A surprising World Bank recipe for industrial policy: new proposal from Justin Lin

July 2, 2010

     By Duncan Green     

Justin Lin, the World Bank’s chief economist, was in London last week and presented his new paper on ‘Growth Identification and Justin LinFacilitation’. Two years ago he came through just after being appointed, promising to bring a ‘new perspective’ to the Bank (see post here). His new paper certainly does that, as its subtitle ‘the role of the state in the dynamics of structural change’ suggests.

In the paper, Lin tries to sort out good industrial policy from bad. When does state intervention lead to structural upgrading, a la East Asia, and when does it merely generate a bunch of uncompetitive companies being kept on artificial life support by state subsidies, as sometimes happened elsewhere? His conclusion is that the state should not depart too far from a country’s comparative advantage, but consciously push it towards upgrading by imitating neighbours that are similar, but have travelled further along the upgrading path – basically the East Asian ‘flying geese’ model. Think of it as the state pulling a country along by a piece of elastic – pull too little and nothing happens, pull too hard and the elastic snaps.

Highlights: first the heresy – Lin broadly agrees with Ha-Joon Chang, Dani Rodrik and various other heterodox critics of the Washington Consensus: “The historical record indicates that in all successful economies, the state has always played an important role in facilitating structural change.”

But to avoid snapping the elastic, Lin suggests a ‘six-step process’:

“First, the government in a developing country can identify the list of tradable goods and services that have been produced for about 20 years in dynamically growing countries with similar endowment structures and a per capita income that is about 100 percent higher than their own.

Second, among the industries in that list, the government may give priority to those in which some domestic private firms have already entered spontaneously, and try to identify: (i) the obstacles that are preventing these firms from upgrading the quality of their products; or (ii), the barriers that limit entry to those industries by other private firms. This could be done through the combination of various methods such as the value-chain analysis or the Growth Diagnostic Framework suggested by Hausmann, Rodrik, and Velasco (2008). The government can then implement policy to remove those binding constraints and use randomized controlled experiments to test the effects of releasing those constraints so as to ensure the effectiveness of scaling up those policies at the national level (Duflo 2004).

Third, some of those industries in the list may be completely new to domestic firms. In such cases, the government could adopt specific measures to encourage firms in the higher-income countries identified in the first step to invest in these industries. The government may also set up incubation programs to catalyze the entry of private domestic firms into these industries.

Fourth, in addition to the industries identified on the list of potential opportunities for tradable goods and services in step 1, developing country governments should pay close attention to successful self discoveries by private enterprises and provide support to scale up those industries.

Fifth, in developing countries with poor infrastructure and an unfriendly business environment, the government can invest in industrial parks or export processing zones and make the necessary improvements to attract domestic private firms and/or foreign firms that may be willing to invest in the targeted industries. Industrial parks and export processing zones also have the benefits of encouraging industrial clustering.

Sixth, the government may also provide limited incentives to domestic pioneer firms or foreign investors that work within the list of industries identified in step 1 in order to compensate for the non-rival, public knowledge created by their investments.”

What this adds up to is a kind of low-risk industrial policy-lite, in which the state spots winners and supports them, rather than tries to create them from scratch, an incremental strategy rather than a Great Leap Forward that may well lead straight into the abyss.

All quite appealing, but I think it has two main potential weaknesses:

1. Political Economy: Justin assumes that states possess a well informed, effective bureaucracy possessing what Peter Evans called ‘embedded autonomy’ – embedded in the realities and needs of local industry, but autonomous enough to be bribed or coerced into becoming a cash cow. That may have been the case in Japan or South Korea, but where it doesn’t exist, how do you create one? Justin seems naively optimistic on this, arguing in the seminar that ‘it’s not that leaders don’t want to pursue growth and create jobs, it’s just that they don’t know how to.’

2. Climate Change: neoliberals always used to argue that globalization meant that what worked in Japan was no longer relevant to the

Washington Consensus view of Industrial Policy

Washington Consensus view of Industrial Policy

present (what Ha Joon Chang and I refer to as the ‘Sex Pistols’ argument – when the punk band’s lead singer was asked why he had just flatly contradicted an earlier statement, he replied ‘that was then; this is now’). Now climate change provides a green variant – what worked in a world oblivious to environmental limits may not apply to one where growing economies will have to move quickly to a low carbon growth model. No point in the flying geese following each other into a high emission dead end.

And how’s all this going down at the Bank? He says these ideas are not that distant from those of Joe Stiglitz, his predecessor as chief economist, but the intellectual environment that rejected them in Stiglitz’s time has changed, especially since the global financial crisis. He’s starting a whole research programme on economic policy and structural transformation (his preferred buzzword for all this – don’t call it industrial policy!)

Lin famously began his career by swimming across the Taiwan Strait to defect to China. He seems to be embarked on something equally heroic at the Bank.