Date: 11/01/2023

Relevance: GS-3: Effects of liberalization on the economy, changes in industrial policy and their effects on industrial growth.

Key Phrases: Industrial Policy, Advanced Economies, Performance, Comparative Advantage, Exports, Entrepreneurs, Discovery, Development, Services Led Growth, Manufacturing.

Context:

• Industrial Policy has been instrumental in the development of now-advanced economies and outcomes of using Industrial Policy tools have ranged from moderate success (Mexico, Brazil, Malaysia and Thailand) to superlative economic performance (Japan, South Korea and Taiwan).

Utility of Industrial Policy:

• Utility of Industrial Policy has been in question by arguing that:-
  • The government and bureaucrats running Industrial Policy cannot pick winning industries and firms better than free markets.
  • As it not only fails but also leads to misallocation of public resources to industrialists (often monopolists) in the form of freebies.
• The basic problem with this argument is that the objective of a successful Industrial Policy is not to pick but to make winners.
• A good policy does not seek to replace the ‘invisible hand’ of markets, but to introduce the guiding hand of the state in places where the former has failed. It seeks to address market failure.
• The objective of Industrial Policy is to pool information, share risk and coordinate actions between the state and private entrepreneurs to meet development goals

Letting Markets Decide Export Winners:

• The argument made in favour of letting markets decide export ‘winners’ through the principle of comparative advantage is flawed because it assumes that entrepreneurs are perfectly informed of all opportunities, which is not always true.
• Under this assumption, barring unplanned discovery, like India’s discovery of labour arbitrage in IT-enabled services, a country will forever be stuck and will be waiting for a comparative-advantage sector to emerge.
• The objective of true Industrial Policy is to fix this information failure and expand the sphere of an economy’s relative advantages.

What does Research say?

• Research has shown that the principle of natural comparative advantage driving exports exists only in the imagination of free-trade fundamentalists.
• Imbs and Wacziarg (‘Stages of Diversification’) show that as a country becomes richer, its sectoral concentration of production and employment falls.
• Klinger and Lederman (‘Discovery and Development’) show that new export products increase as countries become richer. This serves as evidence against comparative advantage.
• The key to success for rich countries has been their ability to expand into newer export areas instead of focusing on areas of comparative advantage.
• This argument is against the strategy that India should focus on “services led growth” rather than manufacturing.
• A valuable lesson for India is that the ability to expand into new export areas is what differentiates moderate success from overwhelming victory.

Comparison with the Successful:

• Latin American countries like Chile, Brazil and Mexico have largely focused their Industrial Policy on areas of some comparative advantage (agriculture, pisciculture and natural resources).
  • As a result, they have grown and have successes like Embraer (aircraft manufacturing), but have remained stagnant from a productivity viewpoint for many years.
• This is in contrast with countries like Malaysia and Thailand which have leapfrogged to middle income status but remain stuck there, unable to attain a trajectory that would help them match advanced countries.
  • They focused on areas beyond their comparative advantage and have seen productivity growth and improved export sophistication but still lag the Gang of Four (Japan, South Korea, Taiwan and Singapore).

Lesson for India:

• Japan, South Korea, Taiwan and Singapore have become advanced countries within two generations because not only did their Industrial Policy focus on areas of comparative advantage, but, importantly, they focused on new technology and harnessed innovation to dominate export markets.
  • Japan focused on becoming a major exporter of automobiles and ships with its own technology in the 1950s, when its per capita gross domestic product (GDP) was only 19% of the US.
  • South Korea entered heavy industries and chemicals in the 1960s with a per capita GDP of 6% of America’s; in 1972, it created the world’s largest shipyard. In 1983, with a per capita GDP of only 14% of the US, South Korea entered chip manufacturing.

Conclusion:

• Government has taken positive steps towards a coherent Industrial Policy. Its recent effort began with production-linked incentives (PLIs) for industries where India has some comparative advantage, and has graduated to mild support for an expansion of India’s comparative advantage (semiconductor subsidies).
• What we need for our exports to flourish, however, is an Industrial policy that not only builds on our comparative advantage and expands it, but also takes moonshots at technology (like green hydrogen) that we can own and export.

Source: Live Mint

Mains Question:

Q. A good Industrial policy is that which not only builds on comparative advantage and expands it, but also takes moonshots at technology it can own and export. Discuss in the context of Industrial policy of India. (150 words).