The emerging markets slowdown and the need for an effective industrial policy

After being seen as the solution to the Great Recession and slow global economic growth, the progress of emerging markets and their catching-up with the rich countries has slowed. Some of this slowdown can be laid at the door of the rich countries themselves, as consumers and firms struggle to deal with the burden of private sector debt, and governments engage in fiscal austerity in order to manage public debt and deficits in many cases caused by the recession. Another source of the slowdown is the adjustment of the Chinese economy to a less investment and export-driven model to one with a higher share of consumption and driven more by domestic demand. This shift is vital and will in the long term lead to a more healthy balance of the components of aggregate demand in China and a helpful rise in demand for Western exports, boosting their economies in the process. But in the short term, the global adjustment to the shifts in the Chinese economy will mean a lower demand for commodities and a fall in commodity prices. This will adversely affect many economies with a large share of commodities in their export profile, and necessitate a diversification of their exports towards a larger share of manufactures.

Much of the character of the globalization of the last decade and more can be usefully analysed by considering the China effect. The rapid, resource-intensive, investment and latterly export-led nature of Chinese economic growth has boosted economies with large stocks of natural resources, as well as those supplying components for manufactured goods and led to an emerging market boom. Now that that boom has come to an end, many emerging market economies are experiencing a slowdown. Their future success will depend on a more diversified export base, and it seems that this will not happen without effective policies from their governments. This will not only mean providing more basic education and infrastructure, but also an effective industrial policy.

The numbers of countries that have made the successful transition from developing through middle-income to advanced economy status during the twentieth century and beyond is few and far between. They could include Taiwan, Singapore, South Korea and not many more than that. All of them used a variety of forms of industrial policy to encourage the growth of competitive domestic industry and manufactured exports. These policies were highly effective, but they were also attempted in many other developing countries during the post-war period with notably less success. Import-substituting industrialisation never developed properly into the export-led growth of globally competitive industries and when liberalisation was eventually adopted, many industries collapsed when exposed to global competition, to be replaced by much lower productivity industries with a lower potential for growth.

Thus a successful industrial policy is a first-best solution to development along with other more universally supported policies. However a failed industrial policy may be worse than no policy at all, as resources are used to support industries that never ‘grow up’ and develop.

Countries that benefited from the commodities boom should have been re-investing the incomes and surplus they received from such exports in education, infrastructure and supporting domestic industry, on the condition that firms become globally competitive, and withdrawing support from firms and sectors that are clearly failing to develop. Industrial policy should therefore take the form of conditional support for the technological learning process that enables sectors to raise their productivity and eventually become successful exporters on world markets. This can take time and has the potential to fail, but if the process is a success, the relevant economy can reap the benefits in terms of productivity growth which is the key to growth in material wealth.

The world economy is not growing as fast as before the Great Recession and even emerging markets are now no longer providing the impetus they once were. China has begun a difficult restructuring which will impact us all, but if the world is to emerge from this into a new phase of rapid growth, those countries which benefited from the China effect, globalization and the commodities boom need to find a way to implement a successful industrial policy. The alternatives will be poor growth records and insufficient economic progress to lift many millions of those living in poverty up to a much better standard of living.

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