Industrial Policy revisited

It is an umpteenth time of revisiting this controversial topic.

Célestin Monga of World Bank argues that industrial policy is not as bad as it is made out to be:

In a recent paper on ‘Growth Identification and facilitation: The role of the state in the dynamics of structural change,’ Justin Yifu Lin and I have tried to suggest a rational way of looking at the trial-and-error process that successful economic development always involves. In a new post on his excellent blog ‘Africa Can,’ my colleague Shanta Devarajan welcomes our work but asserts that we gloss over the politics that underlie efforts by governments to guide certain industries toward success.

Rethinking industrial policy is often considered anathema to many free market economists, as they worry that ‘picking winners’ is nearly impossible, partly because the political economy issues are so problematic. Shanta makes that point and others.

He explains the broad thoughts:

Most of the failures we’ve seen in developing countries to give industries a leg up faltered because the public sector couldn’t come up with good criteria for identifying industries that are appropriate for a given nation’s endowment structure and level of development. In other words, old structuralism as it is now known failed because countries around the world (the former Soviet Union, Mao Zedong’s China, most of Latin America and Africa) tried to defy their comparative advantage instead of encouraging the emergence of private sector industries that were consistent with it. With this in mind, the GIFF involves six steps:

• Step 1: Policymakers should select dynamic growing countries with a similar endowment structure and with about 100% higher per capita income. They must then identify tradable industries that have grown well in those countries for the past 20 years.

• Step 2: If some private domestic firms are already present in those industries, they should identify constraints to technological upgrading or further firm entry, and take action to remove such constraints.

• Step 3: In industries where no domestic firms are present, policymakers may try to attract foreign direct investment (FDI) from countries listed in step 1, or organize new firm incubation programs.

• Step 4: In addition to the industries identified in step 1, the government should also pay attention to spontaneous self discovery by private enterprises and support the scaling up the successful private innovations in new industries.

• Step 5: In countries with poor infrastructure and a bad business environment, special economic zones or industrial parks may be used to overcome barriers to firm entry and FDI and encourage the formation of industrial clusters.

• Step 6: The government should be willing to compensate pioneer firms in the industries identified above with tax incentives for a limited period, co-financing for investments, or access to foreign exchange.

Lin in this paper did explain why China’s 1950s industrial policy failed. The policy was based on nurturing capital-intensive industries which was not China’s comparative advantage. And then in 1979 China got its policies right.

He then looks at some comparisons like India vs Kenya and South Africa’s industrial policy:

In his argument, Shanta uses the example of Kenya and India, arguing that India has double the per-capita income and a similar endowment to India and that therefore, according to a literal application to the GIFF, Kenya should be able to produce high-tech goods and services like India. He then points out that this Kenya-India match up wouldn’t work due to India’s idiosyncratic labor regulations and the nature of its workforce. In turn, he implies this is proof that our framework doesn’t work.

However, I would argue he is setting up a straw man by picking India as a country of “similar endowments” as Kenya. One cannot seriously choose a federal sub-continent of 1 billion people as a model for a centralized country of 39 million. One should not blame the engineer for a faulty use of the equipment.

Then Shanta cites South Africa, identifying labor-intensive industries where the economy could be competitive if not for constraints to lowering the minimum wage. Yet we would argue that a country that’s serious about using the GIF framework must use it in its full sequence and should takes steps to ensure the nation’s workforce is competitive and that its investment climate is business-friendly. A government should not choose to pick one or two recommendations (say, steps 1 and 2) and not be willing to implement the policies recommended in Steps 4, 5 or 6 that complement them.

He invites people on his blog to comment. Shanta has some interesting comments at the end.

Then Gulzar points to this interesting study which says much of US innovations are because of industrial policy. So whether you are using i-phone or cancer patients using cancer treatment machines….it is basically due to government funding of these projects in their earlier forms. I r’ber reading Dani Rodrik saying similar things about US industrial policy.

THis  debate is unlikely to die.

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