The IMF recently published a refreshing paper on the principles of industrial policy. The paper is quite lengthy, so I will summarise and discuss some of the main points here. The authors do not speak for the IMF of course, and it merely reflects their current research, but it remains important.
The paper is important because it unambiguously makes the case for an active industrial policy in developing countries to enable them to catch up with the richest countries.
They argue that successful examples of such a development strategy have been extremely rare in recent decades, but that it is vital to learn from them. They use the case studies of the ‘Asian miracle’ economies of South Korea, Taiwan, Singapore and Hong Kong, which were relatively poor some decades ago, but managed to industrialise and grow rapidly, enabling them to catch up and graduate into the club of advanced economies.
They also note that most if not all of today’s rich countries, including the US, Japan and Germany, followed such a strategy during their catch-up phases of growth, and continue to employ industrial and technology policies, albeit in different forms.
The paper is also refreshing because the IMF, and the World Bank, are not known for supporting the principles of industrial policy as a viable development strategy. In their dealings with financial crises and developing countries in recent decades, they have tended to promote and enforce an anti-developmental state neoliberal policy agenda, known as the Washington Consensus, with often dire results for levels of poverty and inequality and the ability of governments to encourage successful development.
The authors describe what they argue have been successful examples of policy-induced catch up as Technology and Innovation Policy (TIP). They highlight three key principles of such a policy:
- The support of domestic producers in sophisticated industries, beyond any preconceived comparative advantage.
- Export orientation.
- The pursuit of fierce competition with strict accountability.
They also argue for the importance of a ‘triple-A’: ambition, accountability and adaptability. Thus states in developing countries should think big, and be responsive to both successes and failures in terms of policy outcomes.
They describe the policy of going beyond comparative advantage and promoting initially uncompetitive industries as a ‘moonshot’ strategy. This may seem ambitious and risky, but is key for catching up fully and becoming a rich country at the technological frontier. States may therefore need to employ such policies as creating and shaping markets or setting up State Owned Enterprises (SOEs) in certain cases where the private sector has not initiated production in a favoured sector.
In the process of development, they argue that there is a need to overcome government failures and for ‘horizontal’ policies (such as the provision of education and infrastructure, and appropriate regulation, which benefit firms and sectors relatively evenly across the economy, although this is perhaps debatable). But there is also a need for fixing market failures in specific sectors due to externalities and coordination failures. These kind of policies are sometimes described as ‘vertical’.
The authors describe their kind of industrial policy as a TIP to emphasise the importance of rapid productivity growth driven by innovation and increasing export sophistication, which will be reflected in the accumulation of ‘capabilities’ in sophisticated industries, as individual workers, teams, firms and sectors engage in learning-by-doing processes. There is a need to produce goods and services with positive externalities in the form of linkages and spillovers.
Successful late development requires the creation of domestic innovators, with or without Foreign Direct Investment and the transfer of technological know-how which it makes possible.
Given the Asian Miracle case studies the authors examine, it is strange to see them criticise the policy of Import Substitution Industrialisation (ISI). It is certainly true that plenty of late developers tried such a policy during the post-war period, in which domestic producers were sheltered from foreign competition behind trade barriers in order to promote their growth.
This had decidedly mixed results, and in many cases failed to promote a process of sustained catch-up growth. But the few real success stories among the late developers used it as part of their overall strategy and their push to export. Thus the sectors targeted for support behind trade barriers were at some point encouraged to compete on the world market and produce for export. What mattered was that they had accumulated sufficient competitiveness in order to do so.
Sophisticated industries in the authors’ argument can be in the manufacturing or service sectors. The key factor is that they be capable of continuous productivity growth. Service firms in sectors such as leisure and tourism are unlikely to be so, while those in the transport and communications, financial intermediation and business services sectors have much greater potential for growth alongside manufacturing firms, which are more commonly argued as vital for rapid development.
Successful development requires such policies to be a success, as well as some luck in the external economic environment. A global recession with a shrinking world market clearly makes the job of exporting much harder!
It is to be welcomed that the authors acknowledge the influence of more heterodox economists such as Ha-Joon Chang, Robert Wade and Alice Amsden, who have over many years produced copious research on successful industrial policies, particularly among the Asian Miracle economies. They also look ahead to a future paper which will aim to apply the principles of TIP for countries to use depending on their own particular contexts.
However, they do ignore the political economy of industrial policy and development which has long been the focus of economists such as Mushtaq Khan, who addresses some of the deeper reasons as to why only a few late developers were able to successfully become rich countries, while many failed to do so, and others were only moderately successful in their development strategies.
One of Khan’s original contributions focuses on the idea of a ‘political settlement’. He defines this as
“a combination of power and institutions that is mutually compatible and also sustainable in terms of economic and political viability.”
The political settlement represents the balance of political power between different groups in a society, which produces a particular distribution of property rights, in turn giving rise to the degree of success of particular policies. The political settlement is the product of historical processes, including the economic, which can be changed, within limits, by changes in the economic structure, by internal actors such as governments and social classes, or external ones in the case of colonialism.
In the case of South Korea, the state was able to successfully implement policies which supported industries with the potential for rapid productivity growth and successful exporting onto the world market. In sectors which failed to improve, the state was able to withdraw support, so that, as far as possible, resources were not wasted and could be reallocated to new sectors which had greater potential for growth and transformation.
Few late developers possessed states with the ability to do this. This ability is part of what the authors of the IMF paper term adaptability. The South Korean state had a relatively centralised and autonomous state in terms of its relationship to emerging capitalists and other social classes, which meant that during its period of rapid catch-up growth it could credibly threaten to withdraw support from what proved to be weaker industrial firms and sectors.
In Malaysia, which has been a moderately successful late developer, but remains a middle-income economy, the state had to use significant amounts of resources to manage and maintain political stability by redistributing income to and privileging public sector employment for the ethnic Malay population. It also managed to incentivise a certain amount of catch-up productivity growth, often by encouraging technology transfer from foreign investors, but it has been less successful in terms of catching up than South Korea.
The examples of Korea and Malaysia shows that history and context matter for the success of TIP in late developers. The political settlement will have a big influence on the scale and direction of policies which can drive development.
Some sort of TIP is clearly vital to rapidly improving living standards across the populations of late developing nations. And industrialisation is key to such development. An article in the January edition of the Cambridge Journal of Economics (which has a paywall, although you can read the abstract) makes clear that such ideas are not new.
The article focuses on Gebrehiwot Baykedagn (1886-1919), an Ethiopian intellectual, little known outside his home country, but whose writings reflected the ideas of the ‘classical’ development economics that was influential during the post-war period when industrial policies aimed at driving growth and transformation were part of the widely attempted orthodoxy.
For Baykedagn, the keys to development are
“the creation, accumulation and use of knowledge and skill, technology, innovation and technical change and the means of economic development are deliberate, dynamic and comprehensive sets of state-directed, synergistic interventions that aim at moving an economy away from ‘nature-intensive’ economic activities towards knowledge-, skill-, technology- and innovation-based ones.”
He also argued
- That climate, geography and the environment are not destiny in terms of development.
- That widespread prosperity and development via industrialisation are necessary to promote the emergence of a unified nation state, which in turn can aid the development process.
- That context is important in the development process, and that particular forms of governance, institutions and policies need to address this. There is no one size fits all!
- That an increasing diversification and sophistication of production is vital.
- That institutions will evolve as development proceeds, so that transplanting rich country institutions is not necessary to kick-start development and may even be harmful.
- That foreign trade should be managed, and initially prioritise the import of capital goods and the restriction of consumption and luxury goods imports during the early stages of industrialisation, in order to promote domestic productive capabilities for export.
Baykedagn was influenced in part by the ‘American School’ of political economy, and the kinds of ideas he propounded can be found in the work of Friedrich List and modern heterodox development economics, as well as the already mentioned classical development economics of the early post-war period. Some are reflected in the IMF paper discussed above, but are in certain ways more sophisticated in terms of their orientation to political economy and stress on institutional context.
A sustained transformation of the productive structure and rapid productivity growth are thus some of the keys to successful development and becoming a rich country, a feat which has in recent decades proven all too rare. Policies which guide a poor country in this direction can be hard to get right, and the ability of the state to do so depends on more than its autonomy and competent bureaucrats.
Politics and institutions, as well as economic factors, driven by historical processes, mean that context plays a big role in the success of development strategies, not least industrial policy. These ideas are not new, but need to be rediscovered by those with power and influence. Late developers face big challenges, but the widespread dissemination of ideas such as those in the IMF paper discussed above, are an important step forward.
Gray, Hazel (2018), Turbulence and Order in Economic Development: Institutions and Economic Transformation in Tanzania and Vietnam, Oxford: Oxford University Press
Khan, Mushtaq H. and Jomo, K.S. (eds) (2000), Rents, Rent-Seeking and Economic Development: Theory and Evidence in Asia, Cambridge: Cambridge University Press