Kuznets Lecture
New Structural Economics:
A Framework for Rethinking Development
Justin Yifu Lin
Chief Economist and Senior Vice President
the World Bank
March 1, 2011
1
Overview of Presentation
• Why do we need to rethink development
• The New Structural Economics
• Industrial Policy and Growth Identification and
Facilitation: An application of new structural
economics
2
WHY DO WE NEED TO RETHINK
DEVELOPMENT
3
Economic Crisis and
Crisis in Economics
Rethinking
Economics
Economic Theory
Failure to:
Explain Observed
Economic
Phenomena
Failure to:
Guide Economic
Policies or
Choices
4
How has economic development theory
evolved?
Successful East Asian
Tigers: Export Promotion
China, Vietnam and Mauritius:
Dual-track approach to
transition
Rethink
Development
Market based economies with proactive role for government
Structuralist Approach
Focus on Market Failures:
Import Substitution Strategy
Miserable results
1950
1960
1970
Liberalization Approach
Focus on Government Failures:
Privatization and Marketization
Mixed Results
1980
1990
2000
2010
5
World Bank has been in the process of
rethinking economic development
Export
Orientation and
Market Friendly
Government
No one-size fits all
(i) Openness;
(ii) Macro stability;
(iii) High rates of saving &
investment;
(iv) Market mechanism;
(v) Committed, credible &
capable government
6
THE STRUCTURAL ECONOMICS
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Introducing…
New Structural Economics
• Application of neoclassical economic approach to
understand changing economic structure in
development
• Provides a consistent framework for the five
stylized facts of Growth Report as well as the
findings from the East Asian Miracle and Lessons
from the 1990s
• Contributes to new theoretical and policy
insights for economic development
8
Introducing…
New Structural Economics
• Sustainable income growth is the foundation for poverty reduction and
development
• Sustainable income growth is a recent phenomenon
30,000
Western Europe
Western Offshoots
Eastern Europe
Former USSR
Latin America
Japan
Asia excl. Japan
Africa
25,000
20,000
15,000
10,000
5,000
0
1
1000 1500 1600 1700 1820 1870 1913 1950 1973 2001
• The sustainable income growth is a result of continuous technological
innovation as well as structural change
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Industrial Structure in New England, 1900s
10
Industrial Structure in New England, 1600s
11
Industrial Structure in New England, 1800s
12
New Structural Economics (NSE):
Key Concepts
• The main hypothesis: Industrial structure is endogenous to
endowment structure
• Initial Endowments (determine the economy’s total
budgets and relative factor prices at time t)
– Comparative advantage
– Optimal industrial structure (endogenous).
• Dynamics: Income growth depends on
– Upgrading of endowments
– Upgrading industrial structure
– “hard” and “soft” infrastructure
• Following comparative advantage is the best way to
upgrade endowment structure and to sustain industrial
upgrading, income growth and poverty reduction.
13
New Structural Economics (NSE):
Key Concepts (2)
• Firms maximize profits…choice of technology
and industries based on relative factor prices…
Need for competitive market
system
• Industrial upgrading needs to
– Solve coordination problems
– Address externalities
Need for a facilitating state
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NSE and The Growth Commission’s
Stylized Facts
Growth Report
• Policy Recommendation from NSE
– Following comparative advantage : Conditions
Stylized Facts:
• Market economy
• Facilitating State
• The results:
– Openness and advantage of backwardness
– Competitiveness and strong external as well as fiscal
accounts: fewer home-grown crises and larger
scope for countercyclical fiscal policies.
– Large economic surplus and high returns to
investment: high rate of savings and investment.
#4
#5
#1
#2
#3
• The NSE’s recommendations are consistent with
the East Asian Miracle’s findings.
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“No one size fits all” then “What size fits what?”
New theoretical insights from the NSE:
•
•
New structural economics emphasizes that countries at different levels of
development have different optimal industrial structures, firm sizes, capital
requirements and nature of risks, therefore, many institutions and policies should
be different accordingly and have different policy insights compared to the old
structuralism and neoclassics:
Financial institutions:
– Old structuralism: Direct government mobilization and allocation of financial resources.
– Neoclassics: Financial liberalization and development of modern big banks and equity market
– New structural economics: Optimal financial structure will be different depending on level of
development. For low-income countries, small, local financial institutions should be the core
of financial structure; and big banks and equity market will play increasingly important role as
the firm size and risks increase with the level of development.
•
Fiscal stimulus:
– Old structuralism: Keynesian stimulus, using tax and expenditure policies to offset business
cycles.
– Neoclassics: Ricardian Equivalence, warming against the use of fiscal stimulus.
– New Structural economics: Beyond Keynesianism, using public investments to invest in
productivity-enhancing, bottleneck-releasing infrastructure projects as countercyclical
measures.
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THE INDUSTRIAL POLICY
&
GROWTH IDENTIFICATION AND
FACILITATION
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The desirability and failures of Industrial Policy
•
•
•
Economic development is a process of continuous process of industrial upgrading
and structural transformation. The state should play a facilitating role in the
process.
Industrial policy is a necessary instrument for the state to play the facilitating role
– Contents of coordination will be different, depending on industries.
– The government’s resources and capacity are limited. The government needs
to use them strategically.
The sad fact is that most governments in the developing world used industrial
policies but failed, the reason was:
– Attempt to develop industries that went against comparative advantage
– The firms in the industrial policy’s targeted sectors were non-viable in
competitive markets and required government policy supports for their initial
investment and continuous operations.
– The supports were implemented through price distortions. As a result,
planning and administrative allocations were required.
– This led to rent-seeking, directly unproductive profit seeking, and soft budget
constraints.
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The existing approaches for industrial development
and their drawbacks
•
•
•
The existing practices:
– Business environment
• The goal is to introduce a whole set of the first-best institutions
• The issues are:
– The government may not have the capacity to introduce all those changes
– The first-best institutions may be different at different stage of development
– No identification of industries with latent comparative advantages and no compensation
for the first movers
– Growth Diagnostics
• The goal is to remove binding constraints
• The issues are:
– Binding constraints are endogenous to industries
– It relies on survey of existing firms. Many of them may be in industries where the
country has no comparative advantages.
– No firms will be in the new industries that the countries have latent comparative
advantage
Aim before fire: For an industrial policy to be successful, it should target sectors that conform to the
economy’s latent comparative advantage:
– Firms will be viable and the sectors will be competitive once the government helps the firms
overcome the coordination and externality issues
But how to pick the sectors that are the economy’s latent comparative advantages
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What Can Be Learned From History
• Historical experiences show that successful countries’ industrial policies,
in general, targeted dynamic industries in successful countries with a
similar endowment structure and somewhat higher per capita income:
– Britain targeted the Netherlands’ industries in the 16th and 17th century, its per capita GDP was
about 70 % of Netherlands’.
– Germany, France, and USA targeted Britain’s industries in the late 19th century, their per
capita income were about 60 to 75 % of Britain’s per capita GDP
– In Meiji restoration, Japan targeted Prussia’s industries, its per capita GDP was about 40% of
Prussia’s. In the 1960s, Japan targeted USA’s industries, its per capita GDP was about 40% of
USA’s per capita GDP
– In the 1960s-1980s, Korea, Taiwan, Hong Kong, and Singapore targeted Japan’s industries,
their per capita income was about 30% of Japan’s per capita GDP
– In the 1970s, Mauritius targeted Hong Kong’s industries, its per capita income was about 50%
of Hong Kong’s.
– In the 1980s, Ireland targeted information industries, its per capita income was about 45% of
the USA’s.
– In the 1990s, Costa Rica targeted memory chip assembly and testing, its per capita GDP was
about 40% of that of Taiwan, which was the main economy in this sector.
• Unsuccessful industrial policies in general target industries in countries
where their per capita GDPs were less than 20 per cent of those targeted
countries.
• A new approach for industrial policy: Growth identification and facilitation
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Step 1: Identifying sectors with latent comparative
advantage
• Find dynamic growing countries with a similar endowment
structure and with about 100% higher per capita income.
Identify tradable industries that have grown well in those
countries for the last 20 years as the potential targets of
industries for upgrading or diversification
• Similar to Hausmann’s idea of jumping to nearby trees, but
easier to implement
• Consistent with FDI research suggesting technology transfer is
easier when domestic and foreign firms are closer to each
other on the technological frontier (Blomstrom, Kokko)
Step 2: Removing constraints for existing
firms….How?
• See if some private domestic firms are already in those industries
(of which may be existing or nascent). Identify constraints to
quality upgrading, further firm entry, and reduction of transaction
costs (hard and soft infrastructure). Take action to remove
constraints
• Methods:
– Value-chain analysis
– Growth Diagnostics (Hausmann, Rodrik, and Velasco (2008))
– Investment Climate Assessments (World Bank)
• Successful Examples
– Chile: wine
– Ecuador: cut flowers
Step 3: Seek FDI or organize New Firm
Incubation Programs
•
In industries where no domestic firms are currently present, seek FDI from
countries examined in step 1, or organize new firm incubation programs.
•
Famous examples of FDI:
–
–
–
–
–
–
garment sector in Bangladesh
Textile industry in Mauritius
Memory chip assembly and testing in Costa Rica
Electronics and other consumer products in China
Information industries in Ireland
Laura Alfaro and Andrew Charlton, in a paper in the Journal of International Economics, show
that:
•
•
•
Many countries promote FDI selectively
Targeted sectors grow faster
Famous example of incubation programs:
– Taiwan-China’s Hsingchu Science-based Industrial Park for the development of electronic and
IT industries
– Fundación Chile’s demonstration of commercial salmon farming
Step 4: Scale up private firm’s self
discovery
• In addition to the industries identified above, the
government should also pay attention to
spontaneous self discovery by private enterprises
and give support to scale up the successful
private innovations in new industries
• Examples
– India’s information industry
– Ethiopia’s cut flower exports
– Peru’s asparagus exports
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Step 5: Create zones or industrial parks, and
encourage industrial clusters
• In countries with poor infrastructure and bad business environment,
special economic zones or industrial parks may be used to
overcome these barriers to firm entry and FDI and encourage
industrial clusters.
• Examples:
– China’s special economic zones
– Mauritius’ export process zone
• Enormous Increase in Number of Zones World Wide: from 29 in
1975 to 3500 in 2006!
– The zones will be successful only if the industries targeted by the
zones are consistent with the comparative advantages of their
economies
•
Step 6: Provide limited subsidies to
compensate for externalities
The need for subsidizing pioneer firms
–
–
•
Information externality of success and failure
Asymmetry of gain of success and loss of failure
The governments in developed countries compensate pioneer firms by:
–
–
–
–
–
Patents
Supports for basic research
Mandate
Government procurement
Except for patents, the other supports are sector specific
•
The government in a developing country can compensate pioneer firms in the
listed identified in step 1 with
– Tax incentives for a limited period
– Direct credits for investments
– Access to foreign exchanges
•
As the government’s support is only to compensate for information externalities,
the support can, and should, be limited both in magnitude and time.
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