My colleagues Justin Lin and Celestin Monga have proposed a six-step plan for identifying industries that could help developing countries industrialize.
The first step in the plan is to find countries that have a per-capita income that is roughly double yours and have a similar endowment, and observe what they are producing. These industries would then serve as the basis for possible government intervention to either protect or create, depending on the country’s situation.
However, the six-step plan seems to gloss over the fact that countries, even seemingly successful ones, produce certain goods for political rather than economic reasons.
Someone who was trying to apply the framework to Kenya found that the country with double the per-capita income and a similar endowment—in terms of labor/land and labor/capital ratios, etc.--was India, which produces high-tech goods and services. The implication was that Kenya should gear up for making these its future industries. But a paper by Kalpana Kochhar and colleagues shows that India’s pattern of development is idiosyncratic: despite a large pool of unskilled or semi-skilled labor, India produces skill-intensive goods and services. One reason is the restrictive labor regulations in India that leave formal-sector manufacturing at a low level, but are politically very difficult to remove.
Likewise, once an industry has been identified, it may not be competitive because policies and regulations in the poor country make certain prices immovable.
For instance, in South Africa, again for political reasons, it is very hard to lower the minimum wage, so that certain labor-intensive industries, even if they conform to the country’s comparative advantage, may not be the best way to industrialize.
The Lin-Monga framework does consider this, by ensuring in one of the subsequent steps that all other prices in the economy reflect market conditions. But it is not clear what to do when this condition doesn’t hold. Should we work on removing the distortion, or find an industry that doesn’t rely on the distorted prices (something which is hard to do when the distorted price is the price of labor).
The attempt to identify “winners” in a systematic way is certainly welcome. Countries are not satisfied with the recommendation to simply improve the business climate and let the winners emerge.
As Justin and Celestin observe, governments around the world already practice industrial policy; their paper tries to provide some economic reasoning for it. But, in keeping with other self-improvement programs, I hope they will add a seventh step, namely, to examine the political economy of industrial policy—both in the “model” country with double the per capita income, and in the country trying to industrialize.
Photo: Arne Hoel, World Bank