By Matthias Maurer Rueda.
This short blog post attempts to explain two differing stances on industrial policy. Should emerging economies stick closely to their comparative advantages, thus taking full advantage of market forces? Or should government interventions defy the short-term market logic and support sectors that do not take full advantage of their natural endowments?
In late 2009, academic heavyweights Justin Yifu Lin and Ha-Joon Chang participated in a panel to “discuss the role of industrial policy in promoting development”. As revealed by the measly 2300 views on YouTube, they did not capture the fascination of the broad public. That is perfectly understandable. Debates and exchanges of this kind are not meant to become mass events. Nonetheless, efforts should be made to increase the public’s awareness of, and access to, such discussions. This short blogpost attempts to explain two differing stances on industrial policy. Should emerging economies stick closely to their comparative advantages, thus taking full advantage of market forces? Or should government interventions defy the short-term market logic and support sectors that do not take full advantage of their natural endowments? In the end, readers of this article should gain an understanding of how this discussion might affect everyday life, and why we should care about the discussion in the first place.
Shared Assumptions and One Big Disagreement
Industrial policy refers to the degree of government intervention in a country’s economy. The most fundamental clash in this debate took place between Western capitalist economies and their socialist adversaries during the Cold War. Today, differences regarding industrial policy remain very relevant, though the battleground has moved from ideological clashes to technocratic quibbles. Although Lin favours a market-led approach and Chang advocates for more state intervention, they share common premises: both acknowledge the potential benefits of a market economy. Further, they understand development as a gradual structural transformation: Countries go through various stages, gradually developing more complex (but also lucrative) sectors and industries. Lastly, both agree that states play a crucial role in achieving sustainable development. As to the extent of state interventions, however, their opinions differ.
Justin Yifu Lin: New Structural Economics
New Structural Economists argue that a country’s economic structure depends largely on its natural endowments, i.e. the abundance of factors of production such as capital, infrastructure or labour. The relative prices of these factors determine a country’s ability to produce certain goods at lower prices than other economies, hence marking its comparative advantages. As companies make use of said advantages they accumulate capital. Over time, this shifts the endowment structure and new advantages in more productive sectors become apparent. To help them along the way, countries borrow technological innovations made in more advanced economies, saving the time and effort required for Research & Development (R&D).
For an industrial policy to be effective, it should stick closely to comparative advantages, limiting government intervention to facilitating growth in sectors taking advantage of the endowment structures. If governments nurse sectors that are not adhering to these market forces, they move valuable resources away from more productive industries and run a risk of being stuck supporting an industry that will never become competitive.
Ha-Joon Chang: The Long-term Perspective
Chang argues that while comparative advantages are efficient in the short run, they are not useful instruments for a society to shape its middle- or long-term path. Structural transformations based on market logic can lead a country down a road that later proves disadvantageous, because long-term efficiencies are not considered. Similarly, the structural transformations that are needed to progress come with drawbacks: Limited Factor mobility means machineries or human capital cannot be transformed without significant costs: Steel workers are not car-manufacturers, and steel mills make for poor car-factories.
"Steel workers are not car-manufacturers, and steel mills make for poor car-factories."
Chang also casts doubt on the notion that the dissemination of technology allows emerging economies to ‘catch up’. Technology is not universally applicable but rather accumulated through experiences and collective knowledge. For a country to do so, it is necessary to protect industries longer until their technological prowess allows them to survive in the global market. China’s young (but soaring) green energy sector acts as an illustrative example. The main consequence of this line of argument is that governments are given a more active role in defining a country’s economic trajectory. Rather than facilitating, they proactively shape structural transformations. This allows the country to venture into sectors where a comparative advantage is not given.
So…Why should We care? Encountering the Debate in the Wild
Examples of this academic clash can be found everywhere in the news: Mauricio Macri, President of Argentina, recently installed a free trade zone in the northern province of Jujuy. Will the establishment of such zones, clearly a facilitating measure, lead to structural transformation through market forces? Or will the benefits be short-lived, falling short of sustainable structural transformation? In Malaysia, 2010 the largest South Asian market for cars, the automotive industry failed to move beyond its infant stage, despite extensive government interventions. Amongst the reasons listed for the failure are insufficient technology and low-quality production, factors closely linked to an endowment structure not suitable for this industry.
Depending on your stance, world events can be interpreted in radically different ways. The success of the East Asian Tiger states is often used as strong supportive evidence by Chang and his fellow institutional economists. South Korea’s economic success is attributed to an active industrial policy, protecting and subsidizing key sectors, particularly in electronics.
Lin’s account of the same episode reads vastly different. The sectors supported by the government were in line with the competitive advantage of the country, he states. Furthermore, even the sectors under government protection were held to strict principles of market discipline. For Lin, the Korean story is a classic example of a successful implementation of facilitating measures.
Of course, none of the examples should be understood only within discussion surrounding comparative advantages. A myriad of factors plays into the success or failure of government policies. In the grand scheme of things, the issue discussed here is only one of many cogs and levers identified as relevant in designing good industrial policies. Learning to use all these cogs makes for less juicy headlines than large ideological clashes. But each additional cog gives us more agency and options in the fight for sustained and universal development.
By Matthias Maurer Rueda
Matthias was born in Colombia but grew up in Zurich, Switzerland, where he studied Political Sciences and Sociology. Prior to joining IDS, he worked at a consultancy promoting social impact entrepreneurship. He is particularly interested in global inequalities, structural transformations and the impact of globalization on emerging economies.