Capacity to transform

That is the title of a chapter in Charles Kindleberger’s 1962 book Foreign Trade and the National Economy I immediately loved the phrase, and found that it helped me crystallize some thoughts.

The capacity to transform, in Kindleberger’s formulation, is essentially an economy’s ability to re-allocate resources in response to market signals. He discusses it in the context of exports, but it is clearly broader than that:

Capacity to transform is capacity to react to change, originating at home or abroad, by adapting the structure of foreign trade to the new situation in an economic fashion. … A higher price leads to more labor, land, and capital being attracted to a given product, and more output. A lower price results in reduced production.

The capacity to transform varies. Kindleberger thought that traditional societies with pre-modern economies had a lower capacity to transform, as social strictures prevented people from changing occupations or established business practices. The process of economic development is thus in some sense the process of increasing the capacity to transform:

These reactions require responses to profit and to income differences on the part of entrepreneurs and owners of factors which disregard traditional usage. Entrepreneurs are ready to shift to new occupations, labor to take on unaccustomed tasks. There must be occupational, spatial, and probably social mobility to accommodate the shifts of factors required by evolving economic opportunities. Upward social mobility must be possible through economic success, and not only through the army, church, and politics. A minimum of education and literacy are required–more is better–to permit the retraining of labor and its instruction in new tasks.

But he saw clearly that capacity to transform does not simply rise in a straight line, and varies from place to place and time and time. The mobility of labor, workers moving changing locations and jobs to better their pay, is one of the most obvious indicators of capacity of transform. Yet there are numerous examples of workers who did not respond in that way to price signals:

Underdeveloped economies are not alone in their incapacity to adapt. … Distressed areas, pockets of unemployment, and low-income industries and regions are found in countries of all levels of average income.

The reasons for incapacity to adjust are social in developed countries as well as underdeveloped. In Lowell, Massachusetts, the young do not move away when the cotton mills cut back output; they share the work on short time, or take turns in working full time in the mills and drawing unemployment relief. The green valleys of Wales similarly clung to their youth when coal was depressed in the 1930s. Brittany and the Southwest in France and the South of Italy contained disguised unemployment in agriculture, along with industrial workers at less than average national wage rates who refuse to migrate to increase their earnings.

Similar failures of mobility have gotten increased attention in economics in recent years, as research has shown that in countries as different as India and the US, workers often did not move away from regions with declining industries. Here is a recent op-ed on this point by fresh Nobel laureates Esther Duflo and Abhijit Banerjee: 

When jobs vanish and the local economy collapses, we cannot count on people’s desire to seek out a better life to smooth things out. The United States population is surprisingly immobile now. Seven percent of the population used to move to another county every year in the 1950s. Fewer than four percent did so in 2018. The decline started in 1990 and accelerated in the mid-2000s, precisely at the time when the industries in some regions were hit by competition from Chinese imports. When jobs disappeared in the counties that were producing toys, clothing or furniture, few people looked for jobs elsewhere. Nor did they demand help to move or to retrain — they stayed put and hoped things would improve. As a result, one million jobs were lost and wages and purchasing power fell in those communities, setting off a downward spiral of blight and hopelessness. Marriage rates and fertility fell, and more children were born into poverty.

From that, they conclude that in general, “Financial incentives are nowhere near as powerful as they are usually assumed to be.” And they are surely right that “status, dignity and social connections” are the main motivators for human beings, who are fundamentally social creatures.

But it still seems that it would be more productive to treat capacity to transform as a variable, and try to understand how it changes over time and how it varies among different places. The decline in the mobility of labor over recent decades in the US is well-documented, and surely calls out for some kind of theory.

Kindleberger seemed to think that a weakening capacity to transform in advanced economies–like a loss of labor mobility, or the phenomena Tyler Cowen has grouped under the labels of “stagnation” or “complacency”–was part of the natural course of history. He did not quite offer a theory of this, but he sketched the outlines of a model:

Capacity to transform probably follows a pattern. In traditional societies it is minimal. With exposure to the modern world it increases. At some stage in the growth process it reaches a peak, and then there seems to be some diminution in it.

Kindleberger cites the adage “three generations from shirtsleeves to shirtsleeves” (which has an exact counterpart in the Chinese saying 富不过三代 “wealth does not survive three generations”) to illustrate our intuitive understanding that success can weaken the drive to change. So one could posit a “Kindleberger curve” in which capacity to transform first increases as the economy develops, and then decreases.

Such a curve would be close to the mirror image of what James Galbraith proposed, in his 2012 book Inequality and Instability, as the “augmented Kuznets curve,” which shows how inequality evolves as an economy’s level of income rises. Simon Kuznets had originally argued that in the early stages of the transition from traditional agriculture to industry, inequality would first rise as incomes rose, but as that transition advanced further, inequality would decline substantially even as incomes kept increasing. Galbraith recognized that in the decades after Kuznets wrote, inequality in industrialized countries had stopped declining and started to rise again. He argued that another structural transition, involving a rising economic role for finance and high technology, was responsible. Galbraith therefore augmented Kuznets’ original curve by adding an upward swing at the end:

Based on the experience of the US, it seems like the downward slope of the augmented Kuznets curve should roughly coincide with the upward slope of the Kindleberger curve, as should the subsequent rise in inequality and decline in capacity to transform. Since inequality could itself constrain the capacity to transform, and reduced capacity to transform could entrench inequality, these two changes could be related.

But while a declining capacity to transform can be problematic, this does not mean that capacity to transform must always be maximized. Kindleberger also wrote that “Worse than not being able to respond to an economic stimulus may be, under certain circumstances, responding too much.” The examples he gives of “capacity to transform with a vengeance” are less about the re-allocation of labor and more about investment flows: how lags in production of agricultural goods or housing can encourage too much investment in response to higher prices, resulting in a crash later on.

This made me think of China, and its policy-driven booms and busts. Typically, money floods into a sector when it receives government favor and subsidies, leading to a surge in production, and later overcapacity, falling prices, and a shakeout as the government reconsiders subsidies (see: solar panels, wind power, electric vehicles). In terms of labor, the willingness of Chinese migrant workers to uproot themselves and their families also shows no shortage of capacity to transform, but perhaps at too high of a social cost. So while capacity to transform in the US may now be too low, China’s might be too high.

Re-reading the chapter again, it’s still impressive to me how Kindleberger, in this short and quite casual treatment, managed to identify some of the major issues that are still puzzling economists some 60 years on. His concept of “capacity to transform” feels overdue for revival.

Also, here is my previous post on another interesting part of this Kindleberger book.

Who deserves the Nobel for China’s economic development?

The awarding of the Nobel Prize in economics to three academics “for their experimental approach to alleviating global poverty” has prompted some caustic commentary about how much, or little, global poverty has actually been reduced by the highly targeted, small-scale policy interventions evaluated by such experiments.

It’s well known that most of the reduction in global poverty in recent decades, however it is measured, is accounted for by rapid economic growth in big Asian economies. On the World Bank’s numbers, China alone accounts for about 60% of the decline in the number of people living in extreme poverty worldwide (China’s poor population declined by 742 million people, while the world’s declined by 1.16 billion people).

The contribution of randomized controlled trials to China’s poverty reduction has been, to a first approximation, zero. Yao Yang, the dean of the National School of Development at Peking University, wrote in an English-language op-ed that “Experiments might help policymakers improve existing welfare programs or lay the foundation for new ones, but they cannot tell a poor country how to achieve sustained growth.” In a similar vein, Harvard professor Dani Rodrik tweeted: “Remarkable how little today’s development economics has to say about the most impressive poverty reduction in history ever.”

So if the Royal Swedish Academy of Sciences were to award a prize for “contributions to sustained economic growth in China,” who should it go to? This is not a straightforward question. The prize is usually given to academics for contributions to theory and research, not to practitioners for implementing economic policies. As Bruno Frey noted in a 2018 article on China’s absence from the history of winners of the economics Nobel, “It may be argued that the Chinese economy has been successful without the help of high-ranking academic economists.” There are also few Chinese economists that appear in lists of the most-cited scholars–possibly because Chinese economists have historically tended to focus more on advising their own government than publishing in English-language journals.

It’s true that the decisions that led to China’s sustained economic growth were not mostly driven by research published in peer-reviewed journals. But that does not mean that economic ideas did not play a role in those decisions, or that the role of economists was not important. At least, as long as one does not hold to an excessively credential-focused definition of “economist” as meaning only a person holding an economics PhD. Pieter Bottelier’s recent book, Economic Policy Making in China (1949-2016): The Role of Economists, introduces many of these Chinese economic thinkers, few of whom are widely known abroad. One figure particularly stands out: Xue Muqiao. Bottelier writes:

I agree with Wu Jinglian that Xue (who died in 2005, when he was almost 101) was the most important Chinese economist of the 20th century. He was already involved in economic policy and management before the establishment of the PRC in 1949, and after 1949 under Mao. He then became one of the principal architects of market reform under Deng Xiaoping. The evolution of Xue’s thinking on how to develop a “socialist economy” mirrors Deng’s.

While Deng Xiaoping is these days often remembered mainly as an economic reformer, in fact he was not a specialist in the economy, and largely delegated economic management to other leadership figures. Xue seems to have been quite influential in the formation of Deng’s economic thinking.

Xue is particularly famous for is a letter he wrote in 1977, after Mao’s death but before reforms had begun, to Deng and Li Xiannian that laid out many of the problems in the economy. He focused in particular on agriculture, noting that farm output had grown no faster than the population despite collectivization and massive investments in machinery. The letter is translated in the English-language Collected Works of Xue Muqiao:

The CPC Central Committee has pointed out the importance of having agricultural production catch up with industry’s Great Leap Forward. The Ministry of Agriculture and Forestry has recently proposed twelve significant measures to attain this goal. It recommends an increase of investment into agriculture of RMB 30 billion. These measures are necessary, but I think it is more important to implement agricultural policies that improve farmers’ lives, and that arouse their enthusiasm for agricultural production. … It is hard to motivate farmers if growth in agricultural production cannot bring corresponding growth in income. Any interest in working suffers if extra work is not rewarded. … Boosting farmers’ enthusiasm for agricultural production therefore outweighs improving the conditions for agricultural production.

“Enthusiasm” is the term often used in Chinese during this period for what we would today call “incentives.” And there is no economic insight more fundamental than “incentives matter.” This early insight by Xue laid the intellectual groundwork for the later decision to allow farmers to break out of agricultural collectives and farm their own land–a massive change in incentives for agriculture that resulted in a huge boom in productivity. For Xue to be able to break through the deadening grip of Maoist political correctness and recognize that incentive problems were keeping China’s rural population mired in poverty must surely be counted as an intellectual achievement of the highest order.

Over his long life and career, Xue did much more than write one well-timed and well-placed letter. The economic historian Fan Shitao last year made a catalog of Xue’s achievements in the pages of Caixin magazine, in a letter arguing that “Xue should be credited with making the most comprehensive contributions to China’s early reform and opening-up.” I won’t reproduce the entire thing here, but here are a few highlights:

In a long speech presented to the Central Party School in autumn of 1978, Xue was the first official within the ruling Communist Party elite to criticize the catastrophic consequences and painful economic lessons of Mao’s “Great Leap Forward.” By warning that similar mistakes should not be replicated in the future, Xue’s speech paved the way for subsequent adjustments to China’s economic policies. …

As the most authoritative expert on price in the Communist Party, Xue was the first person to point out that price reforms were key to China’s economic reforms. He also differentiated between overall price stability and flexibility of individual prices. In agreement with German economic expert Armin Gutowski, Chinese American economist Gregory Chow, and experienced economist Edwin Lim, Xue promoted price reforms, which was one of the major decisions of the Third Plenary Session in 1984. …

In 1978 Xue pointed out that instead of administrative regions, economic development should focus on economic zones based on resource flows. The economic zone in Shanghai contributed to its becoming one of China’s most capital-abundant cities. Xue’s proposal also later led to the launch of other regional development plans.

So Xue’s intellectual influence can arguably be detected in agricultural decollectivization, the overhaul of central planning, the transition to market prices, and the coastal export manufacturing boom. That is a pretty staggering list.

Of course, China’s decades-long series of economic reforms had no one author or leader. But China’s system of closed-door debate and collective decision-making has long obscured the important contributions of individuals like Xue, and Du Runsheng, another major figure in rural reform.

Xue Muqiao

Kindleberger on the loss of technological leadership

The following passage by the economic historian Charles P. Kindleberger, from his slim book Foreign Trade and the National Economy, was written in 1960-61 but feels remarkably relevant to the present moment:

Technology today spreads in some degree through illegal imitation, including the pirating of design and industrial espionage, but mainly through licensing, direct investment, a simple reading of technical literature, foreign education, and so on. There is little doubt that the speed of diffusion of technology has increased not only among developed nations but between developed and underdeveloped. There need be no direct communication. That one country can produce a particular article may be sufficient spur to others, as Russian, French, and Israeli work in atomic energy may demonstrate.

Technological leadership is harder than ever to maintain, although historians may think it was never held long. The result is that trade based on technical leadership must keep changing, for any given technical gap is foredoomed to closure.

As a general principle, to me that seems probably right. China is busy trying to close many technological gaps between its own industries and the global leaders, and the forces of technological diffusion suggest that time is on its side. Does that mean that the US, by imposing export controls on Chinese makers of telecom equipment, semiconductors and supercomputers, the US is engaged in a hopeless strategy doomed to failure? Not exactly. Historical inevitability can take a long time to play out, and the difference between technological gaps closing in 5 years, 10 years or 20 years is very much a nontrivial one for companies and nations.

And using this general principle to make predictions about how leadership in specific technologies plays out is not always going to work. Kindleberger’s own observations about the threat to US technological leadership from Europe have held up less well:

It looked for a time as though the technical gap between the United States and other developed countries was an enduring feature of international trade. Isolation from the battlegrounds of two world wars, plus an economic history of great labor scarcity relative to land, and later to capital, gave the United States an interest in innovation which was more widespread among the populace and among economic sectors than in other countries.

This view can no longer be held with assurance. … Europe and Japan are innovating positively. Major developments in the particularly American field of innovation–the automobile–have mainly been of European origin: the disc brake, the two-stroke engine, independent springing, and so on.

Particularly interesting is the new spirit of innovation in France, which has produced in the 1950s the Caravelle and Mystere in airplanes, the Citroen DS 19 and “deux chevaux” (two horsepower) in automobiles, high-voltage long-distance electric transmission, and direct transmission at 25,000 volts to electric locomotives. These and other equally radical departures from simple imitation of leading technical performance suggest a surge of independent innovation in France…

The general principle that technological diffusion is going to happen does suggest that the best way to combat the loss of technological leadership in one area is to open up technological leadership in a new area. The US did this fairly successfully in the decades after Kindleberger’s book was written. It still seems that the best response to today’s technological challenge from China (and others) is not going to be a bunch of delaying actions, but a renewed push forward.

There is no problem with small business lending in China

That is not the message you would get from the Chinese government these days, which is devoting an impressive amount of high-level political attention to this issue. Premier Li Keqiang just chaired a State Council meeting which urged banks to deliver more financing to small- and medium-sized enterprises, and at lower interest rates–the latest of many such meetings in which this topic topped the agenda.

In effect, small-business lending is being treated as an urgent national emergency: apparently China’s financial system is systematically failing to deliver what is needed for a healthy economy. Yet it is impossible to see any evidence of this emergency in the data presented in a white paper on the topic published by the People’s Bank of China this week. Here is a brief section of the appendix:

At the end of 2016, the balance of renminbi loans for small- and medium-sized enterprises in China was 42.2 trillion yuan (about 6.1 trillion U.S. dollars), accounting for 56.8% of GDP in the same period, higher than that of Japan (46.1%), Malaysia (22.9%), France (10.0%), Brazil (9.9%), Russia (5.8%), the United States (3.3%, where commercial loans under 1 million U.S. dollars are counted as small enterprise loans) and other countries.

At the end of 2016, China’s SME loan balance accounted for 65.1% of all enterprise loans, higher than Malaysia (43.7%), Brazil (36.9%), France (20.6%), the United States (18.5%), Russia (15.8%) and other countries, only lower than Japan (65.6%) and South Korea (79%).

In 2016, the average interest rate of loans for small and medium-sized enterprises in China was 4.77%, significantly lower than that of emerging market countries such as Brazil (33.50%), Russia (13.03%), Malaysia (7.22%), but higher than that of developed countries such as South Korea (3.58%), the United States (3.46%), France (1.50%), Japan (< 1%).

That’s right: China lends more than twice as much to small businesses, as a proportion of the economy or the banking system, as most other countries, and at a lower interest rate to boot (the data cited are from the OECD’s very useful cross-country survey on SME financing; you can download their detailed data for China here)

Of course, that doesn’t mean small businesses in China have problems getting bank loans–but small businesses everywhere have problems getting bank loans, because they are small and their credit risk is hard to evaluate. There is little evidence this problem is worse in China, and plenty of reason to think that it is actually better. After all, in an economy with a debt-to-GDP ratio of 250%, it is not particularly plausible to assume there are massive shortages of credit.

Almost five years ago I wrote an op-ed for The Wall Street Journal, my alma mater, entitled “Small Business Won’t Save China,” that made these points, and argued that a government drive to deliver aid to small businesses would not actually be very effective. Unfortunately very little has changed since then. Pushing credit to small business is still a politically attractive way of avoiding the structural issues for the private sector in China, and the political pressure on banks to meet arbitrary targets for lending to small businesses has only gotten more intense.

Is state ownership turning into a core interest for China?

Since the breakdown of the US-China trade talks earlier this month, it has often seemed as if Chinese officialdom and state-controlled media have been speaking off of a single script of pure nationalist outrage. But in fact the trade tensions have exposed some interesting differences in views across the system. Consider this part of a Xinhua commentary published on Saturday (you can read the Chinese text or an English summary):

At the negotiating table, the US government made many outrageous demands of China, including restricting the operation and development of state-owned enterprises. Obviously, this goes beyond the scope of trade negotiations and touches on China’s basic economic system. This shows that behind the US trade war with China is an attempt to violate China’s economic sovereignty and force China to harm its own core interests.

Some commentators have noted how the expression “core interests,” previously only attached to territorial issues, has now been applied to state-owned enterprises. But those who track such minutiae will notice that this commentary is signed by two journalists; Xinhua commentaries used to articulate official views are typically written by committee and do not carry a real person’s byline. The more official series of People’s Daily commentaries on the trade war has, as best I can tell, not mentioned state-owned enterprises at all. So my interpretation of this Xinhua piece would be that there are definitely people in the Chinese system who share these views, but the government has probably not (yet) decided to adopt this as its official position.

Now compare this “China has a state-owned economy and we’re proud of it” take with a recent speech from Guo Shuqing, who as Party secretary of the People’s Bank of China and head of the China Banking & Insurance Regulatory Commission is the government’s top-ranking financial official. Guo’s talk on the trade war (Chinese text and English summary) covered a lot of ground, but he also addressed the issue of state ownership:

In recent years, there has been an opinion expressed abroad that China’s rapid economic development is the result of “state monopoly capitalism.” But this kind of talk has no basis. In fact, the composition of China’s economy has become increasingly diversified, and the market share of state-owned enterprises has continuously declined. Including the economic activity of government, the state-owned economy accounts for less than 40% of GDP. Many state-owned enterprises are listed on foreign or domestic stock exchanges, and in fact are joint-stock enterprises; 100% purely state-owned enterprises are rare. Large state-owned enterprises have a large number of subsidiaries whose controlling shareholders are private enterprises. And even the central state-owned enterprises compete with each other. Today, private and foreign investors can enter almost all industries and sectors without any restrictions or barriers.

The tone here is quite different: yes, we have state enterprises, but they are a small and declining part of the economy, and it is more important that there is market competition among all companies. These defensive statements probably are not really completely, objectively true (though I think Guo’s estimate of the state-owned share of GDP is probably not too far off). Guo is what foreigners usually call a “reformer” in the Chinese system, and in a different context I’m sure he would frankly discuss the fact that both foreign and domestic private companies face many barriers. Indeed, at the moment Guo is spearheading a political campaign to increase private-sector firms’ access to bank credit, a campaign whose very existence makes it clear that there is not at all a level playing field.

But I think Guo is here engaging in a strategy that is common for those who want to nudge the Chinese system in a more market-oriented direction: they tend to describe things are being more competitive and market-driven than they actually are, so that marginal change in that direction seems unremarkable and logical. If you pound the table and call China’s state-owned enterprises a core interest of the nation, it becomes quite difficult to change them. If you say, China is mostly a market economy already, then gradually reducing the role of SOEs over time seems pretty unthreatening.

One of the dangers I see in the US-China trade war is that it could become politically more and more difficult for people like Guo to both defend China’s system against foreign attacks, and continue to nudge it in a different direction. “The Americans want us to get rid of state enterprises, and by gosh they’re right” is a much less likely response to US pressure than “How dare those Americans tell us to get rid of our state enterprises?” And that’s true even among people who might not otherwise be disposed to cheer on SOEs.

As is so often the case, Sheng Hong of the Unirule Institute (a libertarian-leaning think tank now mostly banned in China) sees the fundamental political issue quite clearly. Here are a few lines from his recent blog post (I have retranslated the Chinese, since the English version is a bit clunky):

State-owned enterprises account for 10% of exports, so the remaining 90% are made by private and foreign-invested enterprises. Therefore the vast majority of Trump’s tariffs are being imposed on private and foreign enterprises who do not receive government subsidies. This does not correct a market distortion, but actually punishes companies that follow market rules, which makes the market more distorted. …

In order to punish the unfair trade of a small group of companies, Trump has harmed all Chinese companies, and especially private companies. This has caused their feelings to run high and united them in their hatred [of the US], so that in a nationalist fervor they are now supporting their own country’s state-owned enterprises.

In other words, the trade war seems very likely to increase popular support for state-owned enterprises, and push more Chinese people into the view that they do actually represent a core interest of the Chinese nation. And that is probably not in the longer-term interests of the US.

I expect a US trade hawk would likely respond to this by saying that waiting around for China to decide on its own to slim down state-owned enterprises has not worked out for the last decade or so, and the harm this has done justifies putting pressure on China to change more quickly. And they would have a pretty good point. Which is unfortunately why it is now seems hard to be optimistic about the politics on either side.

William James on the value of doctorates and diplomas

Greg Ip at the WSJ has a nice piece responding to the ruckus over the nominations of Stephen Moore and Herman Cain to serve on the Federal Reserve Board. It’s obvious from the Fed’s own history that the mockery of Moore for not having published peer-reviewed journal articles, or not having a Ph.D. in economics, quite misses the point. As Greg nicely puts it, the real question to ask about someone who is may need to make economic policy decisions is whether they are a disciplined thinker, not whether they have a certain credential.

By coincidence, I also recently read an essay by William James entitled “The Ph.D. Octopus,” originally published in the Harvard Monthly in March 1903 (it was reprinted in his essay collection Memories and Studies which is out of copyright and freely available). Some of James’ sentiments still ring quite true:

America is thus as a nation rapidly drifting towards a state of things in which no man of science or letters will be accounted respectable unless some kind of badge or diploma is stamped upon him, and in which bare personality will be a mark of outcast estate. It seems to me high time to rouse ourselves to consciousness, and to cast a critical eye upon this decidedly grotesque tendency.

James worried that the institutionalization of graduate degrees, and in particular their use by employers to screen potential hires, would cause all kinds of negative consequences:

To interfere with the free development of talent, to obstruct the natural play of supply and demand in the teaching profession, to foster academic snobbery by the prestige of certain privileged institutions, to transfer accredited value from essential manhood to an outward badge, to blight hopes and promote invidious sentiments, to divert the attention of aspiring youth from direct dealings with truth to the passing of examinations…

James was deeply aware of the tension between universities’ avowed mission of free intellectual inquiry and their economic function as producers of credentials, and hoped that the former would discipline the latter:

Our universities at least should never cease to regard themselves as the jealous custodians of personal and spiritual spontaneity. They are indeed its only organized and recognized custodians in America today. They ought to guard against contributing to the increase of officialism and snobbery and insincerity as against a pestilence; they ought to keep truth and disinterested labor always in the foreground, treat degrees as secondary incidents, and in season and out of season make it plain that what they live for is to help men’s souls, and not to decorate their persons with diplomas.

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Rediscovering the importance of export discipline

The new IMF working paper on industrial policy, by Reda Cherif and Fuad Hasanov, has gotten a lot of notice, and indeed it is very clear, comprehensive, and useful. But for anyone who has already done some reading on the history of successful Asian economies, particularly Taiwan and South Korea, it is not exactly surprising stuff. Here for instance is their quick summary of the key characteristics of these economies’ successful industrial policies:

  • Intervene to create new capabilities in sophisticated industries: Pursue policies to steer the factors of production into technologically sophisticated tradable industries beyond the current capabilities to swiftly catch up with the technological frontier.
  • Export, export, export: A focus on export orientation as any new industrial product was expected to be exported right away with the use of market signals from the export market as a feedback for accountability. As conditions changed, both the state and the firms adapted fast.
  • Cutthroat competition (at home and abroad) and strict accountability: No support was given unconditionally although performance assessment was not necessarily based on short term profits. While specific industries may get support, intense competition among domestic firms was highly encouraged in domestic and international markets.

The combination of a focus on exports with tough competition sounds a lot like what Joe Studwell, in his 2013 book How Asia Works (which is not cited in the IMF paper’s bibliography), called “export discipline.” His explanation is clearer and punchier:

Governments in all the major economies of east Asia tried at some stage to nurture domestic manufacturers. That those in north-east Asia succeeded, while those in south-east Asia failed miserably, turned on a small number of policy differences. By far the most important of these was the presence – or absence – of what I call ‘export discipline’.

This term refers to a policy of continually testing and benchmarking domestic manufacturers that are given subsidies and market protection by forcing them to export their goods and hence face global competition. It is their level of exports that reveals whether they merit state support or not. …

Where export discipline has not been present, development policy has become a game of charades, with local firms able to pretend that they have been achieving world-class standards without having to prove it in the global market place. In south-east Asia, the energies of entrepreneurs were directed towards fooling politicians rather than exporting.

I would still recommend Chapter 2 of How Asia Works as the definitive comparison of successful and unsuccessful industrial policies in Asia.

The point of such a comparison is to move beyond sterile debates over whether industrial policy can ever work, since in fact basically all countries have some kind of policy for promoting particular industries. As Cherif and Hasanov put it, “The key question is, if many countries have been conducting industrial policy anyway, what should the right way to do this be.” The presence or absence of export discipline should be a useful way to evaluate whether industrial policy is likely to be successful.

Even within Asia this lesson is not as widely appreciated as it perhaps could be. For instance, former Chinese finance minister Lou Jiwei recently made a surprisingly harsh public criticism of Made In China 2025 (for which he has apparently been forced into early retirement). He called it a waste of taxpayers’ money and an unwarranted intrusion of government: “those industries are not predictable and the government should not have thought it had the ability to predict what is not foreseeable.”

While I have a lot of respect for Lou, I’m not sure this is the strongest criticism of Made in China 2025. It’s not clear that “the market” would necessarily pick different industries as being desirable to invest in now: the ideas that people have about what technologies are going to be important in the future don’t seem to be that different across the public and private sectors. The Chinese government have have a plan to promote artificial intelligence, but private venture capital firms are also throwing plenty of money at that sector as well. Semiconductors are one of the key sectors targeted by The Made In China 2025, and I don’t think many people are seriously arguing that semiconductors won’t be important in the future.

This is not to say that venture capital investors are necessarily going to be right about the future either, just that both government officials and venture investors can read the same things and are influenced by the same conventional wisdom. This point is not original to me: I picked it up from Brad DeLong’s 2010 book with Stephen Cohen, The End of Influence:

Americans like to say scornfully that industrial policy is about “governments picking winners.” Picking winner industries is not that hard—even for governments. Most countries trying to climb the ladder of quality and industrial sophistication through selective promotion compiled pretty much the same lists at the same time. Even at the leading edge of the technological frontier, the industries that governments are tempted to promote are largely the same ones picked by the analysts and brokers at investment firms such as Merrill Lynch, Nomura, or Rothschild’s.  …

Picking “winner industries” is not the hard part; winning is. It is difficult to create actual winners, companies that develop into successful competitors.

And that, of course, is where export discipline comes in.

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