Soft industrial policy for developing countries

Industrial policy is used to encourage exports, attract FDI, promote innovation and pick winners in selective industries with high export potentials. How can the government best intervene so industrial policy can achieve its intended goals? Harrison and Rodriguez-Clare argue that this can be done by pursuing “soft” industrial policies, “which aim to develop a process whereby government, industry, and cluster-level private organizations can collaborate on interventions that can directly increase productivity.” Here is the full paper. They have an extensive list of papers (with summaries) on industrial policy, trade and growth.

In some instances, the impact of industrial policy might take a long time to see real changes. Researchers who study the impact of industrial policy shortly after an industrial policy is implemented usually find a negative correlation between industrial policy (protection) and growth. They argue that “there are no studies that attempt to go behind correlations and show causal links.”

Research generally neglects to identify whether interventions were motivated by industrial policy reasons or rent-seeking considerations. In fact, there is no evidence to suggest that intervention for industrial policy reasons in trade even exists. Instead, existing evidence suggests that protective measures are often motivated by optimal tariff considerations, for revenue generation, or to protect special interests (see Broda et al. 2008, Gawande et al. 2005, Goldberg and Maggi 1999, and Mobarak and Purbasari 2006). Tariff protection is also frequently granted to less successful firms or declining industries that have political power (Beason and Weinstein 1996 and Lee 1996).

They argue that trade and FDI policies are most successful when they are associated with increasing exposure to trade, i.e. interventions that increase exposure to trade (such as export promotion) are likely to be more successful than other types of interventions (such as tariffs or domestic content requirements). FDI promotion policies are successful than intervention in trade because it focuses on new activities rather than on protecting (possibly unsuccessful) incumbents.

If such measures are part of a broader effort to achieve technological upgrading then they may be helpful, whereas if they are implemented in isolation they are likely to fail.

Rather than deliberately picking winners, governments could subsidize private efforts to “discover” new areas of comparative advantage (what Hausmann & Rodrik call “self-discovery”) or by working with existing industries and clusters to deal directly with coordination failures that limit their productivity and expansion.

Instead of blanket subsidies for exports and FDI, one can try to attract multinationals to produce key inputs or to bring specific knowledge needed by clusters with the ability to absorb them. As Chandra and Kolavalli (2006) have put it, “without host-country policies to develop local capabilities, MNC-led exports are likely to remain technologically stagnant, leaving developing countries unable to progress beyond the assembly of imported components” (p. 19).

“Soft” industrial policy: They propose “soft” industrial policy for developing countries. It basically seeks to directly address coordination failures that keep productivity low in existing or promising sectors rather than engage in direct interventions that might distort prices. This is like facilitating the process that already looks promising but is not realizing its full potential, rather than instituting one all anew whose success is unclear. Efforts could be of varying range such as helping particular clusters by increasing the supply of skilled workers, encouraging technology adoption, and improving regulation and infrastructure. It avoids tariff protection, export subsidies, and tax breaks for foreign corporations. They acknowledge that “hard” industrial policy might be easier to implement than “soft” industrial policy but there are high possibility of manipulation by vested interest groups in case of “hard” industrial policy.

First, soft industrial policy reduces the scope for corruption and rent seeking associated with hard industrial policy such as protection or selective production subsidies. Second, soft industrial policy is much more compatible with the multilateral and bilateral trade and investment agreements that many LDCs have implemented over the last decades.

NTIS 2010: A Strategy Without A Comparative Advantage

My latest op-ed is about the recently released Nepal Trade and Integration Strategy (NTIS) 2010. As I argue here, there is a good deal of workable ideas in the report, which identifies 19 products that have “export potentials”. Good. Nepal desperately needed a coherent analysis of the messy trade sector so that future policies are in line under one unified theme. My biggest concern with this report is that people are wrongly trying to take it as a “constitution” for exports and integration strategy.

The report does not say if the 19 products can be exported with comparative advantage. It only says that they have “export potential” based on the product’s revenue share in Nepal’s exports basket and their overall market size outside the country. For sustainability of our exports sector, we need products that are price and quality competitive. Just identifying markets and exportable goods is not the final point. Period. That being said the report is excellent. A good contribution to escorting the directionless exports sector in the right direction.

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NTIS 2010: A Strategy Without A Comparative Advantage

Recently the Ministry of Commerce and Supplies released a report, Nepal Trade Integration Strategy (NTIS) 2010, which identified products with “export potential” and market destinations for them. Six years ago a similar report – Nepal Trade and Competitiveness Study (NTCS) 2004 – was released. It did not help much in uplifting exports and diversifying export basket. The new report has reignited the hope of reviving the lost glory of Nepal’s export industry, which has nosedived since 1997.

NTIS 2010 is probably one of the most clear-cut reports so far that delves into product level analysis to identify promising exportable products and market destinations for them. But, it does not say much about the potential to export the products with comparative advantage. Just identifying markets and products does not mean much if we cannot export them with comparative advantage.

The report identifies 19 key commodities and services with ‘export potentials’ that could potentially revitalize Nepal’s export sector. The identified products are cardamom, ginger, honey, lentils, tea, noodles, and medicinal herbs/essential oils in agro-product category; handmade paper, silver jewelry, iron and steel, pashmina, and wool products in craft and industrial goods category; and tourism, labor services, IT and BPO services, health services, education, engineering, and hydro-electricity in services category. Furthermore, five more potential export products/sectors pointed out in the report are transit trade services, sugar, cement, dairy products and transformers. There are numerous recommendations for the government to fine-tune and address non tariff barriers (NTB), and to take advantage of Aid for Trade (AfT) and Trade Related Technical Assistance (TRTA) facilities offered by various international agencies.

The objective of the report sounds like an effort to seek export-led ‘inclusive’ growth strategy with the identification of key products based on Nepal’s existing production capacity. The identification is based on the change in composition of Nepal’s export basket and the growth in exports of key products between 2004 and 2008. It does not say if we can export the key products with comparative advantage. Also, there is no explanation to how the growth in exports will make development inclusive. Just promoting a few agricultural products whose production structure and capacity is not yet fully known will not lead to an inclusive trade-led growth. Nepal has to consolidate and harmonize production structure and capacity in all sectors to exploit economic of scale and to make products competitive right from factor market to product market.

If our focus is to revive the exports sector, then we should be looking for products that could be exported with comparative advantage, be it small or niche or large markets. Products with high relative comparative advantage matters more than the mere identification of exportable goods and services. The growth of revenue generated from, say, iron and steel products by 52.6 percent between 2004 and 2008 does not mean that it will continue to grow linearly in the same fashion. The export value of iron and steel products was low in 2004. During the prosperous periods before the recent economic crisis in the overseas markets, exports of this item increased sharply, leading to a high growth rate of exports revenue. It does not mean that Nepal is enjoying comparative advantage in export of this product.

A ‘product space’ analysis, which is a network of relatedness between products, is necessary to figure out what products Nepal is exporting and can export with comparative advantage. It will show how Nepal can move up the value chain, and identify potential products to successfully upgrade production facilities and technologies so that transition from the production of one comparatively advantageous good to another (“nearby” goods) is easy.

A series of product space studies show that Nepal has very few agricultural goods that could be exported with comparative advantage (see “Is Nepali export passe?” Republica, March 14, 2010). There is more proximity (connectedness) between products in the non-agricultural sector, i.e. product upgrading is easier. In fact, Nepal’s product space of 1985, 2000, and 2007 shows that the agricultural sector did not contribute new exportable product with comparative advantage both in 2000 and 2007.

The report recommends the government to pay “instant attention” to four agricultural products namely tea, lentils, cardamom and ginger. These are agro-based products, whose prices are volatile in the international market. Putting down too much emphasis on agricultural products would invite increased volatility not only in the market of specific items but the whole economy as the value added contribution of the agriculture sector is around 34 percent of GDP and it employs around 66 percent of the population. The promotion of agricultural products should be based on domestic demand, which is higher than the supply as is indicated by food deficit of 316,465 tons in 2009/10.

Less volatile are the industrial and services sectors. Nepal should lay more emphasis on these two sectors than the agricultural sector, if the main objective is to boost exports sustainably and to narrow balance of trade deficit. The agricultural products are usually of low-value added ones when compared to industrial and service sector products.

A change in export composition, based on revenue fetched by individual products, does not mean that these products have more export potential. We really don’t know if they are comparatively price and quality competitive. The change in composition of products in the export basket has not made any noticeable difference in the aggregate export revenue. The growth rate of our total exports is still declining.

That said emphasis on regional integration is commendable. India is by far the most important export destination for Nepali goods and services. Around 60 percent of total trade happens with India. Similarly, China is also an important and expanding market, which has recently offered zero-tariff facility to 4,721 exportable goods. The SAARC and MENA regions could be attractive markets apart from the US and the EU. Around 64 percent of Nepal’s total merchandise trade happens within the SAARC nations. Promoting more regional integration could help the exports sector.

NTIS 2010 is an important contribution to steer the exports sector in the right direction. However, the job is not done yet. It has just begun.

[Published in Republica, July 3, 2010, pp.6]

South-South trade good for Africa; More trading in manufactured goods needed

A new UNCTAD report (Economic Development in Africa Report 2010) backs South-South trade, especially between Africa and other fast growing developing countries, namely China, India and Brazil. For Africa to grow and integrate more with the growing economies, it has to export manufactured goods. Traditionally, it has been exporting low-valued agricultural products and raw materials.

The study warns that so far, trade and investment flows with the South are reinforcing a longstanding trend in which African countries export farm produce, minerals, ores, and crude oil, and import manufactured goods. This situation should be reversed while the South-South trend is still in its early stages. A repeat of the traditional pattern will not help African countries to reduce their traditional dependence on exports of commodities and low-value-added goods.

The scale of African and non-African developing countries trade:

• Africa’s total merchandise trade with non-African developing countries increased from US$ 34 billion in 1995 to $97 billion in 2004 and then jumped to $283 billion in 2008.
• While Africa´s total merchandise trade with China increased from $25 billion in 2004 to $93 billion in 2008, Africa´s total merchandise trade with India increased over the same period from $9 billion to $31 billion, and its trade with Brazil increased from $8 billion to $23 billion.
• The number of "greenfield" foreign direct investment (FDI) projects by investors from non-African developing countries climbed from 52 in 2004 to 184 in 2008. (A "greenfield" investment is an investment in a manufacturing, office, or other physical company-related venture where no previous facilities exist.)
• It is estimated that official aid to the region from developing countries was US$ 2.8 billion in 2006. And it has risen substantially since, as China, which is estimated to contribute over 83% of that aid, committed to double its assistance to Africa by 2009.
• Available evidence suggests that Chinese infrastructure finance commitments in sub-Saharan Africa soared from $470 million in 2001 to $4.5 billion in 2007. An estimated 54% of China’s support to Africa over the period 2002-2007 went to infrastructure and public works.

Share of Africa’s total trade accounted for by selected partners, 1980-2008

MGNREGA so far...

This post is a summary of Amita Sharma's discussion paper (Rights-based legal guarantee as development policy), April 2010. I could not find a link to the full discussion paper but here is a presentation on the same. NREGA (they renamed it to Mahatma Gandhi National Rural Employment Guarantee Act [MGNREGA] this fiscal year) is doing a phenomenal job in rural India at a cost below one percent of GDP. Specifically, the cost was around 0.6 percent of GDP last year. The total number of employment provided to households was over 45 million. Here is major highlights of NREGA. Intro here.

How the districts under different phases were selected?

Districts under phase I, II, and III were 200, 130, and 285 respectively. Mahatma Gandhi NREGA was implemented in phase I districts on February 2, 2006, phase II on April 2007, and phase III on April 1, 2008. The phase implementation was based on a criterion of backwardness, which included a mix of demographic, social and economic indices, formulated by the NPC.  This ranking was used to select 150 districts for the National Food for Work Programme (NFFWP) launched in 2004. However, the districts selected for phase I were not selected serially but to represent all states under NREGA. The districts chosen for phase I were dominantly tribal, low productivity districts, among which almost 50 percent are designated as Drought Prone Areas Programme (DPAP).

Early trends and outcomes

• Increase in employment: SRGY and NFFWP together generated 0.82 billion persondays. Mahatma Gandhi NREGA generated 2.16 billion person-days in 2008-09. Around 50 million households have got employment. Also, a large number of skilled manpower is employed as engineers, village assistants (22063), IT personnel (6056), and accountants (5000) at the block level.
• Enhancing income: Increase in minimum wages of unskilled agricultural workers. The average wage rate rose from INR 65 (US$1.4) per day to INR90 (US$2) per day from 2006 to 2010.
• Targeting: Participation of women has been above 33 percent as required. This year women participation was close to 50 percent. Women have been drawn to work due to equal wages for men and women, flexibility to drop in and out of the program, availability of work in their locality, and no work requirement except willing to do ‘unskilled manual labor.’ Incomes from NREGA have been used to support food and consumer goods needs of households and education of children. Participation of women in local meeting has been increasing. In Kerala, savings of women have increased from US$14.97 million to US$25.61 million between 2008 and 2010. Furthermore, participation of SC/ST has increased. Most of them come from the backward classes.
• Stemming migration: There is evidence of decrease in out-migration in places such as Narmada, Dang, Banaskantha, Dahod, Sabarkantha and Panch Mahals of Gujarat. A study (Will NREGA ensure security against hunger?) conducted by Paulomee Mistry and Jaswal Anshuman (2007) shows that migration from Dungarpur and Udaipur (Rajasthan), Jhabua and Dhar (Madhya Pradesh) and Nandurbar and Dhule (Maharashtra) declined from 1650 persons per year to 682 per year.
• Augmenting productivity: By focusing on natural resource regeneration, NREGA is augmenting productivity. Survey respondents agreed that NREGA had led to increased water availability and a positive impact on agriculture through improved access to irrigation. Moreover, problems of drinking water scarcity have been addressed by NREGA works to some extent. There has been an increase in areas of land used for production. There has been restoration of ecological assets.
• Expanding connectivity: Roads have connected markets, schools and health services. There has been increasing financial inclusion as workers are being paid through banks and postal offices. So far, around 88 million people have opened ban and post office accounts under NREGA. Meanwhile, ICT expansion in rural areas has increased transparency and accountability.

Role of India and the US in helping Africa achieve its development goals

Africa is second fastest growing region in the world and fared well during the global economic crisis. Its expanding middle-class population and growing business opportunities are making it a promising destination for global investment. 

Foreign investors interested in Africa are facing similar risks and opportunities to those they faced when investing in India. African countries can learn from India’s successful economic reforms in service and industrial sectors that helped it achieve an impressive growth rate for several years. Moreover, Africa can also learn from India’s success with social safety net policies such as rural employment creation programs.

At an two-session event organized by the Carnegie Endowment and the Federation of Indian Chambers of Commerce and Industry (FICCI), panelists argued that by partnering on investment and business activities, the United States and India can help Africa get the necessary resources, such as credit facilities, technology, increased capacity, and trade financing, to spur economic development.

Panel 1: Government Policies

Challenges and Opportunities

• The Challenges: African markets face significant challenges and risks related to governance, security, infrastructure, and regulation, acknowledged Rajan Bharti Mittal, president of FICCI. However, there are also tremendous opportunities for companies who can deliver low-cost, high tech products in the healthcare, education, telecommunication, manufacturing, and agriculture sectors.
• Inhibiting Foreign Investment: Africa faces a number of challenges that currently inhibit the promotion of foreign investment in the continent. These include the need to standardize tariffs, improve infrastructure development, and institute transparent business practices, said U.S. Department of Commerce’s Suresh Kumar.
• A Potential Market:  “Africa should be looked at in terms of a market for business and investment opportunities,” asserted Amina S. Ali, Ambassador of the African Union Mission to the United States. “The emerging middle class in Africa will have a huge spending power. Moreover, the large youth population could be a promising market for education, clothing, and health sectors.”

Panel 1

India and the United States

• Lessons Learned: Although India has its own economic problems, it can contribute to Africa’s development by sharing its experiences in mobilizing human capital and in social policy innovation, suggested Carnegie’s Eduardo Zepeda.  One such experience that might be valuable to African nations is the ongoing large-scale rural employment program launched in India in 2006. In fiscal year 2009/10 alone, it provided employment to 52.5 million rural households. India can help Africa produce high tech yet low cost goods that are within the purchasing power of the African people.
• Agriculture: India can help Africa tackle the issues of food deficiency and low agriculture production, stated Meera Shankar, Ambassador of India to the United States. India’s Green Revolution transformed the country from a food deficit nation into a food self-sufficient country. The introduction of high-yielding varieties of seeds, increased use of fertilizers, and improved irrigation helped to increase agricultural productivity in India, leading to self-sufficiency in food grains. It also helped India to effectively address famines.
• U.S. Engagement: Kumar explained that the U.S. government is already engaged in working with Africa in three major fronts: 
  1. trade promotion and advocacy services.
  2. credit facility and finance.
  3. access to foreign markets.
• Areas of Engagement: Ali listed a number of key areas where the United States and India should focus their economic engagement with African nations, including agriculture, food security, energy, transport, trade, governance, climate change, and infrastructure such as roads, railways, and information technology.

The Indian model

• Responding to a question about the investment model followed by India, Shankar said that India is following neither the Chinese nor the US model. “India has its own ‘India model’, which is sensitive to Africa’s development, aspirations and governance issues. India’s model is different from the Chinese model of investment because it uses local labor and resources to the extent that there is no local technical talent,” the Indian ambassador remarked.

Panel 2: Business Practices

The Private Sector

• Energy: Foreign investors have been too preoccupied with energy investment in Africa, argued Stephen Hayes, president of the Corporate Council on Africa. Investment should be increased in non-energy sectors as well.
• Public-Private Partnerships: Hayes advocated that the US government and the private sector consider public-private partnerships approach in order to reduce investment risks while making investments in Africa.
• Familiar Challenges: “Africa has the same business challenges and opportunities as India had few years ago. It is not an unfamiliar challenge for businesses already operating in India,” opined David Good of Tata Sons Ltd. He argued that there is a large growing customer base in Africa and a significant English-speaking population.
• Potential for Business: India and Africa have similar potential: both regions have a large workforce, land, and natural resources. “There are huge opportunities in the commercialization of entrepreneurship, such as micro-banking via cell phones and strengthening innovation in infrastructure,” argued Lockheed Martin’s Ray Johnson.

Panel 2

Financing

• U.S. Banks: U.S. banks are risk-averse and less willing to finance businesses in Africa, admitted Hayes. This creates a financing problem for U.S. businesses interested in doing business in Africa.
• European Banks: European banks have been more forthcoming in financing investment in Africa, said Mittal. For example, when the Indian telecom company Bharti Airtel needed to raise resources worth approximately $10 billion to acquire Zain African, it was not a significant problem.

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[This post is a summary of an event held at Carnegie Endowment. Yours truly was heavily involved in organizing the event and also wrote the summary!]

Is Depression III possible?

Krugman argues that it is possible because of policy failure to spend more when spending is inadequate, leading to large unemployment and deflation. The earlier two depressions were the Long Depression (Panic of 1873 after years of deflation and instability) and the Great Depression (financial crisis of 1929-31 after years of mass unemployment).

"We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.

And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending. 

In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy. 

I don’t think this is really about Greece, or indeed about any realistic appreciation of the tradeoffs between deficits and jobs. It is, instead, the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times. 

And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again." 

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.