Varieties of industrial policy for promoting economic development

The key to a successful industrial policy, one which promotes the growth and structural change in a ‘late-developing’ nation and enables it to catch up with much richer countries, is one which stimulates technological learning by firms and industrial sectors, rapid productivity growth across the economy, and a leap up the technology ‘ladder’.

Industrial policies which have been at least to some degree successful in achieving catch-up growth and development have been carried out in a number of countries, albeit in different forms. In Japan, South Korea and Taiwan for example, policies involved a mixture of import substituting industrialisation and (later on) export promotion. Particular industrial sectors were supported as infant industries which needed to ‘grow up’, even if this meant going against these countries’ comparative advantage, or those industries which were ‘naturally’ price-competitive in national and international markets. Thus these countries’ governments ‘got the prices wrong’, through such policies as tariffs, subsidies, public ownership of particular enterprises and enforced credit allocation through state-owned banks.  This strategy, which promoted domestic firms and sectors as a route to development, resulted in rapid GDP and productivity growth and structural change and a catching-up with much richer countries during the post war period.

By contrast, countries such as Malaysia in the 1970s and 1980s and China in the 30 years since reforms began in 1978, relied more on foreign direct investment (FDI), as a route up the technological ladder. Multi-national corporations (MNCs) were encouraged to invest in special economic zones through a mixture of tax incentives, infrastructure provision and the promise of political stability which, although not a purely economic issue, is surely vital to sustained investment. These zones were intended to be used for production for export. However, in order to achieve technological progress beyond simply the foreign firms themselves, which could have simply imported components for assembly and exported the finished product, with minimal spill-over benefits for the wider economy, these countries’ governments pushed hard for a minimum level of local content inputs to production, in order to stimulate the growth of domestic firms and encourage broader indigenous growth and transformation. Backward linkages from MNCs to local firms were thus an important part of the industrial strategy. The size of the Chinese market and a well educated and cheap labour force were also a factor in its attractiveness to foreign investors.

While growth in Malaysia was never as fast as the East Asian Newly Industrialising Countries (NICs) of South Korea and Taiwan, as well as Japan, it nevertheless grew quickly and achieved its own measure of catching-up development during the last quarter of the 20th century. Growth in China has been more rapid, at an average of around 10% for 30 years.

Thus different types of industrial policy can be compatible with rapid development. In all cases, the state is able to encourage a broad pattern of technological learning and catching up in firms and sectors which act as an engine of growth.

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