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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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Moreover, the Growth Diagnostics Framework is also imprecise in its links to the institutions that facilitate the growth process. The methodology proposed for the identification of the binding constraints to growth is not always straightforward. Even if data on shadow prices were widely available, it is not obvious that this would accurately identify areas in which progress is most needed in each country. For example, one could imagine a simple model of growth for a lowincome country where technology and human capital are complementary. In such a country, the returns to education and technology adoption would both be low due to low levels of human capital and technology. An exclusive focus on shadow prices and an ignorance of cross-country comparison of levels would then suggest no need to improve education levels and encourage technology adoption.

In fact, even in situations where the Growth Diagnostics approach leads to relative certainty about the binding constraints to growth in any given country, there is still a wide range of policy options available to choose from. It is therefore necessary for policymakers to rely not just on one approach but to use several different macro and micro tools to identify binding constraints to growth. Microeconomic analyses of growth show that differentiated firm dynamics drive a good 23    part of aggregate productivity growth and capital accumulation. Establishing a diagnostic at the aggregate level requires a good knowledge of what happens at the micro level. In particular, monitoring the entry and exit of firms and the policy variables that affect them is essential to understanding overall gains in productivity in economies subject to strong structural changes (Bourguignon 2006). One must take account of heterogeneity in country circumstances and among micro agents. This can more effectively be done through country-specific analyses.

Finally, even if one could identify relevant binding constraints to industrial development in industries with comparative advantage and induce improvements in a country’s business environment, the crucial issues of externality encountered by first movers and coordination would remain unresolved. Despite the removal of the constraints, a country may then find its industrial upgrading and diversification process stalled. It is therefore necessary that the Growth Diagnostics framework and other methods of targeting obstacles to industrial upgrading be used in conjunction with the growth identification and facilitation approach.

5. Conclusion

The crisis has inflicted heavy costs on economies around the world. Unemployment is at record levels in many countries, fiscal fragility is a legacy of the crisis in many countries, and capacity utilization rates in industry remain substantially below pre-crisis levels.  Many developing countries have the potential to grow faster than developed countries and are now confronted with the challenge of finding new sources of growth in the context of a multi-polar growth world (Zoellick 2010). In that regard, the role of developing country governments in inducing and accompanying structural change (industrial upgrading and economic diversification) to promote growth, employment, and poverty reduction must regain center stage. Indeed, historical evidence and economic theory suggest that while markets are indispensable mechanisms to allocate resources to the most productive sectors and industries, government intervention—through the provision of information, coordination of hard and soft infrastructure improvement, and compensation for externalities —are equally indispensable for helping economies move from one stage of development to another (Lin 2010).

Because of the many failures observed throughout the world in the post-war period, industrial policy has raised serious doubts among economists and policymakers. Taking into consideration O’Brien and Keyder’s recommendation that “countries should (if possible) be studied in terms of some unique capacity for development at different stages of their history” (1978: 15), this paper has examined the mechanics of structural change in today’s advanced economies and the reason for success in a few developing countries in East Asia and elsewhere as well as suggested a framework for government intervention in the economy.

The paper has argued that the failure of industrial policy is most likely to arise from mistakes made by policymakers in the growth identification process. Industrial policies that are implemented by governments in developed and developing countries usually fall in one of two broad categories: (i) they attempt to facilitate the development of new industries that are too advanced and thus far from the comparative advantage of the economy, or too old and have lost comparative advantage; or (ii) they try to facilitate the development of new industries that are consistent with the latent comparative advantage of the economy. Only the latter type of 24    industrial policy is likely to succeed. High-performing developed and developing countries are those where governments were able to play an active role in the industrial upgrading and diversification process by helping firms take advantage of market opportunities. They have generally done so by overcoming the information, coordination, and externality issues, and by providing adequate hard and soft infrastructure to private agents. It is expected that the growth identification and facilitation approach proposed in the paper can help governments in developing countries identify the right industries in their attempts to facilitate structural transformation in the development of their countries.

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