WP – Discovering Economic Locomotives via Modern Industrial Policy

Working Abstract: This post is excerpted from Post 297 – Modern Industrial Policy Discovers Locomotives in Global Supply Chains

This framework involves using modern industrial policy to institutionalize a discovery process to find and fine tune economic locomotives with high value-adding potential for the wider economy while considering external factors – like global supply chains and not mere import replacement in the home market – and avoiding regulatory capture by vested interests.

Existing successful export and local industries and new General Purpose Technologies like engineering and ICT are good starting points for picking locomotives …

Introduction

Modern versions of industrial policy and the broader field of development economics are coming back into center stage (Joseph Stiglitz). This came after the failure of neoclassical macroeconomics (a) to forecast the 2008 financial crisis and (b) to explain the continuing success of emerging markets like China and India whose strategies do not conform to the Washington consensus.

Again, there was a surprising consensus that industrial policies have played an important role in enhancing growth (though other policies, like “rule of law” and macroeconomic stability are also important). The discussion went well beyond the tired critique of “picking winners” to a more insightful analysis, based on the well-known and documented externalities associated with learning and development, instances in which markets on their own do not necessarily work well.

Joseph Stiglitz, A Balanced Debate About Reforming Macroeconomics, 22.3.11, IFMDirect

BYD electric car from China.

A brief history of industrial policy

The roots of industrial policy go back to the mercantilist era when it was the default strategy of Kings maximizing returns for their countries.

Later, it was the core strategy of Friedrich List, inventor of the concept of infant industry protection, tied up with nationalism for Bismarck’s newly unified Germany to catch up to Britain and France in the 1860s.

The latest incarnation from the1950s was ISI for import-substituting industrialization, including President Carlos Garcia’s Filipino First, that is widely considered a failure.

Modern industrial policy is a very big step up from the traditional one of the 1950s that focused on import substitution industrialization with its trademark protection of local infant industries.

It also does not assume an industrialization based on steel and traditional manufacturing. ‘Industry’ has moved on to other platforms according to the technology trajectory so locomotives may come from service and even agriculture industries.

More importantly, it focuses more on activities than sectors above and requires performance and a time line in return for support.

Friedrich List, National System. Click for Kindle link.

Traditional practice gave industrial policy a bad name

As with nationalism, the traditional practice of industrial policy as import-replacement industrialization (ISI) from the 1950s in the local markets via protection of local infant firms gave industrial policy a bad name.

This old practice resulted into local elites with vested interest running incentivized firms that remained infants for decades to the detriment of local consumers.

The advent of a more productive China exporters in the 1990s mercifully put them to ground – with the hollowing out of uncompetitive local industry and the sad loss of many jobs as indicator of the failed policy – and spared consumers more and taxpayers of their hard-earned wealth.

Modern industrial policy does not promote infant industries while taking advantage of a home market captured by incentives like tariffs – a formula shown to be prone to regulatory capture.

Modern industrial policy disguised by other names

From the successful practice in South Korea and Taiwan later modified by the successes of China, mainly, and India, modern industrial policy discovers economic locomotives from global supply chains, innovates on appropriate technology and institutions by co-evolution, and requires performance in return for incentives and support.

Modern industrial Policy, Dani Rodrik (2008). Click image for Amazon link.

In his paper, Industrial Policy for the 21st Century (2004) from the book at left, Harvard’s Dani Rodrik chooses to keep the damaged brand “for lack of a better term” for the modern practice of industrial policy.

Professor Rodrik of Harvard’s Kennedy School of government defines industrial policy simply as “anytime a government consciously favors one economic activity instead of another.”

With this definition, the clearly implied industrial policy of the Philippines is the export of labor services including the OFW and the BPO industries.

Still, the phrase “industrial policy” is anathema in many countries because of failures in its previous incarnations like import-substitution industrialization (ISI) or from the point of view of political ideology as in America, where it can be labeled as socialism.

Because America ostensibly practices a free-market philosophy, it refuses to call the government’s activity of supporting certain industries for strategic purposes as industrial policy. In my view, that is merely semantics. In any case, all successful economies did practice its more odious elements at the early phase of industrialization.

For America, I can identify three areas where industrial policy is practiced though never called as such while justified as strategic for the nation:

• the defense industry comprised of what President Eisenhower called the military-industrial complex,
• the space industry and the National Aeronautic and Space Administration (NASA), and
• public healthcare systems supported by Medicare and Medicaid.

The Internet, the GPS, various drugs and laparoscopy are famous examples of innovations that were first funded by America’s hidden version of industrial policy and that has been transferred to the public domain.

As with the European plane manufacturer, EADS, there are trade suits against Boeing under WTO procedures claiming effective subsidies earned by what turned-out to be dual-use technologies.

I highlight Medicare and Medicaid as they are notoriously inefficient industrial policy beneficiaries where America spends up to 30% of GDP whereas Japan and Taiwan spends less than 10% of GDP with an older population. Expensive laparoscopy became popular as innovative surgical technology in the more free-spending American public healthcare regime.

In post-war Germany, one of the major pillars of its recovery was the revival of the chemical engineering and automotive industries cartels, that Ludwig Erhard argued against but was overruled. Their revival was justified on two grounds: (a) these large companies were competing in global industries and needed the scale to compete in their commodity businesses, and (b) the Americans kept an eye closed as they needed German industry to fight the Soviet Russian threat.

For Germany, it could well be the advanced stage of development but the cartels did not become inefficient but continued to be globally competitive as with those beneficiaries of industrial policy in successful emerging markets like South Korea and Taiwan.

The recovery in post-war Japan (subject of an upcoming post of the Shigeru-Hayato era) followed a more traditional infant industry approach as the pioneer in the practice of modern industrial policy. Japan did have institutions like the MITI that successfully coordinated the policy.

Taiwan took advantage of the Flying Geese movement of trading-led Japanese manufacturing investments to gain mastery of process and engineering management that followed from this cost leadership strategy.

With mastery in these areas and the choice of the electronics sector – from semiconductor to assembly – as the national locomotive they soon moved up the value chain to becoming and OEM manufacturer for others and finally a branded products manufacturer.

ITRI was the combined techno-economic institution that, like the MITI of Japan, coordinated the process including the initial purchases of machine-embedded technology to later on engaging in leading edge research.

Almost at the same time as Taiwan, South Korea followed the more traditional import-substitution and steel-based industrialization at the start.

The Korean innovation in industrial policy was in the institution of performance standards implemented on a stable of entrepreneurs that created world class businesses in return for incentives. Their innovation in implementation was to make sure to cut losses from cronies who did not perform. It could well be the war-pressure that focused political will on top of Confucian meritocracy but the leadership did it and so Korea is in the OECD today.

After achieving full use of native factor resources, Singapore saved up and lowered the cost of investment finance with the Central Provident Fund while increasing returns to economic activities by discovering economics locomotives – first in foreign regional offices, logistics and transport, tourism and late in private banking, integrated gambling resorts and in life sciences.

India Tata's low-cost car, Nano.

Malaysia -had its great winner and locomotive in Palm oil as reported in SYNTHESiST and is trying to move forward information and communication technologies (ICT).

India stumbled unto information technology and business process outsourcing from links to successful Indian entrepreneurs in Silicon Valley even as reforms came later and infrastructure lags behind. With a huge economy, it has engaged in a form of indigenous innovation via frugal engineering as with the India Tata’s low-cost Nano shown above right.

China had its first flush of indigenous innovation by giving away a lot of technological knowledge resident in the research institutes to the scientists for free.

Subsequently, they also innovated on unique institutions like Town and Village Enterprises (TVE), unusual incremental pricing of agricultural produce from communal farms, and supply chain clusters like the Zhuji pearl industry in Zhejiang. These eased the transition to capitalism taking advantage of low labor costs, at first, the communal nature of most economic activities, and the State’s ability to focus resource spending in such areas as Shenzhen and later Shanghai.

Note: The China experience must be taken with a grain of salt – from Communism and corresponding control institutions, they are opening up while the Philippines would be opening up. Also, modern industrial policy, in joining global supply chains, implies working for international competitiveness and not protection for the internal economy.

The point I wish to make here is that there are multiple factors from appropriate technology, like institutional development and co-evolution, that enabled its success; industrial policy itself is another factor especially when designed according to context and not ideology.

International agreements and leveling the playing field

Many international agreements now, based on the original assumptions of the Washington consensus, prescribed globalization that is mainly framed as open trade.

As with the revival of industrial policy, the financial crisis of 2008 that affected mainly the globally-linked developed countries and the continued growth of the emerging locomotives is causing some questions to these agreements.

Still, these agreements become additional constraints as it is important for any country to comply with agreement that it has ratified.

Philippine designed and fabricated auto-filling machine.

Modern industrial policy

In his book, Professor Rodrik suggests ten design rules for modern industrial policy that I paraphrase below.

One must read the chapter on Industrial Policy for the 21st Century (2004), one of nine papers in his book, to get the full flavor from the detailed discussions on these design rules.

I have my own two reservations on these rules that I discuss below the list.

1. Incentives must be provided only to “new” activities – not to existing ones.
2. Milestones are necessary – there should be clear benchmarks/criteria for success and failure.
3. A clear timeline, as well – there must be a built in sunset clause for performance. Maybe, a pre-defined exit strategy for failure can help as well.
4. Public activities must target activities not sectors – this is a radical departure from current way of giving incentives.
5. Activities that must be subsidized must have a clear potential of providing spillover or demonstration effects. Cluster or network effects that enhance value-additing potential are a must
6. The authority for carrying out industrial policies must be vested in agencies with demonstrated competence.
7. The implementing agencies must be monitored closely by a principal with a clear stake in the outcomes and who has political authority at the highest level.
8. The agencies carrying out promotions must maintain channels of communications with the private sector.
9. Optimally, mistakes that result in “picking the losers” will occur.
10. Promotion activities need to have the capacity to renew themselves, so that the cycle of recovery becomes an ongoing one.

Professor Rodrik is very clear that his methodology in deriving the rules above is neoclassical economics.

As I expected, that constrains him from finding the two aspects that actually drive development through the process: the entrepreneur and technology innovation.

The neoclassical and free market approach treats both as externalities and assumes that both will arise quickly given the environment.

Focused rightly at the firm level and in meso-economics, it can only suggest the design rules above (derived from cases in Taiwan, Korea, and South America and later China and India) will be useful in policy work.

Selecting economic locomotives for the Philippines per modern industrial policy

Product development and quality laboratory

In SYNTHESiST, I have proposed the criterion of value-adding potential, i.e. inherent high productivity, as the most important as measured in terms of the technology trajectories, scope of co-evolution for complementing institutions, presence of leader-entrepreneurs and innovators in clusters, communities or networks.

SYNTHESiST will suggest specific activities including those involving general purpose technologies in future posts.

Still, Professor Rodrik’s work on modern industrial policy, using neoclassical economics as methodology, provides a solid foundation for SYNTHESiST’s own appreciative theory of development.

As applied, discovering economics locomotives is where the rubber meets the road – the third dimension in real world application from the interactive co-evolution between innovation systems and institutions that make development happen for the people.

It helps that Dani Rodrik’s work also refers to that of Richard Nelson and Douglass North at its foundation before proving the details based on empirical studies in successful emerging markets.

Indeed, my preference is for this modern industrial policy micro- to meso-economic approach than the neoclassical macroeconomic that has a gap between the assumptions of the production model to that of reality.

Work-in-Progress – Links

Strategy: Emerging Markets Innovation Systems Must Target Diffusion
Strategy: Beyond Productivity – Competitiveness or Innovation?
Strategy: Technology Innovation Strategy for Emerging Markets
Strategy: Innovation as Intensive Learning and Emulating the East Asian NIEs
Strategy: Creating Innovation Winners for the Philippines

Locomotive: Malaysia Wins with Palm Oil Sectoral Innovation Systems
Locomotive: Philippines Tops India as Site for Business Support Services
Locomotive: Ayala Grabs Leadership in Mobile Banking for Microfinance
Industry Winner: Appropriate Technology for E407a and PNG Carrageenan
Industry Winner: General Purpose Technologies as Enabler to Emerging Markets
Industry Winner by product development: Birdwatching – Innovative Eco Tourism Product for the Philippines
Learning-by-Doing as Winner Potential: Living for Innovation and for Continuous Learning
Infrastructure: Social Innovation and Infrastructure in an Emerging Market

Industry leadership for social enterprise: Philippines World Best in Microfinance Regulatory Framework
Industry Winner as enabler: CARD MRI Fosters an Army of Entrepreneurs with Microfinance

Social enterprise: High Productivity Allows Growth and Equity at the Same Time
History of Social Enterprise: Social Enterprise as the Next Big Thing
Creating Shared Value and Nestle: Nestle Embeds Sustainability into Strategy through CSV – Creating Shared Value

Sustainability: Embedding Sustainability into New Enterprises

<__________________

Updated March 20, 2011: If you are interested to receive similar posts as this, please click ‘Like’ on Facebook SYNTHESiST page as below.

Click image to link to SYNTHESiST at Facebook.

Please click this image to move to Facebook.

As in Facebook, the Page allows more interaction among friends. You can also post status topics for discussion as you wish.

Finally, clicking on ‘Like’ will also send you notification of each new post.