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Industrial Policy Showdown at World Bank: the policy that may not exist also may not work

The World Bank’s PSD Blog has a good discussion of the debate last Monday between Justin Lin (Chief Economist of the World Bank), Ann Harrison (Head of trade policy division at the Bank and well-known trade economist), and myself (random trouble-maker). The debate was very civil, and I am very grateful to Justin Lin for being so willing to debate his ideas openly (as opposed say to a former Chief Economist who forced me to seek political asylum to escape his enforcers :>)

The debate basically boiled down to who is more likely to discover the country’s comparative advantage, the government or decentralized entrepreneurs.

(1) the argument for the government

— according to Ann Harrison, there could be “latent comparative advantage” in industries with increasing returns – i.e., falling unit costs the more is produced. In these industries, they don’t have a cost advantage now because they are not producing much, but if they produced more they would have lower costs. A government could promote an industry to turn latent into actual advantage.

–according to Justin Lin, the market can handle static efficiency, but can’t handle the transition from one stage of exporting to another, like from lighter to heavier industry. All the government needs to do is look ahead at those countries ahead of it on the technological ladder and promote the next rung on the ladder to find the country’s true comparative advantage.

(2) The argument for many decentralized entrepreneurs seeking the next Big Hit

–If it’s so easy for governments to do it, why do we have no success stories of imitating East Asian tigers?

–Ann pointed out that we have little evidence of any actual government policies aimed at finding “latent comparative advantage.” Even deeper than whether industrial policy works is the question of whether it even exists in the real world.

–there are almost 3000 manufacturing products to choose from, so how much guidance does the government get from looking ahead at a very broadly defined “technological ladder?” Entrepreneurs discovered such surprising Big Hits as Fiji exporting women’s cotton suits to the US and Egyptian exports of ceramic toilets to Italy.

–the central government has limited knowledge, limited skills, no direct rewards for finding winners, and lots of problems with corruption (Lant Pritchett reminded me of a recent paper that documented that we can’t even trust Indian civil servants to give out drivers’ licenses) as it tries to pick winners. Entrepreneurs have lots of local knowledge about their industry, specialized skills in that industry, abundant rewards for success, and will not steal from themselves.

–much of the “evidence” that industrial policy “works” is selectively picked from a huge amount of random variation. It focuses almost entirely on industrial policy successes and doesn’t document the much more numerous failures.

In the end, the question boils down to: does a poor country government have a comparative advantage in discovering a poor country’s comparative advantage?

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  1. Pierre-Louis wrote:

    You don’t “discover” a comparative advantage…you “create” it…it’s not like it’s lying around somewhere waiting to be discoovered and exploited.

    Fiji may export cotton suits but it could have been anything else…It’s just an organized and efficient business.

    but the question remains the same…

    Does a poor country government have a comparative advantage in creating a poor country’s comparative advantage?

    no…but I would say it’s more an incentive problem than a lack of information.

    Posted September 18, 2009 at 11:49 am | Permalink
  2. Joe wrote:

    The reality is that poor countries’ entrepreneurs can be more knowledge-poor than governments. Governments have access to greater resources for research as well as the ability to call on international technical expertise. Local entrepreneurs generally do not have knowledge of industries in which they could potentially compete beyond those already established in (at best) neighbouring countries. Many successful examples of industrial ‘clusters’ such as in Bangalore, flourish because their local entrepreneurs have worked in the industries where they innovate for some time abroad – silicon valley in this case.

    In the absence of international mobility of labour for skilled professionals, poor country governments are likely to have some comparative advantage, however small, over local entrepreneurs.

    Furthermore by attempting the exercise (Industrial Policy), governments can encourage financial institutions to think a bit more laterally about the way they allocate credit. In the absence of this push, banks are likely to stick with safe bets in established industries – some might call this a market failure – something for Government to address.

    Posted September 18, 2009 at 12:16 pm | Permalink
  3. Pierre-Louis wrote:

    yeah for sure governments have a role, especially for international trade (as shown by James Rauch’s research). But this role is not about making decisions for entrepreneurs, it’s about helping them (ease of doing business, export promotion agency, court protection, access to credit) no matter what THEY decide.

    Posted September 18, 2009 at 1:38 pm | Permalink
  4. Iyinoluwa Aboyeji wrote:

    Bill might have lost this one-not because his reasoning is unclear but because of the clear cut realities. In an ideal world, Bill would be right. As it is with a politicized trade and development regime, governments are far more likely to do a better job with industrial policy as entrepreneurs in poor countries can hardly identify with the markets they wish to serve (which are sadly rich countries). Unfortunately, until we change the market for the goods of poor countries by regionalizing trade especially for African countries, there will be no other huge successes for us to speak of. The traditional target market (the rich western countries) within which the discussion has been framed is already saturated.

    To put it very succintly:

    In an ideal world, Bill would have won

    In “this” world (under its present circumstances) were the ideal , the World Bank would have won.

    Neither is true. No one win.

    Posted September 18, 2009 at 5:24 pm | Permalink
  5. Jeff Barnes wrote:

    I find the question odd. Neither governments nor entrepreneurs find comparative advantage. Government sometimes try to pick winners by selective investment and if this is what is meant by “industrial policy” then I agree with Easterly. However, I think industrial policy is more than that and there is a lot governments can do by investing in education of its people, investing in infrastructure, etc that will help its entrepreneurs find whatever advantage they may have in the world economy.

    Posted September 19, 2009 at 12:25 am | Permalink
  6. Stephen Jones wrote:

    What I find absurd is the idea that there is some kind of ‘technological ladder’; we had that idea in the fifties but I thought it had been truly dead and buried.

    Posted September 19, 2009 at 3:44 am | Permalink
  7. Jim wrote:

    I’m glad to see that the debate has moved on from ‘can industrial policy work?’ (answer, yes it can) to ‘what are the conditions in which industrial policy can work?’. And yes, the incentives governments face are an important part of the answer to that one. But I’m surprised that nobody has mentioned the fact that most rich countries and every major international economic agency with teeth (that’s the IMF, World Bank and WTO) have been deliberately and strenuously trying to prevent poor countries from implementing any industrial policy for decades now. It’s really no surprise there aren’t many success stories.

    If rich countries and the international agencies actually cared enough about long-term development they could provide the sorts of institutional support and incentives that would greatly improve the prospects of successful industrial policy in poor countries. But they don’t.

    Posted September 21, 2009 at 5:27 pm | Permalink
  8. Nwabu wrote:

    I think that trade comparative advantage boils down to whether entrepreneurs have the skills, the knowhow and the capital not just to discover opportunities but to seize advantage of them at the global level and whether they have the goodwill of their governments to have incentives framed in their favor to facilitate that trade. Where both factors are in place you get the East Asian growth story.

    BUT where only one is present then you get:

    a) an India, Egypt or Mexico where entrepreneurial dynamism is constantly hindered and sabotaged by lazy, incompetent and often corrupt govt officials.

    b) scores of developing countries whose govt ministries are packed with Oxford, Harvard, NYU, MIT, and Sorbonne-trained economists who have all the policies down while their country lacks entrepreneurs willing to seek new global opportunities outside of the needs of the domestic economy or government contracting.

    Posted September 25, 2009 at 9:30 pm | Permalink
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    The Aid Watch blog is a project of New York University's Development Research Institute (DRI). This blog is principally written by William Easterly, author of "The Elusive Quest for Growth: Economists' Adventures and Misadventures in the Tropics" and "The White Man's Burden: Why the West's Efforts to Aid the Rest Have Done So Much Ill and So Little Good," and Professor of Economics at NYU. It is co-written by Laura Freschi and by occasional guest bloggers. Our work is based on the idea that more aid will reach the poor the more people are watching aid.

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