Sunday, May 17, 2009

Industrial policy and emerging economy growth

The ongoing global economic crisis has focussed attention on the role of global macroeconomic imbalances, manifested in the massive savings and trade surpluses run up by the developing countries which finances the voracious consumption appetite of developed world consumers. It has therefore raised doubts about the sustainability of the export-led, reserves-amassing East Asian growth model.

The success of these developing economies have come from diversification into manufactured and other modern industrial goods, following what Dani Rodrik calls "productivist" policies - undervalued currencies, industrial policies, and financial controls. The events of the recent months have exposed the limitations of this growth model, especially for the medium and large-sized developing economies. An undervalued currency, while subsidizing the production of manufactured goods (by making exports competitive), also taxes domestic consumption (by keeping imports costly).

Prof Rodrik feels that the twin objectives of global macroeconomic stability and economic growth in developing countries can be simultaneously achieved if the domestic demand in these economies expands along with economic output. The developing countries can then allow their currencies to find its real market value and still maintain their competitiveness through targetted investments in infrastructure and explicit industrial policies.

Thus developing countries can "grow rapidly even if world trade slows and there is reduced appetite for capital flows and trade imbalances" through a two-track policy of stoking domestic demand and targetted industrial policy. As Prof Rodrik says, "developing countries will have to substitute real industrial policies for those that operate through the exchange rate... Greater use of industrial policies is the price to be paid for a reduction of macroeconomic imbalances." He also exhorts organizations like the WTO to be more tolerant of such industrial policies.

Instead of indulging in semantic jugglery about conditional probabilities, as William Easterly does with his examples of Latin America and Africa, it may be more sensible to take cue from Dani and study the conditions under which such industrial policies are likely to be successful. And, while pursuing such policies, it is of critical importance to keep in mind the dangers of creeping protectionism, in the guise of "industrial policy".

Update 1
Robert Reich joins the debate on industrial policy asking whether, "Could chunks of the old auto industry be adapted to producing high-speed rail or, more generally, highly-efficient people-moving systems of the future or, even more generally, green technologies that support such systems?" He talks of the "need for a broader and more imaginative approach to industrial policy - one that integrates all the different ways government influences industry, and achieves overarching public goals".

Mark Thoma feels that such direct intervention policies could end up creating distortions and prefers governments to put in place incentives that drives businesses to the desired outcomes. He also feels that given the high unemployment rates, the government could do more than it has done in the past to insulate workers from the effects of structural change and to speed the transition.

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