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The role of industrial policy in development

Date
Time (GMT +01) 08:00 09:45
This event has finished, watch or listen to the playback below.

Speakers

  • Andrew Steer (Chair)

    Director General for Policy and Research, Department for International Development (DFID)

  • Justin Yifu Lin

    Chief Economist, World Bank

  • Ha-Joon Chang

    Reader, Cambridge University

  • Dirk Willem te Velde

    Programme Leader, Investment and Growth, ODI (and IPPG)

  • Karen Ellis

    Programme Leader Business and Development, ODI

Justin Yifu Lin - Chief Economist, World Bank

Justin Yifu Lin begun the discussion by suggesting that poverty is the biggest challenge to the development community and that the financial crisis will increase the number of people in poverty by around 90 million. The key for the development community will be to foster inclusive and equitable growth.

Countries developing industrial policy should foster the promotion of industries in which they have a comparative  advantage, allowing countries to upgrade their industries step by step. If countries try to target industries in which there is no comparative advantage then they will have to implement large subsidides for these sectors making them ineficient as well as making economic performance in the long run weak and more volatile than if they were following their comparative advantage. It would also leave behind a large number of people in the informal sector or agriculture as the sector will only create a small number of formal employment opportunities. Further, resources will have to be transferred from other sectors in order to support industries where the country has no comparative advantage leading to further economic inequalities within the country.

In order to test for these hypothesis the Technological Choice Index (TCI) is used as a proxy for the industrial development strategy.  The TCI is an index that looks at the value added per worker in a manufacturing sector (nominator) divided by the gdp per worker. The higher the index the more the country pursues strategies in which it does not have a comparative advantage. The higher the TCI the greater the amount of black market activity within the country as well as reduced economic freedom, more business regulation, decreased economic independence for firms and economic openesses as well as a decreased growth rates and export rates and increased economic volatility and inequality.

The government and firms within a country should instead follow their comparative advantages as this will increase national competitiveness and economic sustainability. In addition clusters will only form if firms follow comparative advanatages. The creating of clusters fosters a compettive domestic market; the size of the domestic market however will not matter much as firms will be serving the global market.

For developing countries the state is useful in order to implement industrial policy that promotes economic development, key industries should not be chosen by developing country governments, rather governmemts should facilitate business. The key strategy that should be used by developing countries is to look at similar countries with similar factor endowments and look at what products were promoted that allowed the country to grow economically and thus promote innovation and research in the products which would help the country to prosper. Following comparative advantages will allow countries to gradually move up the industrial scale, moving from high labour intensive industries to capital intensive industries.

Ha-Joon Chang - Reader, Cambridge University

Ha Joon Chang responded to Justin Lin’s presentation with a number of key points. The first point is that Lin’s theory assumes perfect factor mobility, however in reality perfect factor mobility is not really plausible, for example steel workers will not be able to become electrical engineers in a short period of time but  it would take a significant amount of time in order for new skills to be learned. In addition the theory assumes that sophisticated technology is available to all countries, however this is not the case as not all countries have access to required technologies. There is no general industrial policy as you also need to account for the optimal level of targetting depending on what the specific circumstances of a country. A country needs to be able to accumulate the right capital and human resources in order to produce what it is best at, this however takes time and requires targeted government interventions. Developed countries have taken a long time in order to develop the industries in which they are best at, such as the UK and the USA using strict import tariffs to protect local industries. Deviations from the comparative advantage can however be compatible with economic development, you do not need to simply stick to comparative advantage. The theory of comparative advantage is not wrong per sé, as countries shold specialise in what tehy are best at doing, however the process of industrial theory is too complicated to be guided by such a narrow theory.

Dirk Willem te Velde - Programme Leader, Investment and Growth, ODI (and IPPG)

Dirk Willem te Velde highlighted the fact that there is renewed interest in the role of the state in idnsutrial development, however the key is to identify what the appropriate role of the state is. Theory and practice suggests there are market and co-ordination failures, yet governments fail to overcome this. Comparative advantage conforming strategies are not sufficient, yet comparative advantage defying policies can go wrong. A key focus point should be to understand the nature, form and effects of effective “State Business Relations” examining appropriate institutional set-ups allowing market failures to be overcome without generating failed interventions. He discussed a number of examples from IPPG research suggesting that certain forms of state-business relations helped to formulate appropriate industrial policies.

Karen Ellis- Programme Leader, Business and Development, ODI

Karen Ellis discussed the fact that there is a need for governments to pick winners as market forces and competition do not always determine which markets succeed or fail. Governments affect businesses as there are often very close relationships between big businesses and the government. The government can thus either help or hinder big businesses (especially due to political or developmental objectives) and thus there is a role for government in industrial policy. Governments need to intervene in order to court foreign investors, offer protection to new entrants within a country and target specific investment climate barriers.

Description

The global financial crisis has led to a reassessment of the role of the state vis-a-vis the private sector in promoting growth and development. However, the role of industrial policy has long been the subject of extensive debates. This was most recently illustrated in the September 2009 issue of Development Policy Review, which included a high profile DPR Debate that brought together two well-known researchers, Justin Yifu Lin, Chief Economist and Senior Vice-President of the World Bank, and Ha-Joon Chang, Reader in the Political Economy of Development, Faculty of Economics, University of Cambridge, asking Should industrial policy in developing countries conform to comparative advantage or defy it? Both support a strong role for the state in promoting economic development but differ on the specific role that industrial policy can play.

Following on from this recent debate, ODI invited them both to further the discussion on what role industrial policy can play in promoting development. Presentations from the speakers were followed by comments from Dirk Willem te Velde (ODI), who discussed the topic in light of the ongoing work with the Research Programme Consortium for Institutions on Pro Poor Growth on state-business relations and industrial policy in a number of African countries, and Karen Ellis (ODI), who discussed the topic in light of her recent work on competition policy in developing countries.