Is Industrial Policy Finally Legitimate?

Yves here. It’s become more and more respectable in development economic circles to acknowledge that formerly taboo ideas like trade barriers and other forms of support to emerging industries are sound policy. The reversal by the IMF on the value of industrial policy is nevertheless significant. And that’s before you get to the fact that countries that lack explicit industrial policy wind up having ones by defaul

By Jomo Kwame Sundaram, a former economics professor, was Assistant Director-General for Economic and Social Development, Food and Agriculture Organization, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought in 2007. Originally published by Inter Press Service

For decades, the two Bretton Woods institutions have rejected the contribution of industrial policy, or government investment and technology promotion efforts, in accelerating and sustaining growth, industrialization and structural transformation.

Finally, two International Monetary Fund (IMF) staff members, Reda Cherif and Fuad Hasanov, have broken the taboo. They embrace industrial policy, arguing against the current conventional wisdom that East Asian industrial policies cannot be successfully emulated by other developing countries.

Miracle Economies Not Miraculous

They argue that industrial policy has been key to East Asian ‘miracles’, offering valuable lessons for sustaining ‘catch-up’ growth. For them, appropriate industrial policy interventions have been key to successful entry into more sophisticated industrial activities, early strong export orientation, and fierce competition with strict accountability.

For over half a century, especially following Asian and African decolonization after World War Two, developing countries have gone their separate ways with very mixed results, with all too many falling behind. Meanwhile, very few economies have caught up with some of the most advanced economies and firms.

Between 1960 and 2014, 16 out of the 182 economies they study achieved high-income status, underscoring the difficulties for middle-income countries reaching high-income status within two generations. They distinguish three types of countries which have ‘succeeded’, namely the East Asian miracles, those discovering considerable oil and gas, and those that benefited from joining the European Union.

Cherif and Hasanov insist on the key role of industrial policy in the Asian miracles, and for the US after the Civil War, Germany under Bismarck, and Japan after the Meiji Restoration. They argue that East Asian industrial policies have much in common despite their many differences.

The conventional growth formula — of improving macroeconomic stability (typically through anti-inflationary policies), strengthening property rights, and providing physical and social infrastructure and basic services to address government failures — was not enough.

Drawing useful lessons from varied country experiences is fraught with difficulty, especially considering the exogenous and conjunctural factors affecting growth, including luck. In contrast with the conventional empirical approach emphasizing averages, their analysis of long-term cross-country growth experiences underscores the value of studying the ‘tails’ or exceptions instead.

Technology and Innovation Policy

Contrary to earlier formulations of industrial policy as primarily involving investment and technology, Cherif and Hasanov propose three key principles constituting ‘true industrial policy’, summarized as technology and innovation policy (TIP), namely:

• State interventions to overcome constraints to the early emergence of national producers in more sophisticated industries, beyond conventional notions of ‘comparative advantage’.
• Export orientation, not import substituting industrialization (ISI); this contrasts with providing effective protection in the national or regional market on condition of early export promotion to achieve export competitiveness.
• Ensuring both national and international competitiveness with strict accountability.

Hyundai vs Proton

Cherif and Hasanov also contrast the cases of Malaysia’s Proton with South Korea’s Hyundai in support of their three principles. They argue that Proton did not export enough, reflecting failure to build sufficient managerial and engineering skills as well as an innovative automotive cluster.

Hyundai, by contrast, has successfully created a global brand. Cherif and Hasanov insist that allowing several South Korean industrial conglomerates or chaebols to develop rival auto industries and the push to export were key to its success.

Governments have directed capital and labour into industrial ventures that firms probably would not have undertaken without appropriate incentives, but market competition, market signals, and private sector accountability are also recognized as important.

Without conclusive evidence, Cherif and Hasanov claim that due to the government’s push to export, Korean automakers ‘moved first, then learnt and adjusted’. In exchange for very low real interest rate loans, Korean chaebols had to quickly secure foreign market shares, while accountability was enforced by firing senior managers who failed to reach export targets.

Pressure to compete and export forced Hyundai to increase its R&D effort and technology upgrading, producing its own engine in 1991, and later, its first electric car. Korean encouragement of several chaebols in the automotive industry later forced them to restructure, with few surviving.

But would fostering more than one automotive firm have ensured Proton’s success in light of Malaysia’s smaller domestic market and more modest industrial capabilities? And what were the economic costs of Korea’s arguably wasteful automotive industry competition?

Three Development Policy Options

Cherif and Hasanov emphasize the importance of government ambition, accountability and adaptability. Government ambition is seen in terms of a feasible or pragmatic level of sophistication of new sectors and domestic ownership of industrial technology.

Government policy implementation must be subject to accountability, not only for firms, but also policymakers and senior managers responsible. As conditions change and new knowledge becomes available, policy interventions must adapt to continue to be effective and feasible.

Low gear: The conventional approach to growth — of improving the investment environment, key institutions, infrastructure, macroeconomic stability, investments in education, and minimizing other government interventions — is likely to result in relatively slow ‘snail’s pace’ growth. Such policy interventions typically address government failures, but not necessarily market failures, especially to develop more technologically sophisticated sectors beyond conventional understandings of comparative advantage.

Middle gear: This approach mainly relies on attracting FDI into more technologically sophisticated industries to participate increasingly in global value chains, or by improving the technological level of existing industries. This may accelerate growth for middle-income countries, but is unlikely to lead to sustainable development or ‘high-income status within two generations’ owing to limited national capacities and capabilities.

High gear: The East Asian miracle economies are said to be using a ‘moonshot approach’ for governments to create competitive national firms in frontier technologies, and more sophisticated industries with homegrown technologies, creating conditions for high, sustained long-term growth.

The speed and extent of the leaps to more sophisticated industries and technologies created by national firms are crucial for sustaining long-term development. Countries that manage this process well have better chances of soon becoming relatively advanced economies.

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  1. PlutoniumKun

    Its worth pointing out of course that the Asian template wasn’t invented in Asia – its more or less German 19th Century mercantilism (which was also of course used in the US). Its proven successful in most countries – more than other forms of industrial policy such as growth pole development (very fashionable in the 1960’s) or selective mergers. Although I suspect that there is no one real ‘model’ – a lot depends on luck (picking the right industry at the right time) and most importantly, on the quality of the companies.

    As an example of the latter, Ireland from the 1930’s to the 1950’s attempted to develop national champions in industry. One – the ESB (electricity), became a world leader in managing and implementing electric infrastructure. Another – ‘Posts and Telegraphs’ (telephone and mail) became a byword for inefficiency and excess costs. Most people who looked into it thought that the main reason for the difference came back to the starting points – the former was started from scratch as an engineering focused company, the latter was essentially an arm of the civil service.

    In general Irish industrial policy was probably a failure, especially attempts to create a heavy industrial base behind tariff barriers, although a number of individual companies did thrive and grow, such as the State owned forestry company, and a state owned peat extraction company (notably, both in low value sectors).

    With regard to Proton, they seem to have always had a poor reputation – apparently Mitsubishi (who licensed them car designs) had a dim view of what came out of Proton factories. I once met a Brazilian bike tourer who said that after sending Proton a begging letter, they sent him a plane ticket and booked an expensive hotel, simply so he could talk to them about bikes. They were thinking of copying the Taiwanese and setting themselves up as a hub for bike manufacture and design. He said he was a little shocked at how little the engineers actually knew about bikes, despite being tasked with setting up a design and manufacture facility. Unsurprisingly, you don’t see any Proton labeled bikes around.

    I don’t think there can be any one real ‘model’ as countries vary so much. For one thing, promoting internal competition only really works if there is sufficient scale – most countries simply aren’t big enough to have two or more competing car manufacturers, or shipyards. You have to have a national champion sometimes, and its success requires long term backing, and often this doesn’t work when you have short term political cycles. It only requires one government hostile to state owned industry to screw everything up for decades to come (sadly, this has happened numerous times).

    Irish industrial policy following the 1960’s focused primarily on attracting small foreign companies to use Ireland as its base. Contrary to popular opinion, it had little to do with tax policy (this originated later). The Chinese in particular used the ‘Shannon’ model for new towns focused on specific high value industries. Irish policy was to be the European and worldwide bridgehead for small, mostly US or Japanese companies expanding abroad for the first time. Companies like Apple and Intel established themselves in Ireland when they were still essentially start ups. In other words, Ireland tried to borrow other countries fast growing companies and transplant them, supporting them with trained people and infrastructure. I think this is probably a very good model for smaller countries without the capacity to create tariff walls.

      1. Synoia

        The Treaty of Versailles was in the 20th Century.

        Are you confusing the reunification of German and the Franco-Prussian War, 19th century, with Nazi Germany?

  2. eg

    Ha Joon Chang outlines in “Bad Samaritans” how Korea escaped the low income trap by defying “free trade” orthodoxy and embracing tariffs, credit guidance, and capital controls.

    It’s called “Bad Samaritans” because all of the “free trade” proponent countries disingenuously rose using exactly the same blueprint and then proceeded to “pull the ladders up behind them” by subsequently recommending the opposite (foremost among them the UK and the US).

    For underdeveloped nations, “free trade” orthodoxy means condemning themselves to permanent neocolonial status producing cash crops (rather than feeding their own people) and low value raw materials. They impoverish their masses and enable local oligarchs to stash their ill-gotten gains overseas by eschewing capital controls.

    1. Thuto

      If the courage that allowed politicians during that chapter in South Korea’s rise to openly defy free trade orthodoxy could be bottled and freely distributed to the contemporary political class in developing countries, it’s possible we might have a different global economic landscape. I imagine the IMF looked at this example, thought “never again” and proceeded to tighten/weaponize loan conditions to eliminate such open defiance as an option.

      It’s also possible that economists were kept on a tight leash during that era with limited influence on policy formulation, the exact opposite of what we have today where, as has been mentioned here on NC, they’re the only social scientists with a seat at the policy table (with influence to boot on which policies get passed into law). To put it all into context, it has to be acknowledged that SK’s rise is historically contingent and the boat has probably sailed for countries that would want to replicate its model (the screws have been tightened sufficiently to dissuade any would be renegade countries from even attempting to defy the orthodoxy). The coattails have been rolled up and no country left behind is going to be allowed to ride them to prosperity. It’s refreshing though to see IMF staffers, at risk of being raked over the coals, breaking ranks with institutional dogma.

      1. John Wright

        Re: “It’s also possible that economists were kept on a tight leash during that era with limited influence on policy formulation”.

        I don’t know if economists, in the USA or elsewhere, have much direct influence on elite policy decisions.

        I suspect that what we observe in the USA is that members of the wealthy class want to do something (more tech or low wage worker immigration, more foreign outsourcing, more removal of foreign trade barriers) and then find a suitably credentialed economist to provide justification of their desired action..

        Economists may be of little influence as the policy is already “baked in the cake”.

        Then the think-tank and academic supporting economists are trotted out to the public via the media.

        This suggests media-friendly economists are part of the “manufacturing consent” industry in the USA.

    2. Andy Raushner

      Korea escaped nothing. They were subs of the US. Without that, it’s poof. Trade frankly was irrelevant. Asia itself bowed to the dollar and it’s rise was nothing more than part of the global supply chain of pax americana.

  3. djrichard

    The Princes of the Yen video which has been linked to on NC previously gets into how Japan was still essentially a war economy after WWII, but instead of producing war armaments they produced and consumed goods.

    As that video gets into, the Bank of Japan saw it necessary to create a crisis (bubble followed by deflation) to get the reforms needed to move Japan off of that model and onto American style capitalism.

    1. eg

      Which is why I tend to identify it with the quotation marks — “free trade” is a slogan, not an actual occurring thing.

    2. Stadist

      “Partners in backwardness” makes for nice slogan but implies naivety of the organizations. While I agree the Free Trade repeating dogmatists are certainly naive, World Bank and IMF do not come across as naive or backward, they have probably performed their intended function exceptionally well. The intended function often just isn’t clearly expressed to or even actively shared with spectators.

      I continue to be astonished how Economists in general seem to value theory over any empiricism. Is reality optional, a matter of belief?

  4. Synoia

    They distinguish three types of countries which have ‘succeeded’, namely the East Asian miracles, those discovering considerable oil and gas, and those that benefited from joining the European Union.

    I’d note that the Oil and Gas Countries have enormous inequalities of wealth, and in some cases amazing levels of corruption (Nigeria comes to mind).

    1. James

      Norway is an oil and gas success story. Whether the problems associated with large amounts of oil and gas are somehow instrinsic, or whether they are due to the perfidy of the anglo-american oil cartel that Anthony Sampson describes in his book The Seven Sisters … is an interesting question.

      Russia seems to be doing much better since it kicked out the UK/US oil majors.

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