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«James A. Robinson Harvard University Department of Government and IQSS May 2009 Paper prepared for the 2009 World Bank ABCDE conference in Seoul June ...»

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To study any policy as an equilibrium outcome, to develop a positive theory of industrial policy, we need to do political economy. Variation in the adoption of industrial policy or in its success or failure has less to do with ideas or economists, though these can important in particular circumstances, and much more to do with the nature of the political equilibrium in society – which interests are mobilized, what their interests are, what are the political institutions, etc. Understanding comparative policy is thus an exercise in comparative politics. This is a difficult exercise and we are far from having a satisfactory framework which can explain policy and outcome variation but we certainly will never have such a framework until we start thinking about the issues in the right way.

Political economy focuses on developing a positive explanation for industrial policy.

Does this leave any room for ‘industrial policy’ in a more traditional sense? My argument should make clear that I think the answer to this is no. The problem of underdevelopment cannot be solved by economists coming up with better policies for poor countries to adopt or endlessly hoping for benevolent ‘leadership’. Economists have been proposing good policies for decades, the problem is that they are not adopted (just as poor countries do not adopt many of the other things that make countries such, such as advanced technology).

From my perspective, promoting industrialization, to have an “industry policy”, is an endogenous outcome of the political choices of a society. If interests and institutions are not aligned then industry will not get promoted, whatever the normative consequences are. For outside economists or international institutions to stimulate industry they have to take this into account. This can mean two things. First, trying to change the nature of the political equilibrium in a direction more conducive to industrialization, for example by strengthening the political influence of those groups who would benefit from this. This may seem like a radical idea but in fact the World Bank has few reservations in adopting policies aimed at strengthening the power of poor people (for example through with an eye to generating more accountability and better service delivery). Second, holding the political equilibrium constant, trying to find a way of casting a pro-industry policy which will be incentive compatible for those holding power.

The paper proceeds as follows. In the next section I discuss the normative approach to industrial policy. In section III I then examine what the evidence suggests about the effectiveness of industrial policy. In section IV I emphasize that the differences between the successes and failures are mostly due to differences in political economy. Section V then sketches what a positive political economy theory of industrial policy should look like and section VI then examines what such a positive theory would imply for how we should rethink our understanding of industrial policy. Section VII concludes.

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The welfare economics argument in favor of industrial policy is straightforward and well understood. It is quite likely there are market imperfections, externalities, increasing returns etc. which suggest that various forms of industry policy could be welfare improving and even necessary to create a modern manufacturing sector. The optimal form of the policy will depend on the nature of the market imperfection. For example, if industry is too small relative to the social optimum because of imperfections in the capital market, this does not provide a normative motivation for infant industry protection. Rather policy should be focused on removing the specific market failure (though of course one has to bear in mind the Theorem of the Second Best which suggests that in an economy with multiple market failures removing one of them may make welfare worse rather than better – Lancaster and Lipsey, 1956). The simplest form of industry policy, that of subsidizing industrial activity directly, would follow from welfare economics if industry generated positive externalities. In this case a subsidy would be the canonical Pigouvian intervention. The choice of tariffs as the optimal intervention could arise in open economy models where industry again generated positive externalities and where international prices were such as to keep the industrial sector too small from a social point of view (as in the model of Matsuyama, 1992).

Nevertheless, a large literature has shown that even if one believes market failures are important, actual policies chosen are rarely the ones that normative economic theory would predict – for example inefficient instruments are used when efficient ones are available (see Coate and Morris, 1995, and Acemoglu and Robinson, 2001). In this essay I leave this issue aside and simply observe here that economic theory does provide a solid basis for believing that at least some forms of industrial policy can play a role in improving welfare and economic growth. In the next section I shall argue that there is evidence that this is indeed the case in practice. It should be obvious, however, that this type of theory does not provide a normative bases for many of the industrial policies we see, such as that adopted by the Soviet Union after 1928 though this is possibly the case under some very specific assumptions about the policy instruments available to the government.

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I now briefly discuss a series of examples of failed and successful industrial policy.

My main argument is not that industry policy is always bad or always good. I believe, and I think the evidence suggests, that it has great potential to promote economic development.

However, this potential can only be realized if the political environment is right. The examples are supposed to illustrate this perspective which I then develop more systematically.

The poster children for those who advocate industrial policy are the East Asian “miracle” economies. As I mentioned in the introduction, there is now a large literature documenting this. Wade (1990) Chapters 4 to 6 documents in great detail the case of Taiwan.

There are many fascinating stories about how the government systematically intervened in the economy from the 1950s onwards to promote industry. A famous one is how the government’s chief economic planner K.Y. Lin decided on the basis of a report by a USA consultant J.G. White Engineering Corporation, that plastics was a suitable industry to develop (Wade, 1990, p. 80). He then identified Y.C. Wang, a local businessman, as someone with the resources to do this, apparently through bank records. He then told him to start the business! The first factory was built under government supervision and given to Wang in

1957. Wang, subsequently head of the Formosa Plastic’s Group, went on to become one of the leading entrepreneurs in the country. Wade provides many examples of how the government intervened to stimulate both the quantity and quality of industry, for example publicly destroying 20,000 light bulbs in Taipei to discourage poor quality production (Wade, 1990, p.81). Though the private sector was developed in Taiwan, the public sector was heavily involved in this industrialization drive with as much of 60% of R&D expenditure being attributable to the public sector in the 1980s (Wade, 1990, p. 99) with a key role being played by the Industrial Policy Research Institute started in 1973. This played an important role in reducing technological dependence on the United States and launched “national strategic programs” in eight fields.

The public sector introduced an export processing zone in 1965 and used many complementary instruments, such as credit, to stimulate exports (Wade, 1990, pp. 139-148).

They also started a large-scale integrated steel mill, as in South Korea.

Figure 1 from Wade (1990, p. 111) sums up the periods in different industries where Wade judges that the state played a crucial role in leading particular industries. Some of these initiatives were not hugely successful. For example, unlike Japan or South Korea, Taiwan has not been able to develop an internationally competitive motor vehicle industry despite a sustained attempt. In other areas, such as semiconductors, these interventions have to be judged as very successful.

The evidence on the successful promotion of industry by the government in Taiwan is impressive and convincing. This greatly bolsters the case for industry policy. Unfortunately, however, there are many cases of unsuccessful industry policy. Some of the best documented come from Sub-Saharan Africa. After independence many African countries adopted types of industry policy with some such as Ghana and Zambia announcing five year plans and very ambitious targets. As in Taiwan, these programs were often led by the public sector.

Unfortunately, in no Sub-Saharan African country did they generate internationally competitive industry. Typically, while there was rapid capital accumulation, the industry which was developed was incredibly inefficient so that total factor productivity was abysmal.

One of the most detailed studies of the failure of industry policy in Africa is Killick's book (1978) seminal book about development in Ghana. This should be required reading for anyone advocating industrial policy as a current solution to Africa’s problems. He discusses in great detail examples of industrial projects from the early 1960s and illustrates in one case after another how inefficient they were. He shows that cost benefit calculations were ignored and inefficient investment projects undertaken. One example was a cattle-based industrial complex (Killick, 1978, p. 231), “The footwear factory... would have linked the Meat factory in the North through transportation of the hides to the South (for a distance of over 500 miles) to a tannery (now abandoned); the leather was to have been backhauled to the Footwear factory in Kumasi, in the centre of the country and about 200 miles north of the tannery. Since the major footwear market is in the Accra metropolitan area, the shoes would then have to be transported an additional 200 miles back to the South.” Killick somewhat understatedly remarks (p. 231) that this was an enterprise “whose viability was undermined by poor siting.” Another startling example is the construction of a fruit canning factory “for the production of mango products, for which there was recognized to be no local market, [and] which was said to exceed by some multiple the total world trade in such items” (Killick, 1978, p.229). The governments own report on this factory is worth quoting at some length (Killick, 1978, p. 233) “Project A factory is to be erected at Wenchi, Brong Ahafo, to produce 7,000 tons of mangoes and 5,300 tons of tomatoes per annum. If average yields of crops in that area will be 5 tons per acre per annum for mangoes and 5 tons per acre for tomatoes, there should be 1,400 acres of mangoes and 1,060 acres of tomatoes in the field to supply the factory.

The Problem The present supply of mangoes in the area is from a few trees scattered in the bush and tomatoes are not grown on commercial scale, and so the production of these crops will have to start from scratch. Mangoes take 5-7 years from planting to start fruiting.

How to obtain sufficient planting materials and to organize production of raw materials quickly become the major problems of this project.” Killick’s acerbic comment is that “it is difficult to imagine a more damning commentary on the efficiency of project planning” stated a whole year before the factory was constructed. The problem under Nkrumah was not underinvestment in industry. Indeed, the consensus view is that the capital stock increased by 80% between 1960-1965 (Killick, 1978, p.69), 60% of which being by the public sector (80% of non-residential investment, Killick, 1978, p. 170). The problem was in the way this investment was allocated.

It would be easy to present many pages of other similar examples from Sub-Saharan Africa. Though the situation is perhaps less bad in Latin America with even a few successes, particularly in Brazil, it is again generally true that government stimulation of industry in Latin America has not been a success. Most government protection and subsidization of industry did not create internationally competitive firms it rather led to uncompetitive monopolies or oligopolies producing poor quality goods for protected domestic markets.

–  –  –

What is the difference between the examples of the successful and unsuccessful industry policy? Why did it work so well in Taiwan but not in Ghana? Though there were certainly differences in the way that the policy was implemented (e.g. inward looking versus outward looking) I believe that the main difference between these cases is political. After all the Calico Acts seem to have been an example of successful import substitution and one can argue that in the Taiwanese case early import substitution in the 1950s proved an important period which gave some subsequently dynamic firms a chance to get off the ground. So the strategy attempted, at least on paper in Latin America and maybe even Ghana, could of worked. The fact that it did not was due to the politics of these countries.

To get a sense of my argument let’s return to Africa. Documenting the failure of INDECO the Industrial Development Corporation of Zambia to promote industrialization Tangri (1999, p. 30) argues that this was because “INDECO was subject to a series of ad hoc political directives on specific operational issues, including type and location of investments. Projects were undertaken on political considerations although, as in the case of Mansa batteries, the feasibility study concluded that the project based in Mansa would be uneconomic. Moreover, projects such as the Chinese maize mill at Chingola were started without any feasibility study being undertaken;

the decision was a purely political one, which led to the already planned and evaluated maize mill in Kitwe being abandoned. Directives were also issued regarding the location of projects.

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