TRADE AND DEVELOPMENT REPORT, 2006 - UNCTAD

1 UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENTGENEVATRADE AND DEVELOPMENTREPORT, 2006 UNITED NATIONSNew York and Geneva, 2006 Chapter VNATIONAL POLICIES IN SUPPORTOF PRODUCTIVE DYNAMISMUNCTAD/TDR/ 2006 National Policies in Support of Productive Dynamism149 The widening gap in relative income levelsbetween rich and poor countries has been a majortrend in the world economy over the past 250 one estimate, the difference in per capita in-come between the richest and the poorest countryin the world was about 5:1 before the IndustrialRevolution; today this difference has increased to400:1 (Landes, 1998). While the exactitude of thesenumbers is debatable, there can be little doubt thatthe world economy has been on a long-term pathof substantial and growing divergence in relativeproductivity levels and living standards, both be-tween developed and developing countries andamong developing countries slow per capita income growth in de-veloping countries has left millions of people inpoverty.

2 Nevertheless, recently the growth per-formance of many developing countries has im-proved, especially since the beginning of the currentcommodity price boom in 2002. Rapid growth ina few highly populated developing countries, es-pecially China and India, has helped lift a sub-stantial number of people out of poverty, in thesecountries themselves as well as in other develop-ing countries that have benefited from spilloversof fast growth in Asia. But improved growth per-formance in the developing world will need to bemore broad-based and sustained over a long pe-riod of time if there is to be more substantial progresstowards achieving the Millennium DevelopmentGoals (MDGs) and eradicating the long-term trend towards diver-gence in relative productivity and per capita incomelevels, a number of initially backward countrieshave succeeded, at different times, in catching upto the productivity and income levels prevailingin the frontier countries.

3 It is well known that thecurrent global technology leader the UnitedStates was itself once on a catch-up path withrespect to the then economically and technologi-cally leading country, the United Kingdom. Aus-tralia, Canada, New Zealand, some Latin Americanand many Western European and Scandinaviancountries began catching up about 50 years priorto the First World War. Japan is a prominent ex-ample of catch-up during the decades before andafter the Second World War, as are the East Asiannewly industrializing economies (NIEs) since the1960s (TDR 1997, Part Two, chap. II), and Chinaand India more recently (TDR 2005). Fast growthChapter VNATIONAL POLICIES IN SUPPORTOF PRODUCTIVE DYNAMISMA. IntroductionTrade and DEVELOPMENT report , 2006150in these Asian developing countries, particularlyin China, has even succeeded in pulling alongsome of the lagging economies in Latin Americaand this diversity in the pattern ofdevelopment and determining what governmentpolicy can do to help achieve economic catch-upis among the oldest and most controversial issuesin economics.

4 There is no clear-cut policy pre-scription for success, but investment, technologyadoption and structural change have traditionallybeen considered among the main critical factorsfor sustained economic catch-up. Giving supportto earlier findings (Levine and Renelt, 1992), re-cent empirical analyses underline the importanceof investment in physical capital as a very strong-ly robust growth determinant (Sala-i-Martin, Dop-pelhofer and Miller, 2004; Tsangarides, 2005). Butfor sustainability of economic growth, it is im-portant that output expansionbe based not merely on capi-tal accumulation, but also ona continuous rise in labour pro-ductivity and the maintenanceof productive dynamism overtime, as is obtained throughthe acquisition of technologi-cal mastery over a broad rangeof activities, especially inmanufacturing. The develop-ment of a strong manufacturing sector has been atthe core of all successful catch-up experiencesover the past 250 years, which suggests thatachieving a lasting productivity-based increase inmanufacturing is indispensable for a sustained risein income levels and, ultimately, the eradicationof strategies have varied widelyacross developing countries over the past 50 during the 1960s and 1970s, much ofLatin America, Africa and parts of South Asiaemployed import-substituting industrializationstrategies oriented towards the domestic marketand based on a plethora of protective measuresand other government interventions.

5 Many ofthese countries subsequently abandoned thosestrategies for a variety of reasons, including theirfailure to promote DEVELOPMENT and because ofthe policy conditionality of multilateral lendinginstitutions. Consequently, they began to viewunfettered market forces and deep integration intothe world economy as the most promising meansto economic DEVELOPMENT during the 1980s and1990s. There is some dispute as to the merits of theimport-substituting industrialization strategy as aparadigm (Bruton, 1998), while the outcome ofthe liberalization strategy is generally judged dis-appointing (TDR 2003; World Bank, 2005). In anycase, the annual rate of real economic growth av-eraged about per cent in Africa and LatinAmerica during the 1980s and 1990s, which isonly about half that of these countries growth per-formance during the 1960s and contrast, the East Asian NIEs recordedan average annual rate of real economic growthof almost 9 per cent during the 1960s and 1970sand more than 7 per cent during the 1980s and1990s.

6 Their successful economic catch-up andindustrialization, in particular until the mid-1990s,have been associated with out-ward-oriented industrializationstrategies and strategic integra-tion into the world TRADE and industrialpolicies2 played a key role inthe pace and direction of struc-tural change and economicgrowth particularly in the Re-public of Korea and TaiwanProvince of China (TDR 1996).Similarly, the recent star performers among de-veloping countries in terms of economic growth,particularly China, India and Viet Nam, have notfollowed orthodox policy prescriptions of relyingon unfettered market forces, broad-based liberali-zation and deep integration into the world that economic policies relying on un-fettered market forces have failed to deliver theexpected DEVELOPMENT results over the past twodecades, many developing countries that hadclosely followed the prescriptions of the Wash-ington Consensus have begun to reconsider theuse of proactive TRADE and industrial policies intheir DEVELOPMENT strategies.

7 Arguing that it isfair to say that nobody really believes in the Wash-ington Consensus anymore (Rodrik, 2006 : 2)appears to be an exaggeration. Nonetheless, thereasoning put forward by Rodrik (2004), alongwith the establishment of a task force on Indus-trial Policies and DEVELOPMENT within the Initia-Exclusive concentration onallocative efficiency impliesthat too little attention ispaid to stimulating thedynamic forces of Policies in Support of Productive Dynamism151tive for Policy Dialogue directed by Nobel laure-ate Joseph Stiglitz at Columbia University, andthe publication of a recent study by the WorldBank (2005: xiii) whose central message .. isthat there is no unique universal set of rules ..[and that we] need to get awayfrom formulae and the searchfor elusive best practices ,have given new vigour to theindustrial policy spite of the revitaliza-tion of the debate, much con-troversy remains in develop-ment policy discourse concern-ing the rationale for proactivetrade and industrial policies andthe feasibility for developing-country governments to adopt them.

8 Some havequestioned the efficacy of such policies, tendingto associate them with failed inward-looking,import-substituting strategies, a comprehensiverange of open-ended interventions and a strongbias towards protectionism (Krueger, 1990). Oth-ers have argued that sectoral policies conferredonly modest benefits in the economic catch-up ex-periences in East Asia after the Second World Warand that, due to the associated high risk of pro-tracted rent-seeking and other potentially adverseeffects, developing countries should be excep-tionally cautious before embarking on such poli-cies (Pack, 2000: 64). By contrast, most of therecent DEVELOPMENT literature argues that indus-trial policies were indeed an important supportivefactor for East Asia s economic catch-up. For ex-ample, according to the WorldBank (2005: 83) the role ofactivist industrial policies isstill controversial but is likelyto have been important. The rationale for proactivetrade and industrial policies hasbeen questioned also becauseof their possible adverse ef-fects on efficient resource al-location (Bora, Lloyd and Pangestu, 2000; Packand Saggi, 2006 ).

9 But a major theme in historicalanalyses of economic catch-up in mature and lateindustrializers (Amsden, 2001; Chang, 2002;Rodrik, 2006 ) is that exclusive concentration onallocative efficiency implies that too little atten-tion is paid to stimulating the dynamic forces ofmarkets that underlie structural change and eco-nomic growth. As widely argued in the recent lit-erature (Aky z, 2005; Chang, 2005; Gomory andBaumol, 2000; Hausmann and Rodrik, 2003;Rodrik, 2004; Singh, 2005;Stiglitz, 2005; World Bank,2005), industrialization andeconomic catch-up are notgenerally the result of a natu-ral process simply based onan efficient allocation of re-sources. As recently stated byRodrik ( 2006 : 5), market orgovernment failures that affectaccumulation or productivitychanges are much more costly,and hence are more deservingof policy attention, than distortions that simplyaffect static resource allocation. A recent studyby the World Bank (2005: 10) also argues that growth entails more than the efficient use of re-sources.

10 This is particularly true for developingcountries where economic growth entails dynamicchanges in the structure and technology-contentof this perspective, successful industriali-zation and economic catch-up need to be inter-preted as a process of cumulative causation. Sup-portive national economic policies advocated bythis interpretation focus on strengthening the dy-namic forces of markets related to informationexternalities in the context of innovative invest-ment, coordination externalities associated withcomplementarities in invest-ment, production and consump-tion, and dynamic economiesof scale resulting from cumu-lative production integration into theworld economy helps to maxi-mize the benefits of these ex-ternalities at the level of thenational economy. But all ofthese externalities are inti-mately linked to departures from the competitiveequilibrium ideal of conventional economictheory; if unsupported by proactive national eco-nomic policies, such externalities cause a subop-timal provision in the volume and industry com-position of believe that the newinternational trading rulesreduce the degree offreedom available todeveloping countrypolicymakers.