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«Industrial Policies, the Creation of a Learning Society, and Economic Development1 B. Greenwald and J. E. Stiglitz Industrial policies—meaning ...»

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III. Other instruments of industrial policy

Previous sections have argued that the objective of industrial policy is to shift production towards sectors in which there is likely to be more societal learning, meaning more learning and more learning externalities. There are a variety of other instruments --- indeed, as we comment in the concluding section, almost every aspect of legal and economic policy has some effect in shaping an economy.

Here, we focus on intellectual property. In a sequel (Greenwald-Stiglitz, 2012) we discuss exchange rate policy and foreign direct investment.

The extent to which this is true may vary, e.g. if the foreign bank buys a local bank, it may, at least for a while, provide it with some autonomy.

Intellectual property regimes are supposed to encourage innovation, by providing incentives to do research, enhancing the ability to appropriate the returns. But intellectual property interferes with the dissemination/transmission of knowledge and encourages secrecy, which impedes learning. Increasingly, there is an awareness of other adverse effects of intellectual property regimes, as developed in the advanced industrial countries, especially for developing countries. (See Stiglitz, 2006). Knowledge is the most important input into the production of knowledge, and by restricting the availability of knowledge, the production of knowledge (learning) is inhibited. The patent system gives rise to monopoly power; monopolies restrict production, thereby reducing incentives to innovate. The patent system can give rise to a patent thicket, a complex web of patents, exposing any innovator to the risk of suit and holdup.

Because patents "privatize" knowledge while challenging patents moves knowledge into the "commons," there will be underinvestment in challenging patents and overinvestment in patenting. No wonder then that it is estimated that in the United States, more money is spent on patent lawyers and litigation than on research.

There are two implications of this analysis. The first is that, given the critical role of closing the knowledge gap for successful development, the appropriate intellectual property regime for developing countries and emerging markets is likely to be markedly different than that appropriate for the advanced industrial countries. In this area, more even than others, one size fits all policies are inappropriate. Secondly, there are alternative ways of designing an innovation system, with greater emphasis on prizes and on open source. Patents will play a role, but a good patent system has to pay more attention to disclosure, to problems of hold up,26 to designing better systems of challenging patents. (See Stiglitz, 2013).

IV. Government Investment

e.g. through the use of the "liability system." The US Supreme Court, in its decision for eBay Inc. v.

MercExchange, L.L.C. in 2006, recognized the adverse consequences of the patent system and its enforcement as it had developed in the United States.

In some ways, governments cannot avoid questions of industrial policy; for they have to make decisions about the direction of public investment, say in education and infrastructure, and this has to be based on beliefs about the future directions of the economy, which are in turn affected by these public decisions. But the policies with which we are concerned go well beyond this. For government can use public expenditure policies to partially compensate for deficiencies in market allocations.

To see what this implies, let’s extend our earlier learning model by introducing Public Goods, denoted by G, in each period. For simplicity, we assume we can impose a lump sum tax to finance them and that there are full spillovers. We focus on the “direct” control problem, where we choose the level of spending on each private and public good. Focusing on the first period, we

–  –  –

In deciding on the optimal level of investment, we look not just at the direct benefits, but also at the learning benefits.

But in the absence of subsidies on private goods that take into account the learning benefits and spillovers, the provision of the public good can have another benefit. By expanding the production of public goods which are complements to goods with high learning elasticities and large externalities, the government can help create a more dynamic economy. To see this, we reformulate our optimization as an indirect control problem (still assuming the public good is financed by a lump sum tax) Max V(pt, I- Gt, Gt) +  V(pt+1,I- Gt+1, Gt+1) where V is the indirect utility function, giving the level of utility as a function of prices, income net of lump sum taxes, and public goods. In the absence of product subsidies, equilibrium is characterized by price equaling marginal cost, or pt = 1; pt+1 = 1/H(Lt, Gt) The set of equations can be solved simultaneously for {xit = Lit } as a function of the vector {Gt, Gt+1).27 An increase in Git, financed by a lump sum tax, has complex income and substitution effects on the demand for each commodity. For instance, if some public good is a close substitute for some private good, the lower spendable income as a result of the additional provision of the public good combined with the availability of a public substitute will lead to a reduction in the private demand for that good, but if the public good were a strong enough complement (a free road to a ski resort), it might increase the demand for the good (trips to the ski resort.) We denote by ∂Lj t/∂Gi the change in the demand for (consumption of) good j as a result of an increase in public good i.





–  –  –

The first term (HGi) on the left hand side are the direct learning benefits, the second term [Σj Ljt+1 (∂Lj t/∂Gi)( Hj /Hj 2 )] is the indirect effects on learning as the composition of demand changes.

We expand the production of public goods not only to take into account the learning benefits, but also the indirect effects in inducing more consumption of some goods and less of others, taking into account the total net effect on learning.

V. Concluding Comments Theory of the Second Best With stronger assumptions about separability, it is possible to solve for Lit as a function of Gt, but we consider here the more general case.

Industrial policies distort consumption from what it otherwise would have been. Conventional economics (such as the Washington Consensus policies) emphasized the costs of these interventions. We have emphasized that when there are market failures (as is always the case when there are learning externalities), there will be benefits. Optimal policy weighs the benefits and costs as the margin.

The economics of the second best is of particular relevance here: R&D and learning give rise to market imperfections, sometimes referred to as distortions, where resources are not allocated in a “first best” way. Well-designed distortions in one market can partially offset distortions in others.

I use the word “distortions” with care: Common usage suggests that governments should simply do away with them. But as the term has come to be used, it simply refers to deviations from the way a classical model with, say, perfect information might function. Information is inherently imperfect, and these imperfections cannot be legislated away. Nor can the market power that arises from the returns to scale inherent in research be legislated away. That is why simultaneously endogenizing market structure and innovation is so important (e.g. Dasgupta and Stiglitz, 1980). Similarly, the costs associated with R&D (or the “losses” associated with expanding production to “invest” in learning) cannot be ignored; they have to be paid for.

Monopoly rents are one way of doing so, but—as we argue here—a far from ideal way.

As always in the modern economics of the public sector, the nature of the optimal interventions depends on the instruments and powers of government. Whether the government can abolish monopolies or undo their distortionary behavior has implications for the desirable levels of research and learning. It makes a difference, too, if the government can raise revenues to subsidize or support research or learning only through distortionary taxation rather than through lump sum taxes. There are ways to impose even distortionary taxes (i.e., taxes that give rise to a loss of consumer surplus) that increase societal well-being and the speed of innovation. But the optimal investment in innovation is still likely to be less with distortionary taxation than with lump sum taxation.

Industrial Policies and Comparative Advantage

Justin Lin (2012) has distinguished between industrial policies that defy comparative advantage, which he argues are likely to be unsuccessful, and those that are consistent with comparative advantage, which can be an important component of successful development. While there is considerable insight in this distinction, the key question is, what are a country's endowments, which determine its comparative advantage? This is equivalent to asking, what are the relevant state variables? And what is the "ecology" against which the country's endowments are to be compared, i.e. what are the relevant endowments of other countries?

It has become conventional wisdom to emphasize that what matters is not static comparative advantage but dynamic comparative advantage. Korea did not have a comparative advantage in producing chips when it embarked on its transition. Its static comparative advantage was in the production of rice. Had it followed its static comparative advantage (as many neoclassical economists had recommended) then that might still be its comparative advantage; it might be the best rice grower in the world, but it would still be poor.

Ascertaining a country’s static comparative advantage is difficult; ascertaining its dynamic comparative advantage is ever harder. Standard comparative advantage (cf. Heckscher Ohlin) focused on factor endowments (capital-labor ratios).28 But with capital highly mobile, capital endowments should matter little for determining comparative advantage. Still, capital (or more accurately, the knowledge of the various factors that affect returns, and that is required to use capital efficiently) doesn’t move perfectly across borders: that means that the resident of country j may demand a higher return for investing in country i. There is, in practice, far less than perfect mobility.

Krugman’s research made it clear that something besides factor endowments mattered: he observed that most trade today is between countries that have similar factor endowments.

Thus the "state" variables that determine comparative advantage relate to those "factors" that are not mobile, which, in varying degrees, include knowledge, labor, and institutions.

Multinationals can, however, convey knowledge across borders. Highly skilled people move too. Migration has resulted in large movements in unskilled labor, but in most cases, not enough to change endowments of the home or host country significantly. Even institutions can sometimes effectively move across borders, as when parties to a contract may agree that disputes will be adjudicated in London and under British law. Still, there are numerous aspects of tacit knowledge, about how individuals and organizations interact with each other, and norms of behavior that affect economic performance, and most particularly from our perspective, how (and whether) they learn and adapt.

The "endowment" from our perspective which is most important is a society's learning capacities (which in turn is affected by the knowledge that it has and its knowledge about learning itself) which may be specific to learning about some things rather than others. The spirit of this paper is that industrial policy has to be shaped to take advantage of its comparative learning and learning abilities (including its ability to learn to learn) in relation to its competitors. Even if it has capacity to learn how to make computer chips, if a country's learning capacity is less than its competitors, it will fall behind in the race. But each country makes, effectively, decisions about what it will learn about. There are natural non-convexities in learning, benefits to specialization. If a country decides to learn about producing chips, it is less likely that it will learn about some other things. There will be some close spill-overs, perhaps say to nano-technology. The areas to which there are spill-overs may not lie near in conventional product space. There may, for instance, be similarities in production technologies (as in the case of just-in-time production or the assembly line.) That is why the evolution of comparative advantage may be so hard to predict.

But while standard economic analysis may provide guidance to a country about its current (static) comparative advantage (given current technology, what are the unskilled-labor intensive goods), guidance about its comparative advantage defined in this way (dynamic learning capacities) is much more difficult, partially because it depends on judgments made by other countries about their dynamic comparative advantage and their willingness to invest resources to enhance those advantages. Whether ex ante U.S., Japan, or Korea initially had a dynamic comparative advantage in producing chips, once Korea had invested enough in learning about certain kinds of chip production, it would be difficult for another country to displace it.

Looking at what other countries at similar levels of per capita income did in the past or what countries with slightly higher levels of per capita income are doing today may be helpful, but only to a limited extent. For the world today (both global geo-economics and geo-politics, and technology) is different than it was in the past. Competing in textiles today requires different skills and knowledge than in even in the recent past; it may (or may not) be able to displace a country that currently has a comparative advantage in some product; the country may (or may not) be in the process of attempting to establish a comparative advantage in some other area.

Industrial Strategies



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