Thursday, April 10, 2014

Capacity focus, 82: How industrial policy -- yes, well judged and prudent state-led interventions -- can help to build effective competitiveness (despite the risks of fostering crony capitalism and/or the entrenching of corruption) . . .

Series: 78, 79, 80, 81, 82, b/g

One of the points made in support of the large sums being spent by the American Government to fund the 1960's space race to the Moon, was that the sci-tech "spin-offs" would help create such a wave of innovations that the programme would more than pay for itself.

And indeed, it patently has. 

Ranging from Tang breakfast drink to the PC or Tablet or smart phone you are probably reading this on, ever so many "high" technologies trace back to the massive injection of funding, research and inventive effort that went into the space race.

Where, of course, it is no accident that the United States is still in the lead in the high tech race, having decisively overtaken the Germans through the total mobilisation for war in the 1940's (the British having more or less bowed out of the race and having chosen instead to be a partner with the Americans . . . the new leading maritime power), and having beaten the Russians in the 1950's and 60's. Of course, a big boost came from the GI Bill that sent ever so many veterans of the Second World War to College.  

All of this heavily focussed on oil, the automotive industry, electronics, computers, telecommunications, information technologies and the internet, the industries and innovations that have dominated the last two Kondratiev waves, to date.

All of which, of course was further enhanced by the fact that the industrial base and infrastructure of the United States suffered little or no direct attack during the world war. By contrast, the British, French, Germans, Russians and Japanese were severely damaged or outright devastated, the USSR losing some 25 million people as well.

For that matter, the early industrial development of the United States and other major economies was actively aided by the state, far above and beyond the basic community-based interventions suggested by the following context for the Hayek investment triangle:

This brings us to the issue of how well-judged community and state actions -- and culture -- can demonstrably help transform the state of development of a country.

That is, industrial policy.

Wikipedia aptly summarises:
The Industrial Policy plan of a country, sometimes shortened IP, is its official strategic effort to encourage the development and growth of the manufacturing sector of the economy. The government takes measures "aimed at improving the competitiveness and capabilities of domestic firms and promoting structural transformation." A country's infrastructure (transportation, telecommunications and energy industry) is a major part of the manufacturing sector that usually has a key role in IP . . . . Historically, there is a growing consensus that most developed countries, including United Kingdom, United States, Germany and France, have intervened actively in their domestic economy through industrial policies. These early examples are followed by interventionist ISI strategies pursued in Latin American countries such as Brazil, Mexico or Argentina. More recently, the rapid growth of East Asian economies, or the newly industrialized countries (NICs), has also been associated with active industrial policies that selectively promoted manufacturing and facilitated technology transfer and industrial upgrading. The success of these state-directed industrialization strategies are often attributed to developmental states and strong bureaucracies such as the Japanese MITI. According to Princeton's Atul Kohli, the reason Japanese colonies such as South Korea developed so rapidly and successfully was down to Japan exporting to its colonies the same centralised state development that it had used to develop itself.
So, industrial policy can work, if well done.


In light of the tempting challenge of crony capitalism,  a difficult task. 

Crony capitalism?

Wikipedia is again apt:
Crony capitalism is a term describing an economy in which success in business depends on close relationships between business people and government officials. It may be exhibited by favoritism in the distribution of legal permits, government grants, special tax breaks, or other forms of state interventionism. Crony capitalism is believed to arise when business cronyism and related self-serving behavior by businesses or businesspeople spills over into politics and government, or when self-serving friendships and family ties between businessmen and the government influence the economy and society to the extent that it corrupts public-serving economic and political ideals . . . .
In its lightest form, crony capitalism consists of collusion among market players. While perhaps lightly competing against each other, they will present a unified front (sometimes called a trade association or industry trade group) to the government in requesting subsidies or aid or regulation. Newcomers to a market may find it difficult to find loans, acquire shelf space, or receive official sanction (like the Medallion System of the Taxicabs of New York City created during the Great Depression) to sell their product or services; in technological fields, they may be accused of infringing on patents that the established competitors never assert against each other. Distribution networks will refuse to aid the entrant. In spite of this, some competitors will succeed when the legal barriers are light, especially where the old guard has become inefficient and is failing to meet the needs of the market. Of course, some of these upstarts may then join with the established networks to help deter any other new competitors. Examples of this have been argued to include the keiretsu of post-war Japan, the print media in India, the chaebol of South Korea, and the powerful families who control much of the investment in Latin America.

However, crony capitalism is generally associated with more virulent government intervention. Intentionally ambiguous laws and regulations are common in such systems. Taken strictly, such laws would greatly impede practically all business; in practice, they are only erratically enforced. The specter of having such laws suddenly brought down upon a business provides incentive to stay in the good graces of political officials. Troublesome rivals who have overstepped their bounds can have the laws suddenly enforced against them, leading to fines or even jail time. Even in high-income democracies with well established legal systems and freedom of the press a larger state is associated with more political corruption (including crony capitalism).

States often said to exhibit crony capitalism include Hongkong , the People's Republic of China, India (especially up to the early 1990s when manufacturing was strictly controlled by the government, also known as "Licence Raj"), Indonesia, Argentina; Brazil, United Kingdom - especially in the 1600s and 1700s, United States, Malaysia, Israel; Russia; most ex-Eastern Bloc states, as well as the most well-known case of economic crisis due to cronyism, Greece. Wu Jinglian, one of China's leading economists and a longtime champion of its transition to free markets, says that it faces two starkly contrasting futures: a market economy under the rule of law or crony capitalism . . .
The article continues, soberingly -- we are playing with dangerous matches here and need to understand why strict safeguards are necessary:
In its worst form, crony capitalism can devolve into simple corruption, where any pretense of a free market is dispensed with. Bribes to government officials are considered de rigueur and tax evasion is common; this is seen in many parts of Africa, for instance. This is sometimes called plutocracy (rule by wealth) or kleptocracy (rule by theft).

Corrupt governments may favor one set of business owners who have close ties to the government over others. This may also be done with racial, religious, or ethnic favoritism; for instance, Alawites in Syria have a disproportionate share of power in the government and business there. (President Assad is an Alawite.) This can be explained by considering personal relationships as a social network. As government and business leaders try to accomplish various things, they naturally turn to other powerful people for support in their endeavors. These people form hubs in the network. In a developing country those hubs may be very few, thus concentrating economic and political power in a small interlocking group.
Normally, this will be untenable to maintain in business; new entrants will affect the market. However, if business and government are entwined, then the government can maintain the small-hub network.

Raymond Vernon, specialist in economics and international affairs, wrote that the Industrial Revolution began in Great Britain, because they were the first to successfully limit the power of veto groups (typically cronies of those with power in government) to block innovations. "Unlike most other national environments, the British environment of the early 19th century contained relatively few threats to those who improved and applied existing inventions, whether from business competitors, labor, or the government itself. In other European countries, by contrast, the merchant guilds ... were a pervasive source of veto for many centuries. This power was typically bestowed upon them by government". For example, a Russian inventor produced a steam engine in 1766 and disappeared without a trace. "[A] steam powered horseless carriage produced in France in 1769 was officially suppressed." James Watt began experimenting with steam in 1763, got a patent in 1769, and began commercial production in 1775.

Anthropologist David Graeber's book Debt: The First 5000 Years provides an even broader perspective: For as far back as we can see in the historical and archaeological record, argues Graeber, people with wealth and power, typically a monarch and cronies, have written the rules to benefit them at the expense of others. The situation would deteriorate for common folk until it was interrupted by a peasant revolt. Then the cycle would start over again . . .
 So, there is a fine line to be sailed between legitimate and reasonable support for industry and development and shady or outright corrupt practice that in effect sets up a state-backed business oligarchy that in turn can dominate and utterly corrupt the state. Not to mention, outright block potential breakthroughs.

For instance, the steam engine was the chief "locomotive" -- and, in essence, this is simply a coal-fired steam engine turned into an "iron horse" -- that pulled the train of the first major industrial era  Kondratiev waves of transformation and development.  Showing us the potential in breakthrough energy and transportation or networking technologies. 

(Indeed, across C19,  between the continent-spanning rail network and the telegraph network, the emergence of the United States as a continent-spanning unified industrial power was enabled . . . transforming what would be possible in the 20th Century.)

So, it is not insignificant to see how abuse of power seems to have blocked progress in Russia and France across the 1760's. (We should note, though that Watt had a predecessor in England, Newcomen . . . as early as c. 1710.)

Let's refresh our memories:

That is already a major challenge, one perhaps best faced in a community where there is a strong, vigorous independent media, and a well informed, fearless public. (Which, characteristically will not be the case in a community dominated by cronyism -- and BTW, for those inclined to suggest a radical socialist solution . . .  this boils down to creating a massive state owned monopoly on the commanding heights of the economy driven by political and bureaucratic impulses rather than economic effectiveness, a "cure" the C20 just past has shown beyond reasonable doubt is likely to be worse than the disease. Thankfully, in an era of widespread web access, social media and PCs, Tablets and smart phones, there are alternatives. But in turn, such can all too easily foster the spreading of destructive slanders, bigotry and popular but ill-founded notions. Another cluster of challenges.)

That already means that a viable industrial policy is a complex, delicate challenge.

However, that is only the first challenge. For, in an era where major anti-protectionist agreements abound, industrial policy is obviously a far more complex matter than hitherto. One that is multiplied by the current ferment in macroeconomic thinking.

Synthesist blog, which seems to be based in the Philippines, comments:
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-adding 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 economic.

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.
Big assumption, especially when there is a weak entrepreneurial culture and where there is a serious capacity challenge to be overcome to achieve the required waves of key technological innovations. 

For much of that, a long term investment in a solid education system is a necessity. 

At the upper end, that should feed into a research programme that can be co-ordinated on a regional basis. Much of that can become a partnership between the universities, the region's private sector and governments, probably with significant injections from Commonwealth universities.

But also, such a programme should feed into a carefully developed enterprise incubation programme, backed by mentoring and venture capital, at all scales, including micro.

Across time, this will help develop technological strength and an entrepreneurial culture.

Again: if not now, then when? If not here, then where? If not us, then who? END