Lessons from Development Banking in East Asia

Mauricio de María y Campos, member of the governing board of the Institute for Industrial Development and Economic Growth (IDIC)

Lessons from Development Banking in East Asia
Development banks are an important way to mitigate the most negative effects of the ongoing health and economic crisis and, at the same time, support the transition to a more socially and environmentally sustainable model of production and consumption. The intervention of public sector banking in the historic events described here confirms its successful contribution to the prosperity of those nations.

The year 2020 will go down in history as the year that placed the world in the most complex health, economic, social and environmental crossroads of recent times. The crisis of growth and development that individual countries and the world as a whole had already been experiencing for three decades —particularly since 2008— was intensified by the pandemic and posed the dual challenge of building consensual solutions within countries and undertaking a profound reform of global governance.

In this setting, it is the task of policy makers and executors to promote structural changes that, in the long-term, promote more productive, innovative, inclusive and environmentally sustainable economic dynamics —with a significant reduction in carbon use, for example.

Development banks can and should be a fundamental part of the solution and, of course, of development. The experience of past and present developer States —like Germany and Japan, South Korea and more recently China, Finland and Vietnam—shows that extra-budgetary resources channeled through development banks (guaranteed by the national government and well managed) are capable of providing significant national and international public financing and mobilizing private financing and risk capital to promote long-term transformations with high social returns.1

Since the global crisis of 2008, major reports have appeared from UNCTAD, UNIDO and the BNDES-CAF on the importance of reactivating development banking, a recommendation that has had limited impact in Latin America.2 Today the public health emergency and its economic and social impact are forcing recognition of the strategic role these financial intermediaries play in the region's prosperity.

The experience of development banking in Latin America has been extensively analyzed. The recent BNDES and CAF report provides a good overview of its most recent evolution in Brazil, Chile, Colombia, Peru and Mexico. Its chapter on Mexico's Nafin is very telling.3 Francisco Suárez Dávila's updated essay on development banking in Mexico —published in this issue of Comercio Exterior— makes proposals for stimulus and comprehensive restructuring in the medium term.

Less well known is the successful experience of China and other Asian countries — particularly South Korea and Vietnam— inspired, to a large extent, by German and Japanese developer State models implemented at the end of the 19th century and reproduced at the end of World War II to guide the economic reconstruction and development of these countries. 

 

THE GROUNDBREAKING JAPANESE EXPERIENCE

Japan's experience is one of the best examples of what developer States can do to promote structural change in the industrial and technological fields, as well as the role of development banks in these efforts.  It dates back to the Meiji dynasty's project to modernize the semi-feudal order that prevailed in the country. In 1868, they laid the foundation for building a strong State: inspired by their own values but enhanced by German economic nationalism and supported by an era of sustained economic expansion.4

This vision, which allowed for a successful transition through the interwar crisis and the construction of a developer State, was regained within the framework of the Marshall Plan and gave shape to ‘Japanese style’ Keynesian reforms for reconstruction (1946-47), stabilization (1948-50) and the rapid growth of the 1950s.5

The turning point came in December 1960, when the government launched a plan to double the country's income within a decade. The goal was fully achieved thanks to a set of strategies, policies and mechanisms to promote dazzling industrial development that kept on rising until the early 1980s.6

Two institutions played crucial roles in Japan's industrial turnaround: the Ministry of International Trade and Industry (MITI) and the Industrial Bank of Japan.

The legendary MITI was the driving force behind an ambitious long-term industrial strategy aimed at breaking the monopolistic structures of the past —dominated by conglomerates or zaibatsus— and implementing, through a system of coordinated planning with companies, import substitution policies, protection for nascent industry, and technology imports and innovation, with special emphasis on human resource training.

The creation of the Industrial Bank of Japan was another great success. Financial stimulus policy emerged from the Meiji era as a private institution. The zaibatsus had a monopoly on the issuance of bonds for long-term industrial development starting in 1905. Their role would be strengthened in order to defend Japanese companies in the interwar period and to boost the defense industry during World War II.

Japan initiated a comprehensive financial stimulus policy in 1946. During the first few years, it focused on the recovery of heavy industries through the Reconstruction Finance Corporation with funds from the Central Bank. Between 1950 and 1960, long-term development credit was granted through the so-called policy banks: the Japan Development Bank, the Eximbank, the Housing Loan Corporation, the Small Business Corporation and the Agriculture, Forestry and Fisheries Finance Corporation. Almost two decades later, the Environmental Sanitization Business Finance Corporation was created.7

The aforementioned group of banks not only financed Japan's impressive industrial growth and development but also provided public resources and triggered additional private investment. As well, they participated in investor counseling, prepared prospective studies on strategic industrial sectors, compensated for risk, ensured a steady supply of public and private funds, and provided technical assistance for project formulation and the selection, acquisition and development of technologies.

The outstanding education and training of career employees in Japanese development banks was a prerequisite for their effectiveness —in parallel with the excellence of MITI officials.8

 

THE KOREAN DEVELOPMENT BANK: SECOND-GENERATION ASIAN BANKING

South Korea is another nation that, thanks to a developer State and a favorable environment after the conflict and fragmentation of the Cold War, achieved rapid industrialization and admirable technological development. On the brink of the second half of the 20th century, manufacturing was only 12% of national added value. It rose to an average of 23.5% between 1971 and 1980 and jumped to 27% between 2001 and 2009.9

In tandem with this progress was an important structural change: in 1950 light manufacturing accounted for 80% of total manufacturing. From that point on, light manufacturers began to lose relative importance to the heavy and chemical industries, whose momentum delivered a contribution of 64% of the macroeconomic aggregate in 1980, then 75% in the 1990s, and 80% in 2000.10 Over the past 20 years, the Korean miracle has led to the construction of a national high-tech business sector in activities such as automotives, telecommunications, electronics and, recently, biopharmaceuticals.

A similar change occurred in the structure of its foreign trade. If in 1960 the top ten exported products were raw materials, by 2008 these positions were already held by manufactured goods: ships, cars, cell phones, semiconductors, and they are now working to increase production of active pharmaceutical ingredients.11

This evolution can be explained by the adoption of, during the President Park era in the 1960s and 1970s, a developer State strategic planning model with a Japanese-style mixed capitalist economy, but also by a bureaucracy and a private business sector willing to take risks using a long-term outlook. 

The rapid accumulation of capital since the 1950s was key to industrial transformation. Between the mid-1970s and the 1997 Asian financial crisis, the investment rate ranged between 30 and 40 per cent of GDP. The South Korean government played a crucial role, investing in physical infrastructure, developing strategic industries (fertilizers, cement, refineries, oil and steel) and financing export industries. The Korean Development Bank (KDB) had a central role, providing medium- and long-term loans.12

In addition to the KDB, other development banks were established to finance agriculture, housing, and small and medium-sized businesses. In 1967, the Korea Development Finance Corporation was established to support private companies with long-term loans and venture capital and, in 1976, the Korea Eximbank to finance foreign trade. These policy banks were not authorized to receive deposits from the public. Their funding came from the government, bond issues and international institutions.13

At the core of this financial architecture is the Central Bank of Korea — which also promoted domestic private commercial banking — and a guarantee scheme set up in the 1960s to obtain foreign credit and support the development of domestic technologies and companies.

The KDB has shown great resilience and adaptability throughout its history. After driving heavy industry, chemicals, shipping and the automotive industry during its first decades, in the 1990s it was the main provider of funds for the start of electronics and high-tech industries and their growing presence in international markets. During the Asian financial crisis of 1997, it bolstered the value added of export chains and played a countercyclical role in overcoming the credit shortage. At the beginning of this century, the bank faced an attempted privatization under accusations that it was inhibiting the development of the private financial sector. It managed to survive, and in the last decade has led forward-looking programs for developing the future global economy and financial programs for startups, 4G companies (robotics, 3D manufacturing, artificial intelligence), renewable energies, cultural industries and digital banking. It is also seeking to reduce the relative importance of its support for conventional manufacturing.14

CHINA DEVELOPMENT BANK. THE FINANCIAL DRAGON

Since the 1980s and with Deng Xiaoping's reforms, China has grown at an average rate of more than 7% per year. Development banks have played a key role. In 1981 —as a member of the first Mexican financial mission to China and six other Asian countries headed by Undersecretary of Finance Jesús Silva Herzog— I realized that everything in the country revolved around the People's Bank. Development banking came up in conversations and gave us the opportunity to share information with our hosts about the performance of Nafinsa, Bancomext, Banrural, Banobras, as well as the role of Mexico's Central Bank, Banco de México.

Three years later, in 1984, the People's Bank became the Central Bank and gave rise to four state-owned banks specializing in agricultural activities, construction, foreign trade, and industrial and commercial enterprises. In 1994, these four large institutions were designated as state-owned commercial banks. At the same time, three banks with responsibilities in development policy were created: the China Development Bank (CDB), the China Eximbank and the Agricultural Development Bank. The 1995 reform established a legal framework for the creation of a commercial bank and clarified the roles of the Central Bank and the development bank.15

Financial legislation was adjusted in the late 1990s for two important reasons: China's entry into the WTO and an accumulation of excessive bank debt. As a result, monitoring of the financial health of banking intermediaries was improved and stricter requirements were set for granting credit to state-owned enterprises. The financial injection was estimated at about 3% of GDP.16 

In the 21st century, development banking has played a key role in China's agricultural, infrastructure, industrial, export and technological development. The CDB has been crucial, leading long-term financing for state-owned enterprises and major regional infrastructure projects: the Three Gorges Dam, the Shanghai and Beijing airports, underground transportation systems, the express rail network, and the system of export economic zones.17 At the end of 2010, the CDB had a loan portfolio of US$ 687.8 billion, more than double that of the World Bank.18 

During the last decade, the share of projects in its portfolio related to environmental protection, renewable energy and development of cutting-edge technology has grown, reaching 34% in 2014. Lending to foreign projects quadrupled from 4.7% of the total in 2001 to 16.5% in 2012.19

As of December 2018, the CDB had granted loans of 3.85 trillion yuan (US$ 578 billion) to eleven provinces, accounting for 48% of total new loans. In 2016, China launched a major project to develop the Yangtze River Economic Belt, which covers nine lagging provinces that represent one-fifth of China's territory and 600 million inhabitants who generate more than 40% of GDP. The CDB considers this its flagship project for the immediate future.20

Besides the Silk Road and the Belt and Road initiatives, China promotes the Asian Infrastructure Investment Bank (AIIB) and has played a strategic role in its financing (participation in 84 countries in 2017) with the backing of several Chinese sovereign wealth funds —most notably the Silk Road Fund (2014) and CIC Capital (2015)— as well as increasing bond issuance in global capital markets. This multilateral development bank exceeds the World Bank system's Asian Development Bank in resources and loans.21

 

THE VIETNAM DEVELOPMENT BANK. FOURTH GENERATION IN EAST ASIA

Vietnam is one of the most successful examples in the last 30 years in terms of accelerated growth with social equity and balance between regions. Its GDP has managed to grow at an average annual rate of 7% —second only to China— based on an economic model of a developer State, inspired by the successful experiences of Japan, South Korea and China. It has an authoritarian government like China, but since its major long-term development transformation in 1986—Doi Moi— it has opted for a socialist state with a market economy.22

To maintain control over the mobilization of financial resources, since the end of the 1980s Vietnam has set up its own state-owned commercial banks and created several policy banks. Five state-owned banks control Vietnamese commercial banking today. Four of them emerged from the Central Bank in 1988 —the Vietcombank, the Agribank, the Vietinbank and the BIDV. The Mekong Housing Bank was created in 1997. This system covers almost all cities in the country. Although their relative importance has declined with the emergence and expansion of private bans, the four large banks accounted for 60% of total assets and loans as of 2008.23

The banks historically directed their financing to state-owned enterprises. That policy also changed over the past two decades. The share of loans in their portfolio to the private sector increased from 37% in 1994 to more than 50% in 1999, 70% in 2006, and 80% today.24   

Although there has been strong pressure from the International Monetary Fund and the World Bank to liberalize the sector, the government has resisted. Banks have been taken public though the stock market, but the State retained 90% of capital and companies and, therefore, the ability to direct credit to priority sectors and businesses.25

The Vietnamese government separated commercial and development banks, creating the Vietnam Bank for Social Policies and the Vietnam Development Bank in 2004. This move was taken in preparation for its entry to the WTO; in practice, the four state-owned commercial banks continued to serve state-owned enterprises. However, they now operate under stricter efficiency criteria, particularly in the area of policy lending. According to the World Bank, the most recent annual reports have shown better results.26

Vietnam has been very successful in using its development bank to boost its industry and exports. The UNIDO study, which compared the role of industrial development banks in eight fast-growing countries, highlights the role of the Vietnam Development Bank (VDB). With 54 branches across its territory, it granted, on average, annual financing equivalent to 8.5% of GDP between 2004 and 2014.27

The VBD's medium- and long-term investment loans—which account for 80% of the total—have given impetus to 30.9% of Vietnam's gross fixed capital formation, supporting the creation of major companies in all strategic sectors, which have changed over the past three decades in line with 10-year plans.28  While they focused mainly on agriculture and the food, clothing and footwear industries following the war with the United States, since 2000 they have embarked on a second stage with chemical, electromechanical—bicycles, motorcycles—shipping and electronics industries as the main targets, and are currently promoting strategic domestic private ventures: for example, an electric car and motorcycle industry of their own.

According to the World Bank, over the last five years Vietnam has one of the highest average real credit growth rates in the world, comparable in Asia only to China and the Philippines, a performance that goes a long way toward explaining the economy's accelerated growth.29

In 2020, excellent management of the pandemic and a skilled and highly competitive workforce has brought, in the first nine months of the year, significant inflow of FDI from Japan, South Korea, the United States and Europe. The signing in November 2020 of the RCEP with China and 13 other Asian countries —following implementation in January of the CPTPP, in which they participate along with Mexico— will reinforce this trend. The World Bank forecasts growth of 3 and 4 percent for 2020.30

 

CONCLUSIONS

The experience of Asian development banks makes it evident that in the current situation:

  • Development banks (DB) must be strengthened and capitalized with additional resources to meet the emerging needs of businesses at this critical juncture and promote more dynamic, sustained and sustainable growth.
  • Successful Asian banks show the importance of periodically making changes to credit and risk capital programs, especially in the face of crises, adjusted to long-term reconstruction and expansion requirements of countries' infrastructure and industry.
  • DB must strengthen their technical capacities for project evaluation and formulation, and adopt a proactive attitude to promote new enterprises and projects. 
  • Following the Asian experience, DB should participate, together with the State and the private sector, to develop studies with broad national and regional vision, making it possible to identify industries and service sectors with high added value and potential as well as multisectoral and social impact, and leadership potential in production chains.
  • DB should explore new mechanisms for coordination and liaison with companies willing to take risks, mobilize private capital and undertake their own technological developments, which private banks are not willing to finance but which have positive long-term impacts and social returns. SMEs demand priority attention.
  • It is crucial that, in Mexico and Latin America, DB promote sustainable development objectives, climate change mitigation and prevention —including the use of green technologies and energy, water saving and development of public resources.
  • It is important to foster greater international cooperation to accelerate the transition of DB to the digital era. Capitalize on the multiple opportunities offered by this emerging mode of financing, through the development of common platforms and convergent instruments.

 

1 José Antonio Romero and Julen Berasaluce, Estado Desarrollador. Casos exitosos y lecciones para México, El Colegio de México, Mexico City, 2019.

2 UNCTAD, The Role of Development Banks in Promoting Growth and Sustainable Development in the South, United Nations, New York / Geneva, 2017; UNIDO, The Role of Industrial Development Banking in Spurring Structural Change, Vienna, 2016, in Stephany Griffith Jones and José Antonio Ocampo (eds.), The Future of National Development Banks (Initiative for Policy Dialogue), Oxford University Press, Oxford, 2018.

3  Juan Carlos Moreno Brid, “The case of Nacional Financiera, Mexico’s key development,” in Stephany Griffith Jones and José Antonio Ocampo (eds.), op. cit.

4 William Wirt Lockwood, Economic Development of Japan, Growth and Structural Change. Princeton University Press, 1968.

5 Chalmer Johnson, MITI and the Japanese Miracle: The Growth of Industrial Policy 1925-1975. Stanford University Press, 1982.

6 Francisco Suárez Dávila, op. cit.

7 Japan Development Bank. The Japanese Economic Research Institute, Tokyo. cited by Francisco Suárez Dávila, op. cit., p. 167.

8 Ibid. pp. 167-168.

9 D.H. Kim y Y. Koh, “The Republic of Korea´s Industrial Development Bank” in  Il SaKong and Youngsun Koh (eds.) The Korean Economy: Six Decades of Growth and Development, Republic of Korea Development Institute, Seoul, 2010, cited by UNCTAD, op. cit.

10 Ibid., Table 3.1.