7:42 AM Feb 23, 1996

STILL SCOPE FOR INDUSTRIAL POLICY IN SOUTH - UNCTAD

Geneva 23 Feb (Chakravarthi Raghavan) -- The Uruguay Round multilateral trade agreements in the WTO have reduced the scope for some policy actions by developing countries that the successful East Asian economies adopted, but the East Asian economic model is still valid and individual countries can still design and implement policies for industrialization and structural change, according to UNCTAD.

While changing international trading environment may be restricting the freedom of developing countries to conduct East Asian style policies of an active State role in using selective industrial policies for long-term industrial development and faster economic growth, there is still considerable room for manoeuvre if countries skilfully used "permissible" subsidies, balance-of-payments clauses, non-trade policies and "more creative" interpretations of the new trading rules, UNCTAD says.

But referring to the Singapore WTO ministerial meeting and efforts of major advanced countries to pursue their objectives to subject developing countries to further constraints through the new trade agenda, the report warns that these may have important consequences for the world trading system.

Such a development would frustrate the export-oriented models in the South and the outcome might make developing countries not only sceptical of benefits of free trade, but also weaken prospects for growth in the developed countries, the report warns.

The secretariat view is in a report for a conference next week -- "East Asian Development: Lessons For a New Global Environment". The conference (29 Feb-1 March) at Kuala Lumpur, Malaysia, will bring together some 80 policy-makers, academics and senior economists from various regions to explore the east Asian experience and its relevance in the current global economic environment.

Jointly organized by the UN Conference on Trade and Development and the Institute of Strategic and International Studies (ISIS), and funded by the government of Japan, the outcome of the Conference will be transmitted to UNCTAD-IX.

The successful industrialization and development policies of East Asian countries -- Japan, the first and second tier Newly Industrializing Economies (NIEs) and the newly emerging market economies including China -- has aroused considerable debate among economists over the last two decades or more.

The World Bank and its neo-liberal economists, as well many of the academics of this school,. often in a revolving-door relationship with their Bank counterparts, began this debate when they used the South Korean export success of the 1970s, to claim that South Korea was a model of free-trade-free-market preached by them that other developing countries should follow.

But when countered by the actual reality of those policies, these economists at the Bank and elsewhere, conceded the State role, but went on to claim that the State role and industrial policies did not matter and the successful development and industrialization would have happened any way. The Bank and the Fund pushed the neo-liberal policies through conditionality and policy lending on developing countries, and particularly on Africa from the mid-1980s -- but with disastrous effects on those fragile economies.

Japan challenged these policies at the World Bank's executive Board and as a result, and financed by it, the Bank undertook a study and published its East Asia Miracle volumes whose conclusions were challenged by a range of academics (who drew pointed attention to the facts in the study and variant conclusions) and institutions, both in their writings and at a Japan government sponsored symposium in Tokyo in 1994 where the World Bank economists had to face their critics.

While the government of Japan at that symposium sought to encourage continuance of the dialogue, and for the Bank to apply these to the African economies, the Bank walked away from the debate, arguing in effect that it has had its last say on East Asian experience, that its own priorities were on Africa and that in any event the East Asian experience was not replicable in Africa or other developing countries because of the WTO and the new world trade order and the institutional weaknesses of the developing country governments elsewhere.

Both before and after the East Asia miracle studies of the Bank, UNCTAD in its Trade and Development Reports had been looking at the East Asian experience and the role of the State in their development, and usefulness of those experiences for other developing countries. The Japanese government, and its development cooperation institutions, have funded and encouraged UNCTAD to continue with such studies.

But the December 1994 Mexican peso crisis has brought to the fore the failures of the neo-liberal economics of the so-called Washington Consensus, pushed on developing countries by the Bretton Woods Institutions (and now the WTO) -- both in other Latin American countries which are unable to make fast progress, as well as the failure of the Fund-Bank structural adjustment programmes in Africa and East Europe.

Recently, the World Bank has begun to emphasize its role as a bank, rather than as a 'development institution' to avoid pressures on it for lending policies to subserve social and other objectives. But whether this will also lead to its taking a less messianic view about neo-liberal economic and development policy remains to be seen.

But the increasing backlash, among the public of the North and the South, to the neo-liberal policies, and the 'globalization-liberalization' talk to expand the role of TNCs has led to a renewed development debate on the whole gamut of issues underlying the code words of 'globalization', and 'integration' of developing countries into the 'global economy' to be achieved by fast 'liberalisation' of domestic and foreign sectors of developing countries and the transnational production as promoting global efficiency and global welfare, and for expanding the WTO role over developing countries through an investment agreement and in other new areas.

In questioning some of the simplistic neo-liberal views about development, UNCTAD warns that as each country faces a unique situation, the search for lessons from success stories should not be guided by a desire to exactly replicate experiences elsewhere.

"The real issue," the report says, "is whether other countries can construct their own policy regimes and supporting institutions among development principles that have been a helpful guide to policy-makers and other actors involved in successful development experiences.

"It is clear there is no single path to development which fits every country, or even the majority of countries. However, recognizing this institutional diversity should not be confused with the argument that therefore there are no lessons to be learnt from the East Asian experience. It is both possible and instructive to identify some major principles that underlie this successful experience and try to adapt the policy tools and institutional vehicles to devise new policy tools and institutions.

"Indeed, if East Asian Governments had themselves believed in the impossibility of such institutional adaptation and innovation and had ignored earlier success stories, it is doubtful whether there would have been an East Asian Miracle to discuss," the report says.

East Asia's differing policies, common principles

The historically unprecedented and successful rapid industrialization achieved by the East Asian economies were due to some common principles underlying their policies, even though the exact policy mix and institutional arrangements to implement them differed across the countries.

The common principles behind the differing country policies involved:

* the promotion of a profit-investment nexus -- by providing a stable political environment and pro-investment macro-economic policies to sustain investors' confidence; providing both general and specific investment incentives by using measures to create artificially high profits; and, disciplining entrepreneurs by closing off channels for unproductive investments and capital flight, and restricting luxury consumption.

* the promotion of an export-investment nexus -- initially promoting traditional exports (primary commodities and labour intensive industries) to maximize foreign exchange receipts to buy capital goods that embody more advanced technologies; promoting more demanding industries identified on a number of criteria (e.g. productivity growth potential, conformity with domestic technological capabilities, demand prospects) through creation, manipulation and timely destruction of 'rents'; upgrading through strategic integration with the international economy, using the disciplinary power of international markets alongside measures of rapid export promotion and using FDI selectively and strategically to access more advanced technologies.

* the creation of strong government-business network -- promoting an independent economic bureaucracy including a network of agencies at the sectoral level; and establishing strong links between industrial firms and the financial sector in ways to promote productive investment.

* addressing the danger of marginalisation by supporting small-scale producers both in the rural and industrial sectors through targeted public investment, subsidized credit and appropriate advisory services; and supporting upgrading by linking small producers to large firms and public research institutes.

The UNCTAD secretariat paper analysing the experiences of the East Asian countries (Japan, the first and second tier NIEs of East Asia and South-East Asia, and newly emerging market economies including China), as well as the several supporting papers by some leading academics for the Conference, give a clear rebuttal of the neo-liberal claims that the East Asian experience approximated to what could have been expected from a laisse-faire regime in which higher rate of growth is achieved through improved allocative efficiency, including gains from international trade, resulting from comparative advantages and greater competition.

The report also challenges the oft-repeated views that the lack of strong governments and efficient bureaucracy in other developing countries, and more so in Africa, make inapplicable the East Asian experience, in particular selective intervention policies and a government-business linkages to further stages of industrialization.

Without an active state role and intervention, East Asian economies would not have been able to achieve such an impressive pace of capital accumulation and without which the rapid pace of technological upgrading, productive diversification and increasing international competitiveness would not have been possible.

Simple free market interpretations of their experience no longer enjoy wide support and there is a growing consensus on the positive contribution of the State to the region's success.

The debate on East Asian experience and their relevance for other countries, UNCTAD notes, has raised questions about the institutional prerequisites for successful and selective industrial policy and whether these are possible in today's globalized world economy.

But the challenges of economic development are too vast for economists to rest content with interpretations of the past. They must find solutions to the present and the future and suggesting a "single economic model", based on a highly stylized version of Anglo-American development has not been helpful, the report comments.

Analysing the similarities and differences in the policies followed by the various countries of East Asian region, the report notes that in creating a 'pro-investment' macro-economic climate, they sacrificed consumption rather than investment, when restrictive measures were seen as necessary for national economic goals. A mix of trade, financial and competition policies were used to create "rents" to boost corporate profits and thus availability of potential investible resources. But policy-makers also decided that it was not enough to channel resources into hands of investors, who might simply increase luxury consumption -- "a fear that has materialized after recent liberalization episodes in Latin America". Rather they put severe restrictions on luxury consumption, directly through import restrictions and curbs on domestic production of luxury goods and indirectly through taxation and consumer credits.

They curbed the possibilities of speculative investments for arbitrage gains which are incompatible with encouraging 'animal spirits' (of entrepreneurs) for more productive investments. They also had some tough restrictions on outward capital flows. These introduced at the earlier stages of developed have more effectively reduced the need for them in the longer run.

The East Asians also adopted a range of policies for an export-investment nexus. The initial efforts at industrialization were to rely on a captive domestic market in final goods - a policy though which requires initially imports of large volumes of capital and intermediate goods, but imposed constraints on industrialization process for lack of foreign exchange.

All developing countries try to encourage exports and productive activities exploiting static comparative advantages based on domestic resources and cheap labour.

But East Asian countries, from an early state, anticipated future difficulties of such industries (including rising wages, limits to productivity growth and demand expansion in world markets) and purposefully nurtured new generations of industries.

On the views against industrial policies, based on examples of failures of targeting in the advanced industrial economies, the UNCTAD report notes that unlike developed countries, the developing countries are not initially operating at the technological frontiers of international best practice. Their promotion of industrial development does not involve 'picking winners' in uncertain technologies, but promoting investment along existing learning curves, encouraging acquisition of new technologies whether by importing machines or licensing them.

The East Asians encouraged exports to expose domestic industries, recipients of rents, to a measured degree of competition on world markets, but it did not mean full and unconditional integration with the international economy. Rather they used a range of polices to manage a process for "strategic integration" into the international economy.

At any point of time, the East Asian economies combined high protection for infant industries with low protection for mature industries -- a policy which has been misleadingly called 'neutral incentive regime'.

But strategic integration was not only confined to trade relations, but also in relation to Foreign Direct Investment (FDI), with the government providing a major influence on FDI role -- through joint ventures, screening imported technologies and bargaining over local content agreements, and firmly locating TNCs in a national industrialization strategy.

Measures for government-business links were not confined to the leading parts of industrial sectors. Policies were implemented for integrating smaller scale producers in agriculture and in industry into wider development process, including within the export-investment nexus. Measures were not designed and introduced simply as an adjunct to the more dynamic sectors of the growth process, but integral to their success.

The secretariat report also cogently rebuts the view that the experiences and models of North-East Asia (Korea, Taiwan Province of China) were different from the South-East Asian model. While the principles were applied differently to suit their own needs, the second tier NIEs adopted a range of industrial and trade policies, modifying them at various stages -- including on FDI and TNCs, and even in planning strategic industries.

The arguments about more or less openness to FDI among these countries, and FDI as an alternative to industrial policy, is also incorrect. Among the second tier South-East NIEs, by developing country standards it is only Malaysia that has been exceptionally dependent on FDI. As a proportion of total investments, FDI in Thailand has been about average for a developing countries and Indonesia's well below the average.

The Thai government has successfully used joint ventures, with Japanese TNCs particularly, to acquire technological, management and marketing capabilities. Malaysia has used strong incentives to attract foreign producers to the electronic sector.

But both in Malaysia and Thailand, moves towards a more selective approach to attracting foreign investments in response to human resources and infrastructure bottlenecks, and technology needs, have begun to emerge.

In important respects, the challenge facing South East Asian economies is to move beyond industries relying either on natural resource advance or relatively skilled cheap labour and developing the next generation of industries with higher skill and technological requirements.

While there are causes for optimism, and both Malaysia and Thailand have achieved some upgrading of industrial structures in the recent periods, there are also some genuine worries whether the S.E.Asian economies could fully meet the new challenges -- including concerns that high invest rates conceal large amounts of poorly targeted investments, and thus potentially 'unproductive', infrastructural and housing developments. The fact that Malaysia and Thailand are currently experiencing large-scale immigration to fight wage pressures suggests they may be having difficulty in achieving necessary upgrading.

Malaysia's high reliance on FDI, the report notes, is raising concerns about a 'dualistic economic structure' with insufficient technological and supply links from the TNC-dominated export sectors to the domestic economy. Just as worrying the limited diversification of the export sector, the predominance of simple assembly and finishing operations and low level of technological capabilities in this sector has given rise to the fear that China, Vietnam and other lower-wage Asian countries could take away these sources of growth momentum.

In these respects, the prospects in South East Asia will depend very much upon the strength of government-business relations. But in these countries there now exist relatively independent bureaucracies with capacity and competence to coordinate and discipline private firm behaviour and avoid serious government failure. Given that institutional reforms have been at the centre of the East Asian success, can the East Asian experience be replicated? Do other countries have similar political and bureaucratic strengths?

Institutions comprise individuals and groups, and each country has to find its own mix of institutions. But this does not mean countries cannot import institutions from elsewhere. Just as in the case of technology, late-comers can borrow institutions from abroad and adapt them.

Rebutting the view that sub-Saharan Africa lacks the basic institutional infrastructure to manage complex economic, and hence institutionally demanding policies, UNCTAD says that for many of these countries, restoration of peace and basic social order, after years of civil wars and strives, is a prerequisite for economic development. In other cases, the general economic crises of the 1980s, the accompanying fiscal crisis, and the ideological shift against public activities, have weakened governments in every sense, making it difficult to recommend complex policies.

"But this doesn't mean these countries should not consider their longer-term development options.... rather these must be tied to wider efforts at rebuilding and reforming institutions of the State and civil society... As recently as the 1960s, South Korea used to send its bureaucrats to Pakistan for training in economic policy-making and, initially, both in Korea and Taiwan province of China, government-business relations were initially distant and at times quite tense.."

In South-East Asia governments initially focused on a limited number of selective interventions, and these contributed to accumulation of capabilities and know-how that enabled more sophisticated interventionist policies later on. But the core of bureaucracy must be given a substantial degree of insulation from political pressures and there must be 'meritocracy'.

The report decries in this connection the current tendency among some developing countries to under-estimate the importance of experienced bureaucrats and to put them under the direction of highly qualified but inexperienced outsiders.

"Although civil service reform and construction of better government-business links to promote economic development are no easy task, the assumption that developing countries are stuck with weak governments and institutions and therefore should not try to use any policy that is more sophisticated than prescribed by a laissez-faire doctrine must be rejected as a starting point for policy makers," UNCTAD says.

"Institutions can be built, and not necessarily through some grand design or radical transformation. Although openness to new ideas is important, institution building is as much a product of gradual, but purposeful, process of incremental improvements and learning from one's own experiences and experiences of others. Building, and in some cases rebuilding, good public (and private institutions) will be an essential part of any programme that aims to regenerate growth and prosperity in developing countries," the report adds.