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«Policy Research Working Paper 5313 Public Disclosure Authorized Growth Identification and Facilitation The Role of the State in the Dynamics of ...»

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All European countries trying to catch up with Britain devoted efforts to technology policy. Up to the middle of the first Industrial Revolution, the main important channel for technological transfer was the movement of skilled workers who embodied new knowledge. Latecomers to the industrialization process, such as France, attempted to acquire them on a large scale from Britain but the government there banned the emigration of skilled workers for more than a century, starting in 1719.14 When new technologies became embodied in machines, they too were put under government control—various laws were adopted throughout the 18th and 19th centuries to ban the export of “tools and utensils.”

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In all advanced economies, government supported the acquisition of foreign technology, “sometimes by legal means such as financing study tours and apprenticeships, and sometimes through illegal measures, which included support for industrial espionage, smuggling of contraband machinery, and refusal to acknowledge foreign patents” (Chang 2003: 18). In Germany (Prussia) for instance, Frederick the Great annexed the industrial province of Silesia and promoted the steel and linen industries. Advanced technologies such as iron-puddling technology, the coke furnace or the steam engine were subsequently imported from more successful countries (Kindleberger 1978).

Government intervention took many forms in the early experiences of industrialization. In Japan, the government created many factories (“pilot plants”) in various industries—shipbuilding, mining, textiles, etc. Most of these were subsequently sold off to the private sector at very low prices and further subsidized after privatization. This helped launch the process of industrialization and diversification. Even when government-run enterprises performed poorly,15 there were many cases of failures that generated a burgeoning private sector. This was most notably the case in Japan during the Meiji Restoration16 when a vibrant textile industry emerged from the failure of the poorly managed state-owned enterprise created to produce textiles. Private firms were successful because they learned the skill and management from the state-owned firm, and introduced various process innovations to replace expensive equipment with inexpensive labor, which was Japan’s comparative advantage at the time (Otsuka, Ranis, and Saxonhouse 1988).17 Developed country governments continue to adopt various measures to support industrial upgrading and diversification, even though these policies may not be announced under the formal label of “industrial policy.” Besides patent systems, which are industry neutral, other such measures typically include support to basic research, mandates, allocation of defense contracts and large public procurements. Local governments also often provide all kinds of incentives to private firms to attract them to particular geographic areas and induce new investments. The application of all these measures needs to identify specific industries or products and amounts to “picking winners.” A prime example is that of the U.S., where the government has constantly offered strong incentives to private businesses and academic institutions for discovering new ideas that are valuable for sustaining growth, as well as making such ideas non-rival—besides building infrastructure in key economic sectors such as transportation and providing financing to education and training in order to build the country’s skills base in many industries. This is


For a theoretical exposition, see Jones et al. (1990) and World Bank (1995).

In Japanese history, the Meiji period (1868–1912) refers to the political revolution that brought about the fall of the Tokugawa shogunate and returned control of the country to direct imperial rule under the emperor Meiji. It was the beginning of an era of major political, economic, and social change. According to conventional wisdom, that revolution brought about the modernization and Westernization of Japan. See Beasley (1972).

A common reason for the failure of state-owned enterprises is the government’s attempt to use them as a vehicle to develop industries or adopt technologies that are inconsistent with the country’s comparative advantage (Lin and Tan 1999). Such attempts create a policy burden to state-owned firms and the state is compelled to provide them with subsidies and protection. Information asymmetry prevents governments from knowing exactly what level of subsidies and protection would be adequate and state-owned firms use the policy burden as an excuse to ask for more subsidies and protection, which gives rise to the problem of soft-budget constraint (Kornai 1986).

10    routinely done through subsidies for research and development, and through the granting of patents and copyrights. The Advanced Technology Program for instance, launched in 1990, has been instrumental in the research and development of promising, high-risk technologies. U.S.

government subsidies can also be found in areas such as defense, energy, transportation, and home construction.

The ongoing debate over the need for a U.S. industrial policy18 has not changed the hard facts about the important role played by the federal and local governments in industrial development in recent decades. Their interventions include the allocation of large amounts of public funding to defense-related procurements and R&D spending, which have large spillover effects throughout the economy (Shapiro and Taylor 1990). In fact, the share of the U.S. federal government in total R&D spending, which was only 16 percent in 1930, has remained between 50 and 66 percent during the post-war years (Owen 1966; Mowery and Rosenberg 1993). As Chang observes, “industries such as computers, aerospace and the internet, where the U.S.A. still maintains an international edge despite the decline in its overall technological leadership, would not have existed without defense-related R&D funding by the country’s federal government.” Government support is also critical in other important segments of the economy such as the health industry: public funding to the National Institutes of Health, which in turn support a large fraction of R&D by biotechnological firms, has been essential in helping the U.S. maintain its lead in that industry.

The same is true in Europe where discussions of active industrial policy have been taking place since the end of World War II.19 In fact, many of Europe’s most remarkable industrial successes (space program Ariane, aircraft manufacturer Airbus, etc.) were achieved in the context of intergovernmental cooperation, with decisive political support from the Union. Since the early 1990s, the European Commission has issued several policy papers on the subject, including the 1994 report An Industrial Competitiveness Policy for the European Union, which set the stage for more determined government interventions. Other official strategy documents have focused on the risk of de-industrialization, the regulatory burden, the impact of enlargement of the European Union (EU) on the competitiveness of European companies and their location, etc. In


During the 1984 presidential campaign, Democratic nominee Walter Mondale argued that the economic policies of the country were "destroying industry—not building it," and that federal aid should be directed to "those communities and regions hit hardest by economic change" (Quoted by McKenzie 2007). Economists Bluestone and Harrison (1982) argued that the ongoing process of deindustrialization amounted to a "wide-spread, systematic disinvestment in the nation's productive capacity." Pointing to the postwar economic success of Japan, which he credited to industrial policies orchestrated by its Ministry of International Trade and Industry (MITI), Thurow (1980) worried that if left alone, "our economy and our institutions will not provide jobs for everyone who wants to work," and that "we have a moral responsibility to guarantee full employment." He observed that "major investment decisions have become too important to be left to the private market alone [....] Japan Inc. needs to be met with U.S.A. Inc." Others recommended various measures such as the creation of national and regional economic development banks similar to Herbert Hoover's Reconstruction Finance Corporation, which would use subsidies and federal loan guarantees to slow the contraction of declining industries and to speed the development of emerging industries; the launch of “Tripartite councils" at the national, regional, and firm levels, which would be composed of representatives from management, labor, and government and would seek consensus on how capital investment should be allocated. While often conceding on protectionist proposals, other economists and political leaders have maintained strong opposition to any coherent industrial policy programs.

The European Coal and Steel Community (ECSC) was created in 1951 and the European Atomic Energy Community (EURATOM) in 1957.

11    the context of the review of the Lisbon Strategy in March 2005, EU Member States set the objective of “creating a solid industrial base,” and reiterated the increasing importance attached to R&D and innovation in all forms, as well as information and communication technologies.20 France has always favored government-sponsored economic programs in which the public and private sectors coordinate their efforts to develop new technologies and industries. The French government often provides financial support and capital to the private sector by direct subsidies, tax credits, or government-run developmental banks.21 In Great Britain, the government, which

defines itself as “a market shaper,” has recently released a new industrial policy aimed at:

supporting enterprise and entrepreneurial activity, including the access to finance required for starting and growing firms; fostering knowledge creation and its application; helping people develop the skills and capabilities to find work and build the businesses and industries of the future; investing in the infrastructure required to support a modern low carbon economy;

ensuring open and competitive markets to drive innovation and rising productivity; building on industrial strengths where Great Britain has particular expertise or might gain a comparative advantage, and where government action can have an impact (HM Government 2009).

Another interesting case is that of Finland, a late but successful state-led industrialization.

According to Jäntti and Vartiainen (2009), the economic policy that achieved that objective was a mix of heavy government intervention and private incentives. Government intervention aimed at a fast build up of industrial capital in order to ensure a solid manufacturing base. The main features of the country’s growth regime were: a high rate of capital accumulation, which often required the use of administrative rationing of credit through interest rate controls as well as a policy of selective loan approvals for capital equipment investment; and a high rate of investment in targeted areas of manufacturing, the paper and pulp and metalworking industries in particular. State enterprises were established in the basic metal and chemical-fertilizer industries, and in the energy sector. As late as in the 1980s, state-owned enterprises accounted for 18 percent of the country’s total industry value-added (Kosonen 1992).

Almost all developing countries have tried to replicate the earlier models of state-led structural change strategy, especially after World War II. From the socialist planned economies of Eastern Europe and Asia to left-leaning or even liberal regime in Latin America, Asia, Africa, and


In October 2005, the European Commission announced seven new horizontal initiatives in order to: “(1) consolidate the EU’s legal framework in the area of intellectual property, (2) take into account the links between the issues of competitiveness and environmental protection, (3) adapt the trade policy with a view to developing the competitiveness of European industry, (4) simplify the law governing certain industrial sectors (i.e. construction, food industry), (5) remedy the shortage of skilled labor in certain sectors (i.e. new technologies, textiles), (6) anticipate and support the structural changes in industry, by taking this objective into consideration in other EU policies (structural funds, in particular), and (7), adopt an integrated European approach to industrial research and innovation.” Several proposals are currently under consideration to stimulate innovation and growth in France. The recently issued Juppé-Roccard report by two former Prime ministers (a socialist and a conservative) recommends that France raises 35 billion euros (US$52 billion) through public borrowing to be spent on universities and research (providing them with endowments and incentives to merge or become independent and private), the green economy and hightech to propel growth. Among the projects are plans to expand high-speed Internet, develop green cities, and support innovative small businesses and France's cutting-edge aerospace and nuclear industries. Of the 35 billion euros to be raised, 13 billion will come from the reimbursed bailout packages given to French banks with the remaining 20 billion to be raised on the financial markets.

12    throughout the Arab world, many governments have adopted various policy measures to promote industrial development and industrial upgrading (Chenery 1961). While there have been a few successes in East Asia, most of these attempts have failed to deliver the expected results (Krueger and Tuncer 1982; Lal 1994; Pack and Saggi 2006). Yet, the governments in developing countries will attempt to play the facilitating role continuously in spite of the widespread failures. Therefore, instead of advising the governments in developing countries to give up playing the facilitating role, it is more important to better understand why some countries have been able to succeed while most others have failed so that it is possible to advise the governments to do the right things and avoid the mistakes (Rodrik 2009).

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