In 1961, India’s income per person was $86, South Korea’s was $94 and China’s was $76. India was right in the middle of a very poor pack of countries. India’s income per person today is around $2300, China’s is around $12,500 and Korea’s is around $35,000.
Rajan, Raghuram; Lamba, Rohit. Breaking the Mould: Reimagining India’s Economic Future (p. 47). Penguin Random House India Private Limited. Kindle Edition.
Pictures are worth a thousand words, no?
And as I always say whenever this chart comes up in a class I’m teaching, I don’t think it is possible to look at this chart and not ask “Saala, what did they do that we didn’t?”. And because I like to play around with words, I say that some of the students might also wish to ask what we did that they didn’t.
So what did they do?
They enacted “government policies directed at affecting the economic structure of the economy”, in the words of Joseph E. Stiglitz and Justin Lin Yifu. Or if you prefer shorter, simpler phrases, they had better industrial policy.
So what are these government policies directed at affecting the economic structure of the economy? Why are they needed, what effects do they have, who came up with them, and is there anything special about industrial policy as regards India? Let’s deal with each of these questions in turn, one at a time:
What is industrial policy?
Rapid sustained economic development, Rodrik and Stiglitz tell us, requires an explicit strategy.
And almost always since we came up with the idea of rapid (it’s not always been sustainable in more than one sense of the term, alas, about which more later) economic development, the strategy has always had one goal: how can we industrialize better?
Why industrialize at all is a fair question to ask, of course. And the answer is that it is painfully clear to us that you cannot hope to be a developed nation without industrializing first. This becomes clear by doing lots and lots of complicated econometric studies, or by looking at a chart with a lovely title.
It’s a chart called What The Fuck Happened in 1750? And the answer is industrialization. Industrialization happened, starting 1750. Or there and thereabouts, at any rate:
And so what we would like to do is make sure that as many countries industrialize as quickly as possible, so that the citizens of all countries can live a longer, healthier and more productive life. Or that’s the plan hope, at any rate.
So what is industrial policy? It is a policy aimed at industrializing a country as quickly as possible. And if you go and take a look at the India, China and South Korea chart again, you can now look at it as three separate industrial policy experiments. One of them clearly worked when it was implemented, one figured it out a little while later, while the third is beginning to hit its straps only now.
So did these three countries differ in terms of their industrial policy, or did they have the same type of industrial policy, but different qualities of implementation?
Think diets, if that helps. If three of your friends are comparing their weight loss, were they on different diets, and therefore lost weight at different rates? Or was it the same diet, with some of your friends being better at sticking to it? And in the case of the the countries, it turns out they were implementing wildly different types of industrial policy.
Which begs the question: how many types of industrial policy are there anyway?
Types of Industrial Policy
Dani Rodrik and Mariana Mazzucato present a framework for evaluating the different types of industrial policies in their paper, Industrial Policy with Conditionalities: A Taxonomy and Sample Cases. On pp 8 and pp9 of their paper, they present a simple framework, based on which I have created that picture you see above.
Industrial policy depends, they say, on the answer to these four questions:
- What type of firm behavior are you targeting through your industrial policy?
- Do you hope to ensure equitable access to the products and services that will result from your industrial policy?
- Or do you hope to direct firms’ activities towards socially desirable goals?
- Or do you hope to get the successful firms to share their returns with you, the government (via royalties, perhaps, although other options are also available)
- Or do you plan to require that profits be mandatorily reinvested into productive activities?
- How do you plan to work out the conditionalities associated with the program? Are they up for negotiation, or are they cast in stone?
- Is the upside from the program split? Is the downside split? (When I say split, I mean between the firm in question and the government).
- Finally, what about measurement criteria?
Using this framework, Rodrik and Mazzucato say, you can figure out the type of industrial policy at play.
Here’s how their framework can be applied to the case study of the now famous Oxford/AstraZeneca vaccine program, for example:
So all right, there’s industrial policy, which is about industrialization, and South Korea seems to have done a better job of it than China and India (so far), and that’s because they used a type of industrial policy that worked better. Speaking of types, there’s lots of different types possible. But it still begs the question: what was South Korea’s industrial policy, exactly?
South Korea’s Industrial Policy
Understanding South Korea’s industrial policy requires a book length treatment, and there are more than a few that have tried to tackle the subject. As you might imagine, it is difficult to compress all of that material into a single blog post. But here’s what can be said:
- South Korea’s industrial policy was inspired in part by the Meiji Reformation in Japan
- The Meiji Reformation was in part based on the historical school of economics from Germany.
- This historical school took part of its inspiration from… and this might surprise you a bit… Alexander Hamilton(!)
- In particular, you might want to focus on a specific report:
One that has become especially well known was the ‘Report on the Subject of Manufactures’ submitted to Congress in 1791. In the report, he stressed that the United States needed to develop its manufacturing sector in order to grow its economy, bolster its military, secure its sovereignty, increase productivity, and absorb labour. He also stressed that industrialization was necessary to avoid being disadvantaged in trade with European nations, especially Great Britain, the industrial superpower at the time. The way to do this, according to Hamilton, was for the United States to protect and nurture its manufacturing sector through active use of industrial and trade policy. More specifically, industrialization was to be achieved by strategically applying tariffs and import bans on imported manufactured goods.
Hauge, Jostein. The Future of the Factory: How Megatrends are Changing Industrialization (p. 35). OUP Oxford. Kindle Edition.
And so the outline of South Korea’s industrial policy was to protect and nurture its manufacturing sector. Here are two questions worth asking:
- Protect it from whom?
- Nurture it for what purpose?
It is the answers to these questions that helps us understand where India and South Korea differ in terms of their industrial policy from the second half of the twentieth century.
The Carrot and The Stick
Both South Korea and India, you see, were clear about the answer to the first question. Both of their domestic industries needed to be protected from foreign competition.
But their answer to the second question could not have been more different. South Korea said that the protection and the nurturing was necessary so that South Korean firms could one day become world-beaters.
India, on the hand, ended up protecting its domestic manufacturers in perpetuity. Or least until 1991, at any rate.
We have names for both policies (of course we do). The South Korean policy was about export promotion – protect domestic firms until they learn to play with the big boys on their own turf. The Indian policy was about import substitution – if you’ve ever seen a mollycoddled spoilt Indian kid, that was India’s domestic firms until 1991. (As always, it’s a more complicated story than that, but hey, this post is long enough already. Some other day, maybe, we’ll dive deeper into this)
In other words the South Koreans got their incentives right – they held out the carrot, but didn’t hesitate to wield the stick when necessary. The carrot was pretty much whatever it was that the South Korean firms asked for – cheap labor, state supported finance, guaranteed power, great roads, you name it.
But Rodrik and Mazzucato’s framework comes into play here, because access (pillar 1) was given to export oriented firms, based on strict and non-negotiable conditionalities (pillar 2), with explicit and clear measurement standards (pillar 4):
The capacity to export told politicians in Japan, South Korea and Taiwan what worked and what didn’t and they responded accordingly. Since exports have to pass through customs, they were relatively easy to check up on. In Japan, the amount of depreciation firms were allowed to charge to their accounts – effectively, a tax break – was determined by their exports. In Korea, firms had to report export performance to the government on a monthly basis, and the numbers determined their access to bank credit. In Taiwan, everything from cash subsidies to preferential exchange rates was used to encourage exporters.
Studwell, Joe. How Asia Works: Success and Failure In the World’s Most Dynamic Region (pp. 76-77). Grove Atlantic. Kindle Edition.
And if the measurement in pillar 4 didn’t come up to the expected level, pillar 3 kicked nito play, and how:
North-east Asian politicians then improved their industrial policy returns through a second intervention – culling those firms which did not measure up. This might have meant a forced merger with a more successful firm, the withdrawal of capital by a state-directed financial system, withholding – or threatening to withhold – production licences, or even the ultimate capitalist sanction, bankruptcy. Since the 1970s, there has been much talk about state industrial policy in western countries being an attempt to ‘pick winners’ among firms, something that most people would agree is extremely difficult. But this term does not describe what happened in successful developing states in east Asia. In Japan, Korea, Taiwan and China, the state did not so much pick winners as weed out losers.
Studwell, Joe. How Asia Works: Success and Failure In the World’s Most Dynamic Region (p. 77). Grove Atlantic. Kindle Edition.
India? We have the Industrial Disputes Act, which makes it difficult for us to shut down loss making firms, let alone those firms that are not exporting.
The protection to labour in larger firms is extremely high in India and translates into excessively high effective labour costs. As an example, Chapter V.B of the Industrial Disputes Act of 1947 makes it nearly impossible for manufacturing firms with 100 or more employees to lay off workers under any circumstances. Such high protection makes large firms in labour-intensive sectors, in which labour accounts for 80 per cent or more of the costs, uncompetitive in the world markets. Small firms, on the other hand, are unable to export in large volumes.
Panagariya, Arvind; Bhagwati, Jagdish. India’s Tryst With Destiny . HarperCollins Publishers India. Kindle Edition.
So we’ve learnt:
1. What Industrial Policy is…
2. What types of industrial policy there are…
3. What South Korea’s Industrial Policy looked like back in the day…
4. The importance of negative incentives in designing effective industrial policy (and that India sucked at getting the negative incentives right)
OK, cool. So CTRL-C and CTRL-V the South Korean awesome sauce idea into India and we’re sorted. Right?
Right?
To be continued tomorrow!
EconForEverybody 
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