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Stage III of industrialization: the pursued era

Summary:
From Richard Koo This golden era does not last forever. At  some  point, wages reach a level where foreign competition can gain a foothold. The first signs of a serious threat to Western economic growth appeared when businesses in  the  US and Europe encountered Japanese competition in the 1970s. Many in the West were shocked to find that Japanese cars required so little maintenance and so few repairs. The Germans may have invented the automobile, and the Americans may have established the process by which it could be manufactured cheaply, but it was the Japanese who developed cars that did not break down. The arrival of Nikon F camera also came as a huge shock to the German camera industry in the 1960s because it was so much more rugged, adaptable, easy to  use  and  serviceable than

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from Richard Koo

Stage III of industrialization: the pursued eraThis golden era does not last forever. At  some  point, wages reach a level where foreign competition can gain a foothold. The first signs of a serious threat to Western economic growth appeared when businesses in  the  US and Europe encountered Japanese competition in the 1970s.

Many in the West were shocked to find that Japanese cars required so little maintenance and so few repairs. The Germans may have invented the automobile, and the Americans may have established the process by which it could be manufactured cheaply, but it was the Japanese who developed cars that did not break down. The arrival of Nikon F camera also came as a huge shock to the German camera industry in the 1960s because it was so much more rugged, adaptable, easy to  use  and  serviceable than German Leicas and Exaktas, and professional photographers around the world quickly switched to the Japanese brand. For the  first  time since the industrial revolution, the West found itself being pursued by a formidable competitor from the East.

Once a country is being chased by a technologically savvy competitor, often with a younger and less expensive labor force, it has entered the third or “pursued” phase of economic development. In this phase, it becomes far more challenging for businesses to find attractive investment opportunities at home because it often makes more sense for them to buy directly from the “chaser” or to invest in that country themselves.

Businesses in the pursued country no longer have the same incentive to invest in productivity- or capacity- enhancing equipment at home because there is now a viable alternative – investing in or buying directly from lower-cost production facilities abroad. In this phase, capital invested abroad, especially in manufacturing, earns a higher return than capital invested at home. With constant pressure from shareholders to improve the return on capital, firms are forced to shift investments to locations with a higher return on capital.

Once this stage is reached, productivity gains at home from investment in productivity-enhancing equipment slow significantly. . . .

In a pursued economy, labor demand curve (D4 in Exhibit 1) becomes largely horizontal at wage level EQ, where outsourcing to foreign production sites becomes a viable alternative. This means real wage growth will be minimal from this point onward, except for those workers with abilities that are not easily replicated abroad. 

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