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The role of industrial policy in economic development.

Industrial policy is used by governments to foster economic development through manipulation of market forces (Park, 1990; Thompson, 1995). The economic development of South Korea and Taiwan (SK/T) are heralded as success stories of industrial policy. This success is commonly attributed to export liberalisation, but as Rodrik identifies, this ‘downplays the active role of the governments in Taiwan and South Korea in shaping the allocation of resources’ (Rodrik et al, 1995:56). This essay will consider the role of industrial policy in economic development with regard to the automotive industry; firstly identifying key historical policies utilised in SK/T, before exploring the adaptation of these countries’ policies within the Chinese automotive industry, and concluding with consideration of Brazil’s attempts to reclaim control of their industrial policy.

SK/T shared structural characteristics in the 1950s. Predominately, for implementation of strong industrial policy, this was founded on ‘bureaucratic authoritarianism’ (Huang, 2002:551). Government autonomy, strength and good initial conditions enabled a coordinated strategy of targeted state investment, nationalisation of industry, import substitution, export promotion, subsidized credit, property rights reform, domestic content requirement, protectionist tariffs and quotas, multiple exchange rates and tax incentives (Huang, 2002; Park, 1990; Rodrik, 2001). From the beginning, the benefits of economies of scale were realised and industry was encouraged to build large manufacturing sites. This supported the fulfilment of later export requirements (Park, 1990).

Huang identified the specific component of South Korea’s automotive industry as targeted government support. This led to key firms receiving concentrated benefits and incentives, additionally encouraging achievement of economies of scale (Huang, 2002). Support and protection of infant industries raised productivity, and the competitive advantage of skilled, abundant labour was enhanced further through engagement in ‘higher profit-margin industries or ones with greater technological externalities’ (Huang, 2002:547).

The variety of industrial reforms implemented during the formative development of SK/T demonstrates that opening borders is insufficient for economic development (Rodrik, 2001:56). Rodrik goes on to highlight that many of the policies used are either ‘precluded by today’s trade rules or are highly frowned upon by organisations like the IMF and World Bank’ (Rodrik, 2001:59).

China’s industrial policies present many similarities with those of SK/T. The authoritarian state structure is likened to the ‘political insularity that many analysts attribute to the success of industrial re-structuring in East Asia’ (Huang, 2002:540). Further similarities are found in targeted government interventions and state investment in the automotive industry (Wang, 2003), leading to impressive growth, despite the protectionist regime inciting proliferation of poor production quality (Wang, 2003).

Differences start being witnessed during the late 1970s due to the increasing fragmentation of state autonomy, a key component in SK/T’s success (Rodrik et al, 1995), and foreign direct investment, specifically within the automotive industry through joint venture (Huang, 2002). Fragmentation of state autonomy led to difficulties in coordinating targeted investment, and inability to create import tariffs, which had been set in 1986 at 180 -220%. Had the state been able to set these barriers, this would have enabled exploration of economies of scale (Huang, 2002; Wang, 2003). Direct foreign investment ‘makes export-orientated industries more competitive than the import-substitution sectors directly under the control of the State’ (Wang, 2003:289), leading to faster trade liberalisation than had been experienced in SK/T.

Liberalising trade sequentially, and only after high levels of growth have occurred, has been the strategy of all developed economies today (Hunter Wade, 2010; Rodrik, 2001). China formally entered the World Trade Organisation (WTO) in 2001, a process which ‘accelerated policy reform’ (Wang, 2003:290), leading to four rounds of tariff cuts from 43.2% to 13% on average (Wang, 2003:289). Fast reform of industrial policy and integration into formal world economy institutions has led to countries like Brazil stagnating (Rodrik, 2001; Wang, 2003). Economic stagnation occurs due to the efficiency of multinational corporations, whose capacity and economies of scale, domestic markets find hard to rival. Hunter Wade goes further, stating that liberalising reforms constitute ‘a shrinking not only in terms of development space, but also of self-determination space’ (Hunter Wade, 2010:622), primarily enforced through WTO.

Historically Brazil and Korea were considered to have been at similar stages of development, ‘due to concentration ratios which separates both countries from China’ (Huang, 2002:544): as Brazil and SK/T’s automotive industries became more concentrated, China’s became less so. Unlike SK/T, Brazil had neither authoritarian leadership nor state investment: nevertheless, it pursued a similar path of coordinated policy, incentive, and import substitution (Fiuza, 2002; Huang, 2002). In spite of being the fifth-largest automobile market in the world and the seventh-largest producer (Leahy, 2011), Brazil’s absence of state investment has necessitated industrial policy incentives, to encourage automotive manufacturing development by external owners; firstly in 1959, when ‘multinational auto makers were attracted by Brazilian federal government with tax rebates and market protection to invest in local plants’ (Fiuza, 2002:2). The next attempt to encourage private investment, in 1990, followed Brazil’s divergence from a protectionist industrial policy, towards trade liberalisation: this was a repercussion of the levels of power concentrated in the automotive industry (Fiuza, 2002). The result of liberalisation of trade was to unbalance automotive markets. This, combined with currency overvaluation, was ‘disastrous: and automobile imports soared’ (Fiuza, 2002:5), while economic growth slowed. Brazil attempted to fast-track economic development by reversing liberalising policy: it reintroduced tariffs at 70% (Fiuza, 2002), and introduced a quota regime and tax incentives, to encourage firms to develop a Brazilian manufacturing base. These trade-related incentives came after a deadline set up by the WTO, and were met with protests from other nations (Fiuza, 2002:5). Following the world financial crisis of 2008, the Brazilian government again wants to increase import costs by 32%, in an attempt to encourage foreign automobile producers to create a manufacturing base within the country and ‘reduce imported vehicles which are negatively impacting the domestic automotive industry’ (Leahy, 2011). It remains to be seen how successful this latest attempt at protectionism will be.

The vast economic benefits of external investment in the automotive industry include the generation of commercial tax, foreign exchange savings, export market development, content programmes, no government funding requirement, employment creation and the ‘spillover’ to supporting industries (Fiuza, 2002; Munk, 1969). In exchange, the automotive industry gains access to one of the world’s largest and most heavily protected and subsidised markets (Fiuza, 2002; Munk, 1969). Without investments in Brazil, corporations would find their products subject to exclusionary tactics such as prohibitive tariffs and quotas.

In conclusion, evidence suggests that coordination of industrial policies has been key to the economic development of these countries. This may involve financial subsidy and investment, or manipulation through formal structures such as tariffs.

Bibliography

  • Fiuza, E.P.S. (2002) ‘Automobile Demand and Supply in Brazil: Effects of Tax Rebates and Trade Liberalisation on Markups in the 1990s’, IPEA (Institute of Applied Economics Research), Working Paper No. 916, Brazil November 2002.
  • Huang, Y (2002) ‘Between Two Coordination Failures: Automotive Industrial Policy in China with a Comparison to Korea’, Review of International Political Economy, Vol. 9:3, pp.538-573.
  • Hunter Wade, R. (2010) ‘What Strategies are Viable for Developing Countries Today? The World Trade Organisation and the Shrinking of ‘Development Space’, Review of International Political Economy, Vol. 10:4, pp. 621-644.
  • Munk, B. (1969) ‘The Welfare Costs of Content Protection: The Automotive Industry in Latin America’, Journal of Political Economy, Vol. 77:1, pp. 85-98.
  • Park, Y.C. (1990) ‘Development Lessons from Asia: The Role of Government in SK/T’, The American Economic Review, Vol. 80:2, pp.118-121.
  • Rodrik, D; Grossman, G & Norman, V (1995) ‘Getting Interventions Right: How SK/T Grew Rich’, Economic Policy, Vol. 10:20, pp.53-107.
  • Rodrik, D (2001) ‘Trading in Illusions’, Foreign Policy, Vol. 123, pp. 54-62.
  • Thompson, G.F. (1995) ‘Grounding Industrial Policy?’, International Review of Applied Economics, Vol. 9:2, pp.221-229.
  • Wang, H. (2003) ‘Policy Reforms and Foreign Direct Investment: The Case of the Chinese Automobile Industry’, Journal of Economics and Business, Vol. VI:1, pp. 287-314.

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