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The advantage of this approach was that export data could be used as a reliable indicator to assess whether domestic industry was indeed improving in terms of international competitiveness. South Korea held monthly meetings between top government officials and leading exporters to work out the details of export targets, and successful firms could count on more favourable tax treatment (Noland & Pack, 2002). If a firm failed to increase its foreign sales and meet its export targets, this was seen as evidence that the firm was not doing enough to improve productivity, and support would eventually be withdrawn. Taiwan adopted similar measures in an effort to minimize the inefficiencies associated with trade protectionism. Domestic sales were increasingly subject to price controls, forcing firms to reduce prices in the local market and effectively narrowing the wedge created by tariff protection and aligning domestic prices more closely with international ones (Noland & Pack, 2002). At the same time, exporting firms were offered preferential tax treatment in the form of various tax rebate schemes and duty drawbacks, as well as access to credit on favourable terms (Di Maio, 2008).
In practice, however, governments are often constrained by budgets.
IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy While this system of sticks and carrots was completely lacking in Latin America, Asian states took great care to institutionalize their export orientation through measures such as setting up trade-promotion centres, staffed with highly skilled bureaucrats, that helped small and medium enterprises make contact with foreign buyers and enter new markets (Di Maio, 2008). Special economic zones were another such instrument, being “demarcated geographical areas within a country’s national boundaries where the rules of business are different—generally more liberal—from those that prevail in the national territory” (Farole, 2010, p. 2). After the success of such zones became evident in South Korea and Taiwan, they quickly spread to Malaysia, Indonesia, Thailand and China, and eventually all over the world.
Active government support to domestic industry beyond trade protection has been an important additional component of industrial policies in developing countries. The decades after the end of World War II were marked by substantial involvement of the public sector in domestic investments, notably in infrastructure and industry. Public investments as a share of gross domestic investments in the period from 1960 to 1964 ranged from a high 58 per cent in Mexico to a low 25 per cent in Brazil, being the main driver in total capital formation at that time (Amsden, 2004). Public and private investments alike relied heavily on long-term capital supply provided by national development banks, whose objectives were to facilitate the creation and growth of the domestic manufacturing industry through facilitated credit concessions (Di Maio, 2008). The share of such development banks in total manufacturing investments remained often well above 10 per cent up to the 1990s (Amsden, 2004). Loans were made to strategic projects on a preferential basis and carried below-market and negative real interest rates. While specific activities of national development banks varied across countries, “winning” sectors eligible for support were picked on the basis of similar considerations and
criteria (Di Maio, 2008):
• The presence of large backward and forward linkages in a recipient industry, so as to stimulate upstream and downstream industries as well.
• High market potential.
• High technology intensity, favouring technology adoption and transfer.
• High added value.
Di Maio (2008) also observes a consistent trend in recipient sectors across countries: while the 1950s saw most funding activity in labour-intensive and heavy industries such as basic metals, food products and textiles, the 1970s focus of national development bank funding was in more capital-intensive sectors such as chemicals, machinery and transportation equipment. Asian countries mostly shifted focus during the 1980s toward more technology-intensive sectors.
Apart from favourable credit concessions by development banks, domestic firms also benefitted from various forms of fiscal incentives such as tax breaks, duty drawbacks on imports, accelerated depreciation on capital equipment and direct subsidies. But throughout, countries usually made such support conditional on the fulfillment of certain performance criteria. We will briefly review the two most common policy goals that were sought, namely exports and local content use.
IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy Increasing exports was a policy goal in itself in many countries, and we have already seen in the previous section how Asian countries tied their support to certain export-related performance criteria. Exports not only provide a country with foreign currency, but also stand as testimony to a healthy industry, able to compete in international markets.
Conditional support such as provision of subsidized long-term capital based on export targets was widespread in Asian Tiger countries, but could also be found in, for example, India and Turkey.
Firms were also often required to use locally produced content in their production processes. This requirement was most widespread in the automobile sector, as this particular sector is especially interconnected with other industries, providing for a large array of backward and forward linkages. Local content rules were to ensure the build-up of national firms, enhancing their technological capabilities by substituting often technology-intensive imports with domestic production. The premise was that local content rules squeezed assemblers’ profit margins, which gave them an incentive to train their local parts suppliers, whose greater efficiency would reduce their overall costs (Amsden, 2004). At the same time, localized production would help ease balance-of-payments constraints by saving on foreign exchange, much in the sense of the rationale for import substitution industrialization.
Innovation and Technology Policies
Import substitution and national support schemes for domestic firms and industry all aimed at increasing domestic technological capabilities to some extent, but were in themselves insufficient to substantially decrease reliance on foreign technology over time. Countries worldwide, and especially in Latin America and Asia, made attempts at offering additional support mechanisms for firms to first adopt and then develop new technology as they matured industrially.
Acknowledging the need to socialize risks associated with R&D, many governments set out to undertake the bulk of R&D in publicly owned firms and research institutions. Specific public institutions exclusively dedicated to advancing science were set up as national research councils after World War II. These institutions’ stated goals were multiple, including provision of funding for technological development, coordination of R&D programs, diffusing technological information and administering property rights systems (Di Maio, 2008). National development plans increasingly contained science and technology programs, coordinating, steering and prioritizing R&D activities and thereby explicitly targeting domestic technological knowledge accumulation (Amsden, 2004).
During the import substitution industrialization years, more than 80 per cent of science and technology spending was publicly funded in Latin America (Katz, 2000). But government commitment to supporting technological upgrading and innovation was even greater in the Asian Tiger states. In Korea, imports of technology were strongly subsidized (Lall, 2004): transfer costs for patent rights and technology import fees were tax deductible, income from technology consulting was tax-exempt and foreign engineers were exempt from paying income tax. The Korean government also offered tax-exempt Technology Development Reserve funds, which firms had to use in a specified time span. The Korea Technology Development Corporation provided technology finance, and the government gave grants and long-term low-interest loans to participants in “national projects.” While Korea was certainly the most ardent driver of domestic technological knowledge accumulation, similar policies were employed in other countries as well, such as Taiwan and Singapore.
As industrialization proceeded and domestic firms progressively entered technologically more demanding fields such as informatics, semiconductors and telecommunications, governments increasingly took the role of pioneers and venture capitalists (Di Maio, 2008). While designing careful policies to attract foreign direct investments in relevant sectors, IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy governments set up science parks and technology clusters to harness agglomeration synergies. Public enterprises were essential market actors in technologically advanced sectors in which private firms failed to succeed, generating important demonstration effects that the private sector could ultimately benefit from. Government procurement has been essential in creating demand for high-quality domestic products, notably in the defence sector.
Finally, the emphasis on attracting foreign direct investment (FDI) for technological knowledge accumulation varied quite substantially across countries. Amsden (2004) distinguishes two major groups of countries by their approach to FDI. On the one hand, independentists such as Korea, Taiwan, China and India advocated minimal reliance on FDI and multinational corporations, stressing the importance of strengthening domestic firms and skill formation. In a way, heavy use of industrial policies as described above served to substitute for FDI and multinationals, creating national champions. The other group is referred to as integrationists and comprises Argentina, Brazil, Chile, Indonesia, Malaysia, Mexico, Thailand and Turkey. Countries of this group relied on spillover effects from MNC activity or FDI for technology transfer. Supporting policies to ensure that such transfer would indeed happen comprised local sourcing and subcontracting, local content rules and various obligations to foreign firms and investors to actively transfer technological know-how to domestic actors (Di Maio, 2008).
Complementary Policies and Framework Conditions
Having reviewed the main industrial policies that are usually considered as such, we now turn to complementary and longer-term policies that governments of catching-up countries have enacted over the years. Education is an important such policy that is a priori outside of the scope of immediate industrial policy, but it certainly pertains to industry in important ways. As countries move up the technology ladder and knowledge is used more efficiently, human resource capabilities have to follow suit. The provision of education has a long tradition of government involvement, owing to the fact that investments in human skills are by definition long term and carry externalities for society that cannot usually be appropriated by purely market-driven sources. Good education makes for good citizens, but also good employees.
Education is of course multi-faceted and is difficult to measure appropriately. Formal enrolment in educational institutions is only a rough indicator for countries’ educational levels, as much learning occurs on the job or through other experience. A very basic indicator that is relevant especially for least industrialized countries is the rate of illiteracy. All developing and industrializing countries have made much progress in minimizing rates of illiteracy and creating opportunities for school enrolment. Starting from higher levels of illiteracy than in Latin America after World War II, East Asian states still achieved significant reductions in illiteracy at a much faster pace. Primary enrolment today is universal in all now-industrialized nations. Secondary enrolment nears 100 per cent in Korea and Taiwan, making it comparable to developed nations, but lags, sometimes significantly, behind in other Asian states and Latin America (Lall, 2004).
Tertiary enrolment has followed a similar path, but offers interesting insights in its composition across countries. Those countries that achieved the highest degrees of industrialization are also those with an outspoken concentration of tertiary students in technical and engineering degrees. Rather than a sheer coincidence, this concentration has been the outcome of active policies that provided the necessary infrastructure and legislation (Hanushek & Woessmann, 2008). Investment in technical tertiary education has followed increased demand from industry, but cannot solely be explained by demand factors, as many Korean and Taiwanese graduates in the 1960s and 1970s emigrated to find better employment opportunities (Pack, 2010). Hence, it must be seen as a supply-side complement to industrial IISD REPORT JUNE 2013 2013 The International Institute for Sustainable Development © Industrial Policy for a Green Economy policy, which became necessary as countries’ industry moved into higher-technology sectors, demanding more relevant and sophisticated skills of its labour force.
Another set of policies that is often viewed as external to industrial policy is exchange rate management. Rodrik (2008b) shows that there has been a strong relationship between the level of the real exchange rate and economic growth. Economic growth, especially in Korea, Taiwan and now China, has been preceded and accompanied by a rise in the undervaluation index for their currencies (Rodrik, 2008b). Undervaluation of a country favours exports over imports and is hence consistent with an outward development strategy promoting exports. Ironically, many Latin American countries had difficulty in maintaining undervaluation or at least close alignment of their nominal exchange rates with the real exchange rate. While this made imports of critical inputs cheaper, it defeated the import substitution industrialization strategy and, coupled with poor export performance, led to foreign exchange shortages.
Assessment: Does Industrial Policy Work?