1. 1 Module 3 Chapter 10: Imperfect Markets and Fallible Governments: The Role of the State in Industrial Development Lall Arab Open University - Beirut

2. 2 1. Introduction This chapter considers the case of government intervention in promoting industrialization, specifically in developing countries. This chapter considers the case of government intervention in promoting industrialization, specifically in developing countries. Market imperfections in the industrial sector include: oligopolies, uncertainty, externalities, patented technologies … Market imperfections in the industrial sector include: oligopolies, uncertainty, externalities, patented technologies … If such failures are associated with scale economies and Schumpeterian technological growth, the case for official intervention may be negligible: the costs of market failure may be outweighed by its benefits. If such failures are associated with scale economies and Schumpeterian technological growth, the case for official intervention may be negligible: the costs of market failure may be outweighed by its benefits. Only certain failures call for intervention: where market failures retard industrial development, or where market solutions fail or take too long. Only certain failures call for intervention: where market failures retard industrial development, or where market solutions fail or take too long.

3. 3 2. Approaches to industrial competence Industrial development requires the firm to be technically and managerially efficient. Industrial development requires the firm to be technically and managerially efficient. Firms should gain competence and technological efficiency. Firms should gain competence and technological efficiency. This chapter focuses on the technological rather than the managerial and organizational aspects of efficiency. This chapter focuses on the technological rather than the managerial and organizational aspects of efficiency. There are two main approaches to industrial competence: the neoclassical approach and the capabilities approach. There are two main approaches to industrial competence: the neoclassical approach and the capabilities approach.

4. 4 2. Approaches to industrial competence: The Neoclassical All firms are efficient in the use of technologies, and there is no process of acquiring technological capabilities. All firms are efficient in the use of technologies, and there is no process of acquiring technological capabilities. If inefficiencies happen, they are because of management incompetence or negligence. If inefficiencies happen, they are because of management incompetence or negligence. Even if we are to assume that in the case of developing countries additional costs are needed to absorb new technologies, these costs are assumed to be very trivial, predictable and similar across industries. Even if we are to assume that in the case of developing countries additional costs are needed to absorb new technologies, these costs are assumed to be very trivial, predictable and similar across industries. Firms are assumed to acquire and use technologies as individual units in isolation. There are no linkages, no externalities, and no need to create information networks. No one industry is more strategic than others. Firms are assumed to acquire and use technologies as individual units in isolation. There are no linkages, no externalities, and no need to create information networks. No one industry is more strategic than others.

5. 5 2. Approaches to industrial competence: The Neoclassical And since markets are assumed to operate with equal degrees of efficiency there is no need to devise different policies by the level of development of the countries. And since markets are assumed to operate with equal degrees of efficiency there is no need to devise different policies by the level of development of the countries. Policy might be recommended for developing countries, if it is admitted that some factors may not operate efficiently (education). Policy might be recommended for developing countries, if it is admitted that some factors may not operate efficiently (education). This neoclassical approach does not recommend much intervention from government (liberal in nature). This neoclassical approach does not recommend much intervention from government (liberal in nature).

6. 6 2. Approaches to industrial competence: The Capabilities Acquisition of new technological capabilities (TC) is very important. To master and adapt new technologies, firms in developing countries need to develop new knowledge, skills, and inter- linkages between enterprises. Acquisition of new technological capabilities (TC) is very important. To master and adapt new technologies, firms in developing countries need to develop new knowledge, skills, and inter- linkages between enterprises. Technological capabilities are the information and skills that allow firms to utilize equipment and information efficiently. Such capabilities are firm-specific. Technological capabilities are the information and skills that allow firms to utilize equipment and information efficiently. Such capabilities are firm-specific. The growth of capabilities may be defined as industrial technology development (ITD). This process is evolutionary, and depends on the efforts of every enterprise. The growth of capabilities may be defined as industrial technology development (ITD). This process is evolutionary, and depends on the efforts of every enterprise.

7. 7 2. Approaches to industrial competence: The Capabilities The successful transfer of a new technology to a developing country has to include a major element of capability building: The successful transfer of a new technology to a developing country has to include a major element of capability building: simply providing equipment and operating instructions does not ensure that the technology will be properly used. simply providing equipment and operating instructions does not ensure that the technology will be properly used. Some tacit elements have to be learned (like training, engineering, technical information, experimentation and other capabilities). Some tacit elements have to be learned (like training, engineering, technical information, experimentation and other capabilities). Technological mastery is not a passive process. In order to successfully absorb and deploy new technical information, prior investments have to be made in human capital and organizational capabilities to decode the new technical information and to incorporate it into manufacturing processes. Technological mastery is not a passive process. In order to successfully absorb and deploy new technical information, prior investments have to be made in human capital and organizational capabilities to decode the new technical information and to incorporate it into manufacturing processes. Different firms can thus experience quite different rates of technological development and end up with different levels of efficiency in using the same technologies. There is no predictable learning curve along which all firms travel. Different firms can thus experience quite different rates of technological development and end up with different levels of efficiency in using the same technologies. There is no predictable learning curve along which all firms travel.

8. 8 2. Approaches to industrial competence: The Capabilities Manufacturers develop capabilities in a network of relationships with customers, suppliers, competitors, consultants and researchers. Manufacturers develop capabilities in a network of relationships with customers, suppliers, competitors, consultants and researchers. These linkages help individual firms to deal with each other, to gain access to expensive information and facilities and to create skills and standards that all firms need but no individual firm will generate on its own (public goods). These linkages help individual firms to deal with each other, to gain access to expensive information and facilities and to create skills and standards that all firms need but no individual firm will generate on its own (public goods). In industries with strong inter-linkages a firm cannot know its future cost structure (because it cannot predict the learning process of its suppliers and subcontractors) or take rational investment decisions in isolation. In industries with strong inter-linkages a firm cannot know its future cost structure (because it cannot predict the learning process of its suppliers and subcontractors) or take rational investment decisions in isolation. Efficient resource allocation requires an external agent to coordinate individual investments. The classic case for planning. Efficient resource allocation requires an external agent to coordinate individual investments. The classic case for planning. Developing countries depend on the import of technology and skills from advanced industrial countries. Therefore, technology transfer policy should be selective about what technology to allow into the country. Developing countries depend on the import of technology and skills from advanced industrial countries. Therefore, technology transfer policy should be selective about what technology to allow into the country. Costs of technology transfer are lower when the recipient has absorptive capabilities. Costs of technology transfer are lower when the recipient has absorptive capabilities.

9. 9 2. Approaches to industrial competence: The Capabilities We can have two modes: internalized modes or externalized modes. We can have two modes: internalized modes or externalized modes. Internalized modes are like foreign direct investment (FDI), where the seller of technology retains ownership and control of the utilization of technology. This mode tends to centralize the innovation process in developed economies. They transfer the results of their research to affiliates. Internalized modes are like foreign direct investment (FDI), where the seller of technology retains ownership and control of the utilization of technology. This mode tends to centralize the innovation process in developed economies. They transfer the results of their research to affiliates. Externalized modes are like licensing or equipment purchase, the recipient may not get the technology as rapidly, and has to do much more homework to absorb and build upon it. This may lead to more technological learning and a better understanding of the technology being transferred. Externalized modes are like licensing or equipment purchase, the recipient may not get the technology as rapidly, and has to do much more homework to absorb and build upon it. This may lead to more technological learning and a better understanding of the technology being transferred. The capabilities approach warns us that you cannot always rely on market forces, because market failures can happen. The firm should develop technological capabilities. The capabilities approach warns us that you cannot always rely on market forces, because market failures can happen. The firm should develop technological capabilities.

10. 10 3. The case for interventions in trade It has been empirically proven that Export Orientation (EO) strategies are successful strategies. It has been empirically proven that Export Orientation (EO) strategies are successful strategies. Neoclassical economics assumed that EO is equivalent to free trade. Under perfect competition and efficient markets free trade generates welfare benefits arising from comparative advantage. Neoclassical economics assumed that EO is equivalent to free trade. Under perfect competition and efficient markets free trade generates welfare benefits arising from comparative advantage. If we are to include the technological learning process, welfare implications do not hold. If we are to include the technological learning process, welfare implications do not hold. Free market prices cannot guide resource allocation correctly as far as investments in activities with difficult technologies are concerned. Free market prices cannot guide resource allocation correctly as far as investments in activities with difficult technologies are concerned. Infant industries might need protection until they are strong enough. Infant industries might need protection until they are strong enough.

11. 11 3. The case for interventions in trade The essential feature of industrial investment in developing countries is that they have to create new capabilities to utilize the technologies they import. The essential feature of industrial investment in developing countries is that they have to create new capabilities to utilize the technologies they import. This implies higher costs during the learning period relative to firms that have already gone through the learning process. This implies higher costs during the learning period relative to firms that have already gone through the learning process. In a completely free market regime firms in developing countries may under invest in activities that have costly learning periods. In a completely free market regime firms in developing countries may under invest in activities that have costly learning periods. The case for protection rests on the existence of a number of market failures in a free market that could distort resource allocation. These may create a case for intervention. The case for protection rests on the existence of a number of market failures in a free market that could distort resource allocation. These may create a case for intervention.

12. 12 3. The case for interventions in trade Sources of market failures in trade: Sources of market failures in trade: Trained workers might leave the firm after its investment on technology, or knowledge may leak out of the firm. Trained workers might leave the firm after its investment on technology, or knowledge may leak out of the firm. They may find that their own lack of experience and of supporting suppliers and institutions makes the learning process highly risky and unpredictable. They may find that their own lack of experience and of supporting suppliers and institutions makes the learning process highly risky and unpredictable. Firms may not realize the need for investment in capabilities to raise efficiency. Or firms may not know how to raise capabilities (they have to ‘ learn how to learn ’ ). Firms may not realize the need for investment in capabilities to raise efficiency. Or firms may not know how to raise capabilities (they have to ‘ learn how to learn ’ ). They may be unable to anticipate learning in vertically linked suppliers. They may be unable to anticipate learning in vertically linked suppliers. They may not be able to raise the finances to cover their losses during the learning period (capital market failures). They may not be able to raise the finances to cover their losses during the learning period (capital market failures).

13. 13 3. The case for interventions in trade John Stuart Mill (1848) attacked protection policies. John Stuart Mill (1848) attacked protection policies. Mill is a believer in free trade. Protection in his view should be temporary and for a short time. Mill is a believer in free trade. Protection in his view should be temporary and for a short time. The superiority of one country over another in a branch of production arises only from having begun it sooner; thus acquiring skill & experience The superiority of one country over another in a branch of production arises only from having begun it sooner; thus acquiring skill & experience Protection should be lifted once the necessary skills and experience are acquired. Protection should be lifted once the necessary skills and experience are acquired. Different technologies have different learning costs and periods. Complex, skill-intensive technologies require greater protection than those which have simple processes. Some industries need longer time of protection. Different technologies have different learning costs and periods. Complex, skill-intensive technologies require greater protection than those which have simple processes. Some industries need longer time of protection. Note: A country has certain sectors that are very important (strategic sectors). Note: A country has certain sectors that are very important (strategic sectors). Protection allows industries to have the necessary resources to develop capabilities, but the absence of competitive pressures during protectionist policy might make the firm unwilling to invest in expensive capability acquisition (disincentive effect). Protection allows industries to have the necessary resources to develop capabilities, but the absence of competitive pressures during protectionist policy might make the firm unwilling to invest in expensive capability acquisition (disincentive effect).

14. 14 3. The case for interventions in trade It is possible to offset this disincentive effect by forcing protected industries to enter export markets at early stages even while maintaining protection. This is the secret of the success of export orientation in East Asia. It is possible to offset this disincentive effect by forcing protected industries to enter export markets at early stages even while maintaining protection. This is the secret of the success of export orientation in East Asia. While learning costs always exist, complex technology may be more readily implemented by MNCs than by local firms. Because they have the knowledge, skills and financial resources to take capability development. While learning costs always exist, complex technology may be more readily implemented by MNCs than by local firms. Because they have the knowledge, skills and financial resources to take capability development. Even for countries that wish to depend on MNCs to drive their industrial development, there are many activities where the learning period may be too long and costly to finance in free trade conditions. Even for countries that wish to depend on MNCs to drive their industrial development, there are many activities where the learning period may be too long and costly to finance in free trade conditions. Multi-national companies generally don ’ t transfer their R&D activities to their subsidiaries in developing countries. Trade strategy and foreign investment is therefore necessary for developing countries, to encourage local firms to invest in research and in ‘ know-why ’ capabilities (not just know-how). Multi-national companies generally don ’ t transfer their R&D activities to their subsidiaries in developing countries. Trade strategy and foreign investment is therefore necessary for developing countries, to encourage local firms to invest in research and in ‘ know-why ’ capabilities (not just know-how).

15. 15 3. The case for interventions in trade There are many countries that have technological ambitions they do not wish to depend on foreign firms to transfer all the technologies they need or to conduct all sophisticated technological activity in their countries. There are many countries that have technological ambitions they do not wish to depend on foreign firms to transfer all the technologies they need or to conduct all sophisticated technological activity in their countries. For example Japan and South Korea vs. Saudi Arabia and other Arab countries. For example Japan and South Korea vs. Saudi Arabia and other Arab countries. In the case of Japan trade strategy becomes necessary not only to allow difficult activities to be started but also along with technology strategy, to encourage local firms to invest in developing know-why capabilities. In the case of Japan trade strategy becomes necessary not only to allow difficult activities to be started but also along with technology strategy, to encourage local firms to invest in developing know-why capabilities.

16. 16 4. Interventions in factor markets: Skills Industrialization needs education, experience, training on-the-job, supervisory & other skills. Industrialization needs education, experience, training on-the-job, supervisory & other skills. Companies sponsor some of the formal training of employees in developed countries. Companies sponsor some of the formal training of employees in developed countries. In developing countries, firms don ’ t usually sponsor training, because managers: In developing countries, firms don ’ t usually sponsor training, because managers: are not aware of the needs, and are also not educated enough. are not aware of the needs, and are also not educated enough. there are no suitable trainers locally. there are no suitable trainers locally. the fear that employees may leave to work for competitors. the fear that employees may leave to work for competitors. Many forms of educational investments are non-selective, providing a general base of skills for all activities, like schooling. Many forms of educational investments are non-selective, providing a general base of skills for all activities, like schooling. However, more specialized forms of training are highly industry specific, and policies to address these needs have necessarily to be selective. However, more specialized forms of training are highly industry specific, and policies to address these needs have necessarily to be selective. If the government has an active industrial strategy, pushing the economy into a selected complex areas of activity, it has to ensure that the necessary skills are created by the education system. If the government has an active industrial strategy, pushing the economy into a selected complex areas of activity, it has to ensure that the necessary skills are created by the education system.

17. 17 4. Interventions in factor markets: Technical Effort Most of the technological activity that firms undertake to cope with production problems, cost reduction … is an in-house affair. Most of the technological activity that firms undertake to cope with production problems, cost reduction … is an in-house affair. However such effort may suffer from market failure: However such effort may suffer from market failure: Firms in developing countries may not know that they have to undertake deliberate technological effort to resolve those problems. Firms in developing countries may not know that they have to undertake deliberate technological effort to resolve those problems. They may not have well functioning information and technical support services to draw upon. They may not have well functioning information and technical support services to draw upon. They may not possess the necessary means and facilities in the country. They may not possess the necessary means and facilities in the country. They may loose the knowledge to competitors. They may loose the knowledge to competitors. Government interventions in information and technology markets may be needed to correct such failures. Government interventions in information and technology markets may be needed to correct such failures. Many forms of technical info are available free to firms (journals, conferences … ) more complex info is available commercially from consultants. There is little need for policy intervention here, except to guide firms to the right sources of info. Many forms of technical info are available free to firms (journals, conferences … ) more complex info is available commercially from consultants. There is little need for policy intervention here, except to guide firms to the right sources of info.

18. 18 4. Interventions in factor markets: Technical Effort There are essential technological functions that have public goods features, thus suffer from market failure. These include the encouragement of technological activity in general (the development of special research skills, setting of industrial standards, contract research … ) the provision of these services has to be undertaken as an infrastructural service, or as a cooperative activity. There are essential technological functions that have public goods features, thus suffer from market failure. These include the encouragement of technological activity in general (the development of special research skills, setting of industrial standards, contract research … ) the provision of these services has to be undertaken as an infrastructural service, or as a cooperative activity. The public infrastructure for science and technology (S&T) may comprise a variety of institutions, from universities to standards institutes and R&D institutions. The public infrastructure for science and technology (S&T) may comprise a variety of institutions, from universities to standards institutes and R&D institutions. From the viewpoint of industrial policy, intervention in technology markets have to be integrated with interventions in product markets. Industries being promoted cannot become efficient unless matching measures are undertaken to provide info and technical support. From the viewpoint of industrial policy, intervention in technology markets have to be integrated with interventions in product markets. Industries being promoted cannot become efficient unless matching measures are undertaken to provide info and technical support.

19. 19 4. Interventions in factor markets: Finance The development of technological capabilities (TC) is an investment in time and money. Failures in capital market can therefore be a barrier to capability development, and resources for technology development can be reduced. The development of technological capabilities (TC) is an investment in time and money. Failures in capital market can therefore be a barrier to capability development, and resources for technology development can be reduced. Capital market failures are widespread in developing countries because of weak economic structures. There is also inadequate information, lack of knowledge, along with the usual risks inherent in technological activities. Capital market failures are widespread in developing countries because of weak economic structures. There is also inadequate information, lack of knowledge, along with the usual risks inherent in technological activities. Some countries like Korea and Japan have an industrial policy that involves the direct participation of government in the allocation of investments (by owning banks or industrial enterprises). Some countries like Korea and Japan have an industrial policy that involves the direct participation of government in the allocation of investments (by owning banks or industrial enterprises).

20. 20 5. Some country experiences: Hong Kong Hong Kong followed a laissez faire policy, it did not intervene in product markets. Hong Kong followed a laissez faire policy, it did not intervene in product markets. The Hong Kong government provided The Hong Kong government provided education and training, education and training, subsidized land to manufacturers, subsidized land to manufacturers, It set up the Hong Kong productivity centre to perform various technological services to help producers improve their technologies. It set up the Hong Kong productivity centre to perform various technological services to help producers improve their technologies. Its interventions were predominantly non-selective. Its interventions were predominantly non-selective. Thus the level of intervention was fairly low and trade was always free. Thus the level of intervention was fairly low and trade was always free. Two features of the Honk Kong experience have to be noted: Two features of the Honk Kong experience have to be noted: 1. First, It started with several unique advantages for industrialization. Hong Kong had more than a century and half of intermediate trading experience. Hong Kong had more than a century and half of intermediate trading experience. The presence of several British business and finance houses provided a constant supply of foreign skills and training. The presence of several British business and finance houses provided a constant supply of foreign skills and training. After the communist takeover Chinese entrepreneurs, engineers and technicians came from Shanghai. After the communist takeover Chinese entrepreneurs, engineers and technicians came from Shanghai.

21. 21 5. Some country experiences: Hong Kong 2. Second. The colony started and stayed with light labor-intensive manufacturing industry. The colony started and stayed with light labor-intensive manufacturing industry. Its success was based on the development of operational and marketing capabilities. Its success was based on the development of operational and marketing capabilities. There was little diversification (textile and toy) There was little diversification (textile and toy) There was little natural progression up the ladder of industrial complexity into more difficult and demanding technologies. There was little natural progression up the ladder of industrial complexity into more difficult and demanding technologies. As wage and land pressures increased the colony had to relocate its manufacturing. As wage and land pressures increased the colony had to relocate its manufacturing. Because of the size, location and history of the colony, this industrialization strategy is not one that may be open to other developing countries. Because of the size, location and history of the colony, this industrialization strategy is not one that may be open to other developing countries. But it should be noted that the laissez faire policy prevented the colony from adopting strategies that have generated the computer and telecom products of Singapore, Korea and Taiwan. But it should be noted that the laissez faire policy prevented the colony from adopting strategies that have generated the computer and telecom products of Singapore, Korea and Taiwan. Today the government has toned down the laissez faire policy to permit a new applied research and development scheme. Today the government has toned down the laissez faire policy to permit a new applied research and development scheme.

22. 22 5. Some country experiences: South Korea Its record of industrial development is the most impressive in modern economic history, even more than Japan ’ s. Its record of industrial development is the most impressive in modern economic history, even more than Japan ’ s. Its government intervened extensively in both product and factor markets. Its government intervened extensively in both product and factor markets. It offered high and prolonged periods of protection to selected activities, while forcing those that approached competitiveness to export significant parts of their output. It offered high and prolonged periods of protection to selected activities, while forcing those that approached competitiveness to export significant parts of their output. It directed domestic resources to infant industries, subsidized credit, and encouraged the emergence of giant private conglomerates (chaebol). It directed domestic resources to infant industries, subsidized credit, and encouraged the emergence of giant private conglomerates (chaebol). It invested heavily in education, especially technical, and forced firms to train their employees. It also invested in R&D and technology institutions, while encouraging local firms to open their own research. It invested heavily in education, especially technical, and forced firms to train their employees. It also invested in R&D and technology institutions, while encouraging local firms to open their own research.

23. 23 5. Some country experiences: South Korea The most important aspect of Korea ’ s industrial success is that it was largely based on innate enterprises that imported and integrated complex technologies rather than on technology transfer via direct investment. The most important aspect of Korea ’ s industrial success is that it was largely based on innate enterprises that imported and integrated complex technologies rather than on technology transfer via direct investment. The Korean government was and still is very selective concerning foreign direct investment. The Korean government was and still is very selective concerning foreign direct investment. Korea ’ s investments in education and R&D, and the encouragement of the giant chaebol, were a necessary part of its nationalist strategy, driven by the objective of being efficient in world markets. Korea ’ s investments in education and R&D, and the encouragement of the giant chaebol, were a necessary part of its nationalist strategy, driven by the objective of being efficient in world markets. A strategy of nationalism with inward orientation (India) would have led to less efficiency. A strategy of nationalism with inward orientation (India) would have led to less efficiency. A strategy of outward orientation with reliance on foreign investors (Singapore) would have led to lower domestic innovative capabilities. A strategy of outward orientation with reliance on foreign investors (Singapore) would have led to lower domestic innovative capabilities.

24. 24 5. Some country experiences: Singapore The government has been very interventionist, The economy started with a base of trading, ship servicing and petroleum refining. The government has been very interventionist, The economy started with a base of trading, ship servicing and petroleum refining. After a brief period of import substitution, it moved into export oriented industrialization based on foreign investment and technology transfer by MNCs. After a brief period of import substitution, it moved into export oriented industrialization based on foreign investment and technology transfer by MNCs. The government upgraded the industrial structure by intervening in the entry of foreign investors to guide them to higher value-added activities, and in education to create specific high-level technical skills. The government upgraded the industrial structure by intervening in the entry of foreign investors to guide them to higher value-added activities, and in education to create specific high-level technical skills. They set up institutes jointly with industry to give specialized instruction to employees rather than pre- employment education. They set up institutes jointly with industry to give specialized instruction to employees rather than pre- employment education.

25. 25 5. Some country experiences: Singapore The heavy reliance on FDI for technology and skill transfer led the industry into sophisticated producer and consumer electronics … but the technological depth was low. The heavy reliance on FDI for technology and skill transfer led the industry into sophisticated producer and consumer electronics … but the technological depth was low. The lesson of Singapore: The lesson of Singapore: First, FDI can take a small economy a long way if it is carefully selected and guided, supplied with excellent infrastructure and a trained workforce and given a stable and competitive environment. First, FDI can take a small economy a long way if it is carefully selected and guided, supplied with excellent infrastructure and a trained workforce and given a stable and competitive environment.

26. 26 5. Some country experiences: Taiwan Like Hong Kong, Taiwan has influx of capital, skills, and entrepreneurship from China. Like Hong Kong, Taiwan has influx of capital, skills, and entrepreneurship from China. Like Korea, The state selects and promotes specific industries by protection and credit allocations. FDI is allowed on a selective basis. Like Korea, The state selects and promotes specific industries by protection and credit allocations. FDI is allowed on a selective basis. Heavy industry is led by the public sector. Taiwan has a very large public sector. Heavy industry is led by the public sector. Taiwan has a very large public sector. Most private enterprises are small or medium size, meeting specific market niches rather than mass production, they are labour intensive. Most private enterprises are small or medium size, meeting specific market niches rather than mass production, they are labour intensive. There isn ’ t much R&D conducted, and there is not much emphasis on creating international brand names. There isn ’ t much R&D conducted, and there is not much emphasis on creating international brand names. Taiwan and South Korea intervened heavily to direct domestic credit to chosen activities. They also invested heavily in creating a Science & Technology (S&T) infrastructure. Taiwan and South Korea intervened heavily to direct domestic credit to chosen activities. They also invested heavily in creating a Science & Technology (S&T) infrastructure.

27. 27 5. Some country experiences: India India had a strong manufacturing base including several industries like steel, paper, chemicals, cement, machinery and consumer products. India had a strong manufacturing base including several industries like steel, paper, chemicals, cement, machinery and consumer products. There is an indigenous entrepreneurial class in India, and good infrastructure and administrative system. Macroeconomic policies have been sound. There is an indigenous entrepreneurial class in India, and good infrastructure and administrative system. Macroeconomic policies have been sound. Investments in human capital and the presence of a science & technology plan have been helpful. Investments in human capital and the presence of a science & technology plan have been helpful. Policy interventions by the government to promote industrial development had mixed results Policy interventions by the government to promote industrial development had mixed results

28. 28 5. Some country experiences: India The pros of Indian policy interventions have been: The pros of Indian policy interventions have been: a diverse industrial structure able of producing all industrial products, a wide range of manufactured exports, a diverse industrial structure able of producing all industrial products, a wide range of manufactured exports, and a wide base of domestic capabilities to design complex products. and a wide base of domestic capabilities to design complex products. The cons of Indian policy interventions: The cons of Indian policy interventions: low industrial growth rates, low industrial growth rates, rigid investment licensing and controls on output and technology acquisition resulted in product shortages that inhibited competitive behaviour rigid investment licensing and controls on output and technology acquisition resulted in product shortages that inhibited competitive behaviour high import barriers isolated enterprises from foreign technological developments, high import barriers isolated enterprises from foreign technological developments, rigid regulatory system, constrained firm ’ s ability to enter new markets and expand and their ability to restructure and close down rigid regulatory system, constrained firm ’ s ability to enter new markets and expand and their ability to restructure and close down Continued production by financially weak firms via subsidies, undermined the viability of the remaining more efficient units. Continued production by financially weak firms via subsidies, undermined the viability of the remaining more efficient units. Heavy indirect taxes raised domestic prices constraining firms ability to expand markets and achieve economies of scale. Heavy indirect taxes raised domestic prices constraining firms ability to expand markets and achieve economies of scale.

29. 29 5. Some country experiences: India India did not have good export performance, and its products had high prices and variable quality. India did not have enough technology and efficiency. India did not have good export performance, and its products had high prices and variable quality. India did not have enough technology and efficiency. India have always had high tariffs, a complex licensing system with enormous delays, and export disincentives. There were corrupt processes and many restrictions. India have always had high tariffs, a complex licensing system with enormous delays, and export disincentives. There were corrupt processes and many restrictions. International competitiveness was not considered by the government, and many resources had non-economic uses. International competitiveness was not considered by the government, and many resources had non-economic uses. There has been no productivity growth, no real competitiveness, and very slow upgrading of capabilities in most industries. The imported technology was usually of low quality. There has been no productivity growth, no real competitiveness, and very slow upgrading of capabilities in most industries. The imported technology was usually of low quality. Foreign direct investment was restricted. There were also restrictions on entry and exit, and on growth of large (monopoly) firms. Foreign direct investment was restricted. There were also restrictions on entry and exit, and on growth of large (monopoly) firms.

30. 30 5. Some country experiences: India A variety of activities were reserved to the Indian government. The public sector had privileged access to factors of production like finance and infrastructure, as well as to the science & technology system. A variety of activities were reserved to the Indian government. The public sector had privileged access to factors of production like finance and infrastructure, as well as to the science & technology system. There was low investment in India in skill generation, and there was widespread illiteracy. There was low investment in India in skill generation, and there was widespread illiteracy. R&D scientists and engineers were 150 people per million in India (versus 1283 in South Korea). R&D scientists and engineers were 150 people per million in India (versus 1283 in South Korea). R&D in India accounts for 1% of GDP (versus 2.1% in Korea). There are few linkages between technology institutions and industry. R&D in India accounts for 1% of GDP (versus 2.1% in Korea). There are few linkages between technology institutions and industry.

31. 31 6. Implications The analysis of technological capabilities is essential to understanding industrial development and industrial policy. The analysis of technological capabilities is essential to understanding industrial development and industrial policy. The promotion of capability development is a vital part of the strategy of industrial development. The promotion of capability development is a vital part of the strategy of industrial development. In the presence of market failures, active government involvement is required to ensure capability development. In the presence of market failures, active government involvement is required to ensure capability development. There should be selective and functional interventions in both product and factor markets. There should be selective and functional interventions in both product and factor markets.

32. 32 6. Implications The removal of irrational and inefficient interventions is necessary. The removal of irrational and inefficient interventions is necessary. The determinants of capability development are: the incentive framework, the supply of human capital, the supporting technology infrastructure, finance for technological activity, and access to foreign technologies. The determinants of capability development are: the incentive framework, the supply of human capital, the supporting technology infrastructure, finance for technological activity, and access to foreign technologies. A rational industrial policy in product markets should provide constant competition to enterprises. A new entrant has to incur the costs and risks of gaining technological mastery. A rational industrial policy in product markets should provide constant competition to enterprises. A new entrant has to incur the costs and risks of gaining technological mastery.

33. 33 6. Implications There should be selective and variable infant industry protection. Protection should also encourage efficiency and capability building of local firms. There should be a strong commitment to be export-oriented. There should be selective and variable infant industry protection. Protection should also encourage efficiency and capability building of local firms. There should be a strong commitment to be export-oriented. Factor markets also need policy and intervention. Human capital, technical support, technology, information and finance usually suffer from deficiencies in developing countries. Factor markets also need policy and intervention. Human capital, technical support, technology, information and finance usually suffer from deficiencies in developing countries. Activities being promoted should not be penalized by lack of factors and information. Selectivity and coherence are needed. The supply side of capability building is very important. Activities being promoted should not be penalized by lack of factors and information. Selectivity and coherence are needed. The supply side of capability building is very important. Given imperfect markets, the costs of non-intervention may be very high. Given imperfect markets, the costs of non-intervention may be very high.