Archives for category: Industrial Policy

Uhuru and Ruto wrote in the Jubilee Manifesto that they plan to establish a development Bank to “prop up the private players”. Although nobody is talking about it, and although we have no idea if that will happen anytime soon, this could be a huge deal for the future of Kenya. What is a development bank? And is it a good or a bad idea for Kenya?

A traditional definition of a development bank is one which is a national or regional financial institution designed to provide medium-and long-term capital for productive investment, often accompanied by technical assistance, in less-developed areas. Development banks fill a gap left by undeveloped capital markets and the reluctance of commercial banks to offer long-term financing. [full “primer on development banking” here]

We have to keep in mind is that UhuRuto provided no details about how a development bank fits into their grand scheme for economic development in Kenya. For example, we don’t know if the objective is to promote small businesses (like the informal sector or SMEs), whether they want to finance large infrastructural projects, agriculture or large manufacturing industries.  However, the sure thing is that whenever the plan is to increase the government role in the economy, you attract both huge praise and criticism:  that’s the difference between the “industrial policy view” and the “political view”

According to the industrial policy view, development banks do more than just lending to build large infrastructure projects. They also lend to companies that would not undertake projects if it was not for the availability of long-term, subsidized funding of a development bank. Furthermore, development banks may provide firms with capital conditional on operational improvements and performance targets. In such circumstances, we would expect to see the firms who borrow from development banks increasing capital investments and overall profitability after they get a loan.

According to the political view, on the other hand, lending by development banks leads to misallocation of credit for two reasons. First, development banks tend to bailout companies that would otherwise fail (this is the soft-budget constraint hypothesis, e.g. Kornai, 1979). Second, the rent-seeking hypothesis argues that politicians create and maintain state-owned banks not to channel funds to socially efficient uses, but rather to maximize their personal objectives or engage in patronage deals with politically-connected industrialists.

So, whether a development bank is a good idea or not for Kenya entirely depends on your opinion on the current political class: will they be committed-to-development or good-old rent-seekers? For now I want to keep on the optimist side.

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Over at Foreign Policy:

One living legacy [of colonialism] is a crazy quilt of trade preferences and protection buttressed by a mix of geopolitics, nostalgia, and rich-country interest group protectionism — distortions that undermine growth in export-oriented agriculture and make it tough for women in some of the poorest countries in the world to sew their way out of poverty.

Now consider West Africa’s Benin, one of the poorest countries in the world (GDP per person in terms of purchasing power: $1,700). Benin’s meager trade and living standards are held back by agricultural and industrial tariffs averaging 14 and 12 percent respectively. And it’s pretty much the same throughout the poorer corners of the world. In Cameroon (GDP per capita: $2,300), farmers hide behind agriculture tariffs averaging 22 percent, while manufactured goods are hit with 12 percent import levies. The parallel figures for Burundi (GDP per capita: $600) are 20 percent and 11 percent; for Gambia (GDP per capita: $1,900) 17 percent and 16 percent.

I wouldn’t blame it entirely on colonialism: inside the countries there are interest groups and lobbies that prefer to keep things the way they are. The worst part is that high tariffs are rarely part of an actual industrial policy. So what happens is that they impose a net loss on the economy without trying to incentive domestic production.

When it comes to regional trade, however, non-tariff barriers are the number-one problem:

Arguably, the greater barriers to intra-continental trade (especially in Africa) are bureaucratic and logistical. To carry goods from Kigali, Rwanda to Mombasa, Kenya, trucks “have to negotiate 47 roadblocks and weigh stations,” the African Development Bank reported in 2012. At the time, the Bank also noted, there was usually a 36-hour wait at the South African border for trucks to cross the Limpopo River into Zimbabwe. It was much the same story getting through customs from Burkina Faso into Ghana, from Mali into Senegal — actually, from just about anywhere to anywhere in Africa. 

More here

World Bank’s Marcelo Giugale has a new article in the Huffington Post arguing that industrial policy has failed miserably in the past and that the “new industrial policy”, though better than the previous version, is unlikely to work either.

If you are over 50 and grew up in a developing country, fond memories of your family’s car or TV set are surely coming to your mind: it carried a national brand, cost a fortune and broke down all the time.

But industrial policy is back in the agenda:

You’d be surprised. Today, developing countries rich in oil, gas or minerals are desperately looking for policies to diversify their economies, not just because the price of natural resources could unexpectedly tank, but because the business of extraction does not create enough jobs. They have money to invest–think Africa. Even in countries that are doing well, governments are searching for ways to make their industries more high-tech and avoid being trapped half-way up the technological ladder–think Brazil. But everyone wants a new–read, smarter–industrial policy, one that avoids the mistakes of the past. They just might be on to something.

So, will this “new industrial policy”, which sounds less exciting and less revolutionary than its previous version, work? Let’s say that it cannot hurt. If done in the open, private-public collaboration is a win-win. But you are entitled to be skeptic, especially if your government has not been able to deliver simpler services–like a teacher in every class, clean water and a decent police force. That is, if you live almost anywhere in the developing world.

More here (recommended)

Interesting new paper by Bruce Blonigen from the University of Oregon:

Industrial policies (IPs) include such varying practices as production subsidies, export subsidies, and import protection, and are commonly used by countries to promote targeted sectors. However, such policies can have significant impacts on sectors other than those targeted by the IPs, particularly when the target sector produces goods that are key inputs to downstream sectors. Surprisingly, there has been little systematic analysis of how IPs in targeted sectors affect other sectors of the economy. Using a new hand-collected database of steel-sector IP use in major steel-producing countries from 1975 through 2000, this paper examines whether steel-sector IPs have a significant impact on the export competitiveness of the country’s other manufacturing sectors, particularly those that are significant downstream users of steel. I find that a one-standard-deviation increase in IP presence leads to a 3.6% decline in export competitiveness for an average downstream manufacturing sector. But this effect can be as high as 50% decline for sectors that use steel as an input most intensively. These general negative effects of IPs are primarily due to export subsidies and non-tariff barriers, particularly in less-developed countries.

The Kenyan government provides some support to the few steel industries in the country; as far as I know, it is mostly in the form of cheaper (or free) electricity and water. But that of course does little against growing international competition, especially from India and China. So the sector has stagnated: most firms have not expanded in any significant way, some have ceased their operations. (More info on this document, PDF).

The steel sector was (and still is) considered crucial for industrialization in China, so the government has protected it with heavy tariffs and subsidies. If I was the next President of Kenya, I would work day and night to find a market-friendly way to support innovation in this sector. I would definitely not let it collapse.

HT Circle Bastiat

Taiwan, year 1983. The plan of the government consisted of 3 simple steps:

  1. Identify an imported product that you want to produce locally.
  2. Use red tape to slowdown the import of that product
  3. Let local firms learn the technology, get good contracts, and start producing that good.

As bad as this story may sound (nobody wants red tape!), the strategy was actually successful:

 In the early 1980s Phillips was making TVs in Taiwan, and importing a certain kind of specialized glass from its factory in Japan. The IDB team [Industrial Development Bureau, a Taiwanese government institution].. identified two or three Taiwan glass makers which in their view had the productive capability to make the jump in product quality needed to produce the specialized glass at a price close to the import price. They discussed the possibilities with the firms. The firms said they would invest in the necessary equipment provided they got a longterm supply agreement with Phillips.

Of course Philips didn’t like the idea.

The IDB officials went to Phillips. The Phillips procurement manager said the company was happy with its present arrangement of importing the glass from its factory in Japan, and declined to change suppliers. Soon Phillips found that its applications to import the glass, previously automatically approved, began to be delayed. Phillips contacted the Minister of Foreign Trade, who apologized profusely, and explained that even he was not always able to get the inefficient trade bureaucracy to work quickly. He promised to investigate. The delays lengthened, and lengthened again. The Minister apologized and said he had done all he could. Eventually Phillips got the message, and entered into discussions with one of the Taiwanese glass makers. The upshot was that Phillips offered a longterm supply contract, and the domestic glass maker invested in upgraded equipment. Before long the Taiwanese glass maker was exporting some of the specialized glass.

 I wrote a blog post about this paper a few months back.  It is by LSE professor Robert Wade. Full article is great and you can find it here (pdf)

the 2008 global financial crisis has  enhanced the legitimacy of  industrial policy in a number of ways. First, the crisis prompted some major industrial policy actions – both defensive and proactive. The bail-out of US automakers is the best example of defensive industrial policy and the ‘green’ subsidies to the auto industry in the US and other countries are the best examples of proactive industrial policy. Second, having originated from over-development of the financial sector, the crisis has restored the legitimacy of industrial policy even in countries like the US and Britain, where  it had been a taboo.  Third, the continued rise of China and the solid performance of Germany,  both of which have never been shy about using and talking about industrial policy, throughout the crisis period have also made people think again about the importance of industrial policy.

Despite all of this, however, there is a persistent scepticism about the applicability of industrial policy to  the  African countries. However  well the policy may  have worked in countries like Japan and  Korea in the past, it is argued, it simply won’t work in most developing countries, especially those in Africa. The reasons cited are varied – ranging from excessive natural resource endowments (the so-called ‘resource curse’ thesis), pathological politics, the lack of bureaucratic capabilities, and the changes in the global economic rules –but the implication is that the African countries would be better off sticking to their natural resource advantages, rather than trying to develop manufacturing industries through industrial policy.

That was Cambridge economist Ha-Joon Chang discussing the most common arguments against industrial policy in Africa. Ungated pdf version here, Interesting throughout.

Probably not, the New Structural Economics won’t make it as far as becoming a new consensus in development economics. But the debate triggered by the Chief Economist of the World Bank  Justin Yifu Lin is an interesting one.

The NSE is basically a milder version of economic structuralism, an approach from the ’60s and ’70s that entailed strong state interventions in the economy, import-substitution and protection of domestic industries. The “New Structural Economics” makes a step closer to the  “Washington Consensus”  as it believes that markets are the best mechanism for allocating resources. At the same time, however, it says that governments must play a central role in facilitating industrial upgrading and structural change -not in all sectors of the economy, but only in those where the country has a comparative advantage. In other words, governments must “follow” markets, not “lead” them wherever they hope to succeed.

Lin summarizes the principles of NSE in three points (the ungated older version of the paper is here):

First, an economy’s structure of factor endowments evolves from one level of development to another. Therefore, the optimal industrial structure of a given economy will be different at different levels of development. Each industrial structure requires corresponding infrastructure (both “hard” and “soft”) to facilitate its operations and transactions.

Second, each level of economic development is a point along the continuum from a low-income agrarian economy to a high-income industrialized economy, not a dichotomy of two economic development levels (“poor” versus “rich” or “developing” versus “industrialized”). Industrial upgrading and infrastructure improvement targets in developing countries should not necessarily draw from those that exist in high-income countries.

Third, at each given level of development, the market is the basic mechanism for effective resource allocation. However, economic development as a dynamic process requires industrial upgrading and corresponding improvements in “hard” and “soft” infrastructure at each level. Such upgrading entails large externalities to firms’ transaction costs and returns to capital investment. Thus, in addition to an effective market mechanism, the government should play an active role in facilitating industrial upgrading and infrastructure improvements.

This topic hasn’t “trickled down” yet from academic circles to the blogosphere (or did I miss something?) but several thought-leaders have commented on the issue.

Dani Rodrik, for example, agrees with most arguments but criticizes the idea of following strictly the comparative advantage:

Lin doesn’t want governments to employ “conventional” import substitution strategies to build capital-intensive industries which “are not consistent with the country’s comparative advantage.” But isn’t building industries that defy comparative advantage what Japan and South Korea did, in their time? Isn’t it what China has been doing, and quite successfully, for some time now? According to my calculations, the export bundle of China is that of a country between three and six times richer. If China, with its huge surplus of agricultural labor, were to specialize in the type of products that its factor endowments recommend, would it now be exporting the advanced products that it is?

Anne Krueger criticizes Lin’s excessive focus on industrial expansion for development:

Lin’s NSE seems to equate growth with industrial expansion, ignoring the importance of increased productivity of the large fraction of the labor force (and of land) in rural areas. Failure to invest in agricultural research and development and in rural health and education has been a major weakness of many countries’ development strategies. While strides have been made in reducing discrimination against agriculture, the NSE as exposited by Lin would appear to support the industrial and urban bias that has itself constituted a very large distortion in some countries.

I would like to see some more commentaries on the topic. Hopefully now that the World Bank President has been chosen, there will be more space for some  good-old policy debate.

If you are interested in the book, you can find it here.

Let me start with an anecdote. Two days ago the rainy season began in Kenya (almost a month late) and this morning the roads in the Kariobangi industrial cluster became very muddy. A truck got stuck in one of the roads and it took almost an hour to get it out –all businesses in that road were damaged from a very simple problem.

An entrepreneur came up to me and asked “why did the Italians construct tarmac roads in the Korogocho slum and not the Kariobangi industrial cluster? Nobody cares about small industries in this country”. He was referring to a slum upgrading program financed by the Italian Cooperation to improve the roads in the nearby informal settlement of Korogocho, which was not extended to the Kariobangi Light Industries; he was evidently not happy about it.

I could not come up with a good answer at that moment, but his question reminded me of an excellent paper by Robert Wade, professor of political economy and development at the London School of Economics, which discusses the role of industrial policy in Asia and how donors completely neglected it in Africa.

 I came to Addis in the summer of 2004 with Joe Stiglitz, to participate in what is called a Policy Dialogue. We talked to several groups. At the meeting with aid representatives working in Ethiopia—about 20 of them—we invited each to identify the priorities of their agencies in Ethiopia. They identified more or less the same ones, virtually all in ‘governance’ or the ‘social sectors’ like primary health and primary education. They made virtually no reference to investment in the ‘hardware’ of productive capacities. The closest any of them got was ‘rural roads’, mentioned by just one representative. No-one mentioned aid for agriculture or irrigation or manufacturing or services. When they talked of ‘improving governance’ they were not referring to improving the governance of the processes through which capital accumulation, technological progress, and diversification of production can be directly accelerated, but governance in broader terms related to ‘rule of law’, ‘property rights’, ‘anti-corruption’ and the like. They talked, implicitly, of ‘market-enhancing governance’, not ‘growth-enhancing governance’, as though the former equated to the latter.

… The agendas of the aid donors Joe Stiglitz and I talked to in Addis in 2004 could scarcely be more different from the agenda of America’s large-scale aid for Japan, South Korea and Taiwan in the postwar decades. The comparison is important because the Americans were very serious about accelerating economic development in Northeast Asia. They saw the region as the front-line in the battle against global communism and they wanted economically prospering, militarily strong, and politically stable capitalist allies on the front line. So what did the Americans direct their aid to, when they were deadly serious about accelerating development (as distinct from opening up the economies and claiming that opening was the best route to development)? US aid was targeted explicitly at the development of productive capacities, including lots of assistance for new basic industries (in metals, chemicals, petrochemicals), infrastructure like roads, electricity and water supply, technology institutes, and agriculture (irrigation, improved crop varieties, crop research institutes). US aid even supported large-scale, semi-expropriative land reforms in all three countries, in order to make the rural sector politically stable as well as to raise the productivity of the land.

Yet for the past 25 years the consensus in the donor community has been, implicitly, that the development of productive capacities will result from free markets, provided free market policies are complemented with the development of ‘market-enhancing governance’ capabilities, like those noted above, as well as by investment in primary education, primary health care and the like. The comparison makes one wonder whether the donor community has a collective interest in accelerating development as distinct from reducing poverty and opening up developing economies—which is not the same thing.

Ungated version of the paper here