Industrial Policy, South Korea and Learning by Doing

Amol Agarwal points us to an excellent paper, the title of which is “The Long Term Effects of Industrial Policy“. Here is the abstract:

This paper provides causal evidence of the impact of industrial policy on firms’ long-term performance and quantifies industrial policy’s long-term welfare effects. Using a natural experiment and unique historical data during the Heavy and Chemical Industry (HCI) Drive in South Korea, we find large and persistent effects of firm-level subsidies on firm size. Subsidized firms are larger than those never subsidized even 30 years after subsidies ended. Motivated by this empirical finding, we build a quantitative heterogeneous firm model that rationalizes these persistent effects through a combination of learning-by-doing (LBD) and financial frictions that hinder firms from internalizing LBD. The model is calibrated to firm-level micro data, and its key parameters are disciplined with the econometric estimates. Counterfactual analysis implies that the industrial policy generated larger benefits than costs. If the industrial policy had not been implemented, South Korea’s welfare would have been 22-31% lower, depending on how long lived are the productivity benefits of LBD. Between one-half and two-thirds of the total welfare difference comes from the long-term effects of the policy.

https://www.nber.org/papers/w29263

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Why should you read this paper if you are a student of the Indian economy?

Because industrial policy has been, i,s and will be critical for long run growth in India, and South Korea is an excellent example of getting industrial policy “right”. The reason I put “right” in inverted quotes is because there is still debate about whether South Korea really got it right or not.

If you are interested in reading more about this, part of footnote 4 from the paper is worth reading in greater detail (And the papers that are cited there, naturally):

However, many economists have been skeptical of the effectiveness of industrial policy (e.g. Baldwin, 1969; Lederman and Maloney, 2012). Lee (1996) did not find a positive correlation between sectoral TFP growth and tariff rates in South Korea during the 1970s and interpreted the correlation as the ineffectiveness of industrial policy.

https://www.nber.org/system/files/working_papers/w29263/w29263.pdf, footnote 4, page 5

Me, I’m very Studwellian in my outlook, and am therefore a sucker for papers such as these. And even if the paper were to show that industrial policy had not worked, that in itself is also a lesson worth learning, no? But if you ask me, something worked in South Korea at that point of time, and while causality is tricky, Industrial Policy (IP) certainly seems to have been at least partially at play:

Between 1973 and 1979, the average annual real GDP growth rate of South Korea was 10.3%, and the average export growth rate was around 28%. The HCI sectors increased their share of manufacturing output from 40% to 56% and their share of total exports from 12.9% to 37%.

https://www.nber.org/system/files/working_papers/w29263/w29263.pdf pp 6

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The paper does three things, in my opinion:

1. Establishes that Industrial Policy did too have a role to play in South Korea’s development
2. That role has had effects that have persisted well beyond the years in which that specific industrial policy was “in play”
3. Makes the case for how South Korea’s welfare would have been lower had this policy not been implemented

Your mileage may vary with regards to point 3, no matter how careful the econometric modeling (and it’s pretty careful, if you ask me). But this paper is worth reading because it reinforces my opinion that industrial policy, when done well, can have meaningful impacts upon the development of a nation.

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There is a citation in this paper that is worth reading in its entirety (if you go in for that sort of thing). The citation is that of a chapter in The Handbook of Development Economics, Vol. 5. The title of the chapter is “Trade, Foreign Investment, and Industrial Policy for Developing Countries“

I really do mean the “if you go in for that sort of thing”, because this is assuredly not light reading. Why, the section titled “Concluding Comments” takes up a solid four and a half pages! But I’ll speak here about three things that I found especially relevant from that section alone. Note that this is my paraphrasing, not a direct quote.

1. The infant industry argument is, on the whole, overrated.
2. In general industrial policy that promotes more exposure to international trade is likelier to be more successful
3. The authors say that more work is urgently needed to understand, as they put it, “the human cost of adjustment to trade and FDI reforms”. Maskin and Kremer’s work is worth reading in this regard.

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Finally, “Learning By Doing“. What does it mean, exactly? The classic paper to read is by Lucas, titled “On the Mechanics of Economic Development“, and the classic-er (est?) paper is, of course, “The Economic Implications of Learning by Doing“. But simply put, it is this:

Learning-by-doing is a concept in economic theory by which productivity is achieved through practice, self-perfection and minor innovations. An example is a factory that increases output by learning how to use equipment better without adding workers or investing significant amounts of capital.

https://en.wikipedia.org/wiki/Learning-by-doing_(economics)

It remains underrated at all levels of economic organization, if you ask me.