The standard policies to attract FDI in addition to state intervention to develop industries around comparative advantage sectors may result in leapfrogging and steady growth. By and large, however, these policies might not generate miracles
By Rattan Khushiram
“The empirical evidence shows that the odds for poor or middle-income countries to reach high-income status within a couple of generations are very low. Over 1960-2014, less than 10 percent of economies (16 out of 182) have reached high-income status.” A very interesting piece that may be of interest to our policy makers is the working paper titled “The Return of the Policy That Shall Not Be Named: Principles of Industrial Policy” by Reda Cherif and Fuad Hasanov, March 2019.
The paper analyses the success stories of the Asian economies and found that the determining factor was their industrial policies — what the authors describe as Technology and Innovation Policy (TIP). The TIP can be articulated into three key principles, which were applied at the onset by the Asian miracles: (i) state intervention to fix market failures that preclude the emergence of domestic producers in sophisticated industries early on, beyond the initial comparative advantage; (ii) export orientation, in contrast to the typical failed “industrial policy” of the 1960s-1970s, which was mostly import substitution industrialization (ISI); and (iii) the pursuit of fierce competition both abroad and domestically with strict accountability.
In addition, the extent of the technological leap to sophisticated industries early on and the extent of technology creation by domestic firms would determine how successful the long-term growth outcome could be. Success depends on policies emphasizing innovation and technology at every stage of the development process.
Both the state and the market have their roles to play in implementing TIP. The “Leading Hand of the State” has a role in steering labour and capital into activities the market would not necessarily undertake but market-signal-based decision-making and an autonomous private sector are also crucial.
There is a three-gear approach to implementing TIP. The Asian miracles – the highest gear – are the outcome of TIP in its moonshot approach version. The middle gear is a leapfrog approach and it may provide decent growth leading to the middle-income status, while the lowest gear is a snail crawl approach that results in relatively lower growth.
The three gears correspond to different sets of policies. The authors argue that a standard growth recipe such as improving business environment, institutions, and infrastructure, preserving macro-stability, investing in education, and minimizing government interventions is not sufficient to sustain high long-term growth and, to a large extent, constitutes the lowest gear of TIP, or the snail crawl approach. These policies mostly fix “government failures” but not necessarily “market failures,” especially in the development of sophisticated sectors.
The standard policies to attract FDI in addition to state intervention to develop industries around comparative advantage sectors may result in leapfrogging and steady growth. By and large, however, these policies might not generate miracles. By intervening to fix market failures to develop sophisticated sectors and domestic or home-grown technology, the state could create conditions for high and sustained long-term growth. These ambitious policies pursued by the Asian miracles represent the moonshot approach.
Thus the crux of their arguments is:
- TIP was based on the state intervention to facilitate the move of domestic firms into sophisticated sectors beyond the existing comparative advantage.
- Second, export orientation since the onset played a key role in sustaining competitive pressure and pushing firms to innovate.
- Finally, the discipline of the market and accountability were enforced in a strict manner.
The authors are careful in their definition of TIP; they do give it a broad definition and try to define what it is not. They argue that the tools traditionally associated with industrial policy, such as subsidies, tariffs and the use of State Owned Enterprises (SOEs), are not necessarily effective ways to pursue TIP. Some of these policies could in fact explain the failures of industrial policy in the past.
As regards the role of the State, TIP is the exact opposite of centralized planning, as it favours more competition and autonomy of the private sector, not less. The aim of state intervention is to correct market failures where they exist and enforce a strict market discipline. As such, it is the exact opposite of indefinite support for under-performing, under-innovating and rent-seeking firms. They also agree that TIP is neither that easy to pursue or nor a cookbook recipe. For example, how to select sectors or enforce strict market discipline is still an uncharted territory.
Perhaps their emphasis on the necessary and sufficient conditions for sustained growth may be useful in our case of the snail crawl approach. They point out that the standard recipe of macro-stability, improving institutions and business environment, or investing in infrastructure and human capital may be necessary ingredients, but not necessarily sufficient for high sustained growth. But through the lens of TIP, policymakers can set clearer priorities for their growth strategies, and higher and more sustained growth is possible.
What should be the sectors to focus, what type of institutions to build, and what types of skills and infrastructure to acquire, and how to do so? Cherif and Hasanov will be attempting to address these issues in a follow-up paper.
* Published in print edition on 12 April 2019