Industrial policy and development – some neglected themes

Production_LineThere has been a resurgence of interest in the theory and practice of industrial policy in recent years. To many, the financial crisis of 2008 exposed a general failure of the ideology, if not the practice, of a minimal state. Although the interventions that resulted were necessarily imperfect, they reawakened among more mainstream economists and other social scientists ideas that had for some time been confined to the heterodox margins of academia, at least in economics.

Meanwhile, the experiences of economies in East Asia, such as Japan, South Korea, Taiwan and Singapore, which all experienced significant periods of rapid catch-up growth to advanced country status, revealed that, if one cared to look closely enough, industrial policy had never really gone away.

Moving to the present day, policy-makers all over the world have engaged in unprecedented intervention to try and protect parts of the economy during the Covid-19 pandemic and subsequent widespread lockdown. While these are more general than traditional industrial policies, those economists more sympathetic to state intervention are making the case that economies should learn some lessons from the current crisis, such as that there is very often a need for the state to work with the private sector to tackle public ‘missions’ at the national and international levels.

Two recently published articles in, respectively, the journals Development and Change and the Cambridge Journal of Economics, explore some neglected aspects of industrial policy and its role in economic development. As befits these two journals, the approach of both articles lies in the heterodox or non-mainstream economics camp, drawing on politics and political economy themes such as power, conflict and the role of the state.

The first, by Ha-Joon Chang and Antonio Andreoni, explores four themes which they see as hitherto under-explored and theorised. They go on to describe some of the new realities which have characterised the global economy in recent decades and their impact on the prospects for managing successful industrial policies. The lay readers among you must forgive the use of some academic terminology in defining the issues and theories; I will nevertheless try to describe the ideas in digestible form.

The neglected themes

Commitment under uncertainty: the production of goods and services in an economy requires irreversible commitments, such as investing in new technologies embodied in capital equipment for use in the workplace like computers, robots and other machinery, relationships with suppliers, and skills specific to particular firms or industries. These can potentially increase productivity over time, but make subsequent unforeseen or uncertain changes in the economic environment costly.

Policy-makers can respond to this situation by acting to reduce uncertainty in ways that firms cannot manage themselves: this might take the form of protecting infant industries that are not yet competitive by ensuring their survival for a period of time, allowing them to engage in learning to use technologies which are needed to catch-up with their international competitors.

They can also guarantee a certain degree of market demand by restricting competition in the domestic market or through government procurement schemes. Furthermore, the state can potentially take a long term role in the development of basic technologies through the creation of research consortia, by imposing (early stage) technological standards, or by providing or supporting technology-related public goods to reduce the risk of failure in the private sector. Overall, the state can  develop a joint vision with and credible expectations among private companies around future public investments in order to reduce uncertainty and create new markets.

Learning in production: one way of describing the ultimate driver of successful industrial growth and change, and especially of innovative activity, is as the development and accumulation of productive capabilities. The individual and social learning that this involves is a “collective and cumulative process embedded in existing production structures”. In other words, it needs actual processes of production to take place in order for it to be realised. This is more than what is often called the “learning-by-doing” of workers, but requires organisational restructuring over time. There is a need in all industrial development, particularly in late developers that need to industrialise, both for incentives to help firms produce more and for measures to increase the acquisition and use of knowledge. For the former, this might involve temporary industry protection, subsidies, export promotion and state-led restructuring of failing companies. For the latter, it could mean education and research and development funding alongside knowledge-generating activities such as training or public technology consulting services for small and medium sized enterprises.

Macroeconomic management: the study of industrial policy has tended to focus on supply-side policies and the building of industrial capacity rather than the demand-side of macroeconomic policy. The authors argue that we need to pay attention to the interaction of the two.

Macroeconomic policies that support industrial development might take the form of a period of financial repression which encourages low rates of interest, low and stable exchange rates to promote growth in exports, fiscal policies which avoid austerity and underwrite the expansion of aggregate demand, and controls on the imports of particular goods not needed for early-stage industrialisation in order to prevent excessive current account deficits which could constrain growth and lead to unsustainable international borrowing.

The aim of such policies is to underwrite higher levels of productive investment and its multiplier and accelerator impacts on aggregate demand, which can support growth in output and productivity.

Conflict management: here the authors draw explicitly on political economy. Economic growth and development lead to change which necessarily produces winners and losers. This requires a state which can manage the potential social conflicts which often result. Particularly with industrial policy, which is selective by nature, this process can be very obvious to the actors involved. The maintenance of political stability may well require measures of redistribution and social insurance in forms such as a welfare state, or reactive ones which aid the losers from inevitable industrial restructuring without sustaining social welfare losses in the form of persistent failure among firms and sectors.

The new realities

The authors go on to describe some of the ‘new realities’ of global capitalism which impinge on industrial policy in practice. Firstly, the globalisation of production and the rise of global value chains and increasingly powerful transnational corporations, as well as the blurring of boundaries between different sectors in the economy, have all altered the nature of economic growth and value creation and capture.

Secondly, the rise of financialisation, associated with the increasing size, GDP share and influence of the financial sector in economic activity in many nations may well have had a number of effects on the economy. It seems to have increased short-termism in many firms’ investment strategies, led to rising dividend payouts and share-buybacks at the expense of investment, and driven an increase in financial activities by non-financial corporations.

Overall it has played a role in breaking the connection between profits and investment, to the detriment of long-term economic performance. The rise in predominantly short-term speculative financial flows has also played a role in increasing financial and economic instability, pointing to the need for improved forms of financial regulation which support and allow for industrial policy and development more generally.

Thirdly, new forms of what the authors call imperialism have taken shape in the global economy, driven by international institutions dominated by the richest countries, such as the IMF, World Bank and WTO. The policies they promote in struggling developing economies, such as austerity, trade liberalisation, deregulation, privatisation and the retreat of state intervention in general, have tended to reduce the space for developing countries to adopt industrial policies. But the authors contend that creative interpretations of the rules around trade and investment, which usually favor the richest and most powerful nations and corporations, mean that such policies are not impossible to implement.

Industrial development and political settlements

The second article, by Keston K. Perry, argues for a deeper and more context-specific political economy approach to development, incorporating the “social, political and institutional dynamics and drivers of techno-economic outcomes”. He makes the case for an analysis based on the concept of “political settlements” originated by Mushtaq Khan.

For Perry, and for Khan, the work of Chang and Andreoni neglects the visibly uneven capabilities of states when comparing different countries. Successful late-industrialisers such as South Korea and Taiwan that have gone through periods of rapid catch-up growth and graduated to the rich country club are rare in recent economic history. These case studies may therefore not be particularly relevant to other developing countries that are struggling to industrialise. This does not mean we should ignore the lessons from examples of success, merely that we need to take the economic, social and political history and context into account when trying to design successful industrial policies.

As Khan has argued in another paper on the political settlements framework (link below), the motivation for it is the question as to why the economic and political effects of particular institutions and policies differ in different contexts. Rather than merely looking at successful country case studies, it tries to explain the less successful development experiences, in regions such as South Asia, Latin America and Sub-Saharan Africa. It goes beyond simplistic attributions of success to, for example, the capacity of repressive authoritarian states or, on the other hand, more inclusive democratic states, to accelerate industrial development.

It also tries to explain why the imposition in poor countries of institutions and policies that one finds in the richest countries, such as the rule of law and well-defined property rights, have had poor results in terms of development.

Khan’s definition of a political settlement is that it is “a description of the distribution of power across organisations that are relevant for analysing a specific institutional or policy problem”. In any country, not just a poor one, individuals in government or elsewhere can try to create or change institutions and policies in order to promote economic growth. However, particular organisations can support, resist or distort these institutions and policies, and how successful they are depends on these organisations’ interests and capabilities.

As an example, during its period of rapid growth, the South Korean state was able to make support to particular industrial sectors conditional on improved performance and ultimately the achievement of sufficient competitiveness to export globally. Poor performers often had their support withdrawn, which avoided the risk of industrial policy sustaining ‘lame ducks’ and wasting resources. But many late developer nation states have been unable to discipline emerging firms in this way, due to a different balance of power between the relevant organisations. For these states, a successful industrial policy would require a different approach.

A political settlements analysis therefore requires a historical study of organisational power and the social, political and economic context in the country concerned. This may involve analysing the global context, taking into account institutions and power at the international level as well as domestically.

According to Perry, this richer heterodox approach to problems of development emphasises, as do Chang and Andreoni, the need for the state to steer the economy in late developers to achieve “broad-based development with structural transformation” to raise productivity, deepen the use of technology and produce inclusive job creation in high productivity sectors. But it goes further than them, placing more emphasis on individual country contexts.

All this makes clear that there is plenty of innovative thinking going on with regards to industrial policy and the problems of development. The concept of political settlements argues for us to go beyond a purely economic analysis and adopt a richer interdisciplinary political economy approach incorporating aspects of history, politics and social science more generally. Chang and Andreoni’s article certainly has one foot in this camp, but Kerry’s, and by implication Khan’s work, argues even more strongly for this. We can see that there is no one-size-fits-all set of policies which will accelerate industrial development and enable graduation to rich country status. This is illustrated by the limited number of late developer countries that have managed this during the late 20th and early 21st century. There is plenty to play for, but industrial policy and the problems of development remain complex and contested territory.

References

Chang, H-J. and A. Andreoni (2020), Industrial Policy in the 21st Century, Development and Change, 51(2), p.324-351.

Khan, M. H. (2017), Political Settlements and the Analysis of Institutions, African Affairs, 117/469, p.636-655. This article can be accessed for free here.

Perry, K. K. (2020), Innovation, institutions and development: a critical review and grounded heterodox economic analysis of late-industrialising contexts, Cambridge Journal of Economics, 44(2), p.391-415.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.