10:19 AM Jun 25, 1996

TECHNOLOGY: DEVELOPMENT NEEDS SELECTIVE LIBERALIZATION

Geneva 25 Jun (Chakravarthi Raghavan) -- Developing countries should liberalize rapidly on activities at or near the international frontiers of technology to enable use of existing capabilities and acquire competitivity, but should do so more slowly on activities needing longer periods of learning or 'relearning', according to a reputed development economist and specialist in Science and Technology.

In a study published by UNCTAD's Division for Science and Technology, Oxford academic Sanjay Lall says that from the viewpoint of technological development, the "ideal" form of liberalization based on simple theoretical concepts is not the most desirable policy reform on trade and some tools of selective promotion are an essential part of policies needed for deepening and diversifying technological learning process in the developing countries.

In the study, "Science and Technology in the New Global Environment: Implications for Developing Countries", Lall argues that the existence of market failures, both in input and output markets, makes a case for government intervention in a country to bring about technological development, provided the government could achieve a better outcome than markets.

In simplified text-book economic models, Lall notes, all markets are taken to function perfectly and there is no need for government intervention.

But the requirements for markets to be perfect are extremely rigorous. They call for perfect competition in a static setting which is impossible to achieve in any real market. Also, they call for perfect information and foresight, no economies of scale, no externalities, no risk or uncertainty, no product differentiation, no learning costs,, no different in availability of skills and technologies between firms and countries, and no failures on supply of factors like finance or technical information.

While the fact of imperfect markets per se does not provide a valid case for government intervention, there are certain market failures that retard technological development and which can only be overcome by governments. These market failures, ignored by neo-classical economists, arise from existence of learning costs and risks which are among important sources of under-investment in some activities. In the presence of variable and unpredictable learning processes, a latecomer to industry necessarily faces greater costs than those who have undergone the process.

And a failure to support firms in overcoming the cost handicap of learning more complex technologies can hold back the realization and development of competitiveness in new technologies and can keep a country's enterprises from climbing the technological ladder to higher value-added activities, Lall says.

The case for supporting developing country enterprises in more complex technologies, Lall notes, is not the same as that for industrial policy in the developed countries where such policy is used to sponsor new technologies. The market failures in developed countries are not based on learning costs relative to competitors and the element of risk involved in industrial policy in these countries is hence likely to be much higher than in developing nations.

In developing nations, information and experience on the technological skill and market parameters involved already exists and carefully designed interventions are hence more likely to succeed.

The new global economic environment facing developing countries is made up of technological changes, national policy reforms and changes in the international "rules of the game".

Transnational Corporations, he notes, are spearheading the process of international integration and these changes are being facilitated, even driven, by important shifts in national and international policies.

In general, developing countries have liberalized trade and investment flows -- with Latin America leading, Asia at a more controlled pace, and Africa generally lagging.

While the outward-looking strategies of by the NIEs of East Asia have proved far more effective in stimulating technological competence, outward orientation alone does not provide the complete answer to how the firms of some of these countries developed the capabilities to deal with technologies at world level of efficiency.

Acquisition of technological capacity is a complex and variegated process and technologies can't be transferred to developing countries in the same as a physical product.

It is a process involving time, effort, cost and risk, and complex interactions between firms and between firms and institutions and is a cumulative and evolutionary one, building upon past choices and experience. There is no predictable learning curve down which all firms travel. The costs and risks differ by technology with complex technologies involving much higher costs than simple ones.

The process is very different from the textbook one which forms basis of current analysis and policy advice. This simplified approach assumes there are no learning costs that differ by activity and that "free markets by definition lead to correct choices by firms on which activities to invest in, and any government intervention must always be assumed to be distorting and inefficient.

While technology imports are vital for local technological development, the mode of import is important in how much learning takes place locally. The "deepening" of indigenous technological activity is a vital part of technological development and involves a country mastering more complex and demanding tasks over time -- including complex capabilities of adaptation, improvement and design and development.

"Internalized" modes of technology transfer, such as wholly owned foreign investments, tend to be very effective for transfer of know-how, but not of know-why, says Lall.

Arms-length purchases of technology - through import of capital goods, licences or minority joint ventures - create more learning because the local firm has to do more "home work" to understand the technology and solve problems.

The relationship between technology import and local capacity-building is thus partly complimentary and partly competitive.

The experiences of Japan, South Korea and the Taiwan Province of China suggest that "restrictions and selectivity" on FDI may be a necessary part of technological development policy. The latter may be the result of the interplay between incentives, capabilities and institutions.

If there were no market failures in any of these elements, there would be no need for policy interventions and the best policy would be to free markets entirely.

But if there are market failures affecting adversely the process of technological development, there would be a case for intervention, if governments could achieve a better outcome than the market.

Such market failures, Lall notes, can exist in output or input markets.

The most significant market failure in developing countries in output markets are those arising from costly learning and this provides "a valid case of infant-industry protection that has to be selective, often high, and sometimes prolonged, depending on the nature of the technology."

However there is an inherent danger in use of selective protection: while giving time and resources to new entrants to invest in capability development, it reduces the incentive to undertake such investments. Protection must hence be geared to learning needs of the technology, and offset by export-orientation to induce firms to develop technologically.

As for input markets, failures in skill markets are now widely acknowledged, and governments have to intervene through education and training systems.

There are also well recognized failures in information and technology markets. International technology markets are imperfect and fragmented and developing country governments can help their enterprises to find, bargain for and transfer new technologies.

But the mode of technology transfer is also important, Lall underlines. The deepening of local capabilities sometimes requires that "arm's-length" modes be given preference over "internalized" modes where the entire process remains within the TNC which find it economic to retain the innovative base in the developed countries.

But simply restricting FDI does not add dynamism to local technological activity. The incentive structure must be conducive -- export oriented -- and other supply side measures must also be undertaken to promote R & D by industrial enterprises. But setting up large research institutes delinked from productive sector have been wasteful, and the incentive systems must be more responsive to the technological needs of industry.

And the provision of capital for technological effort is an important part of the supply-side support for development of S & T.

But developing countries at different levels of development face very different problems in technological development and the policy needs are correspondingly different.

But the main barrier to promoting technological development is that governments often lack skills, impartiality and will to design and implement policies.

While the cost of government failure may end up worse than a market failure, governments do not fail absolutely, and there are degrees of failure and hence possibilities of remedying them, Lall says. The evidence of East Asia shows under certain conditions governments can intervene very efficiently and add dynamism to the process of technological development.

However the new international rules of the game -- the trade rules after the Uruguay Round and the structural adjustment policies (SAPs) of the World Bank -- are prompting developing countries to move to very liberal trade and industrial policies.

While in trade matters there are some clear benefits in reforming past strategies of massive and unselective intervention, Lall says "there remains a role for government in trade policy: promotion of new infant industries and controlling the exposure of existing activities to world competition."

In terms of the new international rules of the game, most developing countries will have less freedom to use protection to promote infant industries than in the past, and those that accept rapid liberalization will not be able to use selectivity in opening up existing industries to import competition.

In investment, services and intellectual property rights, the new trade rules provide for more transparent, welcoming and non-discriminatory regimes and stronger protection (for investments and IPRs).

While this is generally welcome in that it will promote international investment and technology transfer, and eliminate costly and inefficient policies, "it may unduly restrict governments from the legitimate promotion of national development policies".

"Local content rules and number of foreign-exchange balancing provisions have sometimes proved to be effective mechanisms for stimulating local linkages and technology diffusion, and for encouraging firms that have been developed in the context of import-substituting activities to also engage in exports.

"Their rationale is exactly the same as for infant-industry protection: free markets do not give correct signals for resource allocation in the presence of market failures."

While international competition is essential to stimulate enterprises to invest in building up healthy capabilities, and liberalisation is a desirable long-term objective, it is important for developing countries that "they retain some tools for promotion of infant industry -- to be used sparingly and for limited periods, and to promote new activities that have difficult learning periods and substantial external benefits."

They should liberalize rapidly on activities at or near international frontiers to enable use of existing technological capabilities or invest in bringing them to competitive levels with no further need for protection.

But they should liberalize more slowly on activities needing longer periods of learning or "relearning" -- to absorb new technologies and create new skills in order to become fully competitive, while laying out and adhering to a strict programme of opening up the economy.

Developing countries should also integrate all these moves with appropriate supply-side measures -- to ensure that firms' own efforts to develop capabilities are supported by necessary skills and provision of requisite finance, information and extension services.

The present conventional wisdom that "getting prices right" is all that is required to cope with technology and globalization is an unwarranted simplification and based on the assumption that there are no learning costs in using industrial technologies. They often lead to misleading policy recommendations.

Industrial reform policy, Lall says, must have the same basic elements as industrial development policy. Industrial reform and restructuring must address various determinants of capability development: the incentive framework,, the supply of human capital, the supporting technology infrastructure, finance for technological activity and access to foreign technologies.

The design of policy reform must be very different from what the typical structural adjustment package contains or some of the prescriptions in the GATT/WTO agreement.

"An appropriate reform package should be more gradual and retain a large role for the government to overcome market failures. It would be phased in according to the needs of relearning and factor market upgrading. It would ultimately retain a number of instruments of intervention in trade and technology that are needed to set up new infant industries -- among the first casualties of SAPs.