3a. Industrialization and industrial policy

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Overview

Rationales for industrializationSEA industrialization patternsIndustrial promotion policies, esp. tariffsEffects of a tariff on industry growth, welfare and

distribution

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Motives for industrializationModernization, technology transferDiversification

Less reliance on season/climateLess price risk – manufacturing prices are stableLess dependence on foreign sources

(Belief in) increasing returns in some industries - lower unit costs permit more output using same resources.

Marshallian interfirm/interindustry externalities (shared infrastructure, agglomeration externalities)

Overall aim: capture 'long-run comparative advantage' as an industrial economy.

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Why so much variation in industriztn and employment rates and patterns among apparently similar economies?

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GDP Share 1990 Output per worker 1990

Country Agric Ind. Serv. Agric Ind. Serv.

Indonesia 22 40 38 0.4 2.9 1.2

Philippines 22 35 43 0.5 2.3 1.1

Thailand 12 39 48 0.2 2.8 2.2

Source: World Development Report, various years. Y/L in $’000

Industrial promotion strategiesWhy? Promote industrial growth, get growth

dividendHow? Mainly, but not exclusively, trade policiesEconomics of protectionism

Tariffs are most popular, if not best, way to protect favored industries. Easier to monitor trade flows at the port Raise revenue for G. Easy to levy (many losers, but per capita losses are

small) Some of the biggest losers may be foreigners anyway.

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A tariff boosts production by raising domestic price from p* to p*(1+t)-- Diverts demand from imports to domestic products (a)-- Reduces total demand (consumers must pay more)-- Raises gov’t revenue (c)-- Causes deadweight losses through misallocation (b + d)

0 Q1 Q2 Q3 Q4

p*(1+t)

p*

S

D

a b c d

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• Supply of forex comes from exports; demand is to cover imports• Tariff on imports reduces the demand for forex

-- Floating exchange rate: tariff causes ER appreciation• Lerner symmetry: a tariff discourages both imports and exports

D = import bill

D'

S = export earnings

For. exchange

Exch. rate(Rp/$)

E0

E1

F1 F0

Philippine protectionism and development In SE Asia, the Philippines had highest and most persistent

tariffsHigh rates of nominal protection on imports produced

negative effective protection for traditional exports (agriculture)

Effective protective rates by import category:

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Import category

1960 1970

Consumer items

Nonessential 349 354

Semiessential 149 57

Essential -15 5

Producer items

Nonessential 173 203

Semiessential 52 14

Essential 50 19

Trad’l exports -27 -33• What effect would these have had on incentives to produce and invest?

Static gains and losses from protectionProtected industries grow, at expense of

foreigners, consumers and other industriesGov’t revenue will probably be higher due to

tariffsInward orientation: domestic markets for all

goods become relatively importantIndustry structure: protection tends to create

monopolies“rent-seeking society”

• Distortions to investment and FDI incentives

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Dynamics: growth implications of protection

Does inward orientation have long-run effects on growth?

Answer depends on how protection is usedDo infant industries really do grow up?Do the costs of protection inhibit/enhance growth

in other sectors?Protection and growth in the long run

Incentives & opportunities for rent-seeking (infant industries fail to grow)

Investment follows rents rather than seeking efficient opportunities …

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The Bhagwati effect in Thailand

Bhagwati hypothesis: rent-seeking FDI creates fewer productivity gains than efficiency-seeking FDIHigh tariffs and monopoly power attract rent-seeking FDIProtected industries are more capital-intensive than average,

so there’s a ‘technology gap’ as wellGrowth dividends from this FDI are small – or even negative

Kohpaiboon (World Dev 2006) finds this for Thailand:At the mean rate of industry protection, labor productivity is

lower by 0.15% for every 1% higher foreign ownership shareImplication: protection “damages” the growth effect of FDIAny comparisons with Vietnam?

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Protection and income distribution (1)

Supply side (factor markets) What are the characteristics of industries most likely

to be awarded protection?Which industries display least comp. adv?

What are the likely factor market effects of expansion in these industries (& contraction/slower growth in others)? Factors used intensively in expanding industries enjoy

price rises (demand for their services has risen)Factors used intensively in contracting sectors lose

In SE Asia, which factors are likely to gain most from industry promotion? Lose most?

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Demand side (product markets)Consumers of goods produced in protected industries lose

thru higher prices. Industries using inputs produced by protected sectors lose. Consumers of goods whose prices are indirectly affected

(N goods) lose. Protection and non-traded goods: if T and N goods are

substitutes, raising some T prices will increase N demand and price

Combined distributional outcomesLosers from protection are owners of factors not

intensively used in protected industries, and/or consumers of protected goods and/or non-traded goods.

Winners and losers from protection

Given the chance, which groups would vote for industry protection, and which against? Why? (at least 3 reasons…individual interest and national interest)Manufacturing sector capitalistsFarmers in export crop sectors (coffee, coconut, tropical

fruit)Skilled workers/middle classUnskilled workers 16

Industrialization and protection: summary

Development benefits of industry growth are clearBut ISI in SE Asia was not the most efficient path to

industrializationUncompetitive industries rely on (small) domestic marketProtected industries are capital-intensive, their growth

does not generate many jobsSpillover costs to other industries, including exportersProtected industries attract ‘bad’ (rent-seeking) investmentProtection favors owners of capital against owners of labor

Any alternatives? Under what conditions might industry grow successfully without protection?

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