Monday, June 21, 2010

Industrial and trade policies as competitiveness policy

Reis and Farole argue that industrial and trade policies are here to stay, especially after the economic crisis, which decreased confidence in the market system (it has not wiped confidence completely; it should not. We just need to doubt some of the hyped virtues of markets). If government activism is here to stay then how can it promote competitiveness rather than resort to old-school industrial policy that accentuates import substitution policies. They explore areas where governments can use industrial and trade policies to enhance competitiveness of domestic firms.

First, how are we sure that there will be more government activism in the coming years. The authors point three reasons for active involvement of governments in implementing industrial policy and trade policy after the economic crisis.

  1. The crisis has discredited some of the over-blown virtues of laissez-faire approach. Governments will be more active in designing policies to shape markets that the market itself would try to bypass.
  2. Diversification of sectors, products, and trading partners will be top of the policy agenda in most of the developing countries, opening more room for government activism. Diversification lowers export-led growth volatility. Also, see this blog post.
  3. Still, most of the developing countries’ products are not competitive in the international market despite sweeping liberalization since the 1980s. Governments would be designing policies to make their industrial products price and quality competitive.

Governments need to use industrial and trade policies in such a way that it fosters competition, not distort market incentives and diminish the gains from trade liberalization. They should play a critical role in overcoming market failures. Governments can help by ensuring the supply of inputs to private firms and creating a good functioning market environment where firms can operate. These policies can include facilitation of self-discovery (Hausmann & Rodrik 2002) and promotion (and realization) of the benefits of agglomeration economics (Porter 1990).

The authors argue that governments should focus on enhancing both macro (long term)- and micro-economic environment. Macroeconomic/long term environment include enhancing human capital, creating sound macroeconomic foundations, and instituting basic institutions such as property rights, the rule of law, and effective regulation. The microeconomic environment induce:

  • Aligning micro incentives (removing tariff and nontariff barriers, real exchange rate misalignment, fiscal health, easy of doing business, etc.)
  • Reducing trade-related costs (improving ICT services, improving capacity and coordination among government services, RTAs, improving logistic services constraints, reducing transportation costs, etc.)
  • Overcoming government and market failures (promotion of technology creation and adoption, product certification standards, trade finance, SEZs, industrial clusters, etc.). The more effective the export-promotion agencies, the more will be the survival rate of the exporters (see the figure below) Export promotion agencies work but small and focused ones are better.

Brazil’s success with the green industrial policy is discussed here. Asia’s experience and their standing in 2030 discussed here. Justin Lin demystifies the Chinese miracle and export-led growth. Finland’s experience with industrial policy discussed here. Degol Hailu explains the developmental state in Indonesia. Industrial policy in the US after the crisis discussed here. Industrial policy ain’t protectionism. Jeff Madrick explains why government intervention works. Catch-up growth is facilitated by active government involvement. South Africa’s experience with electricity crisis and government activism discussed here.

Growth in developing countries after the economic crisis and the prospect for outward-oriented growth strategy discussed here. The use of industrial policy after the economic crisis by governments around the world discussed here. Indeed, industrial policy is back, argues Rodrik. Robert Wade on industrial policy here. Ha-Joon Chang calls for constructive debate on industrial policy.

A discussion of export-led growth and the growing importance of South-South trade here. More on the future of export-led growth here. Stiglitz on the role of governments here and here. The NAFTA’s achievement shows that trade policy does not necessarily mean development policy.

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