Industrial Policy in Emerging Markets

The literature on industrial policy is large. There is no consensus on the necessity or the success of industrial policy. On the one side there are those who believe that government intervention is necessary for economic growth and development. On the other side there are those who consider that government intervention leads to rent-seeking activities because markets are efficient. The establishment of infant industries, knowledge spillovers and scale economies, coordination failures, informational externalities, support of exports and FDI are the main arguments for industrial policy. A general or traditional definition of industrial policy implies that every country has an industrial policy in one form or another. In the past industrial policy played an important role in the development of current advanced economies. This is true also for the recently industrialized economies. However there are failure stories as well as success ones. The counter argument for the success stories is that the market oriented policies might have produced the same results, if not better. Because no counterfactual data are available, it is not possible to reach the correct conclusions. The failures are seen as the result of governments’ mistakes in identifying the appropriate industries given the endowment structure and development level of the economy. Furthermore industrial policies in the form of import substitution, planning, and state ownership produced some success stories, however when they were not adapted to new conditions and did not undergo any progressive change they failed and led to big economic crises in some cases. The industrial policy experience of the East Asian countries are considered as successful, while the Latin American ones are full of failures. The changes that have been taking place in the global economy together with the establishment of WTO which imposed new restrictions on trade policies and subsidies led to what is called the “new” industrial policies. With the Washington Consensus some economies seemed to abandon industrial policies for a period, however gradually they started to return to some form of industrial policy. The new industrial policies focus more on horizontal policies; and they do not carry much ideological content as the traditional ones. In this study the evaluation of industrial policies are done in two stages. For the first stage Brazil, China, Egypt, India, Iran, South Korea, Turkey, and Vietnam are selected. These are some of the countries where industrial policies were implemented at some periods and/or are being implemented. The first stage evaluations are based on the trend analysis of economic indicators such as GDP growth, human development index, economic structural transformation (shares of major sectors in total value added and total employment), economic complexity index, labor productivity, competitiveness index, share of exports of goods and services in GDP, and globalization index. The results suggest that South Korea and China have more successfully utilized industrial policies to achieve these goals of economic growth and structural transformation than the other countries in the sample. For the second stage of evaluation three countries are selected: South Korea as one of the leading example of employment of industrial policies; Brazil as the representative of Latin American economies; and Vietnam as a latecomer to the scene. These economies are analyzed in more detail. The indicators mentioned in the preceding paragraph are evaluated for each period of distinct industrial policy implementations. Thus, it would be possible to see if there is a correlation between the policies and indicators. The determination of these periods is based on the relevant literature. Furthermore, these periods are determined empirically using least squares with breaks. For some indicators and periods a correspondence between the industrial policy and performance are empirically valid. The same is true for the literature based and empirically determined periods, that is, the empirical results support the literature-based determination of periods. The disadvantage of this method is that it may miss the performance which was a result of policies in an earlier period. During the 1960-1973 period, priorities were exports and key sectors were labor-intensive manufacturers in South Korea. On the other hand, main instruments were import tariff protection, export subsidies, tariff-refunds, and subsidized credit and export targeting. The priorities during the 1973-1980, were heavy and chemical industries, with priority sectors steel, petrochemicals, nonferrous metals, shipbuilding, electronics and machinery and priority firms selected large enterprises. In addition to main instruments used during the earlier period, of policy loans to fund priority sectors and firms, and tax credits as investment incentives were also used as main policy instruments. During the 1980-1990 period priorities moved to high technology exports sectors, and small and medium enterprises. Main instruments used during this period were import liberalization, incentives for research and development, direct lending, and removal of restrictions on foreign investment. From 1990, priorities were private sector-led development, competitiveness in international arena. Main instruments were supporting research and development, open capital account, and financial sector reforms. These four periods are used in this study. Brazil roughly represents the Latin American example of industrial policies. During 1950-1980 Brazil experienced high growth rates, increase in productivity and developed a strong manufacturing base. However, it was not possible to continue with those policies which was instrumental in obtaining those developments. The abandonment of industrial policies provided stability and increased Brazil’s integration to the world economy. On the other hand, the manufacturing base got smaller and productivity increases were negligible. During the recent decades various governments introduced industrial policy measures. However, it is early to see the results of these policies. The case of Brazil also shows that macroeconomic policies, institution building, transparency, good governance constitute the background of industrial policies. If this background is not available then industrial policies may fail. Forty-five years ago, Vietnam was a war-torn, centrally planned and predominantly rural country. Its export earnings could barely finance a third of its imports. For the following ten years, its economy muddled through with a heavy dependence on external aid from the former Soviet Union. In 1986, the Communist Party Congress adopted Doi Moi (Economic Renewal), a transition reform program while reiterating the Marxist-Leninist principles of the state. The principal elements of the program were: rural reform and return to private farming, price liberalization, fiscal and monetary reforms, openness to FDI and regulatory relaxation. The collapse of the former Soviet Union in 1989 halted the external assistance leading to a slowdown in growth. The economy recovered thanks to growth in agriculture and starting flow of external finance from western sources. Low wages and openness helped inflows of FDI to prime the manufacturing sector. Since then, Vietnam’s industrial policies have been broad and comprehensive in design, covering not just manufacturing but a broad range of sectors from agriculture to infrastructure and financial services. Vietnam’s route to become an export oriented industrial economy was quick and effective. Essentially, Vietnam mounted itself on global supply chains taking advantage of its low wages and geographical proximity. Attempts to replicate the Vietnamese version of the Korean chaebols, however, failed when the bureaucrat-run large state enterprises could not compete even with heavy protection. Vietnam’s growth rate averaged 6.5 percent a year between 2000 and 2019 while exports of goods and services grew on average by 16 percent a year in current USD terms during the same period. The share of exports which accounted for 54 percent of GDP in 2000, went up to 106 percent of GDP. The share of high technology exports in manufacturing went up from 8 percent in 2008 to over 40 percent in 2018 and the share of ICT goods exports from 5 percent over a third of the total, respectively. Industrial policy was not only confined to manufacturing. Vietnam managed to become a major producer and exporter of coffee and a net exporter of rice. This impressive record, however, came at a price. The financial system has been stressed because credit demands of large SOEs which has crowded out the private sector, in particular, new entrants. Sustainability of the financial system which needs to provide a level field for private sector, including foreign firms and SOEs, will be critical for the continued growth of the economy. While low wages were an important factor in attracting FDI initially, the education and training system fell short of providing the skills demand, hence resulting in a pressure on wages. There are also serious concerns about increasing corruption with the rapid transition the economy is undergoing. The findings suggest that industrial policies in general are successful in promoting growth and structural transformation. The economic development of South Korea is a good example of well-designed and well-implemented industrial policies. On the other hand, the cases of Brazil and Vietnam show that the policies were instrumental in the establishment of an industrial base and integration with the global economy. However, the government, bureaucracy and entrepreneurs were not able to adapt to the changing conditions, and industrial policies lost their effectiveness. Usually, this situation leads to economic downturn and corruption. Brazil and Vietnam lived through these periods.