Stop blaming industrial policy

Vladimir Popov, Jomo Kwame Sundaram

BERLIN, KUALA LUMPUR: Industrial policy – or the promotion of particular investments, technologies, industries, regions and enterprises – has been practiced by a variety of governments to try to accelerate economic growth and transformation.

The ascendance of the Washington Consensus, inspired by the neoliberal counter-revolution in economics, focused on alleged national macroeconomic mismanagement in developing countries and later, transition economies. This was typically blamed on ‘soft budget constraints’ (SBCs) in socialist states and enterprises, macroeconomic populism and industrial policy.

Blaming industrial policy

Enterprise-level SBCs have also been wrongly blamed on industrial policy to promote certain economic activities, usually manufacturing with more advanced technologies. In practice, most industrial policy was quite selective, i.e., involving support of some industries, regions and enterprises at the expense of others.

While such selective support may or may not have been successful in promoting targeted industries, industrial policy has been wrongly, and sometimesdeliberately blamed for both enterprise and national level fiscal SBCs. Fiscal SBCs have been wrongly blamed on enterprise-level SBCs in socialist states, macroeconomic populism and industrial policy.

But contrary to many economists’ presumptions, in most economies, including many centrally planned ‘socialist’ ones, few enterprises were exempted from budgetary discipline. SBCs were therefore the very rare exception, not the rule, to promote desired new economic activities.

Enterprise-level SBCs did not “permeate all organizations” in socialist countries, as often claimed and assumed, but were instead quite selective, i.e., subsidies were provided to some enterprises, industries or regions, typically at the expense of others.

All centrally planned economies had both explicit and implicit subsidies. In most Eastern European and Soviet countries during 1989-1992, on the eve of transition, direct subsidies in the government budget amounted to 10-15% of national income.

In addition to direct subsidies for public utilities, housing and food, there were implicit price subsidies, particularly for users of fuel, energy and raw materials. Besides explicit subsidies from government budgets, rents from unsustainable, non-renewable resource extraction were shared with industries and consumers via lower prices.

Dwarf infant industries

The fiscal problem was not due to subsidization per se, or even to subsidization of manufacturing – at the expense of resource industries, trade and financial services. Rather, the problem was in the way such subsidization was carried out, i.e., by maintaining higher domestic prices for manufactured goods.

Such import-substituting industrialization (ISI) typically created industries which rarely became internationally competitive and viable. There have been all too many examples of failed ISI requiring ongoing subsidization of ‘infant industries’ incapable of ever becoming internationally uncompetitive.

These industries were exposed as unviable and unsustainable with trade liberalization and the end of Soviet era trade arrangements in the 1990s. Soviet industrialization from the 1930s had survived before that due to its insulated economic environment, with the ratio of Soviet exports to GDP not rising until fuel sales abroad rose with higher prices from the 1970s.

Perestroika reforms, initiated by reformist Soviet leader Gorbachev after the mid-1980s, failed to accelerate needed enterprise reforms or economic growth, but instead led to the ‘transformational recession’ of the 1990s, greatly exacerbated by the reforms during Boris Yeltsin’s first presidential term.

Many other enterprises – mainly in heavy industries, and often relying on Soviet technology, advice and aid – in other ‘socialist’ economies and developing countries subject to Soviet influence, experienced similar fates.

Thus, nations which tried to challenge Western hegemony met similar fates despite trying to make a virtue of ‘self-reliance’ compelled by the need to cope with Western-led trade and investment sanctions.

Successful industrial policy

Most countries trying to industrialize or to accelerate industrialization started with ISI, with effective protection enabling new enterprises to produce for domestic markets by keeping out imported foreign substitutes with prohibitively high tariffs and non-tariff trade barriers.

But many IS enterprises continued to survive, even profit from such supposedly temporary tariff protection and other government support, never becoming internationally competitive as promised by the ISI strategy.

In more successful ‘late developing’ economies, government support was conditional on meeting performance criteria which effectively attracted private investments. Such investors sought more handsome ‘rents’ by accelerating technological progress, productivitand international competitiveness.

Thus, for example, ‘effective protection conditional on export promotion’ enabled the emergence of internationally competitive enterprises in some East Asian economies. Export orientation has been especially important in improving output quality to meet internationally competitive product quality and performance standards while achieving cost competitiveness.

Without more effective means for disciplining enterprises to accelerate development, export-orientation – promoted by government policy, incentives and other support – has contributed to successful catch-up growth. East Asian economies subsidized competitive export-oriented industries which accelerated economic growth and transformation, some more successfully than others.

In China, for instance, exports compared to GDP increased from 5% in 1978 to 35% in 2006, before declining to 20% in 2018, while its GDP grew at an average of 10% annually, with its population rising slower than in most other developing countries due its ‘one child’ policy.

Appropriate industrial policy needed

Budget constraints in socialist economies were generally stronger than in developing countries and no less strict than in developed countries on average. SBCs in socialist economies were never pervasive, as widely believed, but selective, i.e., subsidizing some enterprises or industries at the expense of others.

Such selective support, while typical of industrial policy, may or may not successfully promote internationally competitive enterprises, but certainly provides no empirical support for the claim of pervasive SBCs in ‘socialist’ economies.

With state-owned enterprises, strict fiscal and enterprise-level discipline, including budget constraints, have led to restructuring, and more rarely, closures. But even when budget constraints have been less than strict, they have not been pervasive, as fiscally disciplined ‘socialist’ economies could not afford otherwise.

National-level macroeconomic mismanagement in developing countries and transition economies has all too often by ideologically defined by neoliberal economics. In so far as macroeconomic challenges are real and demand pragmatic policy attention, they should not be defined by distracting neoliberal chimera of alleged SBCs variously blamed on socialism, populism and industrial policy.

Unfortunately, the mythology surrounding SBCs has been used to throw the industrial policy baby out with the bathwater of ISI cul de sacs. Much more appropriate, yet pragmatic industrial policy is needed for developing countries and transition economies to ‘catch up’, as achieved by some East Asian and other economies.

Financialization: Tackling the Other Virus

By Jomo Kwame Sundaram and Michael Lim Mah Hui

KUALA LUMPUR and PENANG, Jul 9 2020 (IPS) - The 1971 Bretton Woods (BW) system collapse opened the way for financial globalization and transnational financialization. Before the 1980s, most economies had similar shares of trade and financial openness, but cross-border financial transactions have been increasingly unrelated to trade since then. Although Covid-19 recessions have rather different causes and manifestations from the financially driven crises of recent decades, financialization continues to constrain, shape and thus stunt government responses with deep short-, medium- and long-term consequences. 

It is thus necessary to revisit and contain the virus of financialization wreaking long-term havoc in developing, especially emerging market economies. No one is financing work on a vaccine, while all too many with influence seek to infect us all as the virus is touted as the miracle cure to contemporary society’s deep malaise, rather than exposed for the threats it actually poses.

Financialization

Global financialization has spread, deepened and morphed with a changing cast of banks, institutional investors, asset managers, investment funds and other shadow banks. Transborder financialization has thus been transforming national finance and economies. 

The changing preferences of financial market investors have been reshaping the uneven spread of market finance across assets, borders, currencies and regulatory regimes. To preserve and enhance their value, new financial asset classes and relationships have been created. 

Within borders, banks and shadow banks are lending to households, companies and one another, while national frontiers do not matter for securities and derivative markets, often financed via wholesale money markets. 

Over the last four decades, the scope, size and concentration of finance have grown and changed as mainly national regulatory authorities try to keep up with recent financial innovations and their typically transnational consequences. 

Managing discontents

Financialization has involved reorganizing finance, the economy, and even aspects of society, to enable investors to get more from financial market investments, effectively undermining sustainable growth, full employment and fairer wealth distribution. The following measures should help slow financialization and limit some of its adverse effects: 

Strengthen international financial regulation

While financialization has become transnational, financial regulation remains largely national, albeit with some transborder effects of the most powerful, e.g., US tax rules and Fed requirements. Transnational finance has often successfully taken advantage of loopholes and ‘arbitrage’ to great profit. 

Multilateral cooperation to strengthen effective and equitable regulation will be difficult to secure as voting power in the only multilateral institution, the IMF, remains heavily biased against developing countries. 

Strengthen national capital account management

Transnational financialization has made developing countries more vulnerable to transnational finance and its rent-gouging practices, while also causing greater instability, and limiting policy space for development. 

Although the IMF’s Article 6 guarantees the national right to capital account management, all too many national authorities in developing countries, especially emerging markets, have been deterred from exercising their rights effectively.

Improve national regulation of finance 

Improving effective, equitable and progressive national regulation of finance, particularly market-based finance, remains challenging, especially in emerging market economies where typically divergent, if not contradictory, banking and capital market interests seek to influence reforms differently in their own specific interests. Strengthen bank regulation

There were few banking crises from the 1930s to the 1970s after banking was strictly regulated following the 1929 Crash. With financial deregulation from the 1980s, major financial and currency crises have become more frequent. More effective regulation and supervision are urgently needed, not only of banks, but also of ‘shadow banks’, that account for a large and growing share of transnational finance. 

Make finance accountable

Instead of improving regulations to achieve these objectives, the growth and greater influence of finance have led to regulatory capture, with reforms enabling, not hindering financialization, including its adverse consequences. Political financing reforms are also urgently needed to limit the influence of finance in politics. 

Promote collective, not asset-based welfare 

Financialization has been enabled by the reduced role of government. Nationalizing or renationalizing pension funds and improved government ‘social provisioning’ of health, education and infrastructure would reduce the power and influence of institutional investors and asset managers. 

Ensure finance serves the real economy

The original and primary role of finance – to provide credit to accelerate productive investments and to finance trade – has been increasingly eclipsed by financial institutions, including banks, engaging in securities and derivatives trading and other types of financial speculation. 

Such trading and speculative activities must be subjected to much higher and more appropriate regulatory and capital requirements, with commercial or retail banking insulated from investment or merchant banking activities, e.g., insulating Main Street from Wall Street, or High Street from the City of London, instead of the recent trend towards ‘universal’ banking.

Promote patient banking, not short-termist profiteering

National financial authorities should introduce appropriate incentives and disincentives to encourage banks to finance productive investments and trading activities, and deter them from pursuing higher short-term profits, especially from daily changes in securities and derivatives prices.

This can be achieved with appropriate regulations and deterrent taxes on securities and derivatives financing transactions. An alternative framework for banking and finance should promote long-term investment over short-term speculation, e.g., by introducing an incremental capital gains tax where the rate is higher the shorter the holding period. 

Ensure equitable financial inclusion 

While financial exclusion has deprived many of the needy of affordable credit, new modes of financial inclusion which truly enhance their welfare must be enabled and promoted. 

Ostensible financial inclusion could extend exploitative and abusive financial services to those previously excluded. In some emerging market economies, for example, levels of personal and household debt have risen rapidly, largely due to inclusive finance initiatives.

New financial technologies

Financial houses are profitably using new digital technologies to capture higher rents. While technological innovations can advance financial inclusion and other progressive development and welfare goals, thus far, they have largely served financial rent-gouging and other such exploitive and regressive purposes. 

For example, while big data has been used to track, anticipate and stop the spread of infectious diseases, it has also been more commonly abused for commercial and political purposes. 

National regulators must be vigilant that ostensibly philanthropic foundations and businesses are actively promoting ‘fintech’ in developing countries without sufficient transparency, let alone consideration of its mixed purposes, implications and potential. 

Minimize tax avoidance 

Besides curtailing and penalizing tax avoidance practices at the national level, tax accountants, lawyers and others who greatly enable and facilitate tax evasion and related abuses should be much more effectively deterred. 

Strengthen multilateral cooperation to equitably enhance national fiscal capacities 

Governments must cooperate better multilaterally to more effectively and equitably tax transnational corporations and high net worth individuals. Such cooperation should effectively check illicit financial flows with strict regulations to deter private banking, banking secrecy, tax havens and other international facilitation of tax evasion. 

Existing initiatives need to be far more inclusive of, sensitive to and supportive of developing country governments. OECD led initiatives previously excluded developing countries, but their recent inclusion, while an advance, remains biased against them.

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Financialization: Tackling the Other Virus

Covid-19 Straw Breaks Free Trade Camel's Back

KUALA LUMPUR, Malaysia, May 19 (IPS)  - Economic growth is supposed to be the tide that lifts all boats. According to the conventional wisdom until recently, growth in China, India and East Asian countries took off thanks to opening up to international trade and investment.

Such growth is said to have greatly reduced poverty despite growing inequality in both sub-continental economies and many other countries. Other developing countries have been urged to do the same, i.e., liberalize trade and attract foreign investments.

Doha Round ‘dead in water'

However, multilateral trade negotiations under World Trade Organization (WTO) auspices have gone nowhere since the late 1990s, even with the so-called Doha Development Round begun in 2001 as developing countries rallied to support the US after 9/11.

After the North continued to push their interests despite their ostensible commitment to a developmental outcome, the Obama administration was never interested in completing the Round, and undermined the WTO's functioning, e.g., its dispute settlement arrangements, even before Trump was elected.

To be sure, the Doha Round proposals were hardly ‘developmental' by any standards, with most developing countries barely benefitting, if not actually worse off following the measures envisaged, even according to World Bank and other studies.

GVC miracle?

According to the World Bank's annual flagship World Development Report (WDR) 2020 on Trading for Development in the Age of Global Value Chains, GVCs have been mainly responsible for the growth of international trade for two decades from the 1990s.

GVCs now account for almost half of all cross-border commerce due to ‘multiple counting', as products cross more borders than ever. Firms' creative book-keeping may also overstate actual value added in some tax jurisdictions to minimize overall tax liability.

WDR 2020 claims that GVCs have thus accelerated economic development and even convergence between North and South as fast-growing poor countries have grown more rapidly, closing the economic gap with rich countries.

Automation, innovative management, e.g., ‘just-in-time' (JIT), outsourcing, offshoring and logistics have dramatically transformed production. Labour processes are subject to greater surveillance, while piecework at home means self-policing and use of unpaid household labour.

WDR 2020 out of touch

WDR 2020 presumes trends that no longer exist. Trade expansion has been sluggish for more than a decade, at least since the 2008 global financial crisis when the G20 of the world's largest economies and others adopted protective measures in response.

GVC growth has slowed since, as economies of the North insisted on trade liberalization for the South, while abandoning their own earlier commitments as the varied consequences of economic globalization fostered reactionary jingoist populist backlashes.

Meanwhile, new technologies involving mechanization, automation and other digital applications have further reduced overall demand for labour even as jobs were ‘off-shored'. Trump-initiated trade policies and conflicts have pressured US and other transnational corporations to ‘on-shore' jobs after decades of ‘off-shoring'.

Nonetheless, WDR 2020 urges developing countries to bank on GVCs for growth and better jobs. Success of this strategy depends crucially on developed countries encouraging ‘offshoring', a policy hardly evident for well over a decade!

As the last World Bank chief economist, albeit for barely 15 months, Yale Professor Pinelopi Koujianou Goldberg recently agreed, "the world is … retreating from globalization". "Protectionism is on the rise — industrialized countries are less open to imports from developing countries. In addition, there is by now a lot of competition".

The Covid-19 crisis has further encouraged ‘on-shoring' and ‘chain shortening', especially for food, medical products and energy. Although the Japanese and other governments have announced such policies, ostensibly for ‘national security' and other such reasons, Goldberg has nonetheless reiterated the case for GVCs in Covid-19's wake.

Trade does not lift all boats

After claiming that "economists have argued for centuries that trade is good for the economy as a whole", Goldberg has also noted that "trade generates winners and losers", with many losing out, and urges acknowledging "the evidence rather than trying to discredit it, as some do."

Following Samuelson and others, she recommends compensating those negatively effected by trade liberalization, claiming "sufficient gains generated by open trade that the winners can compensate the losers and still be better off" without indicating how this is to be done fairly.

Compensation and redistribution require transfers which are typically difficult to negotiate and deliver at low cost. Tellingly, like others, she makes no mention of international transfers, especially for fairly redistributing the unequal gains from trade among trading partners.

Interestingly, she also observes, "There are plenty of examples, especially in African countries, where wealth is concentrated in the hands of a few… even when the tide rises, only very few boats rise. Growth doesn't trickle down and doesn't improve the lot of the poor."

Unlikely Pan-Africanist

After decades of World Bank promotion of the ‘East Asian miracle' for emulation by other developing countries, especially in Africa, Greek-born American Goldberg insists that what worked for growth and poverty reduction in China will not work in Africa today.    

Echoing long time Bank critics, she argues, "If trade with rich countries is no longer the engine of growth, it will be more important than ever to rely on domestic resources…to generate growth that does trickle down and translates to poverty reduction."

Instead, as if supporting some contemporary pan-Africanists, she argues, "Africa needs to rely on itself more than ever. The idea that export-led industrialization as it happened in China or East Asia is going to lead growth in Africa becomes less and less plausible".

She argues that "the African market is a very large market with incredible potential. It has not been developed yet. So, regional integration might be one path forward. Rather than opting for global integration, which may be very hard to achieve these days when countries are retreating from multilateralism, it might be more feasible to push for regional trade agreements and create bigger regional markets for countries' goods and services".

Acknowledging "We are still a very long way from there because most countries are averse to this idea — they see their neighbors as competitors rather than countries they can cooperate with", not seeming to recognize the historical role of the Bank and mainstream trade economists in promoting the ‘free trade illusion' and discrediting pan-Africanism.

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