Rents, rent-seeking and the role of industrial policy in economic development

The role of industrial policy in helping countries such as Japan, South Korea and Taiwan ‘catch up’ economically with the world’s rich countries in the post-war period has been extensively documented. Yet industrial policy, defined here as a government policy of targeting particular industries and technologies with support with the view that their rapid development has wider social and economic benefits in the national interest, has been far from a universal success story across developing countries. In fact, the failures probably outnumber the success stories in that only a few countries have made the successful transition from developing to rich country status. Rent-seeking processes have often been blamed for these failures, yet such studies ignore the pervasiveness of rents and rent-seeking in all modern economies. As will be discussed below, the desire to eliminate rents and rent-seeking is misguided and the creation of rents which support the development process has been key to the success of a number of newly industrialised countries (NICs).

In order for poor countries to catch up with the rich ones, they need to go through a process of rapid productivity growth and structural change, much faster than that prevailing in the technological leaders. Their companies need to learn how to use increasingly sophisticated technology as they move up the  ‘ladder’. At the early stages of development, innovation is probably less important than technological ‘learning-by-doing’: they must learn how to use technologies already in existence, rather than create new ones, although there is likely to be a degree of adaptation to local conditions, which could be seen as a kind of innovation.

Rapid transformation from being a poor country to a rich one will in almost all cases involve industrialisation, the structural shift from an economy dominated by agriculture to one of industry and services. Productivity growth needs to take place in all three of these sectors, while labour shifts from the primary to the secondary and tertiary sectors.

While technological backwardness and the dominance of agriculture offer potential for catching-up, this is far from an easy or automatic process. It is widely acknowledged that in countries such as Japan during the 1960s and 1970s, and South Korea and Taiwan during the 1970s and 1980s, the state had a strong developmental role and used a range of policies to promote particular industries in the service of broader economic goals. The results were dramatic in terms of GDP and productivity growth, which were rapid over these periods. A second tier of countries, particularly in South East Asia, such as Malaysia and Thailand also grew rapidly during the late twentieth century, in the run-up to the Asian Crisis of 1997-8, when they entered deep recessions. Industrial policy was attempted in these latter two, but was not as extensive as in the NICs, largely due to political constraints, as they possessed a different balance of power between the state and various social classes which left a faithful copying of the industrial policies of the NICs very difficult.

Many other countries tried industrial policies during the post-war period, such as nations in Africa and South America, as well as South Asia. This often involved nationalisation of particular industries and import-substituting-industrialisation (ISI), in which domestic industries are protected from foreign competition by tariffs, as a form of infant industry protection. The aim is that companies should be sheltered from more productive rivals until they ‘grow up’ and are able to compete in terms of price, technological sophistication and product quality. This will occur if the protected firms and those they employ engage in learning-by-doing and especially if they can take advantage of economies of scale in production, both of which can stimulate productivity growth. However, many of these industries, while they made initial progress and contributed to fairly rapid growth in the aforementioned countries, never fully grew up to compete internationally and continue to produce for export, without government support. By contrast, in the successful NICs, initially protected industries did become internationally competitive after a period of protection. Government support in the form of subsidies, tariffs and preferential access to credit was withdrawn after a time, and the industries continued to grow and become more productive.

What was the difference between the industrial policy successes and failures? The economist Mushtaq Khan has argued that the view that differences in corruption and other forms of rent-seeking explain the contrasting fortunes is misleading, as corruption tends to be a structural feature of all developing countries. While all developing countries (and indeed probably all rich countries as well) suffer from rent-seeking, the major differences between successful late-developers and those countries which have not performed as well, are the rent outcomes produced by the rent-seeking processes.

The most successful of the late-developers such as South Korea and Taiwan had states that were able to carry out policies which targeted support at particular industries in a time-limited fashion: support was withdrawn both when sectors became competitive internationally and could engage in exporting and also when they failed to become competitive. One difference with less successful countries was that governments in the latter failed to withdraw support even when the sectors and firms didn’t to grow up to be competitive and such economies were left with substantial welfare losses and without the successful exporters that the NICs possessed. Khan argues that the outcome of failed industrial policies can be worse than simply ‘leaving it to the market’, due to both static and dynamic welfare losses. The first best outcome would be rapid development as a result of successful industrial policies, as in the East Asian NICs, but such policies, certainly in the way they were carried out in the NICs, are not possible everywhere. What countries need to do is to match their policies which aim to stimulate technological and industrial upgrading with what is possible given the balance of power between classes, which produce a particular political settlement. If particular social classes are able to prevent the withdrawal of state support to firms and sectors, even when these have not grown up and become competitive, then economic stagnation can result. In these cases, the rent outcomes will be negative. By contrast, a different balance of power within a society, from a strong state insulated from the such social classes, and/or one whose interests are aligned with capitalists providing kickbacks to the state, can produce positive rent outcomes which may outweigh the rent-seeking costs which are likely to prevail in all societies.

It follows that, certainly at earlier stages of development and during the catching-up phase of growth, states should focus on industrial policies that are achievable and, if none are, then political reform is important to enable such policies to be put in place. In short, state industrial policies should provide targeted and time-limited support to particular sectors, conditional on performance. If firms and sectors do not perform well and become competitive, ultimately on an international scale with export potential, then support should be withdrawn. The necessary political reform obviously goes beyond economics, and shows the importance of a political economy approach to development.

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