3a. Industrialization and industrial policy 0

Overview Rationales for industrialization SEA industrialization patterns Industrial promotion policies, esp. tariffs Effects of a tariff on industry growth, welfare and distribution 1

Motives for industrialization Modernization, technology transfer Diversification Less reliance on season/climate Less price risk – manufacturing prices are stable Less dependence on foreign sources (Belief in) increasing returns in some industries - lower unit costs permit more output using same resources. Marshallian interfirm/interindustry externalities (shared infrastructure, agglomeration externalities) Overall aim: capture 'long-run comparative advantage' as an industrial economy. 2

Growth rates of GDP and mfg value added (av. annual %) 3

Employment in industry (% total labor force) 4 Why so much variation in industriztn and employment rates and patterns among apparently similar economies?

Labor productivity: sectoral differences 5

Industrial promotion strategies Why? Promote industrial growth, get growth dividend How? Mainly, but not exclusively, trade policies Economics of protectionism Tariffs are most popular, if not best, way to protect favored industries. Easier to monitor trade flows at the port Raise revenue for G. Easy to levy (many losers, but per capita losses are small) Some of the biggest losers may be foreigners anyway. 6

Outcomes of protection: one sector 7 A tariff boosts production by raising domestic price from p* to p*(1+t) -- Diverts demand from imports to domestic products (a) -- Reduces total demand (consumers must pay more) -- Raises gov’t revenue (c) -- Causes deadweight losses through misallocation (b + d) 0 Q 1 Q 2 Q 3 Q 4 p*(1+t) p* S D a b c d

Intersectoral effects of protection 8 Supply of forex comes from exports; demand is to cover imports Tariff on imports reduces the demand for forex -- Floating exchange rate: tariff causes ER appreciation Lerner symmetry: a tariff discourages both imports and exports D = import bill D' S = export earnings For. exchange Exch. rate (Rp/$) E0E1E0E1 F 1 F 0

Philippine protectionism and development In SE Asia, the Philippines had highest and most persistent tariffs High rates of nominal protection on imports produced negative effective protection for traditional exports (agriculture) Effective protective rates by import category: 9 Import category Consumer items Nonessential Semiessential14957 Essential-155 Producer items Nonessential Semiessential5214 Essential5019 Trad’l exports What effect would these have had on incentives to produce and invest?

Static gains and losses from protection Protected industries grow, at expense of foreigners, consumers and other industries Gov’t revenue will probably be higher due to tariffs Inward orientation: domestic markets for all goods become relatively important Industry structure: protection tends to create monopolies  “rent-seeking society” Distortions to investment and FDI incentives 10

Dynamics: growth implications of protection Does inward orientation have long-run effects on growth? Answer depends on how protection is used Do infant industries really do grow up? Do the costs of protection inhibit/enhance growth in other sectors? Protection and growth in the long run Incentives & opportunities for rent-seeking (infant industries fail to grow) Investment follows rents rather than seeking efficient opportunities … 11

The Bhagwati effect in Thailand Bhagwati hypothesis: rent-seeking FDI creates fewer productivity gains than efficiency-seeking FDI High tariffs and monopoly power attract rent-seeking FDI Protected industries are more capital-intensive than average, so there’s a ‘technology gap’ as well Growth dividends from this FDI are small – or even negative Kohpaiboon (World Dev 2006) finds this for Thailand: At the mean rate of industry protection, labor productivity is lower by 0.15% for every 1% higher foreign ownership share Implication: protection “damages” the growth effect of FDI Any comparisons with Vietnam? 12

Protection and income distribution (1) Supply side (factor markets) What are the characteristics of industries most likely to be awarded protection? Which industries display least comp. adv? What are the likely factor market effects of expansion in these industries (& contraction/slower growth in others)? Factors used intensively in expanding industries enjoy price rises (demand for their services has risen) Factors used intensively in contracting sectors lose In SE Asia, which factors are likely to gain most from industry promotion? Lose most? 13

Protection and income distribution (2) 14 Demand side (product markets) Consumers of goods produced in protected industries lose thru higher prices. Industries using inputs produced by protected sectors lose. Consumers of goods whose prices are indirectly affected (N goods) lose. Protection and non-traded goods: if T and N goods are substitutes, raising some T prices will increase N demand and price Combined distributional outcomes Losers from protection are owners of factors not intensively used in protected industries, and/or consumers of protected goods and/or non-traded goods.

Winners and losers from protection Given the chance, which groups would vote for industry protection, and which against? Why? (at least 3 reasons…individual interest and national interest) Manufacturing sector capitalists Farmers in export crop sectors (coffee, coconut, tropical fruit) Skilled workers/middle class Unskilled workers 15

Industrialization and protection: summary Development benefits of industry growth are clear But ISI in SE Asia was not the most efficient path to industrialization Uncompetitive industries rely on (small) domestic market Protected industries are capital-intensive, their growth does not generate many jobs Spillover costs to other industries, including exporters Protected industries attract ‘bad’ (rent-seeking) investment Protection favors owners of capital against owners of labor Any alternatives? Under what conditions might industry grow successfully without protection? 16