Rethinking the Developmental State Ha-Joon Chang Faculty of

Rethinking the Developmental State Ha-Joon Chang Faculty of Economics AND Centre of Development Studies University of Cambridge hjc 1001@cam. ac. uk

Why bother? I • If we define the developmental state narrowly (a state that derives political legitimacy from its record in economic development, which it tries to achieve mainly by means of selective industrial policy, as seen in East Asia between the 1950 s and the 1980 s), there is no point in continuing this talk – Jordan is not Japan, South Africa is not South Korea – End of story.

Why bother? II • Ultimately, all experiences are unique and you cannot really learn straightforward lessons from anyone else, but there are still reasons to look at other experiences – Other experiences shake us out of our usual assumptions about how things work and what is possible (‘The Singapore problem’ - Reality is often stranger than fiction. ) – Learning from other experiences, however ‘different’ they are, has been an essential element in any development strategy. • However, if we define the developmental state broadly as a state that deliberately change the structure of the economy in order to accelerate economic development, examples abound (at least three varieties – ‘Classic’, Scandinavian, and American).

Models of Developmental State I • ‘Classic’ cases (Not just the East Asian countries, but also France and Austria after WWII) – Political hegemony by nationalistic, interventionist Right (LDP in Japan, various military dictatorships in Korea, Kuomintang in Taiwan, PAP in Singapore, Gaullists in France) – Planning/coordination by a ‘pilot’ agency (MITI in Japan, EPB in Korea, IDB in Taiwan, Planning Commission in France) – Sectoral industrial policy

Models of Developmental State II • Scandinavia – Selective industrial policy and state promotion of R&D – Welfare state and labour market policies • The welfare state reduced worker resistance to structural changes, • ‘Active labour market policy’ (provision of retraining and job search help) promoted reallocation of workers • Sweden’s ‘solidaristic wage’ policy (equal wages for same workers in different industries) pushed out low-productivity sectors

Models of Developmental State III • USA – Before WWII, the home of developmentalism, if not developmental state • The ‘infant industry’ argument was invented by Alexander Hamilton, the first finance minister of the USA • The most protectionist country in the world most of the time between the 1830 s and WWII – After WWII, the ‘hidden’ developmental state • Between 1950 -1990, the US federal government financed between 47% and 65% of national R&D spending, as against 20% in Japan and Korea and 30% in Europe. • R&D and public procurement for high-tech industries (computer and the internet by the Pentagon, semiconductor by the Navy, aircraft by the Air Forces, drugs and genetic engineering by the National Institutes of Health) • The US military as the most successful SOE in human history?

What kind of industrial policy? • There is an increasing recognition that industrial policy, if not necessarily a full-blown developmental state, is necessary (even Mexico …) • However, there is still a reluctance to adopt ‘developmentalist’ industrial policy, because the prevailing view is that industrial policy should be: – in line with the country’s comparative advantage – export-oriented, rather than protectionist – general (horizontal) rather than targeted (vertical, sectoral)

Comparative Advantage? I • In the short run, free trade may be good (in most cases), as it allows countries to exploit their comparative advantages and use their resources most efficiently. • However, in the medium term, saying that free trade may be good is not the same as saying that ‘freer trade’ (or trade liberalisation) is better. – Limited malleability of productive resources (infrastructure, physical capital, skills) means that sudden and large-scale trade liberaliation can have high economic costs, not to speak of social costs.

Comparative Advantage? II • In the long run, you can – and should – defy your comparative advantage and deliberately change your underlying productive capabilities. – No ‘natural’ reason why the Japanese should be good at making cars or the Koreans should be good at making steel. • After all, many of ‘comparative advantage’ activities are the results of someone else’s industrial policy – Coffee in Asia and Latin America (originally from Ethiopia through the Arab world, brought by the Dutch and the Portuguese) – Rubber in Malaysia (stolen from Brazil by the British) – Tea in India and Kenya (stolen from China by the British) – Cocoa in Africa (originally from Mexico, brought by the British and the French)

Kicking away the ladderpicture

Need to be export-oriented? I • Export success is absolutely necessary for economic development. – Economic development requires importing better technologies, which requires foreign exchanges • But, this is not to say that developing countries should have free trade. • Export success often requires significant industrial policy even for comparative advantage-conforming industries, as export markets have high fixed costs of entry. – supports for R&D and export marketing in agriculture in the Netherlands and Denmark in the past (late 19 th-early 20 th century) and Chile since the 1970 s. – state export marketing agencies in Japan (JETRO) and Korea (KOTRA) crucial in manufacturing export success

Need to be export-oriented? II • Continuous success in export requires continuous promotion of comparative advantage-defying infant industries and the rejuvenation of ‘senile’ industries, both of which require industrial policy – “There are no condemned sectors; there are only outmoded technologies. ” (Pierre Dreyfus, French Minister of Industry, 1981 -2) South Korea –‘ 50 s: tungsten, fish, seaweed (based on ‘natural’ comparative advantage) –‘ 60 s – early ‘ 70 s: wigs, T-shirts, shoes (attraction of labour-intensive FDI); textile, transistor radios, plywood (support for local export-oriented firms) –mid-’ 70 s to ’ 80 s: basic steel, bulk ships, TV, PCs, cheap cars (ISI through ‘Heavy and Chemical Industrialisation’) –‘ 90 s to today: expensive ships, semiconductors, mobile phones, tablets, expensive cars (support for R&D)

Only horizontal industrial policy? • The distinction between horizontal (nontargeted) industrial policy (e. g. , R&D support, infrastructure, education) and vertical (targeted) industrial policy is false. – In the real world, every policy choice you make, however “general” it may look, has discriminatory effects that amount to targeting • R&D: some sectors do more R&D than others; R&D funding is usually for specific technologies • Education: no such thing as “general” engineer • Infrastructure: no infrastructure that can be moved around and remoulded

Only correct for market failures? • Sounds sensible, but it is not always a useful advice. • This is because different economic theories have different expectations on what ideal markets can do, and therefore what you see as market failures depends on your economic theory. – In a dynamic economy with a lot of innovations, there will be a lot of monopolies. – Neoclassical economists would consider this a situation of ‘market failure’, but Joseph Schumpeter would have argued that this is a case of ‘market success’.

Many different ways to ‘do’ a developmental state I • Countries have used very diverse forms of industrial policy • Even within East Asia, quite a lot of differences – Japan : strong ‘pilot agency’ (MITI), close collaboration with large local private sector firms (virtually no SOE in manufacturing), highly regulated banking, virtual ban on TNCs, promotion of SMEs – Korea: Similar to Japan, but even more planned than Japan (planning ministry, the EPB, controlled even budget), some SOEs (e. g. , POSCO) but mainly reliant on private conglomerates (chaebols), less hostile to TNCs than Japan, banks all state-owned until the mid-1980 s, SMEs neglected – Taiwan: friendlier towards TNCs, far more reliance on SOEs (still produces 16% of GDP), SMEs promoted; banks state-owned most of the time (as in Korea) – Singapore: heavy reliance on TNCs and SOEs (produces over 20% of GDP)

Many different ways to ‘do’ a developmental state II • While having a powerful pilot planning agency (EPB, Korea or CGP, France) is useful, industrial policy can also be pursued by: – a line ministry (MITI, Japan) – a coordinating committee (IDB, Taiwan; EDB, Singapore) – sectoral agencies (NASA, ARPA or NIHs of the US) – SOEs (Singapore, Taiwan, France, Finland, Austria, Norway)

Many different ways to ‘do’ a developmental state III • Need for government agencies for special functions – Public R&D institutes (Fraunhofer, Germany; NIH, US; EMBRAPA, Brazil; KAIST, Korea; ETRI, Korea; CORFO, Chile) – Public ‘extension service’ (or consulting) agencies for SMEs (IDB, Taiwan) or farmers (US, Japan) – Export marketing agencies (JETRO, Japan; Pro. Chile, Chile; agricultural marketing board, Denmark in the early 20 th century)

Many different ways to ‘do’ a developmental state IV • Need to have continuous dialogue with private sector associations – Forums for dialogue with the private sector (Tripartite commissions in the Scandinavian countries, deliberation councils in Japan and Korea) – Business associations (general or industry-specific) can impose standards (especially regarding quality) and monitor policy compliance of their members • Public-private partnerships – Fraunhofer (Germany): public R&D institute but provides contract research and skills training for private sector firms – Fundacion Chile (Chile): public-private sector joint venture supporting innovation (critical in the development of the salmon export industry)

Many different ways to ‘do’ a developmental state V • Need to have long-term-oriented public sector financial institutions and/or encourage private sector banks to engage in long-term financing through government policy (‘directed credit programmes’) – State-owned universal banks (France, Korea, Taiwan, Germany) – State-owned development banks/investment banks (Kf. W in Germany, JDB in Japan, KDB in Korea, BNDES in Brazil) – State-owned special-purpose banks (SMEs, agriculture, etc. ) – State-owned venture capital (SITRA and Tekes, Finland) – Public R&D funding (especially important in the US, but in many European countries too) – ‘Directed credit programmes’ administered by private sector banks (Japan)

Political Economy Questions I • Successful industrial policy requires right “political” conditions – leadership commitment to development, the coherence of the state machinery, and the state ability to discipline the recipients of its supports. – Few countries have such conditions. • But in the real world, successful countries are the ones that have managed to find “good enough” solutions to their political economy problems and went on to implement policies – Many of the ‘Classic’ cases (France, Korea, Taiwan) – Partial successes of the past (Brazil and Mexico ‘ 30 s-’ 70 s; Pakistan as Korea’s ‘teacher’ in the ‘ 50 s-’ 60 s) – Today’s burgeoning cases (Ethiopia, Rwanda, Ecuador, Uruguay)

Political Economy Questions II • In order to improve the political conditions, we need to move away from the unrealistic ‘one-size-fits-all’ governance reform agenda and think concretely about issues like: – (i) how effective political visions can be formed and deployed to inspire various individuals and groups to act in a concerted manner – (ii) how to build nations and communities out of groups that may have very long history of hostility and mistrust – (iii) how to work out social pacts and build lasting coalitions behind them – (iv) how to minimise socially harmful lobbying while maximising the flows of information between the state and the private sector

Bureaucratic Capabilities I • “Industrial policy is particularly difficult and thus requires exceptionally capable bureaucrats. ” • But, there is no basis for the assumption that industrial policy is more difficult than other policies. • Industrial policy does not require sophisticated knowledge of economics, as often believed. – The industrial policy-makers of East Asia were not economists (lawyers in Japan and Korea, engineers in Taiwan and China today), and what little economics they knew was usually the “wrong” kind – Marx, the German Historical School, Schumpeter. • High-quality bureaucracies are not as impossible to build as people think. – France, Korea and Taiwan in the post-WWII period

Bureaucratic Capabilities II • There is also “learning-by-doing” in policy. – Without trying out “difficult” policies, capabilities cannot be improved. • The fact that something is “difficult” cannot be a reason not to recommend it. – After all, developing countries are routinely told to adopt “best practice” or “global standard” institutions used by the richest countries, when many of them clearly do not have the capabilities to effectively run such institutions.

Concluding Reflection: Isn’t this all too risky? • A country – or a company or even an individual – will never develop if it only does things that are not risky (“If you are not failing, you are not trying hard enough. ”) • Indeed, businessmen succeed exactly by doing things that everyone else thinks will not work – that is called entrepreneurship – so we should think the same when it comes to the state. • While it is very important to be realistic and pragmatic in terms of how you reach your goals, you need to be set ambitious goals (Japan-LA car example).