Development optimism from Justin Lin: review of ‘The Quest for Prosperity’

‘Every developing country has the opportunity to grow at over 8% a year for 20-40 years, and to get rid of poverty within a generation.’ There’s something very refreshing about listening to East Asian development economists, in this case the prolific Justin Lin, a former World Bank chief economist, launching his new book The Quest for Prosperity, at ODI just before Christmas. The contrast between his can-do optimism and the dark clouds of Eurogloom and Afropessimism could not have been greater. But is he right?

While others in development wonkland are increasingly scathing about blueprints and best practice guidelines, Justin is unabashedly a man with a plan. The book takes his paper on ‘Growth identification and facilitation’, (see my earlier review, and Justin’s reply), and boils his thinking down into what he calls a ‘six point recipe’ for developing country governments.

1. ‘Choose the right target’:  find a country that looks like you in terms of ‘endowments’ – geography, natural resources, markets etc, but that is doing much better, with a per capita income that is, say, double yours. Then imitate it. This is a straight lift from Asian ‘flying geese’ story.
2. ‘Remove binding constraints’: identify which of your own industries look like those in the target countries and find out what’s holding them back (infrastructure, credit, red tape etc). Sort those things out first. Justin draws heavily on Dani Rodrik and Ricardo Hausmann’s work on growth diagnostics.
3. ‘Seduce and attract Global Investors’: Justin goes for Washington Consensus-style openness to FDI, along lines of Bangladesh or Singapore rather than the more protectionist route followed by South Korea and others
4. ‘Scale up self-discoveries’: But he also thinks governments need an active industrial policy to spot and support local innovation and technological upgrading (eg Indian IT or cut flowers in Ethiopia)
5. ‘Recognize the Power and Magic of Industrial Parks’: he won’t make many friends among the trade unions on this one, but (drawing on China and Vietnam), he sees export-processing zones as the best way to overcome dilapidated infrastructure and get exporting quickly
6. ‘Provide limited resources to the right industries’:  a tentative support for an activist industrial policy

What this amounts to is an attempt to mash together elements of the structuralism of the 1950s, the East Asian experience, new thinking from people like Rodrik and Hausmann, and the Washington Consensus of the 1980s, not so much splitting the difference as combining the best bits of all of them. It’s politically cautious, trying to play to both sides of the aisle (for example, he says his recipe is ‘consistent with The East Asian Miracle’, the World Bank’s notorious and largely discredited attempt to rewrite the East Asian tigers as a neoliberal success story).

The ensuing discussion at ODI was pretty critical, although Justin defended his recipe with passion. ODI’s Dirk van de Velde argued that it’s no good having a good recipe if you don’t have any cooks. Justin is much stronger on the economics than the politics, and ‘assumes a tin opener’ in the shape of an effective state both willing and able to implement his recipe. That’s a big assumption. When challenged he is pretty naive on the politics, arguing that leaders will be motivated to do the right thing because they want ‘a good name in history’. Yeah, right.

Kunal Sen from Manchester argued that the political economy of growth accelerations is very different from growth maintenance. Lots of political regimes produce growth spurts followed by busts, very few can keep it going for Justin’s ‘20-40 years’ and we need to understand better why that is.

Sheila Page stressed the limits to imitation: as the technological product cycle grows ever shorter, it is becoming less viable to rely simply on imitation, because the technology will already have moved on by the time you have absorbed the knowledge. No good arriving ten years late with a really cheap fax machine.

What about finance? I wasn’t clear from Justin’s presentation what role he sees for financial integration, given that financial markets are sources of huge volatility, put pressure on economic policy-makers to follow a more free market route, and often don’t lend to the right people (eg small and medium enterprises).

Is this a genuine recipe, or does it always rely on hindsight? I asked Justin if he would have predicted in the 1960s that South Korea had a ‘latent comparative advantage’ in iron and steel. He said yes, but I have my doubts.

Beyond these concerns, I applaud the intention, but worry that the attempt is flawed on two fronts. Firstly, I share the general scepticism on blueprints, and secondly, I’m not sure it’s actually possible to mix and match such opposing schools of thought in this way.

As for the book, it’s very sweetly written, and dotted with great quotes. My favourite is from Einstein, ‘Theory is when you know everything but nothing works. Practice is when everything works, but nobody knows why. We have put together theory and practice: nothing is working, and nobody knows why.’

Guest blog: World Bank chief economist replies on his industrial policy proposals

Last week I wrote about Justin Lin’s intriguing suggestions for how developing countries can best pursue a low risk/high return form of industrial upgrading. Here Justin responds to some of the concerns and questions raised in that post:

“I am grateful to Duncan Green for his comments on my recent paper “Growth Identification and Facilitation”, which offer me the opportunity to clarify some of the ideas discussed there, and respond to the very pertinent questions he raised at the end of his post.

I certainly do not assume that “states possess a well informed, effective bureaucracy”. In fact development is a challenging process everywhere and all types of public policies and strategies—from education to health, from structuralist import substitution to Washington Consensus reforms— require some government capacity. However, the required capacity for the proposed Growth Identification and Facilitation framework is relatively minimal, compared to almost any other policy proposal: many of the specific instruments recommended in the paper are far easier to implement in low-capacity environments: setting up an export-processing zone for instance requires much less capacity than building infrastructure for the whole country as often advocated; implementing tax exemption  schemes for a few years to attract investments in industries with latent comparative advantage is easier than collecting large tax revenues or repressing the financial system to subsidize nonviable firms for endless years in industries that are inconsistent with a country’s comparative advantage.

Economic policy never takes place in a vacuum and there is wide consensus on the importance of having capable, credible, and committed governments to design and implement viable economic development strategies—something that is lacking, by definition, in many poor countries. The question is how to facilitate their emergence. While there is probably no ready recipe for generating effective bureaucracy, I would argue that the framework proposed in my paper would not lead to heavy-handed government interventions and large administratively-created rents. To the contrary, what I am proposing would help developing countries minimize the risks of poor governance and pervasive corruption. At the same time as the framework is easier to implement and likely to yield quick wins, the government’s commitment, credibility and capability may be enhanced as a result of following this approach.

Another important point raised by Duncan is whether ineffective leaders in developing countries actually know better which policies could lead to sustained growth but cynically choose not to implement them. The implicit assumption here is that the appropriate policies for generating and sustaining economic growth are known, but because of their bad instincts or the prevailing incentive systems, political leaders ignore them. It seems to me that things might not be that clear-cut. After all, economists have been looking for the recipe for growth for more than 200 years. The dominant theories for development policy in developing countries proposed by economic profession have been rooted in either structuralism (roughly from the 1940s to the 1970s) or in Washington Consensus-types of frameworks (from the 1980s onwards). The empirical evidence shows that both of them are inadequate.

My view is that most political leaders would like to gain legitimacy, stay in power and have a good name in history. They will be willing to do the right thing to achieve those personal ambitions if only they knew what that is and how to do it. Delivering sustained dynamic and inclusive growth during their tenures should be consistent with their personal goals.  Yet, the quest for growth has been elusive, to use Bill Easterly’s famous book title. The Growth Identification and Facilitation approach does not claim to offer a magic bullet, but it suggests a logical framework that could allow policymakers in developing countries to emulate successful strategies implemented throughout history. It is therefore compatible with prevailing political incentives.

Duncan’s last point is about the likelihood that old high-carbon growth pathways may not be an option for developing countries in the future due to the concern of climate change, rendering the industrial ladders implied in the Growth Identification and Facilitation inappropriate. One can realistically expect that as long as there will be demand for goods and services around the world, countries with the lowest production costs will be competitive in those industries. If one accepts that proposition, then two scenarios are likely to materialize: if low-carbon technology is not available at reasonable costs and the production of goods and services continuously relies on the existing technology, low-income countries could successfully move up the development ladder by using their low-wage advantage as suggested by the Growth Identification and Facilitation framework. If the new low-cost clean technology becomes available, low-income countries should adopt it and enjoy the “advantage of backwardness” in adopting new technology in their industrial upgrading process. However, the selection of their targets for industrial upgrading should still follow the methodology suggested in the Growth Identification and Facilitation Framework.”

A surprising World Bank recipe for industrial policy: new proposal from Justin Lin

Justin Lin, the World Bank’s chief economist, was in London last week and presented his new paper on ‘Growth Identification and Facilitation’. Two years ago he came through just after being appointed, promising to bring a ‘new perspective’ to the Bank (see post here). His new paper certainly does that, as its subtitle ‘the role of the state in the dynamics of structural change’ suggests.

In the paper, Lin tries to sort out good industrial policy from bad. When does state intervention lead to structural upgrading, a la East Asia, and when does it merely generate a bunch of uncompetitive companies being kept on artificial life support by state subsidies, as sometimes happened elsewhere? His conclusion is that the state should not depart too far from a country’s comparative advantage, but consciously push it towards upgrading by imitating neighbours that are similar, but have travelled further along the upgrading path – basically the East Asian ‘flying geese’ model. Think of it as the state pulling a country along by a piece of elastic – pull too little and nothing happens, pull too hard and the elastic snaps.

Highlights: first the heresy – Lin broadly agrees with Ha-Joon Chang, Dani Rodrik and various other heterodox critics of the Washington Consensus: “The historical record indicates that in all successful economies, the state has always played an important role in facilitating structural change.”

But to avoid snapping the elastic, Lin suggests a ‘six-step process’:

“First, the government in a developing country can identify the list of tradable goods and services that have been produced for about 20 years in dynamically growing countries with similar endowment structures and a per capita income that is about 100 percent higher than their own.

Second, among the industries in that list, the government may give priority to those in which some domestic private firms have already entered spontaneously, and try to identify: (i) the obstacles that are preventing these firms from upgrading the quality of their products; or (ii), the barriers that limit entry to those industries by other private firms. This could be done through the combination of various methods such as the value-chain analysis or the Growth Diagnostic Framework suggested by Hausmann, Rodrik, and Velasco (2008). The government can then implement policy to remove those binding constraints and use randomized controlled experiments to test the effects of releasing those constraints so as to ensure the effectiveness of scaling up those policies at the national level (Duflo 2004).

Third, some of those industries in the list may be completely new to domestic firms. In such cases, the government could adopt specific measures to encourage firms in the higher-income countries identified in the first step to invest in these industries. The government may also set up incubation programs to catalyze the entry of private domestic firms into these industries.

Fourth, in addition to the industries identified on the list of potential opportunities for tradable goods and services in step 1, developing country governments should pay close attention to successful self discoveries by private enterprises and provide support to scale up those industries.

Fifth, in developing countries with poor infrastructure and an unfriendly business environment, the government can invest in industrial parks or export processing zones and make the necessary improvements to attract domestic private firms and/or foreign firms that may be willing to invest in the targeted industries. Industrial parks and export processing zones also have the benefits of encouraging industrial clustering.

Sixth, the government may also provide limited incentives to domestic pioneer firms or foreign investors that work within the list of industries identified in step 1 in order to compensate for the non-rival, public knowledge created by their investments.”

What this adds up to is a kind of low-risk industrial policy-lite, in which the state spots winners and supports them, rather than tries to create them from scratch, an incremental strategy rather than a Great Leap Forward that may well lead straight into the abyss.

All quite appealing, but I think it has two main potential weaknesses:

1. Political Economy: Justin assumes that states possess a well informed, effective bureaucracy possessing what Peter Evans called ‘embedded autonomy’ – embedded in the realities and needs of local industry, but autonomous enough to be bribed or coerced into becoming a cash cow. That may have been the case in Japan or South Korea, but where it doesn’t exist, how do you create one? Justin seems naively optimistic on this, arguing in the seminar that ‘it’s not that leaders don’t want to pursue growth and create jobs, it’s just that they don’t know how to.’

2. Climate Change: neoliberals always used to argue that globalization meant that what worked in Japan was no longer relevant to the

Washington Consensus view of Industrial Policy

present (what Ha Joon Chang and I refer to as the ‘Sex Pistols’ argument – when the punk band’s lead singer was asked why he had just flatly contradicted an earlier statement, he replied ‘that was then; this is now’). Now climate change provides a green variant – what worked in a world oblivious to environmental limits may not apply to one where growing economies will have to move quickly to a low carbon growth model. No point in the flying geese following each other into a high emission dead end.

And how’s all this going down at the Bank? He says these ideas are not that distant from those of Joe Stiglitz, his predecessor as chief economist, but the intellectual environment that rejected them in Stiglitz’s time has changed, especially since the global financial crisis. He’s starting a whole research programme on economic policy and structural transformation (his preferred buzzword for all this – don’t call it industrial policy!)

Lin famously began his career by swimming across the Taiwan Strait to defect to China. He seems to be embarked on something equally heroic at the Bank.