In the famous movie Forrest Gump (1994), which is the story of an innocent man who represents how the world should be, the main character Tom Hanks remembers: “My Mama always said, ‘Life is like a box of chocolates; you never know what you’re gonna get.’” Development economists working on industrial policy should always keep in mind that motherly wisdom and maintain humility in their random quest for the recipe for economic growth.
In a recent paper on ‘Growth Identification and facilitation: The role of the state in the dynamics of structural change,’ Justin Yifu Lin and I have tried to suggest a rational way of looking at the trial-and-error process that successful economic development always involves. In a new post on his excellent blog ‘Africa Can,’ my colleague Shanta Devarajan welcomes our work but asserts that we gloss over the politics that underlie efforts by governments to guide certain industries toward success.
Rethinking industrial policy is often considered anathema to many free market economists, as they worry that ‘picking winners’ is nearly impossible, partly because the political economy issues are so problematic. Shanta makes that point and others.
Before countering that view, let me explain what’s behind the growth identification and facilitation framework, or GIFF, that we propose.
Most of the failures we’ve seen in developing countries to give industries a leg up faltered because the public sector couldn’t come up with good criteria for identifying industries that are appropriate for a given nation’s endowment structure and level of development. In other words, old structuralism as it is now known failed because countries around the world (the former Soviet Union, Mao Zedong’s China, most of Latin America and Africa) tried to defy their comparative advantage instead of encouraging the emergence of private sector industries that were consistent with it. With this in mind, the GIFF involves six steps:
• Step 1: Policymakers should select dynamic growing countries with a similar endowment structure and with about 100% higher per capita income. They must then identify tradable industries that have grown well in those countries for the past 20 years.
• Step 2: If some private domestic firms are already present in those industries, they should identify constraints to technological upgrading or further firm entry, and take action to remove such constraints.
• Step 3: In industries where no domestic firms are present, policymakers may try to attract foreign direct investment (FDI) from countries listed in step 1, or organize new firm incubation programs.
• Step 4: In addition to the industries identified in step 1, the government should also pay attention to spontaneous self discovery by private enterprises and support the scaling up the successful private innovations in new industries.
• Step 5: In countries with poor infrastructure and a bad business environment, special economic zones or industrial parks may be used to overcome barriers to firm entry and FDI and encourage the formation of industrial clusters.
• Step 6: The government should be willing to compensate pioneer firms in the industries identified above with tax incentives for a limited period, co-financing for investments, or access to foreign exchange.
In his argument, Shanta uses the example of Kenya and India, arguing that India has double the per-capita income and a similar endowment to India and that therefore, according to a literal application to the GIFF, Kenya should be able to produce high-tech goods and services like India. He then points out that this Kenya-India match up wouldn’t work due to India’s idiosyncratic labor regulations and the nature of its workforce. In turn, he implies this is proof that our framework doesn’t work.
However, I would argue he is setting up a straw man by picking India as a country of "similar endowments" as Kenya. One cannot seriously choose a federal sub-continent of 1 billion people as a model for a centralized country of 39 million. One should not blame the engineer for a faulty use of the equipment.
Then Shanta cites South Africa, identifying labor-intensive industries where the economy could be competitive if not for constraints to lowering the minimum wage. Yet we would argue that a country that’s serious about using the GIF framework must use it in its full sequence and should takes steps to ensure the nation’s workforce is competitive and that its investment climate is business-friendly. A government should not choose to pick one or two recommendations (say, steps 1 and 2) and not be willing to implement the policies recommended in Steps 4, 5 or 6 that complement them.
Shanta is right to stress the importance of governance, which he suggests should be Step 7 in the GIFF. But the causality between economic growth and good governance is not unidirectional. Therefore, the expectation that developing countries can solve their institutional problems before engaging in any type of industrial policy which may leave some room for discretion is too idealistic.
Moreover, governance is endogenous to economic growth. Empirical studies show that today’s less corrupt countries were not always so. Work by Edward Gleaser, Raven Saks, Claudia Goldin and others on the economic history of corruption in the United States for example is quite humbling. It reveals that in the nineteenth century, the degree of fraud and corruption there approached that of today’s most corrupt developing nations, as municipal governments and robber barons alike found new ways to steal from taxpayers and swindle investors (Glaeser and Goldin 20061).
Finally, the GIFF actually minimizes opportunities for rent-seeking in developing countries since it only promotes self-sustaining private firms and opens their economies to global competition by fostering actual and latent comparative advantage.
I welcome further debate on both the GIF framework and on the merits of revisiting industrial policy in the developing world.
1Glaeser, E. L. and C. D. Goldin, 2006. Corruption and Reform: Lessons from America's Economic History, Chicago, The University of Chicago
This is a very interesting discussion. Just goes to show that the industrial policy debate is well and alive. I see a bit of a disconnect between Shanta's blogpost and your response Celestin . My read was not that Shanta is saying that governance issues have to be worked out before undertaking industrial policy. It is just that any policy (not just IP) has to internalize the political realities and need to be politically feasible. And that is where the seventh step proposed by Shanta becomes so important. Otherwise, you are trapped in analytically elegant but utterly infeasible or even dangerous realm of the first-best.
Yes, the price of labor in South Africa cannot be made flexible. It is just not politically feasible. If it could, then it is all too simple. But that does not mean that the GIFF cannot be applied. Only that you would need to temper it a bit to political realities and think of second-best and ring-fenced solutions.
By looking at it this way the circle is squared, I think.
Célestin: Thanks for responding, and I agree that this debate is both interesting and important. Like Sandeep, I'm not sure you're addressing the arguments I made in my post.
First, the theory of comparative advantage (which is the underlying framework of GIFF) refers to endowments in terms of the relative size of factors of production within a country (e.g., the capital-labor ratio, labor-land ratio, etc.) It does not say anything in its pure form about the size of the country. So comparing India's endowment to Kenya's (where these factor ratios are approximately the same) is not a straw man but the application of standard trade theory. The fact that India is a federal country and Kenya is unitary is beside the point: there is nothing in GIFF that distinguishes between forms of government (in fact, this is my general point--GIFF doesn't enable us to distinguish between different types of government failure). Finally, if using India as a comparator is misleading because it's a large and federal country, why do so many people (including yourselves) refer to the example of China?
But the main point I was making is that the products that India is producing are not suited to India's comparative advantage (as the Kochhar et al. paper shows). I'm not sure what to do in this case, which is why I'm asking the engineers before I try out the equipment!
Second, Sandeep has already eloquently responded to the point about what to do when there is an inflexible price. The one thing I would add is that the requirement that we should only pick a country that "takes steps to ensure the nation’s workforce is competitive and that its investment climate is business-friendly" narrows the choice set considerably. Alternatively, if a country does these two things, it probably doesn't need an industrial policy.
Third, when speaking about governance, I wasn't referring to corruption only, and of course governance and growth are endogenous. What I was referring to are political market failures that lead certain anti-growth, anti-poor policies to remain in place. You and I know of lots of examples (including from the country we have in common), such as labor regulations, infrastructure pricing, and the accountability of service providers. While GIFF does reduce the opportunity for rent capture by opening firms to global competition, note that it does so only in the tradable sector. Yet many of these rents are in the nontradable sector (infrastructure, health, education) which are much harder to constrain by exposing the economy to global competition. The point is not that we should try and solve these governance problems before embarking on industrialization. Rather, these problems can undermine the solution that emerges from applying steps 1-6 of GIFF. That is why I was proposing a seventh step.
The big question for Kenya is whether it should emulate China (global center for manufacturing exports) or India (global centre for service exports)? More importantly, what is feasible for Kenya(read Howard Pack's blog on why it may be difficult to emulate China)?
There are two things that policy makers care about--the pace of "growth" and "inclusiveness of growth"--the latter gets reflected in the pattern of growth. Shanta rightly seems to be more concerned about the "pattern" of growth or inclusiveness, But should this come at the expence of the pace of growth?
India's "idiosyncratic" growth pattern was led by service exports because India took advantage of globalization of service, while China was focused on the globalization of manufacturing. Shanta is correct in arguing that service is generally more skill intensive compared to manufacturing, and does not create as many jobs. But it did deliver a fast pace of growth for India.
Kenya need not just focus on what is wrong with its current and past system, or for that matter what is wrong with the current systems in China and India. It needs to anticipate the future, and do what it will take to advantage of it. Globalization of service may just be the tip of the iceberg (Blinder). Jobs are created by entrepreneurs. The world production systems have become more skill intensive So Kenya should take advantage of it, even if it means fewer jobs. But they are good and productive jobs.