The Industrial Policy Revolution II

Africa in the Twenty-first Century

J. Esteban, J. Stiglitz, J. Esteban,J. Stiglitz,Kenneth A. Loparo, J. Esteban, J. Stiglitz, Justin Lin Yifu

• Publisher: Palgrave Macmillan
• Year: 2013
• ISBN:
  9781137335234
• Topic: Economics
• Subtopic: Economic Policy
• Index: Economics

This volume is the result of the 2012 International Economic Association's series of roundtables on the theme of Industrial Policy. The first, 'New Thinking on Industrial Policy, ' was hosted by the World Bank in Washington, D.C, and the second, 'New Thinking on Industrial Policy: Implications for Africa, ' was held in Pretoria, South Africa.

Part I
New Thinking on Industrial Policy

1.1

Learning and Industrial Policy: Implications for Africa¹

Bruce Greenwald and Joseph E. Stiglitz
Columbia University

Over the past thirty years, Africa has suffered from deindustrialization. The quarter century from the early 1980s was a period of declining per capita income and increasing poverty. Structural adjustment policies advocated by the IMF and the World Bank were predicated on the belief that by eliminating “distortions” in the economy, Africa would grow faster – by constructing an economy based on principles of free and unfettered markets, with the government restrained to ensuring macro-stability (which typically just meant price stability), economic performance would be increased and all would benefit.

It was recognized, of course, that eliminating trade protection would result in the loss of jobs, some in agriculture, many others in industry. The strongly held belief, however, was that these workers would quickly find jobs in new industries, consistent with the country’s comparative advantage. Moving resources from inefficient protected sectors to more efficient competitive sectors would raise incomes. Little attention was paid to the distribution of income, perhaps because of an implicit belief in trickledown economics – somehow, if the economic pie grew, all would benefit.

Things didn’t turn out as the advocates of these policies had hoped. Rather than growth there was decline. Job creation didn’t always keep pace with job destruction, and so workers moved from low-productivity protected sectors to even lower-productivity unemployment, open or disguised. When there was growth, the benefits often went disproportionately to those at the top, and didn’t trickle down to the rest of the economy.

When, growth resumed, in the first decade of the 21st century it was largely based on the boom in commodity prices. The share of global manufacturing value added in Africa in 2008 was 1.1 percent in 2008, down from 1.2 percent in 2000 (UNCTAD, 2011). Even countries that achieved macroeconomic stability and evidenced reasonably good governance seemed unable to attract much investment outside of the extractive sector.

It is imperative that this course of events be changed, particularly since the extractive sector typically does not give rise to many jobs, and certainly not enough jobs for the burgeoning labor force in many of the countries. (The African labor force is expected to grow – working-age Africans today comprise some 500m people; by 2040, that number will be 1.1 billion.²)

A propitious time for Africa

Fortunately, there are a set of events that may be propitious for the subcontinent. First, increasing wages and an appreciation of exchange rate in East Asia may enhance Africa’s comparative advantage in manufacturing. The high levels of productivity growth in manufacturing – exceeding the increases in demand – imply that global employment in manufacturing will be declining; but it may be possible for Africa to seize a larger share of these jobs.

Moreover, there are some spillovers from even imperfectly managed natural resources: higher incomes give rise to a demand for more consumption, and some of this will be locally produced and/or serviced. There is an increasingly large middle class. Indeed, by some estimates, only around a quarter to a third of the sub-continent’s recent growth is directly attributable to natural resources.³

Moreover, with the weaknesses in Europe and the United States that began with the Great Recession of 2008 looking likely to extend for at least a decade, those with funds are looking elsewhere for places in which to invest their money. Africa is looking more attractive, with its share of global foreign direct investment projects increasing to 5.5 percent in 2011.⁴

But many African countries still face serious disadvantages. Deficiencies in infrastructure increase both the cost of production and also the costs of bringing goods to market and of obtaining necessary inputs. There are also important shortages of skilled personnel, even in an environment in which unskilled workers are in abundance.

This paper is predicated on the belief that these disadvantages can be overcome by appropriate government policies, but such policies necessitate moving further away from the structural adjustment/Washington Consensus (WC) policies, by embracing industrial policies – policies that were shunned under the WC programs. Industrial policies are what we call those policies that help shape the sectoral composition of an economy. The term is used more broadly than just those policies that encourage the industrial sector. Thus a policy that encourages agro-business, or even agriculture, is referred to as an industrial policy.

Such government policies can enhance the ability of African economies to seize an even larger share of global foreign direct investment, to create new domestic enterprises, and to expand existing enterprises. While many countries within Africa are benefitting from natural resources, most countries have not taken full advantage of those resources, to create new industries and to provide employment for more of their citizens.

Industrial policies and market failures

At the International Economic Association/World Bank meeting on industrial policy in Washington, in May, 2012,⁵ there was a broad consensus on why countries should have such policies: to correct market failures, situations where markets by themselves do not lead to efficient, or desirable, resource allocations; and in some cases, even to correct other government failures, where other, harder to alter, government policies “distort” resource allocations.

Market failures arise whenever private rewards and social returns differ, and since the work of Greenwald and Stiglitz (1986) it has been recognized that such discrepancies are pervasive. Industrial policies are designed to correct major sectoral or other misallocations.

Objectives of industrial policies

For Africa, there are at least three objectives of such policies. With many countries facing high unemployment, there is an imperative to create more jobs. The labor market is not working the way it does in neoclassical models, where there is full employment. That means that the market price of labor is almost surely markedly higher than the “shadow price,” the opportunity cost of labor. Government should encourage labor-intensive sectors and technologies. To the extent possible, government should be sensitive to the kinds of labor that are being demanded, using both industrial and educational policies to bring the demand and supply of, say, school-leavers and university graduates into better alignment.

Secondly, many African countries have been marked by large increases in inequality.⁶ Industrial policies can affect the extent of inequality, by increasing the demand for lower-skilled workers, driving up their wages and lowering their level of unemployment. While policies focusing on distribution have traditionally been centered on tax and transfers, it has long been recognized that it may be better (more efficient) to have policies that change the before-tax- and -transfer distribution of income. Such policies reduce the burden imposed by distortionary redistributive policies (Stiglitz, 1998a).

Thirdly, it has increasingly been recognized that development requires the structural transformation of the economy (see Lin, 2012; Stiglitz, 1998c). Markets themselves are not very good at such structural transformations, partly because the sectors that are being displaced – resources that have to move from one sector to another – typically suffer large wealth and income losses, and are thus not well placed to make the investments required for redeployment. And well-understood capital market imperfections (based on information asymmetries) limit access to outside resources.⁷

Fourthly, it has long been recognized that what separates developed from developing countries is not just a gap in resources, but rather a gap in knowledge (Stiglitz, 1998b). More broadly, even in developed countries a large fraction of the increase in per capita income over the last two centuries is attributable to technological progress, to learning how to produce things more efficiently (see Solow, 1957). And the fact that some countries and firms have “learned how to learn” helps explain why the last two centuries have seen such remarkable increases in standards of living, in comparison to the millennia that preceded it, which were marked by stagnation (see Maddison, 2001).

If this is so, then it means that development strategies should be centered on promoting learning, and closing the knowledge gap between developing countries and less developed countries.

Market failures, learning, and industrial policies⁸

We suggested earlier that industrial policies are motivated (in part) by an attempt to correct market failures, by the failure of markets by themselves to yield socially desirable outcomes. There can be too much inequality, too high unemployment, too little growth. This paper centers around the failure of markets in learning.

Knowledge is different from ordinary products. Knowledge is essentially a public good, that is, its consumption is non-rivalrous (Stiglitz, 1987a, 1999). When one individual shares knowledge with someone else, it does not diminish the amount of knowledge that the first person has. Markets by themselves are never efficient in the production and utilization of public goods. The producer of the knowledge may restrict the usage of the knowledge (through secrecy or patents), in an attempt to appropriate returns, in which case there is underutilization. More generally, there will be underproduction, because – even with effectively enforced patents – there are important spillovers from learning. What one firm or industry learns enhances the productivity of others. When learning is a by-product of investment or of production, a corollary is that there will be underinvestment or under production (Arrow, 1962; Stiglitz, 2012a).

There are other market failures associated with learning: because learning is a fixed, sunk cost, sectors in which learning is important are likely to be imperfectly competitive.⁹ Because investments in learning cannot be collateralized, imperfections of capital markets may restrain research expenditures, say, relative to real estate speculation. With learning-by-doing, optimal production may entail firms increasing production today, beyond the point where they are breaking even, in return for the benefit of lower production costs in the future, but with capital market imperfections, firms cannot finance the ensuing losses (Dasgupta and Stiglitz, 1988a). The fact that investments in learning are highly risky, and risk markets are absent (especially in developing countries), also discourages such investments.¹⁰

The general theory of learning and industrial policies is taken up in Greenwald and Stiglitz (2014a, 2014b). Here, we focus on several topics that illustrate the general themes discussed there and that are of particular relevance to Africa.

The inevitability of industrial policy

First, however, we want to reiterate an important point raised in our earlier paper: governments are inevitably involved in industrial policy, in shaping the economy, both by what they do and by what they do not do. If they don’t manage well the macro-economy, then more cyclically sensitive industries will be discouraged. If they use interest rate adjustments to stabilize the economy, interest sensitive sectors will suffer. If they don’t stabilize the exchange rate, then non-traded sectors are encouraged.

Some are wont to say, just let market forces shape the economy, but market forces don’t exist in a vacuum. Every market is shaped by laws, rules, and regulations. A bankruptcy law that gives priority to derivatives encourages these financial products. A bankruptcy law that says that student loans can’t be discharged, even in bankruptcy, encourages banks to make more student loans. A tax law that provides for deductibility of mortgage interest leads to more mortgages. A tax law that taxes capital gains at lower rates than ordinary income encourages land and financial market speculation.

Moreover, in almost all countries, governments play a central role in education, health, infrastructure, and technology, and policies and expenditures in each of these areas – and the balance of spending among these areas – also shapes the economy. In short, all governments really do have an industrial policy. The only difference is between those who construct their industrial policy consciously, and those who let it be shaped by others, typically by special interests, who vie with each other for hidden and open subsidies, and for rules and regulations that favor them, usually at the expense of others. Even the agenda of financial market liberalization was an industrial policy – one pushed by the banks and the financial sector, the effect of which in many countries was to lead to a bloated financial sector, rife with explicit and implicit subsidies (reaching record levels in the crisis of 2008–09), diverting resources from other uses that arguably would have led to high sustained growth. It was an industrial policy that led to more macroeconomic instability, which, as we explain below, was itself adverse to learning....

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of Tables
• List of Figures
• List of Boxes
• Notes on the Contributors
• Foreword
• Acknowledgements
• Introduction: Industrial Policy in the African Context
• Part I New Thinking on Industrial Policy
• Part II Structural Transformation: Lessons from History
• Part III New Global Order and African Reindustrialization
• Part IV Macroeconomics and Governance: Creating an Enabling Environment
• Part V Trade, Finance, and Sectoral Policies
• Part VI Country Experiences and Perspectives
• Index