Industrialization transforming agrarian economies into modern manufacturing powerhouses dramatically raises productivity, incomes and living standards. But crafting effective industrial policies is challenging given risks like governments picking losers, fostering rent-seeking and protectionism. This section examines key issues and evidence on industrialization strategies for late developers seeking to catch up, considering both state interventions and market forces in shaping outcomes.
Classic theories from List (1885) to Gerschenkron (1962) argued that late industrializers require greater state intervention to compensate disadvantages vis-a-vis established leaders. Post-WW2 East Asian policies leveraging strategic trade protection, subsidies and planning illustrate strong state-led industrialization, contributing to rapid growth. However, costs of intervention surfaced in inefficiencies like India’s license raj and Latin America’s import substitution policies. New trade theory provides qualified support for infant industry protection, but stresses limits.
In practice, developmental states balancing cooperation and discipline across business and government appear most effective for industrial promotion without excessive rents (Evans, 1995). Facilitating technology acquisition through FDI, diaspora networks and innovation systems can assist industrial upgrading and export success. Beyond targeting specific sectors, improving the general investment climate and institutions enabling entrepreneurship, skill flows and access to finance and infrastructure is vital (Harrison & Rodriguez-Clare, 2010). The mix of selective interventions and market competition must evolve with capabilities.
Import Substitution and Export Promotion Strategies
Pioneering late industrialization in 19th century America and Germany involved import substitution (IS) approaches: high tariffs sheltered infant industries producing basic consumer goods like textiles to serve domestic demand, initially too uncompetitive to export (Chang, 2002). Post-war development strategies across Latin America and South Asia also adopted inward-looking IS policies, raising barriers against imports of manufactured goods to foster industrial self-sufficiency.
However, IS yielded disappointing results in many countries. Expanding production behind high tariff walls bred inefficient, uncompetitive firms. Argentina and India’s experiences showed costly distortions from over-protected, over-regulated IS (Bhagwati, 1988). Domestic markets were often too small to enable scale economies. State interventions like licensing replaced competition, encouraging rent-seeking and corruption more than innovation. Isolated from trade, neither production skills nor technological capabilities advanced significantly.
The failures of IS led scholars like Little, Scitovsky and Scott (1970) and Balassa (1971) to argue for neutral, market-friendly policies rather than intervention. However, others contended IS could succeed with modifications and highlighted achievements like Brazil’s steel industry development. Moreover, few countries industrialized through free trade alone – even Britain restricted textile imports when its industry began. Selective protection with incentives to promote exports and competition may be beneficial, subject to political economy constraints (Krueger, 1990). Indeed export promotion (EP) emerged as an alternative model.
Export Promotion Strategies
In contrast to IS, EP strategies prioritize building internationally competitive export industries over import substitution. Post-war Japan, followed by South Korea, Taiwan, Singapore and others in East Asia, adopted EP approaches from the 1950s with apparent success. Export discipline screened viable industries, while exchange rates kept input costs low. State assistance including subsidies for R&D, credit and infrastructure was contingent on meeting export targets (World Bank, 1993). Export processing zones attracted foreign technology and marketing know-how. Progress via exports facilitated upgrading along global value chains.
However, EP policies also had limitations often requiring corrections. Early efforts excessively emphasized labor-intensive sectors with static comparative advantage like textiles, neglecting skills and technology development. Over time education, R&D and competition policies became more balanced. EP also involved costs from subsidies, credit misallocation and picked losers. But strong conditionality and performance benchmarks proved critical governance tools limiting inefficient protection (Pack & Saggi, 2006). Overall, EP appeared more dynamic than IS by leveraging global markets to spur industrial upgrading. Its protection was purpose-limited, not general. Integration in rules-based multilateral trade gradually replaced discretionary policies.
Indeed export orientation strongly correlates with manufacturing export success across developing regions since the 1960s (UNIDO, 2013). Balancing strategic EP with neutral incentives and competitive pressures brought considerable achievements for East Asian late industrializers, though initial conditions and policy designs differed. Most successfully married interventions to build capabilities and address information problems with market competition and discipline. Across poorer Southeast Asian economies like Vietnam and Bangladesh adopting trade reforms and EP from the 1990s, export-led manufacturing growth also became the engine of development.
Infant Industry Protection Controversy
To advance beyond resource extraction and basic processing, late developers must acquire capabilities in more sophisticated manufacturing activities. But infant industries initially lack scale and experience to compete with established foreign producers. A classic debate is thus how trade policy should support industrial learning and upgrading. Should temporary assistance be provided to nurture promising infant sectors, or is free trade better for growth? Alexander Hamilton pioneered the infant industry argument, but Friedrich List developed the seminal 19th century case for temporary industrial tariffs in Germany until capabilities matured.
In neoclassical trade theory, market prices reflecting comparative advantage should guide resource allocation, suggesting infant industry protection (IIP) is distortive (Smith, 1994). However, dynamic IIP advocates counter that temporary assistance can shift developing countries to higher growth paths by facilitating industrial upgrading. Targeted support compensates for information and coordination failures that inhibit emergence of new competitive industries with positive externalities. Backward linkages also foster industrial clusters (Rodrik, 2004). If designed well, transparently withdrawn as sectors “grow up”, IIP can catalyze structural change.
But IIP risks entrenching inefficient industries that fail to become competitive even after long assistance, as well as rent-seeking over subsidies. Effective governance is essential, hence mixed evidence across countries. Wade (1990) argued IIP facilitated rapid industrialization in East Asia, but findings were contested by critics highlighting failed interventions (Lall, 1996). Overall, economists suggest IIP be selective and time-bound, avoiding general protectionism. But casting all interventions as detrimental deviations from free trade doctrines may unduly narrow policy space needed for learning and capability development in poorer nations (Stiglitz et al., 2013).
New Trade Theory Perspectives
New trade theories developed over the 1980s-90s qualified earlier rejection of industrial policy and protection. Krugman’s model shows how IIP facilitating economies of scale in domestic firms could reshape comparative advantage to a country’s benefit. Grossman and Helpman explain how lobbying for protection could increase national welfare by solving coordination failures, if compensation schemes curb inefficient rent-seeking. However, they note good governance is essential for public interest outcomes – otherwise protectionism can spiral out of control.
Overall, new trade theory provides cautious, limited support for IIP in theory. The rationale weakens further in more open trade regimes with multinational production networks. Targeted interventions still have potential to foster competitive exports and growth if designed well, but gains appear marginal not transformative. Helpman (2004) concludes that building fundamentals like human capital and institutions are more important than IIP for long-run development. While selective interventions might at times assist industrial upgrading, they cannot substitute for broader fundamentals and competitive pressures driving sustained progress.
Industrial Policy Design Issues
A vast literature examines how to craft effective industrial policies, defined as interventions aimed at particular sectors for economic objectives like productivity growth. Strategic IIP requires identifying sectors with scale economies and positive spillovers to assist. But governments have limited information vs. market actors, risking capture by lobbies or misdirecting resources to ‘white elephant’ projects with negative returns. Hence checks and discipline are vital to contain rent-seeking and politically-driven allocation distortions.
Encouraging ‘deliberation councils’ and structured public-private interactions to share information and build consensus behind interventions can assist sound selection and monitoring (Sabel, 1994). Competitive pressures help gauge viability. Clear benchmarks, sunset clauses terminating support, and reform incentives conditional on export discipline and meeting milestones can mitigate moral hazard risks and screen for efficiency. Embedding support in reciprocal control mechanisms helps align public and private goals (Amsden 1989). Capable, autonomous bureaucracies implementing policies can limit distortionary political interference (Evans, 1995).
Beyond targeting particular sectors, a broader focus on improving the investment climate, skills and infrastructure that widely facilitate industrial development is vital (Harrison & Rodriguez-Clare, 2010). Select interventions complement but cannot substitute for fundamental enablers and competitive incentives driving sustained upgrading and diversification. Ultimately nurturing novelty and entrepreneurial dynamism requires an evolving, pragmatic policy approach open to experimentation and learning (Rodrik, 2004; Sutton, 2012).
Conclusion
Industrialization is a complex process requiring mobilization of resources, skills and linkages on an economy-wide scale. For late developers, active policies to facilitate industrial learning and upgrading have potential benefits but also risks from rent-seeking and lost flexibility. Pragmatic strategies blending selective interventions with market pressures and openness have proven most effective for capability advancement and export success, anchored in fundamentals like skills and infrastructure. With progress, policies should evolve toward neutrality and competition. Balancing strategic support with transparency, incentives and competitive discipline helps secure advantage from globalization. Adaptive, experimental policy approaches attuned to uncertainty can assist industrial development.
References
Amsden, A. H. (1989). Asia’s next giant: South Korea and late industrialization. Oxford University Press.
Balassa, B. (1971). Trade policies in developing countries. The American Economic Review, 61(2), 178-187.
Bhagwati, J. N. (1988). Export-promoting trade strategy: issues and evidence. The World Bank Research Observer, 3(1), 27-57.
Chang, H. J. (2002). Kicking away the ladder—development strategy in historical perspective. London: Anthem Press.
Evans, P. (1995). Embedded autonomy: States and industrial transformation. Princeton University Press.
Gerschenkron, A. (1962). Economic backwardness in historical perspective: a book of essays. Belknap Press of Harvard University Press, Cambridge, MA.
Grossman, G. M., & Helpman, E. (1994). Protection for sale. American Economic Review, 84(4), 833-850.
Harrison, A., & Rodríguez-Clare, A. (2010). Trade, foreign investment, and industrial policy for developing countries. Handbook of development economics, 5, 4039-4214.
