Industrial policy lessons for advanced countries from Asia: some notes

Industrial policies are back in the advanced countries. This is very much the case in the US, as part of ‘Bidenomics’. Many would argue that they really never went away, if defined fairly broadly. But they have certainly become more prominent in the last few years, maybe even since the global financial crisis and subsequent recession that began in 2007. The role of state intervention in the economy more generally has been given a boost by successive crises, including the GFC, despite the subsequent turn to austerity in many countries; then the pandemic saw significant fiscal stimuli enacted across the world. All this makes some on the political right uncomfortable, and perhaps hopeful that this new prominence remains only temporary; for those on the left, the hope is that it is far from temporary and that it will provide new legitimacy for governments to tackle long-standing injustices and poor economic performance.

The notes that follow these introductory paragraphs draw heavily on a chapter by my former lecturer at SOAS, Professor Mushtaq Khan, and are taken from a 2015 edited volume on industrial policy in the UK, though they are very much applicable to any advanced country today. Like many of the academics in his department, Khan specialises in the economics of developing countries, particularly in his case the political economy of corruption, but also in institutional economics and industrial policy. His background therefore gives him a unique perspective on the application of the latter to advanced countries.

Why industrial policy?

As already mentioned, industrial policy is achieving a renewed prominence these days, inciting discussion across policymaking and academic circles. In fact however, and especially among non-mainstream or heterodox economists, it has never really gone away. My 2001 graduate dissertation at SOAS was on industrial policy in Malaysia, and the option to study aspects of IP was readily available there. Admittedly, the SOAS economics department has a special focus on heterodox ideas, alongside the teaching of mainstream ones, so it provides a fascinating environment for those who want to explore ‘alternative’ approaches to the subject.

According to Ha-Joon Chang, another professor at SOAS, and the author of a number of popular economics books, every advanced country of today used state intervention, including IP, to aid its industrialisation and enable its economic, social and political development. Across both the advanced and the developing world, and in the wake of new ideas about development, the thirty years which followed the Second World War were perhaps the highpoint of the use of IP and support for intervention more generally, before the tide turned towards more ‘free market’ thinking and policymaking from the late 1970s. The post war ‘Golden Age of Capitalism’ in fact saw faster and more equitable economic growth than ever before, or since, across the rich world, and some success among many poorer nations too. Economic growth necessarily proceeds unevenly, both across historical time and geographical space, but overall it seemed that state intervention in the economy was no barrier to economic success, and in many cases helped the process.

Despite the shift towards free markets in many countries more than forty years ago, IP in practice remained, particularly in East Asia, where it saw perhaps its greatest successes in driving rapid development. But it could also be found in the US, where for example the military-industrial complex meant that state-funded innovation for military use ultimately spilled over into commercial civilian applications. Heavy state spending in this way has arguably helped the country retain a technological lead across a range of sectors.

Fast forward to today, and IP has taken on a new prominence in the wake of President Biden’s CHIPS Act and Inflation Reduction Act, which together with an infrastructure bill aim to accelerate the domestic growth of hi-tech industry and the use of renewable energy, among other elements. The use of subsidies to encourage domestic hi-tech manufacturing investment has concerned policymakers in the rest of the advanced world, who are beginning to follow with their own subsidies to encourage new industrial investment in particular regions and sectors. The urgent necessity for rapid transitions to a green economy to reduce the risks of climate change has also galvanised support for IP.

Like it or not, the use of IP is inciting increased discussions, even among more mainstream economists, who can no longer ignore its overt application. This is welcome, but I would argue that they can learn plenty from their heterodox or non-mainstream cousins, as well as researchers in other social sciences, who have generated a continuous and voluminous literature on IP over many decades.

As Khan notes at the beginning of his chapter, countries such as the US and particularly the UK have experienced patterns of deindustrialisation in recent decades, leading to a loss of specific ‘organisational capabilities’ which need rebuilding if they are to achieve greater industrial success in the future. These capabilities can only really come about through the accumulation of tacit knowledge which is acquired, not through study as with codified knowledge, but rather by practical activity in the form of ‘learning-by-doing’ in the process of production. If this is unlikely to happen automatically through the operation of market forces, it requires IPs in response.

Why Asia?

Khan focuses on the lessons drawn from the use of IP in Asia. Many countries in East and South Asia used IP during the twentieth century, particularly from the 1950s onwards, with mixed results. They therefore provide helpful lessons, both in their successes and their failures, which can potentially be applied to the advanced world.

Japan and the Asian Tigers South Korea, Taiwan and Singapore all achieved rapid episodes of growth and development during the second half of the twentieth century, which saw them catch up with and ultimately transition to membership of the advanced country ‘club’. On a larger scale, China provides the most spectacular example of rapid development and mass poverty reduction in history, with its experience in transitioning from communism to capitalism following its reforms which began in the late 1970s.

Countries in South-East Asia such as Indonesia, Malaysia and Thailand also saw periods of decent growth, though these were not as rapid as the Tigers, and they remain middle income rather than advanced economies. The South Asian states of India, Pakistan and Bangladesh saw some decent growth during the period, though it proved even less sustainable.

All of these countries attempted to use IP interventions to accelerate their development, and it is therefore useful to draw on the general lessons that they provide. The main lessons that Khan draws are listed in bullet point form below.

Aspects of industrial policy

• Khan defines IP or technology policy more generally as “policies that aim to support the development and adoption of technologies and capabilities that raise social productivity”.
• What economists call comparative advantage, which is used to justify free trade so that all countries can gain from specialising in industries in which they are relatively productive, is not necessarily ‘given’ but can be created by judicious state intervention to promote particular industrial firms and sectors.
• The classic argument for IP in developing countries is for states to support ‘infant industries’, to enable these to ‘grow up’ and ultimately become internationally competitive. They might do this through forms of protection from imports and export promotion. But history shows that success in this form of IP is not guaranteed, though it is possible. Successful IP needs to learn from the historical successes and failures.
• Support for innovation, which generates new technologies and knowledge with potentially productive applications, may not automatically raise productivity. IP also needs to support the development of competitive production capabilities that turn ideas into marketable products. It needs to promote the acquisition of tacit knowledge through learning-by-doing in actual production.
• “The most fundamental requirement of success is that emerging firms can acquire the organizational and technological capabilities to become competitive.”
• There is a need to identify the key market or contracting failures and constraints correctly and to design responses to these problems that will work given local implementation and enforcement capabilities on the part of states and local governments.
• There is also a need for an ‘experimentalist’ approach to IP, so that policymakers can respond to failures and be able to change course over time. The successful East Asian policymakers learned from their early mistakes and were able to do so, thus engaging in a process of incremental evolution.
• IPs have been termed either ‘horizontal’, which aim to be non-discriminatory between firms and sectors, such as investment in infrastructure or general education and training, or ‘vertical’, which do discriminate and target specific actors. In practice the two overlap, as it is impossible for policies to be completely neutral in their effects. For example, levelling the industrial playing field may require support for some firms and not others, while apparent policy neutrality can support an undesirable (read unproductive) status quo. Thus horizontal IPs inevitably tend to discriminate!
• In general IPs need to target the most important problems or constraints first if resources are limited, which they generally are.
• In the Asian successes, “policy solutions were implementable and enforceable in particular political and institutional contexts”.

Building capabilities

• As China, the world’s dominant force in manufacturing, sees its wages rise over time, there is an opportunity for the ‘reshoring’ of some production to advanced countries.
• Domestic innovation by itself can lead to production moving elsewhere if a base of competitive firms with sufficient capabilities is not present in a particular country or region.
• Learning-by-doing in production to acquire tacit knowledge needs the doing, but also the compulsion or incentives for sufficient effort in order to rapidly acquire organisational capabilities. This may in turn need initial loss financing while these capabilities are acquired, and therefore support from the state in the form of IP. This could take the form of subsidies, tax breaks, regulation or tariffs which for a time protect against established foreign competition.

Successful policies

• There is a need for IP support to be conditional on the achievement of competitive success. Whether financial or other support is provided before or after the latter, successful Asian states were able to withdraw or withhold it if firms did not raise their capabilities or productivity sufficiently.
• What Khan calls the ‘political settlement’ is a way of describing the distribution of organisational power in a society, such as that between the state, firms and others.
• History and institutions matter! The contexts that they provide give rise to a particular PS. There is therefore a need for well-designed IPs which are appropriate to these contexts. In Asian countries for example, various colonial inheritances gave rise to a particular PS and determined what kinds of IPs worked.