrated under his vision, decision
making became faster, and dialogue among concerned ministries, domestic andforeign firms, and international partners was activated. Policy directions werealso clearer. The Thaksin government wanted to promote industries that hadhigh domestic value-added and created many jobs regardless of the nationalityof the firm. Targeted industries included automobiles, agro-industry, fashion
goods, high-value services, electronics and ITC, and energy and renewableenergy. For the automobile industry, Thaksin declared the vision of Thailand
becoming the “Detroit of Asia” while leaving the Ministry of Industry (MOI) to
define what it exactly meant. For this purpose, the master plan of the automobile industry 2002-2006 upheld the following numerical targets: (i) produce 1
million cars per year; (ii) export 40% of the cars; (iii) produce 2 million motorcycles; (iv) export 20% of the motorcycles; (v) export 200 billion baht of high49

Kenichi Ohno

quality parts; and (vi) achieve localization of over 60%. These targets were fulfilled in 2005, one year ahead of schedule, by close cooperation among producers, MOI, and the Thai Automotive Institute, a body set up by the Thaksin government to promote the industry. While Thaksin was ousted for corruption
charges in 2006 and the overall effectiveness of his rule remains an open question, his leadership style in industrial promotion has attributes that are well
worth investigation (Ohno, 2006a)19.

5. Entry points for African industrialization
It was argued earlier that policy making in latecomer countries is acomplex game due to the interaction of politics and economics. How outsiders
such as donors and foreign advisors can help in this process, by bringing new
insights that fit the economic reality, political configuration, and administrative
capacity of the country, is even more complex. In this final section, four suggestions are made so that Japan, a donor with rich experience in assisting East
Asian developing countries, may begin to make a meaningful contribution to
the development of Sub-Saharan Africa (GRIPS Development Forum, 2008b).
All of the four entry points for engagement proposed here are the ones that arecommonly practiced in East Asia. But their application to a new region requires
care and sufficient lead-time because the East Asian way is unfamiliar there andinitial conditions, including the state of intra-regional manufacturing dynamism,
are not the same as in East Asia.
Align assistance to existing policy vision and strategies
If the country already has a valid vision and strategies for development, donors and foreign advisors should provide support for their realization.
The vision and strategies must be clear, mutually consistent, and have the quality of being ambitious yet attainable with concentrated effort among all stakeholders. They must be strongly owned by the country’s top leaders and sharedby all policy makers. However, latecomers that satisfy these conditions are not
1950

Another policy that Thaksin introduced was subsidies and support for the rural poor who had
long been neglected by Thai politics. This made him unpopular with urban voters and partly
contributed to his downfall.

Dynamic Capacity Development

Table 2. Japan: Policy Menu for Enhancing Industrial Capability in East Asia
Policy area
1. Capacity building(for specific firms)

2. Human resource(general or institutional)

3. Finance

4. Incentives
5. FDI-local linkage

6. FDI marketing

7. Policy framework

Measures- Shindanshi (enterprise evaluation) system- TA for management and technology- Mobilization of current or retired Japanese engineers- Intensive support for limited sectors (e.g., die & mold)- Awards, PR and intense support for excellent local companies- Management/technical centers and programs- Mobilization of current or retired Japanese engineers- Alliance between FDI firms and local universities/centers- Monozukuri school (to be upgraded to university)- Meister certification system- Credit guarantee- SME finance institutions- Two-step loans- Exemption or reduction of taxes and custom duties- Grants or loans for specified actions- Database and matching service- FDI-vendor linkage program- Parts Industry Association and Business Study Meetings- Trade fairs and reverse trade fairs- Improving logistics- Creation of strategic industrial clusters- Industrial parks and rental factories- Efficient logistics and infrastructure- FDI marketing targeted to specific sectors or companies- Supporting industry master plan
- SME law
- SME ministry- Business associations and industry-specific institutes- Quality standards and testing centers

Note: this table summarizes Japan’s assistance measures to East Asian countries contained in the New
Aid Plan for ASEAN (late 1980s to early 1990s), the Mizutani Report for Thailand (1999), theUrata Report for Indonesia (2000), and ongoing discussion for strengthening Vietnam’s supporting
industries (Ohno, 2008b).

very many20. Five-year plans, industrial master plans, and vision papers are produced in abundance but few are really operational.
If the vision and strategies are reasonably good, there is no need tostart from debating a national vision. Existing strategies may be revised overtime but should be accepted in principle. However, even in a country with awell-formulated vision and strategies, implementation is usually weak and con20

Ethiopia, which has a core vision of Agricultural Development Led Industrialization (ADLI,
formulated in 1991) backed by the Ethiopian Industrial Development Strategy (2003), the Rural
Development Policies, Strategies and Instruments (2002), PASDEP (five-year plans), and otherstrategic and sectoral documents, MTEF and annual plans, may be an exception.

51

Kenichi Ohno

ditions that facilitate implementation are missing—including human and financial resources, institutional mechanisms, private-public partnership, and coordination among programs. Thus, enhancing the ability to design and execute concrete action plans becomes crucial.
In East Asia, there is a standard set of policy measures for industrial
promotion. Table 2 shows such measures contained in recent support programsof the Japanese government. In light of the fact that both FDI and local firms
must play important roles in industrialization, some of these measures assist
local firms, others are aimed at inviting a sufficient volume of targeted FDI
firms, and still others provide links between the two groups of firms and a business-friendly policy framework for all.
In Africa, JICA has recently provided technical cooperation to assist
the formulation of a master plan for quality and productivity improvement in
Tunisia, where concrete measures were introduced at individual pilot firms in
the electronic and electrical industry and the food processing industry (Kikuchi,2008).
Policy dialogue with a view to future actions
If the country does not yet have a vision and strategies that are goodenough, Japan usually prefers to start with a bilateral policy dialogue whichleads either immediately or eventually to concrete actions. This may take government-to-government form or private-public partnership depending on theagenda. Each project usually lasts for two to three years, but policy dialogue
often continues in multiple phases or overlapping projects with slightly different objectives.
In a country with little knowledge of East Asian policy formulation ora transition country unfamiliar with the market mechanism or global competition, a general research project that assesses the country’s current status andintroduces relevant international experiences may be initiated (the Okita Projectfor Argentina, the Ishikawa Project for Vietnam, the Hara Project for Laos, andthe Shiraishi and Asanuma Project for Indonesia, and the Odaka Project for
Myanmar; the name of the project refers to the professor(s) who led theresearch group). If the target area for policy action is already identified, the dialogue may take an appropriate style for that purpose such as the business forum

52

Dynamic Capacity Development

Table 3. Japan-Vietnam Bilateral Policy Dialogue for Industrial
Competitiveness
Program

PeriodPrincipal
actor(s)Content

Ishikawa Project (Studyon the Economic
Development Policy in
the Transition toward a
Market-oriented
Economy in Vietnam)

Joint research on macroeconomics,
finance, agriculture, industry, integration,
1995-2001
currency crisis, SOE reform, PSD; based
MPI-JICA(3.5 phases)on the principle of country ownership andmutual respect, with emphasis on longterm real sector issues.
Quick disbursing loan (20 billion yen)
New Miyazawa Initiativewith conditionalities in PSD, SOE
auditing, and tariffication of non-tariff(Economic Reform
1999-2000
JBIC
barriers. Action plans in PSD were
Support Loan)monitored and evaluated.
Bilateral agreement and implementation
Vietnam-Japan Jointof concrete action plans which were
Initiative to Improve
2003-2009
monitored and reported to high-level,
Business Environment(3 phases,
MPI-4J
with focus on removal of FDI/businesswith a View toongoing)
impediments, strengthening of local
Strengthen Vietnam’s
capabilities, and drafting of missing
Competitivenessindustrial strategies.
Analyses by Vietnamese and Japanese
Joint Work between
experts as inputs to the drafting of theVietnam and Japan toFive-year Plan 2006-2010, with attention
Strengthen the2004
MPI-4J
on industrial policy formulation andCompetitiveness ofcompetitiveness issues of individual
industries (automobile, electronics,
Vietnamese Industries
supporting industries, etc.)
Joint
Drafting of master plan following new
Working
content and method, with active
Joint drafting ofGroupparticipation of large motorcycle
Motorcycle Master Plan
2006-2007(MOI, VDF, assemblers and interaction with other
under MOI and VJJI2
producers, stakeholders; VDF serving as facilitator.
experts)
Master plan approved in August 2007.
Build strategic partnership formonozukuri (high-skill manufacturing)
Vietnam-Japan(Under(To bewith Japan transferring its know-how to
Monozukuri Partnershippreparation)
decided) Vietnam. Action plans for supportingfor Supporting Industries
industry promotion to be implemented
with joint effort.

for improving investment climate and the producer-government dialogue fordrafting an automobile master plan. Table 3 lists past and current action-oriented policy dialogues between Japan and Vietnam. Similar bilateral dialogues arealso conducted in other ASEAN countries.
The Ishikawa Project, formally the “Study on the Economic Development Policy in the Transition toward a Market-Oriented Economy in the Socialist Republic of Vietnam,” was the first large-scale bilateral research project for

53

Kenichi Ohno

Vietnam after diplomatic relations with the West were restored in the early
1990s. The project was officially agreed by the two governments when theCommunist Party General Secretary Do Muoi visited Tokyo in April 1995.
Shigeru Ishikawa, professor emeritus of Hitotsubashi University, was appointed
by the General Secretary as the leader on the Japanese side. The Ishikawa Project was implemented jointly by Vietnamese and Japanese teams over six years
in 3.5 phases as part of JICA technical cooperation. The research examined
issues related to the formulation and implementation of Vietnam’s long-term
development plans and made policy proposals to address them.
An increasingly popular format is the one adopted by the VietnamJapan Joint Initiative. Several issue areas such as law and regulations, industrial
policy, labor issues, etc. are identified and a working team is set up for each.
Representatives from relevant ministries are appointed on the Vietnamese sideand general directors of Japanese firms operating in Vietnam and industrial
experts are appointed on the Japanese side. In each working team, concrete targets are proposed, agreed, implemented, monitored, and followed up if notproperly executed. Each phase lasts for two years and the Initiative is currently
in its third phase. In each phase, a total of about 45 problems are solved with ahigh completion rate of 70-80%21.
In Africa, JICA is conducting the “Triangle of Hope” project in Zambia, mobilizing a Malaysian consultant to provide policy advice to improve theinvestment climate as an example of South-South cooperation. The working
format is somewhat similar to the Vietnam-Japan Joint Initiative in that concrete tasks to be completed are reported in matrix form with vivid colors showing the degree of progress made for each task. Based on this work, FDI marketing is underway, targeting Indian and Malaysian firms who might be interested
in coming to Zambia. Also, a master plan and a feasibility study for the establishment of Multi-Facility Economic Zones (MFEZ), as a receiver of FDI firms,
are being conducted.

21

54

In the first phase, 44 items were chosen for improvement and 85% of them were successfully
implemented. In the second phase, 46 items were chosen and 74% were achieved. In the ongoing third phase, 37 items have been raised.

Dynamic Capacity Development

Regional development around a core infrastructure
A large part of Japanese ODA regularly goes to building large-scale
infrastructure, especially in the transport and power sectors. When such infrastructure is built, it is customary that supporting programs that take advantageof that infrastructure or complement it are also provided for effectiveness andsynergy. This includes the formulation of master plans for regional or industrial
development, operation and maintenance programs, human resource development, safety and environment programs, local SME development, the “one village one product” program, and the installation of one-stop border posts.
In East Asia, there are a large number of core infrastructure projects
accompanied by satellite programs. Examples include the Eastern Seaboard
Development Program in Thailand that created huge industrial zones around aport infrastructure; the development of the Hanoi-Haiphong transport corridor
along National Highway No.5 in conjunction with Haiphong Port improvement,
FDI attraction, and traffic safety programs in Vietnam; and the development of
Sihanoukville Port and power and telecommunication networks combined withthe construction of a special economic zone and FDI marketing in Cambodia.
At even a larger scale, the development of the Greater Mekong Region encompassing six countries (China, Thailand, Vietnam, Laos, Cambodia, and Myanmar) is promoted under the leadership of Japan and the Asian Development
Bank where the East-West and the North-South corridors serve as the core
infrastructure.
In El Salvador, Japan supports the development of La Union Port situated in the Eastern Region of this small country. By international standards,
the quality of El Salvador’s transport infrastructure—seaports, airports and theroad network—is above average and even considered the best in Central America. For this reason, infrastructure was not identified as the “binding constraint”
in the growth diagnostics conducted for this country by Hausmann and Rodrik(2005). However, the government of El Salvador hoped to upgrade the existing
port to augment the country’s position as the regional transport hub. This could
also contribute to the development of the Eastern Region which was the poorest
region of this country. The Japanese government assisted the drafting of the
Master Plan for the Development of the Eastern Region, provided an ODA loan
to expand La Union Port as the core infrastructure, and aligned other aid pro-55

Kenichi Ohno

Figure 4. El Salvador: The Japanese Aid Package around La Union PortKEY INFRASTRUCTURE- Construction of La Union Port- Rebuilding an old bridge (Honduras border)- Digital map technology for efficient planning- Urban development planning for La Union City

Social & Human RD- MEGATEC La Union(training center)- Primary schools &math- Clean water- Rural electrification- Solid waste control

Support for
Productive Sectors

Eastern Region
Development- SME promotion- Aquaculture- Small-scale
agriculture- Reservoirs &
irrigation- Small-scale livestock- La Union Port
- Plan Puebla Panama- CAFTA & other FTAs
- Cent Amer.
integration- M/P for Eastern
Regiongrams to it. For example, an old bridge on the Honduras border was rebuilt, digital map technology was introduced, and the development planning of La Union
City was conducted. In addition, Japan provided training for port workers andimplemented social sector programs such as education, clean water and rural
electrification as well as productive sector programs for SME promotion, aquaculture, agriculture, irrigation and livestock (Figure 4). Although this assistancetook place outside East Asia, it had all the features of East Asian policy formulation such as real-sector pragmatism and boosting the country’s strength rather
than working generally on its weaknesses.
In Africa, Japan is interested in a multi-faceted project along the
Nacala corridor in Mozambique which will be coupled with industrial development in the Nacala port area—with more programs to follow. The Nacala corridor will become an international corridor when it is extended into Malawi and
Zambia, with a possibility of even greater impact on the regional development
across national borders.
Providing conditions for concrete foreign investment
Finally, Japanese ODA may be mobilized in conjunction with the56

Dynamic Capacity Development

planned investment by a large-scale foreign (especially Japanese) firm. In a
low-income country, FDI with a large sunk cost (requiring large capital equipment or geological exploration, for example) will not occur unless sufficient
infrastructure and friendly policy environment are in place. Moreover, Japanesemanufacturing enterprises are by far the most cautious investors in the world
and Africa is a destination largely unknown to them. To reduce the cost anduncertainty associated with the proposed investment, the Japanese government
may build the necessary infrastructure and engage in a policy dialogue with thehost government to improve the business environment surrounding the project.
The private decision to invest and the official decision to build infrastructure
must be made in tandem and in close consultation to overcome the coordination
problem. Without such cooperation, the investment will not happen and the
ODA project will be underused. In this way, ODA can catalyze private investment in a new region.
For a long time, the Japanese government has been cautious about
using public money to assist only one firm (or a very few firms). However, suchstigma is gradually melting away and active support for Japanese firms withconcrete investment projects abroad is becoming more acceptable—and evendesirable in the name of public-private partnership. Although there is no theoretical reason to exclude non-Japanese firms to participate in this strategy, thecore investment is most likely by a Japanese firm for political reasons. In Japan,
there are some constituencies that insist that ODA should be used mainly oreven exclusively for pursuing (narrow) national interest.
In reality, Japan has often built large-scale infrastructure in developing countries with the implicit understanding that FDI firms will surely comeafter its completion (or even before). The two examples mentioned above, theEastern Seaboard Development Program in Thailand and the Hanoi-Haiphongtransport corridor along National Highway No.5 in Northern Vietnam, attracted
a large number of Japanese manufacturers in the automobile industry in the former and the motorcycle and printer industries in the latter.
In Sub-Saharan Africa, initial large-scale investors from Japan may
be in the extractive or energy-intensive sector rather than manufacturing. For
this reason, the interest of the host country and the interest of Japan may have tobe properly adjusted and aligned. Although ODA may be used to build trans-

57

Kenichi Ohno

portation or power capacity to execute a particular investment for the benefit ofa Japanese private firm, the core infrastructure should be accompanied by arange of other programs such as regional development, SME promotion, humanresource development in the same way as discussed in the previous subsection.
Corporate social responsibility of the investing firm may also be evoked to generate the spillover effect to the host society.

References

Fujimoto, T. (2004). Nihon no Monozukuri Tetsugaku [Japan’s Monozukuri Philosophy]. Tokyo: Nihon Keizai Shimbunsha.
————— (2006). Architecture-based Comparative Advantage in Japan and Asia. In
K. Ohno and T. Fujimoto (Eds.), Industrialization of Developing Countries: Analyses by Japanese Economists (pp. 1-10). Tokyo: National Graduate Institute for Policy Studies.
Fujimoto, T. and Shintaku, J. (2005). Architecture-based Analysis of Chinese Manufacturing Industries. Tokyo: Toyo Keizai Shimposha.
Grindle, M. (2004). Good Enough Governance: Poverty Reduction and Reform in
Developing Countries. International Journal of Policy, Administration and Institutions, vol.17, no.4, pp.525-548.
GRIPS Development Forum. (2002). Japan’s Development Cooperation in Vietnam:
Supporting Broad-based Growth with Poverty Reduction (English, Japanese, andVietnamese). Tokyo: National Graduate Institute for Policy Studies.
——————————— (Ed.). (2008a). Diversity and Complementarity in Development Aid: East Asian Lessons for African Growth. Tokyo: National Graduate Institute for Policy Studies.
——————————— (2008b). Proposal for a New African Growth Support Initiative. Policy Note No. 5. GRIPS Development Forum. Tokyo: National Graduate
Institute for Policy Studies.
Hausmann, R. and Rodrik, D. (2005). Self-Discovery in a Development Strategy for El
Salvador. Economia, vol.6, no.1, pp.43-101, Brookings Institution Press, Fall.
Hausmann, R., Rodrik, D., and Velasco, A. (2005). Growth Diagnostics. Mimeo. MA:
Harvard University, Kennedy School of Government.

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Khan, M. H. (2008). Governance and Development: The Perspective from Growthenhancing Governance. In GRIPS Development Forum (Ed.), Diversity and Complementarity in Development Aid: East Asian Lessons for African Growth (pp. 107152). Tokyo: National Graduate Institute for Policy Studies.
Kikuchi, T. (2008). The Quality and Productivity Improvement Project in Tunisia: A
Comparison of Japanese and EU Approaches. In GRIPS Development Forum (Ed.),
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Ohno, I. (Ed.). (2005). True Ownership and Policy Autonomy: Managing Donors andOwning Policies. GRIPS Development Forum. Tokyo: National Graduate Institutefor Policy Studies.
Ohno, I. and Shimamura, M. (2007). Managing the Development Process and Aid: East
Asian Experiences in Building Central Economic Agencies. GRIPS Development
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Ohno, K. (Ed.). (2006a). Industrial Policy Formulation in Thailand, Malaysia andJapan: Lessons for Vietnamese Policy Makers. Hanoi: Vietnam Development
Forum (English and Vietnamese).
———— (2006b). The Economic Development of Japan: The Path Traveled by Japan asa Developing Country. GRIPS Development Forum. Tokyo: National Graduate
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Asian Lessons for African Growth (pp. 37-61). Tokyo: National Graduate Institutefor Policy Studies.
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Ohno, K. and Fujimoto, T. (Eds.). (2006). Industrialization of Developing Countries:
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Shimomura, Y. (2005). The Role of Governance in Development Revisited: A Proposalof an Alternative View, FASID Discussion Paper on Development Assistance, no.5.
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Chapter 3
Avoiding the Middle Income Trap
Renovating Industrial Policy Formulation in Vietnam

Vietnam’s growth in the last one-and-half decades has been driven by the liberalization
effect and large inflows of external purchasing power. Now that the processes of systemictransition and global integration have deepened, Vietnam needs to create internal value tocontinue to grow and avoid the “middle income trap.” The country has reached the point
where growth towards higher income cannot be secured unless policy making is renovatedsignificantly to activate the country’s full potential. The vision of Industrialization andModernization to be achieved by 2020 must be backed by realistic industrial strategies andconcrete action plans, which are currently lacking. Stakeholder involvement in policy
design, inter-ministerial coordination, clear directives from the top, and incentive structure
for government officials must be improved. This in turn calls for radical changes in policy
administration. A new style of leadership, a technocrat team directly serving the top leader,and strategic alliance with international partners are proposed as key entry points for therenovation of Vietnam’s industrial policy formulation.

1. Entering a new era
The Vietnamese economy has grown rapidly with the average growthrate of 7.5% in 1991-2007. In 1990, Vietnam was among the world’s poorest
countries with GDP per capita of $98 (ADB data). By 2007, with the GDP per
capita of $835, Vietnam is swiftly approaching the status of a lower middle
income country by the World Bank classification method22. The growth has

22

The World Bank revises country classification annually. Based on the World Bank’s 2007 GNI
per capita data, the current classification is as follows: low income countries ($935 or less);
lower middle income countries ($936-$3,705), upper middle income countries ($3,706$11,455); and high income countries ($11,456 or more). Separately, the World Bank defines
IDA-only countries to be those with per capita income of less than $1,095 (using 2007 data) andlacking the financial ability to borrow from IBRD. IDA loans are deeply concessional but IBRD
loans are non-concessional. Due to inflation and overvaluation, Vietnam is likely to become a“middle income country” sooner than expected, in 2008.

61

Kenichi Ohno

been broad-based and touches virtually everyone’s life and generates profoundsocial changes in the entire country. This is quite different from the experiencesin Latin America or Sub-Saharan Africa where growth occurs in limited sectors
and benefits only few people while poor farmers see little improvement in theirlives. However, Vietnam’s achievements up to now have been driven mainly by
one-time liberalization effects and external forces associated with global integration rather than internal strengths. Despite impressive growth records andreform efforts in the last one-and-half decades, local firms remain generally
uncompetitive, and policies and institutions remain very weak by East Asianstandards.
From the mid 1980s to the mid 1990s, growth was stimulated by the
incentive and re-allocation effects of internal economic liberalization (doi moi).
Subsequently, from the mid 1990s to present, growth has been supported by
new trade opportunities as well as large inflows of foreign funds. Industrial
activities—especially manufactured exports-continue to be dominated by foreign firms, and value creation by local firms and workers has been limited.
Now that Vietnam is nearing the final stages of systemic transition and global
integration, productivity breakthrough is needed to climb further. Future growthmust be fueled by skill and technology rather than a mere injection of purchasing power.
Growth statistics presented in Table 1 are consistent with this interpretation. Until the mid 1990s, the incremental capital-output ratio (ICOR) was
low and the contribution of total factor productivity (TFP) to growth was high,which indicates that growth was achieved through improved efficiency-albeit
from a very low level of planning years-without much investment23. In the latter
period, ICOR rose, TFP’s contribution to growth declined, and capital’s contribution increased significantly. That is an indication of investment-driven
growth with low efficiency in capital use.
The “Washington Consensus” policy package prescribed by theWorld Bank and the IMF such as liberalization, privatization, legal reforms,
23

62

ICOR is computed as investment ratio (I/Y) divided by real growth (∆Y/Y). The higher the
ICOR, the more capital formation is required for growth (i.e., investment is inefficient). TFP isa broad definition of productivity calculated as residual growth after the increases in factor
inputs such as labor and capital are accounted for.

Avoiding the Middle Income Trap

Table 1. Vietnam: Summary of Growth Performance

1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007

Population(million)GDP(USD
billion)GDP per
capita
(USD)

66.0
67.2
68.5
69.6
70.8
72.0
73.2
74.3
75.5
76.6
77.6
78.7
79.7
80.9
82.0
83.1
84.2
85.2

6.5
7.6
9.9
13.2
16.3
20.7
24.7
26.8
27.2
28.7
31.2
32.7
35.1
39.6
45.4
52.9
60.9
71.1

98
114
144
189
230
288
337
361
361
374
402
415
440
489
554
637
723
835

Economic
size
relative to
ASEAN4
2.2%
2.4%
2.7%
3.3%
3.5%
3.9%
4.2%
4.9%
7.9%
6.9%
6.8%
7.4%
7.0%
7.0%
7.2%
7.6%
7.2%
...

Real
GDP
growth
(%)
5.1
5.8
8.7
8.1
8.8
9.5
9.3
8.2
5.8
4.8
6.8
6.9
7.1
7.3
7.8
8.4
8.2
8.4

Growth accounting (%)
Capital

Labor

TFP

6.6
8.4
13.0
41.5
39.0
39.9
36.4
54.9
64.1
62.2
47.4
59.9
44.2
72.1
61.5
59.8
57.1
59.5

43.9
16.9
14.5
21.6
18.5
16.2
1.5
16.0
18.6
17.4
13.8
20.6
27.7
43.7
21.9
16.4
14.3
14.8

49.5
74.7
72.5
36.9
42.5
43.9
62.1
29.1
17.3
20.4
38.8
19.4
28.2
-15.8
16.6
23.8
28.6
25.7

ICOR
3.31
2.92
2.23
3.25
3.14
3.12
3.34
3.80
5.59
6.59
4.80
4.89
5.01
5.09
4.91
4.68
4.88
4.90

Sources: General Statistical Office (GSO); Asian Development Bank Key Indicators (2008); For growthaccounting, Tran Tho Dat, Nguyen Quang Thang and Chu Quang Khoi, “Sources of Vietnam’s
Economic Growth 1986-2004,” mimeo, National Economics University (2005) for 1990-2004
and unofficial calculation by GSO’s SNA Department for 2005-2007. Continuity between thetwo is not guaranteed.

macroeconomic stability, and so on, may achieve middle income if they areproperly executed, but that is not enough for continued growth to higher
income. Vietnam’s growth pattern basically follows the past experiences ofEast Asian neighbors whose features include openness and regional integration
as an initiator of growth; deepening intra-regional trade and FDI; high savings
and investment; dynamic transformation of industrial structure; urbanization
and rural-urban migration; and growth-generated problems such as income andwealth gaps, congestion, pollution, financial bubbles, and so on. At the sametime, a number of new elements for Vietnam, such as faster integration than
ASEAN4, must also be acknowledged.
Within this dynamic East Asian context, Vietnam must successfully
conduct three crucial policies to sustain growth, namely: (i) generation of internal value; (ii) coping with new social problems caused by rapid growth; and63

Kenichi Ohno(iii) effective macroeconomic management under financial integration. The firstpromotes drivers of growth while the second and the third prepare political stability and social support without which industrialization and modernization cannot be sustained. By 2008, the risks of social problems such as traffic congestion and environmental destruction as well as macroeconomic imbalance suchas asset bubbles and price instability have become evident in Vietnam. Management of industrialization in this broad sense must be installed to face new challenges, or the entire process of industrialization may stall (Murakami 1992,
1994). While all three tasks are important, the present analysis focuses on thefirst issue of internal value creation while leaving the discussion of the remaining two to other occasions.

2. The middle income trap
A low income country which has gone through a war, political turmoil, socialist planning, or severe economic mismanagement is usually characterized by a fragile economic structure. It relies heavily on extractive resources,
monoculture export, subsistence agriculture, or foreign aid. Internal value created by traditional industries such as mining and agriculture is small, but theabsence of vibrant manufacturing activities makes them loom large in production and trade shares. This is stage zero on a long road to industrialization.
From the East Asian perspective, economic take-off starts with thearrival of a sufficient mass of manufacturing FDI firms that perform simple
assembly or processing of light industry products for export such as garment,
footwear, and foodstuff. Electronic devices and components may also be produced this way. In this early stage (stage 1), design, technology, production andmarketing are all directed by foreigners, key materials and parts are imported,and the country contributes only unskilled labor and industrial land. While thisgenerates jobs and income for the poor, internal value remains small and value
created by foreigners dominates. Vietnam’s industrialization up to now is basically characterized by this situation.
In the second stage, as FDI accumulates and production expands, thedomestic supply of parts and components begins to increase. This is realized
partly by the inflow of FDI suppliers and partly by the emergence of local sup-64

Avoiding the Middle Income Trap

pliers. As this occurs, assembly firms become more competitive and a virtuous
circle between assemblers and suppliers sets in. The industry grows quantitatively through the internal supply of physical inputs. Internal value creation
rises moderately, but production basically remains under foreign management
and guidance. Obviously, local wage and income cannot rise very much if allimportant tasks continue to be performed by foreign hands. Thailand andMalaysia have already reached this stage.
The next challenge is to internalize skill and knowledge by accumulating industrial human capital. Locals must replace foreigners in all areas ofproduction including management, technology, design, factory operation, logistics, quality control, and marketing. As foreign dependence is reduced, internal
value rises dramatically. The country emerges as a dynamic exporter of highquality manufactured products challenging more advanced competitors and reshaping the global industrial landscape. Korea and Taiwan are such producers.
In the final stage, the country acquires the capability to create new
products and lead global market trends. Japan, the United States, and somemembers of the European Union are such industrial innovators.
However, progress is not guaranteed for all. A large number of countries that receive too little manufacturing FDI stay at stage zero24. Even after
reaching the first stage, climbing up the ladders becomes increasingly difficult.

Figure 1. Stages of Catching-up Industrialization

Technology
absorption
Agglomeration

STAGE ONE
Simplemanufacturing
under foreign
guidance

Vietnam

STAGE TWO
Have supporting
industries, but still
under foreign
guidance

Creativity

STAGE FOUR

STAGE THREE

Full capability ininnovation andproduct design as
global leader

Technology &management
mastered, canproduce highquality goods

Japan, US, EU

Korea, Taiwan

Thailand, Malaysia
Glass ceiling for
ASEAN countries(Middle income trap)

65

Kenichi Ohno

Another group of countries are stuck in the second stage because they fail to
upgrade human capital. It is noteworthy that none of the ASEAN countries,
including Thailand and Malaysia, has succeeded in breaking through the invisible “glass ceiling” in manufacturing between the second and the third stage25. A
majority of Latin American countries remain middle income even though they
had achieved relatively high income as early as in the 19th century. This phenomenon can be collectively called the middle income trap.
East Asian growth performance has differed significantly in depth
and speed even among countries that are considered “successful.” There should
be a clear distinction among Taiwan and South Korea (high achievers),
Malaysia and Thailand (middle achievers), and Indonesia and the Philippines(low achievers). The first group is far ahead of the second or the third in termsof income and industrial capability.
Figure 2 shows per capita real income of selected East Asian
economies relative to the United States level. Until the mid 1960s, these
economies (except Japan) showed no clear sign of catching up. However, Taiwan and Korea, which started from equally low levels, took off in the late1960s and have improved income dramatically. In comparison, the catching up
of Malaysia and Thailand looks less impressive, and Indonesia and the Philippines failed to improve their positions vis-à-vis the United States. In addition,
there are economies which are not even on our radar screen-those that continue
to struggle at the bottom of income ladders such as Cambodia, Laos, Myanmar,
East Timor, Myanmar, and North Korea. Divergent performance comes fromdifferent speed of catching up rather than delayed starts (except Vietnam wherewars and socialist planning prevented economic take-off until the early 1990s).
ASEAN4 are taking much longer to reach the industrial capability that Taiwan
and Korea had achieved in the 1980s and 90s.
Low-income countries may receive FDI in mining, telecom, power, tourism, or property development. While such projects based on locational advantages are lucrative for investors and cangenerate jobs for the poor and provide basic infrastructure for the nation, these alone cannot put
the country on a dynamic path of structural transformation as manufacturing does.
25
Within ASEAN, the two small nations of Singapore and Brunei have achieved high income
through non-manufacturing industries (high-value services and oil and gas, respectively) and are
therefore beyond the scope of our analysis. Figure 1 illustrates manufacturing, especially assembly-type manufacturing such as electronics, automobiles, motorcycles, industrial machinery andprecision equipment which has played a key role in East Asia’s growth dynamism.
24

66

Avoiding the Middle Income Trap

Figure 2. Different Speed of Catching Up(Percent of US real income)

100%
Japan
80%

TaiwanS. Korea

60%

Malaysia
Thailand40%

Indonesia
20%

2005

2000

1995

1990

1985

1980

1975

1970

1965

1960

Vietnam
1955

1950

0%

Philippines

Sources: Angus Maddison, The World Economy: A Millennium Perspective, OECD
Development Centre, 2001; the Central Bank of the Republic of China; and IMF
International Financial Statistics (for updating 1998-2006).
Note: Per capita real income relative to the United States as measured by the 1990
international Geary-Khamis dollars.

Starting from a very low level, Vietnam is currently in the first stageof industrialization trying to reach the second in Figure 1. Large FDI inflows, anecessary condition for this transition, are already happening. Neighboring
ASEAN countries even fret about losing FDI to Vietnam. While Vietnam’s
short-term goal is the attainment of physical expansion of the industrial base, it
should also simultaneously prepare to avoid the middle income trap in the nextstage. For this, front-loaded and well-targeted policy action for upgradingindustrial human resources is the key.
In order to overcome the middle income trap, a developing country
needs to acquire capability to embrace an appropriate industrial vision andimplement effective measures toward it. Required action is more aggressive
than suggested by the Washington Consensus. Deregulation, privatization, integration, and providing a sound business environment are good enough up toStage 2 in Figure 1, but insufficient to improve skill and technology and break
the glass ceiling towards Stages 3 and 4. This is true even in the 21st century

67

Kenichi Ohno

when globalization has deepened and WTO rules and FTA proliferation havesignificantly narrowed the policy space of latecomer countries.
Even under the restricted policy space currently available, however, it
is possible to design and execute meaningful strategies to accelerate industrialization. For example, the promotion of supporting industries and industrial
human resources does not violate WTO rules at all. Measures to enhance infrastructure, logistics, industrial clusters, technology transfer, education and training, FDI marketing, SME finance, factory evaluators, industrial parks, and soon, are also permissible under the current international regime.
At the same time, it should also be recognized that the catching up of
latecomers is becoming increasingly difficult for the following three reasons.
First, because of forced early integration, they are not given temporary protection periods which were available to their predecessors. Second, today’s latecomers generally lack a strong private sector comparable to Japanese industrial
groups, Korean chaebols, or Chinese and Indian merchant networks. Third,
their governments are often without developmental orientation or sufficient policy capability. The last two can be regarded as weaknesses associated with thelosers’ bias. If they initially had a strong private sector and a good government,
they would have joined the flying geese much sooner and would not havestayed poor until now. How to overcome these latecomer problems in the early
21st century will be the topic of the remaining sections.
The point that developing countries must acquire skill and technology, rather than just offering factory space and cheap labor, can be stressed invarious ways. Four such arguments are presented below to make this point fromdifferent angles.
First, at the general level, it can be argued that the only way for acountry to remain competitive is to improve labor productivity faster than wage
increase. Competitiveness depends on the difference between the two, not on
the absolute wage level. Wage increase should be a boon to workers, and there
is no reason to fear it as long as productivity is improving in tandem. In thecontext of Vietnam, this point has consistently been made by Professor Tran
Van Tho of Waseda University since the mid 1990s. Under wage pressure,
Malaysia and China have already stopped inviting labor-intensive FDI projects
and turned to more “high-tech” investors. Vietnam is also experiencing rising68

Avoiding the Middle Income Trap

wages as a result of large concentration of labor-intensive FDI in some areas
such as northern Dong Nai as well as an inevitable response to the 2007-08
inflation. If wages begin to rise rapidly now, Vietnam may not have enoughlead-time to improve productivity.
Second, the concept of manufacturing plus plus, which governed
Malaysia’s Second Industrial Master Plan (IMP2) 1996-2005, is instructive
because it concisely states what middle income countries should do to climb up
to Stage 3 Manufacturing plus plus expresses the two dimensional desire fordomestic industries to (i) expand along the value chain to encompass higher
value-added activities; and (ii) uplift the whole value chain by raising productivity (Figure 3). Since Malaysia started industrialization as a conventional
assembler, which was the lowest point in the value chain, it wanted to master
R&D, design, product development, distribution, marketing, and so on horizontally, and improve the skills of all these activities vertically. In principle, this iswhat Vietnam—and all other latecomers—should do. IMP2 selected eightindustrial clusters to be thus strengthened: electronics and electricals, textiles
and apparel, chemicals, resource-based industries, food processing, transporta-

Figure 3. The Manufacturing ++ Strategy of Malaysia
Valuecreation

R&D Product Assembly & Distribution Marketing
design production

Source: Economic Planning Unit of the Prime Minister’s Department, Malaysia (re-drafted byauthor).

69

Kenichi Ohnotion equipment, materials, and machinery. However, Malaysia did not succeed
greatly in achieving this goal during the implementation period of IMP2 (Ohno
2006).
Third, the Japanese concept of monozukuri, which literally means“making things,” may give some hints on the direction to go. Monozukuri is
manufacturing for the primary purpose of achieving customer satisfaction
through high quality in the spirit of a proud and dedicated artisan, rather thanjust making profits. To achieve this, long-term relationship and internal accumulation of skill and knowledge are institutionalized within each company aswell as among partner companies (between assemblers and suppliers, for example). Practical means of productivity improvement such as 5S, QCD26, kaizen,
just-in-time method, and quality control circles have been established and available to companies in the developing world through experienced instructors andmanuals. In the policy realm, the concept of monozukuri is often highlighted by
the Japanese government for the purpose of upgrading domestic manufacturing
capability and spreading the Japanese business model abroad (Tsai, 2006).
Fourth, the theory of business architecture advanced by Takahiro
Fujimoto and his research team at the University of Tokyo elaborates how firms
in developing countries can form strategic alliance with Japanese manufacturing firms (Fujimoto, 2004, 2006; Fujimoto and Shintaku, 2005). According tothis theory, business models can be divided into two broad categories: modular
and integral. Modular manufacturing is characterized by easy assembly of globally common parts and components (for example, a desktop computer) while
integral manufacturing features unique design of parts and components for eachmodel based on long-term collaboration among assemblers and suppliers (forexample, a passenger car). The former is suitable for realizing quick profits
under flexible combination of outsourced business components while the latter
permits a continuous pursuit of high quality over time. Fujimoto argues that the26

70

The 5S is the most elementary yet important way to improve production efficiency by keeping
the factory tidy and well organized. Its elements are seiri, seiton, seiso, seiketsu, and shitsuke,
which roughly mean remove unnecessary things, arrange tools and parts for easy view, keep thework place clean, maintain personal hygiene, and behave with discipline. Meanwhile, QCD
means Quality, Cost and Delivery (zero defects, cost reduction, and on-time delivery without
failure). Japanese manufacturing firms recognize them as the general source of competitivenessas well as the criteria for selecting business partners and subcontractors.

Avoiding the Middle Income Trap

United States and China are appropriate production partners because they bothpractice modular manufacturing. Meanwhile, Japan is an integral producer
without an effective international partner. For developing countries, integral
manufacturing is harder to learn but eventually more rewarding as production
technology is internalized rather than outsourced. While none of the ASEAN
countries has acquired sufficient skill and technology for integral manufacturing, Fujimoto regards Thailand and Vietnam as likely candidates for Japan’s
future monozukuri partner provided that they level up their internal capability(Fujimoto and Ohno, 2006).
While the Malaysian experience or the Japanese business theory may
not fit every country, they point clearly to the importance of internal value creation through skill and technology and the existence of concrete strategies andmethods to attain it.

3. Policy vision and orientation
In high performing economies in East Asia, industrial policy has usually taken a goal-targeting form. The top government leader launches a longterm national vision which shows a general direction without specifying details.
To realize this, appropriate government organizations are designated or newly
created to draft feasible strategies and execute concrete action plans. Actionplans may take the form of readable documents and matrices or may remain aprocess without such documentation. Strategies and action plans may be revised
as circumstances change, but the long-term vision remains intact.
Japan in the 1960s had the goal of doubling income within the decadeas well as competing effectively with Western multinationals as trade barriers
were lifted. The Ministry of International Trade and Industry (MITI) together
with the Japan Development Bank coordinated and assisted private efforts inimproving productivity. In Malaysia, Vision 2020, an aspiration to become a“fully developed country” by 2020 set by former Prime Minister Dr. Mahathirin 1991, remains the overarching goal. The Economic Planning Unit (EPU) of
the Department of the Prime Minister directs national effort to concretize thisvision under a system of overlapping policy documents and cascading organizations27. Thailand under Prime Minister Thaksin Shinawatra (2001-2006) put up

71

Kenichi Ohno

industrial visions which were both ambitious and ambiguous, such as becoming
the “Detroit of Asia,” the “Hub of Tropical Fashion,” or the “Kitchen of theWorld,” while leaving the details to be worked out among relevant ministries,
private businesses, and experts. For execution, industry-specific committees
and industry-specific institutes were established, and the private sector additionally had direct access to the prime minister when necessary (Ohno, 2006).
This policy formulation method, which has been the hallmark of successful East Asian development policies, can be summarized as working backwards from broad goals to phased strategies and concrete action plans, while
making necessary adjustments and accumulating experience and confidencealong the way. This pragmatism, which we prefer to call Dynamic Capacity
Development, allows the gradual building of policy capability as concrete problems and challenges are encountered over time.
At the beginning of industrialization, most East Asian countries had
weak governments. In 1960, the Korean civil service was widely viewed as acorrupt and inept institution (World Bank, 1993). Similarly, in 1959, Thailand
was given a low mark for the absence of investment planning and an acuteshortage of qualified personnel (World Bank, 1959). But through trials anderrors and learning by doing, their administrative capacity has greatly
improved. This hands-on approach is in sharp contrast to the current global aid
practice, such as the good governance drive28, where all countries are urged tocorrect their weaknesses ex ante relative to some international norm without
reference to any concrete national goal and before formulating a specificgrowth strategy.
From this perspective, Vietnam’s industrial vision leaves much to be

Dr. Mahathir advanced nine general challenges without further elaboration: national unity, confidence, democracy, moral and ethics, tolerance, science and technology, caring culture, economic justice, and prosperity. To achieve this, Malaysia drafts multiple layers of policy documents such as industrial master plans (Ministry of International Trade and Industry), Outline
Perspective Plans (EPU), and Malaysia Plans (i.e., five-year plans, EPU). Under MITI, special
agencies such as MIDA (FDI policy), SMIDEC (SME promotion), MATRADE (trade), andMPC (productivity) have been established.
28
The World Bank’s Worldwide Governance Indicators (WGI) consist of six dimensions: voice
and accountability, political stability, government effectiveness, regulatory quality, rule of law,and control of corruption. Each country is evaluated and ranked annually according to these criteria.
27

72

Avoiding the Middle Income Trap

desired. Vietnam already has a long-term vision of attaining industrializationand modernization by 2020. The ambiguity of this vision does not worry us toomuch as with the case of Dr. Mahathir’s 2020 vision or Mr. Thaksin’s call forbecoming the Detroit of Asia. However, the problem with Vietnam is the lackof proper strategies, action plans, and institutions to follow up on this vision.
The present administrative system does not permit necessary policies to be
drafted and implemented.
It is essential that Vietnam formulate as soon as possible a clear
roadmap of industrialization to inform and guide its people, investors, and policy makers. It should outline a strategic path towards the 2020 vision backed by
concrete action plans. Vietnam should declare, among other things, its strong
resolve and clear plan to secure an important position in the East Asian production network. It should affirm that the private sector, not the state or stateowned conglomerates, should be the agent of production and investment; thatgrowth should be driven by the skill, technology, and hard work of the Vietnamese people; that openness and the market mechanism are defended as a matter of principle; and that the state will actively support and coordinate the private sector without dictating its business plans; Policy orientation in the areas ofsavings mobilization, financial development, usage of foreign resources,
income gaps and other emerging social issues, and sectors under external competitive pressure should be clarified.
At present, Vietnam does not have an overall industrial master plan.
The industrial chapters of the Five-year Plan and the Ten-year Strategy do notoffer a consistent industrial vision. As a result, many important policy questions
remain unanswered, including the future roles of SOEs, private firms, and FDI,
respectively; the choice between export orientation and import substitution
under deepening integration; and the scope and extent of official support toemerging as well as declining industries. Sectoral master plans for steel, automobiles, motorcycles, electronics, textile and garment, and so on, are being
drafted and approved without overarching principles at a higher level. Private
investments and official aid pour in without knowing exactly where Vietnam isheaded in the coming decades. In this connection, it should be noted that somecountries, with much lower income levels than Vietnam, already have industrial
visions and action plans which are more consistent and far detailed than those73

Kenichi Ohno

of Vietnam29.
One of the issues in promoting a mechanical industry under globalization is the choice between direct and indirect promotion (infant industry promotion versus FDI-led industrialization). Malaysia established Proton, a national
car company, in 1983 and supported it with heavy subsidies and protection.
Starting from the knock-down production of Mitsubishi Lancer, Proton subsequently internalized capability in styling and design, platforms, engines, logistics, marketing, and so on. By 2005, Proton had become the largest supplier ofpassenger cars in Malaysia with the domestic market share of over 40% and
286 local suppliers producing its parts. However, as globalization deepened, it
became apparent that Proton’s production volume was too small and technology
not high enough to compete with global giants from Japan, Korea, EU, and theUS, and it also began to lose the domestic market as foreign models invaded.
The strategy of internalizing capability under strong official support has hit athick wall. By contrast, Thailand created a relatively free environment for FDI
car makers to achieve large production volume, quality, and even exports. By
not insisting on national brands, it succeeded in creating the largest automotive
cluster in Southeast Asia. However, Thailand’s problem is the slow pace ofdomestic capacity building and the continued dominance of foreign design andtechnology.
Vietnam has not clearly stated whether or how it wants to promote
such industries as automobiles, audio-visual devices, home electronics, andgeneral machinery. Under the current situation in which discriminatory measures are no longer permitted under WTO rules, refraining from supporting such

29

74

Ethiopia, one of the poorest countries with the per capita income of $160 in 2007, establishedthe vision of Agriculture Development Led Industrialization (ADLI) in 1991. Its contents arefurther specified in the Ethiopian Industrial Development Strategy (2003) and other sectoral
strategies. This industrial strategy asserts the leading role of the private sector, agriculturaldevelopment as the source of industrialization, export-orientation, importance of labor-intensive
sectors, the need for strong state guidance, and so on. Prioritized sectors are meat, leather andleather goods; textile and garment; agro processing; construction; and micro and small enterprises. The master plans for leather products and textile and garment have been drafted and arebeing implemented with the help of UNIDO, GTZ, USAID, and other donors. The monthly
Export Steering Committee reviews the performance of key industries, and the Ministry ofTrade and Industry regularly talks with firms, industrial associations, and national and regional
chambers of commerce. Involvement of the private sector is further activated by the enhanced
Public-Private Forum.

Avoiding the Middle Income Trap

industries and letting the market decide their fate is one option. But if the Vietnamese government wants to promote them, it must do some serious thinking to
see what are realistic goals and what strategies and action plans can be adopted
without violating international commitments.

4. Policy making procedure and organization
Vietnam’s failure to produce effective industrial strategies and actionplans comes mainly from the structural weaknesses in policy making. Vietnam’s policy formulation is saddled with the legacies of planning days and cannot cope effectively with problems in the age of global competition. After thegrowth bout of the 1990s and the early 2000s driven by economic liberalizationand large capital inflows, Vietnam has reached the point where further progress
towards higher income is increasingly difficult without a radical reform in policy formulation procedure and organization.
The problems associated with Vietnam’s industrial policy making aremany. However, instead of presenting a long list of problems, we will highlightjust two procedural problems and two organizational problems which are interrelated and constitute the main sources of formalism and the general lack of
creativity and responsiveness in policy making. These problems are unique toVietnam in the sense that they are not observable in East Asia’s other high performing economies30.
The most serious procedural problems in designing and executing
industrial strategies and action plans are the lack of involvement of the business
community and the lack of inter-ministerial coordination, which together renderapproved policies ineffective and even unimplementable. In any developing
country, policy implementation is a big challenge due to shortages of budget,
human resources and proper mechanisms. However, the proportion of unimplemented policies in Vietnam is exceptionally high not only in industrial matters
but also in other policy areas. It can even be said that very few policies are actu30

In 2005 and 2006, the Vietnam Development Forum (VDF) and Vietnam’s Ministry of Industry(MOI) organized joint research missions to Thailand, Malaysia and Japan to study the design,
implementation and monitoring of industrial policies of respective countries. For missions’ findings, see Ohno (2006).

75

Kenichi Ohno

ally implemented as stipulated in Vietnam because of delays in preparing“implementation details;” the non-provision of necessary budget, personnel orequipment; the lack of support from the business community; and the lack ofability or interest among responsible ministries to solve these problems31.
The policy making process in Vietnam is closed within the government with little involvement of other stakeholders. Within each ministry, anorder to draft a master plan is handed down to a drafting team, which normallyconsists of a middle-ranking official supported by a few experts in the ministry.
The team collects internal data and data from other ministries, and may commission additional analyses to experts in other ministries or research institutes.
The budget for each master plan is fixed by an inter-ministerial circular andused mainly for securing external data and analyses as well as conducting
domestic travel, interviews and hearings. The master plan is drafted internallyby the team members and submitted to the minister or the vice minister incharge for internal review. After that, it is circulated among relevant ministries
for comment (which is rarely substantive) and then submitted to the prime minister for final approval. Significant delay may occur at internal review or final
approval. Requests for revision are also common. In this process, debates on thefundamental direction or crucial issues rarely take place. The drafting team isroutinely overworked with a large number of master plans to finish each year,
which does not allow sufficient time (or money) to think creatively, interact
with non-government stakeholders, or publicize the final result. Approved master plans are neither translated into English nor uploaded for dissemination
although summary versions for the prime minister’s approval, in the Vietnamese original, are usually available on the web.
If a domestic or foreign firm wants to raise its voice, it must devise its
own way since the current procedure does not allow meaningful involvement of
the business community. Although enterprise hearings are becoming more popular in recent years, sufficient details of the master plan draft are not revealed atsuch hearings and enterprises therefore can only make general requests. If a
firm later finds certain points in the master plan objectionable (for example,
31

76

In response to the protestation by FDI firms about certain parts of an industrial master plan, an
official who drafted it reassured them that there was no need to worry because master plans in
Vietnam were not implemented.

Avoiding the Middle Income Trap

demand forecasts, taxes and import duties, numerical targets for production orexport, designation of producers for certain products, and so on), it needs toseek meetings with responsible ministries, use symposiums and media to makethe point, or write a letter to the prime minister, to request a change in thealready approved policy. This situation is in sharp contrast to Malaysia, where
private sector participation is institutionalized as members of the steering committee and task forces in drafting the Industrial Master Plan; Thailand, where
the private sector decides targets and action plans and the government merely
accepts them; or Japan, where business decisions on technology, products,
investment and so on are left to individual firms and the government provides
only supplementary services such as trade negotiation and setting standards for
quality, safety, environment, and industrial property (Ohno, 2006).
Another procedural problem is the absence of inter-ministerial coordination on policy substance as well as implementation details, which in turncomes from the lack of mechanism to force different ministries to work together. Compartmentalization of the government along ministerial lines is a common problem around the world, but most governments manage to somehow
ameliorate it. One solution is to have a strong top leader with a good economic
mindset who directs various ministries and becomes the hub of policy making
himself. In this case, policy components become mutually consistent eventhough ministries still fail to talk to each other (Thailand under Thaksin Shinawatra, 2001-06; Ethiopia under Meles Zenawi, 1991-present). Another way is
to establish a powerful technocrat team directly serving the president or theprime minister which makes key policy decisions while ministries become executing agents of the plans emanating from this team (South Korea’s Economic
Planning Board, 1961-1994; also see below). Still another way is to let a superministry, with sufficient policy authority and instruments at its disposal, leadindustrial policy making and be responsible for it (Japan’s Ministry of International Trade and Industry in the 1960s). Finally, it is also possible to install amechanism to guarantee the representation of all relevant ministries and nongovernment stakeholders in the official drafting process as well as in informal
exchange (Malaysia’s drafting of the Industrial Master Plan at present). In Vietnam, though all policy documents specify a leading ministry and a list of related
ministries, the mechanism to make them work as one is entirely missing.

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We can go deeper to see why it is difficult to ensure involvement of
non-government stakeholders and inter-ministerial coordination. Behind these
problems lie fundamental issues in policy making organization. The most serious ones in this regard are the lack of clear directives from the top and the distorted incentive mechanism among government officials that causes brain
drain.
It is well known that Vietnam’s decision making is based on consensus. Checks and balances are in place horizontally (across ministries and departments), vertically (between central and local levels) and geographically (North,South, Middle and remote areas). There are three top national leaders and theParty and the Government interact in a complex manner. This system can produce stability and continuity but it is not suitable for staging bold reforms or
responding quickly to the changing world. Policies remain mostly reactive
rather than pro-active. Development effort centered on a clear roadmap towards
a national vision with concrete strategies and action plans, which is the hallmark of East Asian industrialization, is missing in the Vietnamese policy
process.
The Vietnamese government copes with urgent issues—be it inflation
or traffic jam—in a bottom-up fashion and without a clear focal point of leadership or responsibility. When a serious problem is identified, an inter-ministerial
committee is called and its chair is appointed. Each ministry proposes solutions
from its perspective, which are summarized into general policy recommendations without execution details. Bureaucracy can supply broad ideas touching
every aspect of the problem, but it does not lead to prioritization or selectivity
for real action. This approach must be supplemented by a person or an organization that decides on a short list of actions and sequencing of measures among
many proposals. There should be an interaction between the high level and theimplementing level of the government to produce policies which are both realistic and sharply focused.
Another problem which is common in many countries and also
becoming highly visible in Vietnam is the decline of quality and morale among
government officials, prompting an exodus of talented people to other sectors.
Vietnam’s public service must overcome the problems of overstaffing, lowsalary, prevalence of second jobs, formalism, rigidity, nepotism, corruption,

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relation-based promotion, and ODA-related benefits (foreign travel, training,
benefits associated with supervising aid projects, etc.). These were the legaciesof the subsidy system existing up to the 1980s, where the public sector was theprovider of jobs, minimum income and social security for all and where noalternative employment opportunities were available in the private or foreign
sectors with far more attractive salaries and rewarding duties. Under the present
circumstance of market orientation and global integration, the public sector
only attracts people who want stability, people who genuinely believe in theimportance of public service, or people who want to take advantage of official
privileges to study abroad or receive training as a stepping stone to a better-paying job in the future. As a result, highly qualified and motivated people are
becoming difficult to recruit or retain.
This problem cannot be solved by minor repairs or ad hoc adjustments. ODA-supported training programs of government officials may only
worsen the brain drain without raising the average level of official competency.
To reverse the hollowing-out of the Vietnamese government, far reachingreforms to completely remake the public administration is needed as soon as
possible. This should encompass, among others, a significant down-sizing of
the public sector through leaner organization, forced retirement, and outsourcing of non-essential services; a competitive and transparent recruitment system;a higher and performance-based salary schedule and promotion linked to transparent personnel evaluation; and clear rules regarding the conduct of public servants and their interaction with citizens, businesses, and service providers.
Obviously, these are not easy because of the magnitude of required tasks andpolitical resistance. But they are also absolutely necessary for Vietnam to move
forward. Vietnam’s public administration lags far behind other successful
economies in the region such as Singapore, Malaysia, and Thailand. It should
also be mentioned that the initiative for such reforms must come from the top
rather than the bottom. No bureaucracy can transform itself so radically without
the order from a strong leader.

5. How to break a solidified system
To propose a solution is one thing. To carry it out is quite another.

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Even if Vietnam knows the best policy formulation procedure and organization,
how can it make sure that they are actually adopted?
According to comparative institutional analysis, a branch of institutional economics that relies heavily on evolutionary game theory, a society may
get stuck in a bad equilibrium owing to institutional complementarity, strategic
complementarity and path dependence (Aoki 2001a, 2001b). Institutional complementarity means that any social system has resilience to shocks because its
institutional components enhance each other. For example, Vietnam’s education, recruitment, salary and promotion systems are mutually complementary to
produce relation-based rent sharing. Strategic complementarity means that individuals in such an institutionally solidified society have little incentive to deviate from the dominant behavior. Finally, path dependence underscores theimportance of the beginning. Once installed by chance or design, any social
system requires a large amount of political and social energy to change it.
Together, these concepts point to institutional inertia and difficulty of reforming
any established system.
Policy impasse arises when an inefficient method of policy formulation is set up and then solidified, and institutional components and people’s attitude to support it have formed. Removing one person or reforming one organization does not improve the situation because of institutional and strategic complementarities mentioned above. Changing the policy formulation method in afundamental way, as proposed by this paper, will surely require enormous energy and meet fierce resistance.
However, this does not mean that there is no way out. There are times
when a social system jumps to another social system. Comparative institutional
analysis suggests the following occasions and agents of change.
(i) Collective mutation—a large number of people inside a society may
mutate simultaneously, as if their DNA has changed. If only a few people behave differently, they are simply called “crazy” or “silly” and thesystem remains unchanged. But a sufficiently large mass begin to behave
differently, institutional and strategic complementarities of the old typestop working and rules and customs start to change. This is a spontaneous and internally driven change, which may occur when a large number of people feel suppressed or victimized under the existing system. In

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a rapidly growing economy, this may also happen when a generation
with new values and behavioral patterns grow up, or when people begin
to have new demands and expectations from the government as a resultof successful development and higher income. A small incident may trigger a large social movement by letting accumulated public discontent tocome to the open.
(ii) Foreigners—foreign governments, firms and individuals follow different
systems and are not bound by the behavioral code of the domestic society. They bring and sometimes even force new elements, which causes
friction and inconsistencies with the indigenous system. In low income
countries, bilateral donors and international organizations are particularly
powerful. Foreign firms and investors as well as international migrationand human exchange may also produce foreign pressure on a society. If
this prompts a change in a direction that generates healthy development,such pressure is highly welcome. However, not all foreign influences aregood from the viewpoint of social evolution. For this reason, the government must guide and coordinate foreign pressure to prevent undesirable
changes.
(iii) Policy—even without domestic or foreign pressure, the government as
deux ex machina can start a change from inside the system by introducing policies that upset existing calculations and complementarities. Herethe key question is who will activate such policies. As noted before, it isextremely difficult for bureaucrats to initiate a bold reform. Their power
within the government is miniscule compared with enormous institutional and strategic complementarities they face. Drastic policy shifts areusually introduced when a new, strong top leader comes to power. Leadership equipped with strong will and economic literacy is crucial for thisto succeed. When such leadership skillfully and strategically aligns withforeign partners who want go in the same direction, even a very boldreform becomes possible.
In view of these theoretical implications, let us identify three playersthat may make institutional reforms possible in the Vietnamese context. They
are leadership, the technocrat team, and foreign partnership.

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Leadership
Crucial importance of leadership is made sufficiently clear in the discussions above. Leadership is the prime force of change while other necessary
conditions can be created or reshaped by the leader if they do not already exist.
In countries with advanced political systems, policy initiative can also emerge
from various domestic groups such as civil society organizations, intellectuals,
interest groups, and political parties because legal mechanisms to capture andreflect their opinions are firmly in place. However, in developing countries
where political systems are less well developed, only a small number of channels of effective participation are available. For all practical purposes, initiative
for bold change in these circumstances must come from the top leader. Whensuch leadership is combined constructively with the aspiration of domestic
groups and foreign pressure, reforms become possible. For the leader to playproper roles in development, it is not always necessary to change the existing
political regime or expending social energy to change it. The Vietnamese political regime at present is flexible enough to allow a strong leader with politicalsavvy to emerge and orchestrate policies.
The technocrat teamIn high performing economies of East Asia, the existence of a technocrat team directly under the top leader (the president or the prime minister) has
played a crucial role. This team is created from the brightest officials from various ministries as well as the smartest returnees who have studied or taught
abroad. Prominent business leaders with strong policy mindset may also bemobilized. The team receives full confidence and responsibility from the top
leader to concretize the policies that this leader envisions. It also acts as thecommand post for all ministries which are obliged to implement the policies
that this team drafts. It acts as the nation’s brain for development without whicheven excellent leaders cannot function. The Economic Planning Board in South
Korea, the Kuomintang technocrats in Taiwan, the Economic Planning Unit
(EPU) in Malaysia, the National Economic and Social Development Board(NESDB) in Thailand, the so-called Berkley Mafia in Indonesia, and the
National Economic Development Authority (NEDA) in the Philippines, allaimed to fill this need at certain critical points in their economic development

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with varying degrees of success. Japan’s Ministry of International Trade andIndustry (MITI), although being one of the ministries rather than above all ministries, also operated effectively to strengthen the competitiveness of Japanesemanufacturing industries in the high growth period of the late 1950s and the1960s.
Vietnam also had the Prime Minister’s Research Commission(PMRC) until recently, but it was an advisory group rather than a central policy
making body entrusted with the power to lead the entire government. Its
responsibility was too weak and its members were experienced but perhaps tooold. Nor does Vietnam have a super-ministry such as Japan’s MITI to centrally
coordinate development effort; the Ministry of Planning and Investment (MPI)
is not strong enough in terms of authority, capability and policy instruments toundertake this task. It is strongly suggested that Vietnam create a new dynamic
technocrat team within the government as a focal point of policy making
authority and responsibility. In its design, experiences of other East Asian countries, with necessary modifications, should be referenced. Vietnam needs such ateam at least for the next few decades to climb to higher income and cope withgrowth-generated problems and instabilities.
Foreign partnership
Vietnam’s foreign policy shifted dramatically in the early 1990s when
the close ties with the Soviet bloc were replaced by multi-directional diplomatic
relations and re-integration into the global economy. Since then, interaction
with foreign actors has exerted indirect and subtle influences on Vietnam’s
development orientation although the Vietnamese government never allows foreigners to take the driver’s seat (I. Ohno, 2005). Bilateral and multilateral
donors have registered their desire to see faster reforms and more administrative transparency and efficiency on such occasions as the semi-annual consultative group (CG) meetings, comments on the Five-year Plan and the Ten-year
Strategies, policy dialogue for the Comprehensive Poverty Reduction and
Growth Strategy (CPRGS) and the Poverty Reduction Support Credit (PRSC),
and so on. Foreign businesses also have pressed the government to improve thelegal and policy framework, the tax and import duty system, and other businessrelated matters through the Vietnam Business Forum, government-business dia-83

Kenichi Ohno

logue, trade fairs, and symposiums. As Vietnam graduates from the status of a
low income transition country into the status of an industrializing middle
income country, the focus of foreign concern should also shift from the removalof the negatives to the creation of Vietnam’s unique strengths.
As the leading economy in East Asia, Japan has also contributed significantly to Vietnam’s development through trade, investment, aid, and humanand knowledge exchange. Japanese businesses and officials are particularly

Table 2. Vietnam-Japan Bilateral Policy Dialogue for Industrial
Competitiveness
ProgramIshikawa Project (Studyon the Economic
Development Policy in
the Transition toward a
Market-oriented
Economy in Vietnam)

PeriodPrincipal
actor(s)Content

Joint research on macroeconomics,
finance, agriculture, industry, integration,
1995-2001
currency crisis, SOE reform, PSD; based
MPI-JICA(3.5 phases)on the principle of country ownership andmutual respect, with emphasis on longterm real sector issues.
Quick disbursing loan (20 billion yen)
New Miyazawa Initiativewith conditionalities in PSD, SOE(Economic Reform
1999-2000
JBIC
auditing, and tariffication of non-tariff
Support Loan)barriers. Action plans in PSD weremonitored and evaluated.
Bilateral agreement and implementation
Vietnam-Japan Jointof concrete action plans which were
Initiative to Improve
2003-2009
monitored and reported to high-level,
Business Environment(3 phases,
MPI-4J
with focus on removal of FDI/businesswith a View toongoing)
impediments, strengthening of local
Strengthen Vietnam’s
capabilities, and drafting of missing
Competitivenessindustrial strategies.
Analyses by Vietnamese and Japaneseexperts as inputs to the drafting of the
Joint Work between
Five-year Plan 2006-2010, with attention
Vietnam and Japan toon industrial policy formulation andStrengthen the2004
MPI-4J
competitiveness issues of individual
Competitiveness ofVietnamese Industries
industries (automobile, electronics,
supporting industries, etc.)
Joint
Drafting of master plan following new
Working
content and method, with active
Joint drafting ofGroupparticipation of large motorcycle
Motorcycle Master Plan
2006-2007(MOI, VDF, assemblers and interaction with other
under MOI and VJJI2
producers, stakeholders; VDF serving as facilitator.
experts)
Master plan approved in August 2007.
Build strategic partnership formonozukuri (high-skill manufacturing)
Vietnam-Japan(Under(To bewith Japan transferring its know-how to
Monozukuri Partnershippreparation)
decided) Vietnam. Action plans for supportingfor Supporting Industries
industry promotion to be implemented
with joint effort.

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interested in bolstering Vietnam’s industrial competitiveness and have initiateda number of bilateral programs to this end. They include the building of infrastructure especially in power and transportation, education and training ofindustrial human resources, and a series of action-oriented bilateral policy dialogues (Table 2).
These bilateral dialogues aim to improve Vietnamese policies where
Japan has particular interest or comparative advantage. At the same time, they
have the additional purpose of institutionally correcting the weaknesses of Vietnam’s policy formulation by introducing new procedures and organizations. For
example, concrete action plans are bilaterally agreed and rigorously monitored
to prevent non-implementation (the New Miyazawa Initiative, the VietnamJapan Joint Initiative, and the proposed Vietnam-Japan Monozukuri Partnership). Inter-ministerial cooperation is ensured by making the leading ministry,
typically MPI, responsible for the participation of all other ministries (theIshikawa Project, the Vietnam-Japan Joint Initiative, and the proposed Vietnam-Japan Monozukuri Partnership). Active involvement of non-government
stakeholders (especially major manufacturers) was enforced throughout thejoint drafting process of the Motorcycle Master Plan—perhaps for the first timein Vietnam’s master plan drafting. Japanese officials and businesses are wellaware of the structural shortcomings of Vietnam’s policy making, and they arewilling to spend time and energy to work with the Vietnamese side to solve
them, without which they know their dialogue will not lead to meaningfulactions.
These policy dialogues have so far been initiated mainly from theJapanese side. It is suggested that the Vietnamese government should be more
pro-active in reforming its policy formulation and inviting Japan (and othercountries) to participate in the effort.

6. Concluding remarks
While Vietnam’s past achievements as a developing and transition
country are great and many, this paper has focused on the future and offeredcandid evaluation and advice so that Vietnam might develop its potential to thefullest extent. I trust that the Vietnamese people and government are not satis-

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fied by merely achieving MDGs or stopping at middle income. Their aspirationmust be set higher, and it is surely attainable if the nation clearly identifies its
present shortcomings and squarely faces its challenges. The key message of thispaper can be summarized as follows.
Vietnam has reached the point where further progress towards higher
income can be secured only if internal value creation is enhanced. This calls forproper government action, rather than laissez-faire, to guide and complement
private sector dynamism and avoid the middle income trap. To improve policy
quality, Vietnam needs to change the policy formulation process. This in turnrequires a radical change in the public administration system. The scope andsequencing of reforms must be chosen carefully to minimize the political andsocial energy needed to change the system while maximizing their positive
impacts. Enlightened and strong leadership, a new technocrat team, and strategic partnership with foreigners have been proposed as effective starting points
that satisfy these conditions.

References

Aoki, M. (2001a). Information, Corporate Governance, and Institutional Diversity:
Competitiveness in Japan, the USA, and the Transitional Economies. Oxford:
Oxford University Press.
———— (2001b). Toward a Comparative Institutional Analysis. Cambridge, MA: MIT
Press.
Fujimoto, T. (2004). Nihon no Monozukuri Tetsugaku [Japan’s Monozukuri Philosophy]. Tokyo: Nihon Keizai Shimbunsha.
————— (2006). Architecture-based Comparative Advantage in Japan and Asia. In
K. Ohno and T. Fujimoto (Eds.), Industrialization of Developing Countries: Analyses by Japanese Economists (pp. 1-10). Tokyo: National Graduate Institute for Policy Studies.
Fujimoto, T. and Shintaku, J. (2005). Architecture-based Analysis of Chinese Manufacturing Industries. Tokyo: Toyo Keizai Shimposha.
GRIPS Development Forum. (2002). Japan’s Development Cooperation in Vietnam:
Supporting Broad-based Growth with Poverty Reduction (English, Japanese, and86

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Vietnamese). Tokyo: National Graduate Institute for Policy Studies.
Ichikawa, K. (2005). Building and Strengthening Supporting Industries in Vietnam: A
Survey Report. In K. Ohno and N. V. Thuong (Eds.), Improving Industrial Policy
Formulation (pp.95-112). Vietnam Development Forum. Hanoi: The Publishing
House of Political Theory.
Motorbike Joint Working Group. (2007). For Sound Development of the Motorbike
Industry in Vietnam. Hanoi: Publishing House of Social Labor (English and Vietnamese).
Murakami, Y. (1992). Han Koten no Seiji Keizaigaku [Anti-classical Political Economy], vol.2. Tokyo: Chuo Koronsha. English translation by Kozo Yamamura, AntiClassical Political Economy, Stanford University Press (1996).
—————— (1994). Han Koten no Seiji Keizaigaku Yoko: Raiseiki no tameno Oboegaki [Outline of Anti-classical Political Economy: A Memorandum for the Next
Century]. Tokyo: Chuo Koronsha. English translation of chapter 6 in K. Ohno and
I. Ohno (Eds.), (1998).
Thuy. N. T. X. (2007). Supporting Industries: A Review of Concepts and Development.
In K. Ohno (Ed.), Building Supporting Industries in Vietnam, vol.1 (pp. 27-50).
Hanoi: Vietnam Development Forum.
Ohno, I. (Ed.). (2005). True Ownership and Policy Autonomy: Managing Donors andOwning Policies. GRIPS Development Forum. Tokyo: National Graduate Institutefor Policy Studies.
Ohno, K. (Ed.). (2006). Industrial Policy Formulation in Thailand, Malaysia and Japan:
Lessons for Vietnamese Policy Makers. Hanoi: Vietnam Development Forum (English and Vietnamese).
———— (Ed.). (2007). Building Supporting Industries in Vietnam, vol.1. Hanoi: Vietnam Development Forum (English and Vietnamese).
———— (2008a). The East Asian Growth Regime and Political Development. In GRIPS
Development Forum, Diversity and Complementarity in Development Aid: East
Asian Lessons for African Growth (pp. 37-61). Tokyo: National Graduate Institutefor Policy Studies.
———— (2008b). Vietnam-Japan Monozukuri Partnership for Supporting Industries:
For Leveling Up Vietnam’s Competitiveness in the Age of Deepening Integration.
Hanoi: Vietnam Development Forum. (This document was translated into English
and inserted as Chapter 4 in this book.)87

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Ohno, K. and Ohno, I. (Eds.). (1998). Japanese Views on Economic Development:
Diverse Paths to the Market. London and New York: Routledge.
Ohno, K. and Fujimoto, T. (Eds.). (2006). Industrialization of Developing Countries:
Analyses by Japanese Economists. Tokyo: National Graduate Institute for Policy
Studies.
Tsai, M. H. (2006). The Myth of Monozukuri: Manufactured Manufacturing Ideology.
ITEC Working Paper Series 06-04, Doshisha University.
Vietnam Development Forum (VDF). (2007). Supporting Industries in Vietnam from the
Perspective of Japanese Manufacturing Firms. In K. Ohno (Ed.), Building Supporting Industries in Vietnam, vol.1 (pp.1-26). Hanoi: VDF.
Watanabe, T. (1995). Shinseiki Asia no Koso [Designing Asia for the New Century].
Tokyo: Chikuma Shinsho. Partly translated and published as chapter 11 in K. Ohno
and I. Ohno (Eds.), (1998).
World Bank. (1959). A Public Development Program for Thailand, Report of a Mission
organized by the IBRD at the request of the Government of Thailand. The Johns
Hopkins Press.
————— (1993). The East Asian Miracle: Economic Growth and Public Policy.
New York: Oxford University Press.

88Chapter 4
Vietnam-Japan Monozukuri Partnershipfor Supporting Industries
For Leveling Up Vietnam’s Competitivenessin the Age of Deepening Integration

This paper was drafted by Kenichi Ohno, the co-leader of the Vietnam Development
Forum (VDF), in August 2008 for the purpose of stimulating policy dialogue between
Vietnam and Japan to initiate an action-oriented bilateral program to strengthen the supporting industries in Vietnam. It was prepared in three languages: English, Vietnamese andJapanese. The arguments in this paper selectively incorporate the results of VDF’s industrial research, the proposal letter of the Vietnam Chamber of Commerce and Industry (VCCI)
dated 16 May 2008, and a series of discussions among Japanese industrial officials andexperts from May to August 2008. The analyses and proposals in this paper do not represent the official view of either government, and Ohno bears the full responsibility for thecontent.

Part I. The vision and the purpose
As international integration deepens, Vietnam must greatly improvethe capability of local enterprises in order to survive and effectively competewith imports and global competitors. Up to now, quantitative expansion has
been achieved through economic liberalization, external opening and large
inflows of foreign capital. In the years to come, however, the implementation of
WTO obligations and the completion of AFTA liberalization process by 2018
will exert enormous pressure on local enterprises. If local capability in technology and management remains as weak as today, a large segment of indigenous
industries is likely to shrink or even disappear under severe competitive pressure, and Vietnam will be locked into the position of a producer of low-value
goods under the dominance of foreign firms.
The 2020 vision of industrialization and modernization must be89

Kenichi Ohno

achieved through domestic value creation and highly skilled manufacturing, notby a continued expansion of simple assembly or copy production with little
domestic value. Vietnam needs to shift to a new manufacturing model to realize
this goal.
In order to level up Vietnam’s local manufacturing capability, a bilateral strategic partnership between Vietnam and Japan in monozukuri is proposed in sectors in which Japan has strong comparative advantage: transport
equipment, electronics and electricals, and precision machinery32. Monozukuri
is a Japanese term that describes a special way of organizing and executing
manufacturing. It features internal skill accumulation, pursuit of high performance, demand on QCD (quality, cost and delivery), long-term trust and cooperation among assemblers and suppliers, and strict compliance with safety, environmental and intellectual property standards.
By transferring the monozukuri spirit and method from Japan to Vietnam, Vietnam can bolster local manufacturing capability and differentiate its
products from others, while Japan can have a reliable developing country partner that can perform monozukuri together. For this partnership to be successful,
Japan should intensify its effort to transfer technology related to monozukuri toVietnam, and Vietnam should vigorously learn and absorb this technology as
top national priority.

1. Vietnam’s challenges
Despite good performance in growth, institutional reforms and international integration in the last decade, Vietnam’s domestic capability in manufacturing has not improved dramatically. The structure of manufactured exports
has not changed very much since the mid 1990s. It still relies heavily on simple
labor-intensive products with large import components. High quality products
are dominated by foreign names while local industrial products serve secondtier domestic markets only. FDI firms continue to complain about the lack of
32

90This includes motorcycles and automobiles; consumer electronics; white goods (refrigerators,
washing machines, air conditioners, etc.); audio-visual equipment; computers, copiers and otheroffice machines; mobile phones and other telecom equipment; digital cameras and camcorders;industrial machinery requiring precision; and so on.

Vietnam-Japan Monozukuri Partnership For Supporting Industries

quality, reliability and aspiration of local suppliers. Many weaknesses continue
to be reported in management, quality control, marketing, finance, and labor
quality.
Vietnam is in the final stage of global and regional integration. Commitments of AFTA, WTO and other FTAs must be implemented. In particular,
protection against ASEAN products must be completely removed by 2018. Thisis a great concern for Vietnam since ASEAN is the strong production base ofJapanese products such as automobiles and electronics. Without further cost
reduction, Japanese FDI producers in Vietnam will be forced to switch toimports of their own products from neighboring countries rather than assembling them in Vietnam. If major products such as automobiles and electronics
must be imported almost entirely, there will be a large negative pressure on thebalance of payments.
In addition, wage pressure is already visible in the labor market. If thewage and other costs continue to rise, Vietnam will no longer be a low-cost hostfor foreign producers and will not be able to offer a “China-plus-one” option.
As a result, FDI may shift to other countries with lower costs. One way out is todevalue the currency to retain the status of a cheap-labor country. But the better
solution is to increase productivity to continue to attract investors even withhigher production cost.
To avoid the middle income trap or regression to simple labor manufacturing, Vietnam must now adopt a new approach to manufacturing with sufficiently large impact. Partnership with Japan will provide a great opportunity
to enhance local manufacturing capability to a higher level.

2. Japan’s challenges
Japan has high manufacturing technology, but its population is aging.
A large number of experienced managers and engineers, born in 1947-49,
began to retire in 2007. Meanwhile, young workers who are willing to learn
their skills and knowledge are in short supply. This situation is expected tointensify as time passes. If no action is taken, Japan’s monozukuri tradition may
be lost forever. To retain and further develop this tradition, the Japanese government targets both domestic and foreign human resources as receivers of such

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skill and knowledge.
Moreover, the wage level in Japan is very high while Japanese enterprises competing fiercely in global markets are under constant pressure to
reduce cost. As a result, labor-intensive monozukuri processes are no longer
competitive in Japan and need to be transferred to a developing country where
the wage is lower. Only through a proper international division of labor, where
capital-intensive processes are performed in Japan and labor-intensive processes are performed abroad, Japanese manufacturing can achieve both quality andcost. But Japan has not yet found a suitable monozukuri partner. While Thailand
and Malaysia are improving their manufacturing capabilities, they still fall shortof the expectation of most Japanese enterprises.
With diligent labor and a central location in East Asia, Vietnam ispotentially a very attractive manufacturing partner for Japan. This is a consensus evaluation by Japanese businesses and experts in Vietnam. At present, however, inadequacy of government policy and business management prevents
Japan from choosing Vietnam as such a partner.

3. Monozukuri partnership
In order to solve the problems described above, in complementarityand mutual benefit, the governments of the two countries should forge a strategic partnership to elevate the bilateral relationship to a higher level. Japan
should regard Vietnam as an emerging monozukuri partner and provide sufficient assistance to realize this goal. In turn, Vietnam should regard Japan as asource of new skill-based manufacturing and aggressively adopt monozukuri
skill and knowledge (with local adaptation if necessary).
This strategic partnership should be strongly owned and supported by
the highest level of political leadership in each country, and be concretized inproper documentation. Vietnam should recognize the significance of this partnership in the national development strategy. Japan should do the same in its
economic cooperation strategy for Vietnam.
Vietnam-Japan Monozukuri Partnership should aim to achieve thefollowing with active participation and contribution of both Japanese and Vietnamese sides, and both governments and enterprises:

92Vietnam-Japan Monozukuri Partnership For Supporting Industries(1)Resetting the mindset—at present, Vietnamese managers seem passive or
hesitant in acquiring new technology or approaching foreign companies.
Vietnamese workers do not seem very motivated or far-sighted in improving their skills and accumulating experience. These attitudes should bechanged and manufacturing should be accorded with great importance andpride by a systematic national campaign.
(2)Technology transfer and capacity building—supporting industries andhuman resource are the core to local capability building (see below). Basicknowledge for high skill manufacturing, such as 5S, kaizen and production management, should be taught at schools and centers in large numbers, while factory-specific consultation and patented knowledge should
be made available with reasonable payments. There should be mechanisms to accelerate technology transfers through policy, external assistance and business contribution.
(3)Commitment to international standards—from the very beginning, bilateral monozukuri partnership should strongly adhere to international standards in product quality, safety, environment and intellectual property sothat the product will be competitive in any market in the world.
(4)Positioning in the global value chain—Japan and Vietnam should specialize in manufactured products and components that use high skill labor
while outsourcing other inputs and services. Although business firms are
the ultimate designer of product and investment strategies, the two governments in consultation with businesses should provide policy support
for private dynamism.
(5)Reforming policy methodology—Vietnam’s industrial policy formulation
should be renovated significantly to respond quickly to business needs andmarket shifts, and effectively carry out the proposed Vietnam-Japan
Monozukuri Partnership.
(6)Non-exclusivity—although this is a bilateral partnership, any benefits it
generates should be available to all firms of any nationality. By allowing
such “free riders,” the partnership aims to achieve the “win-win-win” situation for all (for Vietnam, Japan and others). Vietnam is also free tochoose other models of manufacturing from any country it desires. The
Japanese model is not imposed exclusively or unconditionally.

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4. The importance of supporting industries
The promotion of supporting industries is the necessary condition as
well as the first important step toward realizing the vision of Vietnam-Japan
Monozukuri Partnership. The term “supporting industries” (Japanese original:susono sangyo) refers to multiple layers of establishments located inside a
country that supply parts and components to assembly-type manufacturingfirms in that country. This term was first used officially by Japanese MITI’s
White Paper on Economic Cooperation (1985) to point out the absence of suchindustrial activities in Southeast Asia when Japanese FDI inflows to that region
greatly increased in the 1980s.
Since the largest value (typically 80-90%) of mechanical products
comes from parts and components while labor-intensive assembly adds relatively little value (typically 5-10%), international competitiveness requires easy andreliable access to suppliers of parts and components that can offer QCD. Without strong supporting industries, assemblers must import a large amount ofparts and components. This will add international transport cost and long leadtime to production, reducing competitiveness vis-à-vis rival companies withquick access to suppliers in the same country.
When supporting industries are undeveloped, assemblers cannot
expand since they have no cost advantage. But when assemblers remain small,no suppliers will invest or expand in that country since parts cost cannot be
reduced with small orders. This is the vicious circle observed in the early stageof industrialization, which can be broken only by the strong policy initiative toinvite both assemblers and suppliers in large numbers. This is the realizationthat ASEAN4 have come to after many decades of industrialization effort.
The scope of supporting industries can be decided strategically to suitthe policy purpose at hand. For the purpose of improving Vietnam’s manufacturing capability through the proposed bilateral monozukuri partnership, targeted sectors can be defined as metal parts and processing and plastic parts andprocessing for the industries mentioned earlier33. More specifically, this will33

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See footnote 32. If necessary, rubber, glass, ceramic, cloth and other parts of mechanical products may be added to the list.

Vietnam-Japan Monozukuri Partnership For Supporting Industries

cover:
Parts—metal and plastic parts for mechanical products; electricalwiring; screws, nuts and bolts; springs;
Processes—production and maintenance of die and mold; pressing,casting, forging, machining, plating, coating, heat treatment
Targeted enterprises include both FDI suppliers and Vietnamese suppliers. The relative importance of these suppliers will vary according to specificsector, parts and processes. For FDI suppliers, strategic FDI marketing should
be conducted to entice them to invest in Vietnam in accordance with the clearly
formulated industrial strategy. For local suppliers, producers with strong will
and potential to learn should be supported strongly but selectively, based on
proper screening and monitoring.
Industrial human resources are the most important cross-cutting factor
in supporting industry promotion at both FDI and local firms. They are classified into (i) top managers, (ii) middle managers and engineers, and (iii) workers. All of these segments should be targeted, with particular emphasis on thefirst and the second. Besides this, support for capital and equipment is sometimes also needed.

Part II. A proposal for concrete action plan contents
This part contains preliminary ideas of some Japanese experts forconcretizing the Supporting Industry Promotion Action Plan for Vietnam. They
are presented as an initial input to this effort and are therefore subject to revision by subsequent discussion among Vietnamese and Japanese stakeholders.
The promotion of supporting industries overlaps but does not coincide with the promotion of SMEs. The proposed Action Plan aims to strengthen
Vietnam’s supporting industries for industrial competitiveness rather thanassisting all SMEs to generate income and employment.
ASEAN4 countries have a long history of promoting supporting
industries and SMEs, and Japan has assisted their efforts with a large number of95

Kenichi Ohno

Policy area
1. Capacity building(for specific firms)

2. Human resource(generalor institutional)

3. Finance

4. Incentives
5. Linkage

6. FDI marketing

7. Policy framework

Measures- Shindanshi (enterprise evaluation) system- TA for management and technology- Large-scale mobilization of retired Japanese engineers- Intensive support for limited sectors (e.g., die & mold)- Awards, PR and intense support for excellent suppliers- Management/technical centers and programs- Large-scale mobilization of retired Japanese engineers- Alliance between FDI firms and local universities/centers- Monozukuri school (to be upgraded to university)- Meister certification system- Credit guarantee- SME finance institutions- Two-step loans- Exemption or reduction of taxes and custom duties- Grants or loans for specified actions- Database and matching service- FDI-vendor linkage program- Parts Industry Association and Business Study Meetings- Trade fairs and reverse trade fairs- Linkage with Taiwanese suppliers (motorcycles, electronics)- Improving logistics between Hanoi and HCMC
- Creation of strategic industrial clusters- Industrial parks and rental factories- Efficient logistics and infrastructure- FDI marketing targeted to specific sectors or companies- Supporting industry master plan
- SME law
- SME ministry- Business associations and industry-specific institutes- Quality standards and testing centers

technical and financial programs. The policy menu is similar across countries,
but results seem to vary according to political will, economic environment,
design details, and coordination and monitoring in implementation. The policy
package that Vietnam should adopt will be overlapping with this common
menu.
The table below shows policy areas and possible measures for Vietnam in light of ASEAN4 experiences as well as recent discussions in Vietnam.
Since all measures cannot be adopted at once, selectivity, sequencing andadjustments will be necessary.
Below, short-term means by end 2009, medium-term means by 2013,and long-term means by 2020.
For an effective implementation of the Action Plan, it is essential for
the Vietnamese people to recognize the importance of monozukuri and support-

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ing industries for Vietnam’s industrialization. It is hoped that the Vietnamese
Government will take a strong leadership in launching a national campaign todirect people’s attention to these topics.

1. Capacity building (for specific firms)
In order to transfer the know-how of monozukuri to Vietnam, Japanese should visit Vietnam, Vietnamese should visit Japan, and Vietnamese whohave acquired relevant skills should teach other Vietnamese. Moreover, thesemust go on in sufficient scale and duration to make a great impact. For this purpose, it is proposed to establish the SME management shindanshi (enterpriseevaluator) system in Vietnam as an institutional core, and produce technology
promotion instructors and management improvement instructors. At the sametime, there should be a mechanism to mobilize a large number of Japanese engineers, and the programs to send Vietnamese to Japan (or Japanese firms) for
education and training must also be scaled up. It is needless to say that both theVietnamese side and the Japanese side should make utmost effort and sufficient
contribution to make this endeavor successful.
<Short-term>■ Survey of capabilities required of Vietnamese local supporting industries

in the near future.
■ Determination of program design, organization, and roadmap for establish-

ing the shindanshi (enterprise evaluator) system which fits Vietnam’s reality.
■ Designing a mechanism for large-scale mobilization of Japanese engineers(current and retired).
■ Designing ways to expand education and training of Vietnamese students

and workers in Japan or at Japanese enterprises.
<Medium-term>■ Large-scale mobilization of Japanese engineers.
■ Implementation of expanded education and training of Vietnamese inJapan or at Japanese enterprises.

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■ Training of SME instructors (technology promotion instructors and man-agement improvement instructors).
■ Establishment and implementation of the SME management shindanshi

system.
■ Establishment, expansion, and strengthening of quality standards and test-

ing centers.
■ Design and implementation of a program to gradually transfer high-levelparts and processes from FDI firms to Vietnamese firms.
■ Strengthening of mechanisms for accelerating technology transfer to Viet-namese enterprises such as FDI-supplier matching, subsidies, and investment finance support.
<Long-term>■ Scaling up of the entire capacity building system with the SME manage-

ment shindanshi as the institutional core. Its links with financial support,
technical assistance, FDI-supplier linkage, and database should beenhanced.

2. Human resource (general or institutional)
Leveling up of engineering students as well as current workers will
equally benefit FDI firms and Vietnamese firms. To improve their educationand training, it is essential to correctly identify the requirements of enterprises
and supply students and workers who can satisfy them. Improvement andexpansion of curriculums, teaching staff, and teaching equipment must be done
primarily for this purpose. To facilitate this effort, a mechanism for close collaboration between hiring enterprises and teaching institutions must be created.
<Short-term> Student education■ Review of current status of education and training institutions (functions ofvarious institutions at each level, capabilities of graduates, job market situation of graduates, etc.).
■ Review and problem identification of curriculums of education institu-

tions.

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Vietnam-Japan Monozukuri Partnership For Supporting Industries■ Human resource needs survey for promoting supporting industries (identi-

fication of levels and areas to be prioritized).
■ Collecting information on cross-country recognition of technical education

certificates (Washington Accord).
<Short-term> Worker training■ Mapping of existing training institutions (MPI, MOIT, MOST, MOLISA,

VJCC, provinces, VCCI, etc.).
■ Review of training programs and training organizations of Vietnamese

Government (including laws and regulations such as Decision 143).
■ Identification of target training institutions for supporting industry promo-tion.
■ Review and problem identification of existing training programs (for eacharea such as production technology, production and quality control, management, finance and accounting, etc.).
<Medium-term> Student education■ Improvement of policy mechanism for human resource development(coordination among MOET, MOIT, MOLISA, etc.)■ Improvement of education curriculums (with the participation of Japanesefirms).
■ Teacher training, enhancement of education facilities, and coordination

among education institutions.
■ Factory visits and internship at Japanese firms, skill competition andOlympics, and job placement service for graduating students.
■ Establishment of collaborative schemes between FDI firms and universi-

ties.
■ Large-scale mobilization of Japanese engineers (same as 1. above).

<Medium-term> Worker training■ Improvement of training curriculums (with the participation of Japanesefirms).
■ Education and training of teachers.
■ Implementation and scaling up of worker training (including training in

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factory)■ Links with FDI-local linkage programs (inviting workers of potentiallygood firms to attend training and receive factory training, etc.).
■ Establishment of collaborative schemes between FDI firms and training

centers.
■ Large-scale mobilization of Japanese engineers (same as 1. above).

<Long-term>■ Introduction of skill certification system and industrial Meister award sys-tem.
■ Participation in cross-country recognition of technical education certifi-

cates (Washington Accord).
■ Possible establishment of SME University or Monozukuri University.

3. Finance
Vietnam intends to use private commercial financial institutions as
main providers of SME loans, with the backing of subsidies, credit guarantee,
and two-step loans. However, this effort has just begun recently. Generally
speaking, SME finance is saddled with a number of difficulties related to thelack of management and technical capabilities, insufficient corporate financial
information and banks’ evaluation capacity, and collateral requirement. Continuous institutional invention and adjustment is needed to overcome these problems. It is proposed that preferential measures for supporting industries be
added to the process of improving SME finance in general.
<Short-term>■ Strengthening of financial services for supporting industries (establishmentof supporting industry promotion department in each bank, assisting theanalysis and evaluation of supporting industries and individual suppliers,
introduction of asset based lending).
■ Encouraging banks to take a leading role in supporting industry cluster

promotion, and show initiative and commitment to the formulation offinancial infrastructure policy.

100Vietnam-Japan Monozukuri Partnership For Supporting Industries■ Japanese-local enterprise matching through SMEFP3 (JBIC two-step loan

program), creation of model reporting format for business relations with
FDI firms, and preferential loans for firms with such relations.
■ Strengthening the credit guarantee fund (CGF), including review ofadvanced cases abroad, creation of the credit insurance system and its
operational guidelines.
<Medium-term and long-term>■ Expanded use of the credit guarantee fund (institutionalization of subsi-

dized low-interest policy loans).
■ Promotion of using non-property collaterals (loans backed by accounts

receivable, speedy execution of collateral rights, and utilization of nonbanks and leasing).
■ Upgrading of the standard of bank loans (roadmap for Basel II compliance,building a common database to share among banks information on corporate finance, bankruptcy, asset evaluation etc.).
■ Development of preferential financial services for companies with techni-

cal training certificates or corporate financial statements properly checkedby certified accountants or shindanshi.

4. Incentives
Preferential measures for production, investment, education, andtraining related to supporting industries should be introduced as soon as possible and at levels sufficiently competitive and reasonable (neither too much nor
too little) in comparison with other East Asian countries. For this purpose, eligible firms and activities must be clearly specified.
<Short-term>■ Agreement on the definition of “supporting industries” eligible for prefer-ential measures.
■ Determination of concrete preferences in taxes, import duties, and subsi-

dies. For example, tax holiday (reduced corporate tax of 10% during six
years following the first profitable year, etc.), exemption of import duties

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on equipment, subsidies on education and training, and working permit
waiver and subsidies for Japanese engineers traveling to Vietnam, etc.
<Medium-term>■ Early implementation of agreed preferential measures (by 2010, for exam-ple).
■ Active PR of preferential measures and FDI marketing for eligible firms

and activities at investment seminars and other occasions.
<Long-term>■ Continued implementation of preferential measures. If necessary, adjust

preferential measures in light of actual results and situations in rival countries.

5. Linkage
After studying the strengths and weaknesses of BUILD and NSDP in
Thailand, VDP and ILP in Malaysia34, and so on, design a new scheme for promoting FDI-local production linkage in Vietnam. For this to succeed, it is necessary to closely coordinate multiple measures such as narrowing the perception
and information gaps between the two sides, database and directory construction, selection of potential local suppliers, focused assistance on selected suppliers, and enhancement of industry associations and trade fairs.
<Short-term>■ Creating the initial list of potential local suppliers based on existingsources (first step toward database construction).
■ Award-giving, book publication, and PR of excellent local suppliers.
■ Design of a new linkage program (target firms, content of assistance, androadmap).
■ Design of a new database based on the review of existing databases and34

Respectively, the Board of Investment (BOI) Unit for Industrial Linkage Development, theNational Supplier Development Program, the Vendor Development Program, and the Industrial
Linkage Program.

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international experience.
<Medium-term>■ Further collection of supplier information, and addition of new potential

local firms.
■ Construction and uploading of the database (at the earliest possible date).
■ Institutionalization of award-giving and PR of excellent local suppliers.
■ Scaling up of technical assistance to potential local suppliers.
■ Assistance in establishing industrial associations, and assistance to parts

manufacturers association, enterprise study meetings, and industry-specificresearch institutes.
■ Inclusion of third-country assemblers and suppliers into the supporting

industry promotion system (for example, Taiwanese companies in electronics and motorcycle).
<All periods>■ Facilitation of enterprise matching (introduction to Japanese business prac-

tices, product marketing, changing the mindset, follow-up after initial contact, successful cases, etc.)■ Providing opportunities for enterprise matching (reverse trade fairs, exhi-

bitions, meetings organized by individual buyers, visits to Japanese firms,
inviting Japanese business missions to Vietnam, individual matching by
TAC, etc.)

6. FDI marketing
For the rapid and healthy development of supporting industries, Vietnamese local suppliers and FDI suppliers investing in Vietnam both must play
important roles. The exact roles and weights of these two types of suppliers
should depend on the product, the required level of technical competence, andthe time scope. It is necessary to come to the clear and common understandingof the role of each, and effectively implement FDI supplier attraction measuresand local supplier promotion measures, respectively.

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<Short-term>■ Broad-based campaign to nationally recognize the importance of support-

ing industries.
■ Review of the current situation of Vietnam’s supporting industries.
■ Identification of the appropriate roles of FDI suppliers and local suppliers,and design of FDI supplier attraction measures and local supplier promotion measures based on their respective roles.
■ Conducting active PR on policy measures. Use investment seminars to

explain preferred parts investment to FDI suppliers, and use various seminars, brochures, and media ads to explain to local suppliers.
■ Study and design the industrial cluster strategy.
■ Prepare a plan for supporting industry industrial parks. They should pro-vide small rental lots (5,000m2 for example), standardized rental factories,
support center on the premise (administration, accounting and personnel
services for companies in the industrial park), etc.
<Medium-term and long-term>■ Construction and marketing of supporting industry industrial parks.
■ Strategic enhancement of infrastructure and logistics for the promotion of

supporting industries and supporting industry industrial parks.
■ Implementation of the industrial cluster strategy.

7. Policy framework
Although ASMED/MPI is designing and implementing SME promotion policies, assistance to SMEs remains inadequate in both quality and quantity. These policies must be strengthened. At the same time, supporting industry
SMEs (which are a subset of SMEs) should be properly recognized for theirimportance, and a legal framework and policies to specifically assist themshould be installed. Policy authority is decentralized at present, which prevents
strong and consistent SME policy formulation. In the future, after a sufficient
review of international experiences, reorganization of the SME promotion system as well as the possibility of a new unified organization may be considered.

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Vietnam-Japan Monozukuri Partnership For Supporting Industries<Short-term>■ Completion of revision of Decree 90, currently under way at MPI/ASMED(key points include sector-specific definitions of SMEs, prioritization ofpolicy support, assistance of policy formulation at the local level, credit
guarantee fund, SME promotion fund, etc.)■ Missions to Japan and neighboring countries for the study of SME policy

formulation and implementation.
■ Determining the scope of “supporting industries” for policy purposes.
■ Selection of prioritized assistance areas (for example, die-and-mold, press-

ing, casting, welding, etc.)■ Government-led popular campaign for better understanding and higher

interest in monozukuri and supporting industries.
<Medium-term>■ Drafting and passing of the Basic Law of SMEs and the Law on the Pro-

motion of SMEs.
■ Design and implementation of action plans for activating inter-ministerial

collaboration, private-public partnership, and industry-university partnership.
<Long-term>■ Establishment of a new government body specializing in SME promotion(reorganized ASMED or a new organization).
■ Revision of the Supporting Industry Development Master Plan in order togreatly level up supporting industries, including material industries, so that
Vietnam will become a truly industrialized country.

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About the Author
Kenichi OHNO is a Professor of Economics at the National Graduate Institutefor Policy Studies (GRIPS), Tokyo, and the Research Director of the Vietnam
Development Forum (VDF), Hanoi. He graduated from Hitotsubashi University
and received his Ph.D. degree in Economics from the Stanford University.
He is an author and editor of a number of books on international and development economics, including International Monetary Systems and Economic Stability (Toyo Keizai Shimposha, 1991, in Japanese; Mainichi Shimbun Economist Award), Strategy for Introducing Market: Creation of a New Economic
System and Japan’s Intellectual Contribution (Yuhikaku, 1996, in Japanese;
Mainichi Shimbun Asia Study Association: Asia-Pacific Special Award),
Development Economics of East Asia (Yuhikaku, 1997, in Japanese, withKojiro Sakurai, in Japanese), Dollar and Yen (MIT Press, 1997, with Ronald I.
McKinnon), Japanese Views on Economic Development (Routledge, 1998, with
Izumi Ohno), Globalization of Developing Countries (Toyo Keizai Shimposha,
2000, in Japanese; Suntory Prize for Social Sciences and Humanities / Osaragi
Jiro Literary Award for Critical Works in 2001), and The Economic Development of Japan: The Path Traveled by Japan as a Developing Country (GRIPS,
2006).

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