China's Industrial Policies and the Global Business Revolution

Ling Liu

• Publisher: Routledge
• Year: 2005
• ISBN:
  9781134253852
• Edition: 1
• Topic: Business
• Subtopic: International Business
• Index: Business

As China has blended market reforms with comprehensive industrial policies, most research has focused on the national government's strategies for economic growth. However, one of the unique characteristics of industrial policy in China is that it involves government intervention at all levels, from the political elite all the way down to village leaders.This book focuses on the domestic appliance industry, and China's three major business groups in this area - Haier, Hisense and Aucma. The Haier Group, in particular, is one of the most successful and competitive enterprises in China and is very well-placed to compete globally as the Chinese economy becomes more integrated with the world trading system. This volume shows how industrial policy is formulated at the national level and implemented at the local level, and examines how local government frequently intervenes in local enterprises' business strategy and management.Of practical importance, this book provides academics, business people and policy makers with valuable insights into the development process and a concrete understanding of the challenges faced in the global business revolution by one of the world's most dynamic economies.

1 Industrial policies and globalisation in theoretical and historical perspective

Introduction

This book attempts to answer the following questions: what are the rationales behind government intervention, the trend towards globalisation and the global business revolution? How do recent global tendencies affect governments and firms in developing countries? What are the new constraints and opportunities for developing countries trying to catch up in global industries? How do the industrial policies of the government, at central, provincial and municipal level, affect the domestic appliance industry in China? How can these policies nurture big businesses as they face the challenges of an ever changing world business system? What is the position of China’s domestic appliance firms as global production becomes integrated? Can Haier, Hisense and Aucma, the three firms in the case studies, compete with global giants with continued state support after China joins the WTO?

To answer these questions, some theoretical and historical background on government intervention and globalisation is essential, as these underlie the internal debates over China’s industrial policies. This is the subject of this chapter. The first section reviews the literature on government intervention; the second section reviews the literature on globalisation and the global big business revolution.

Debates on government intervention

Debates on the appropriate role of government in economic development have engaged policymakers and scholars since the study of economics began. Three mainstream views have emerged: neoclassical, revisionist and market-friendly.

The neoclassical view considers markets to be crucial mechanisms for generating efficient resources: once competitive markets are in place, investment can be left to take care of itself. It argues in favour of a minimalist state to reduce as far as possible unproductive state activities and rent-seeking behaviour by public agents and bureaucrats (Bhagwati 1982;

Buchanan et al. 1980; Findlay 1992; Krueger 1974). The appropriate role of government is to provide a suitable macroeconomic environment for the free functioning of the market and to supply certain ‘public goods’ where it has a clear comparative advantage relative to private agents, for example in physical infrastructure, defence and national security, and education. Policies should be geared to moving from inward-looking strategies towards liberalisation of the foreign trade regime and export promotion; ensuring a reliable legal framework for domestic and international competition; privatising state-owned enterprises; and following the dictates of the market price system.

The revisionist view stresses market failure as a justification for government to lead the market in critical ways. Based on convincing evidence that the governments in East Asian economies – especially Japan and South Korea – intervened forcefully in their markets, the revisionist view argues that economic development can occur as a result of intelligent and strategic government intervention to promote long-term industrialisation, rather than through a free-market approach. By ‘governing the markets’ and ‘getting prices wrong’, government accelerates development by systematically distorting incentives; that is, it facilitates the establishment and growth of industrial sectors that would not have thrived under the workings of comparative advantage (Wade 1990). In sharp contrast to the neoclassical school, the revisionist view sees the rent-seeking activity of governments as a source of capital accumulation rather than inefficiency and corruption.

The market-friendly view, addressed by World Bank (1993a), occupies the middle ground between the neoclassical and revisionist views. Bearing in mind that market failure and government failure are both important impediments to rapid growth, it perceives rapid growth in developing countries as associated with effective but carefully limited government activism, so-called ‘selective intervention’. To put it another way, governments ‘not only need to do less in those areas where markets work, they also need to do more in those areas where markets cannot be relied upon’ (World Bank 1993b). However, while recognising that both market failure and government failure occur, it believes that government failures are more frequent and more serious, and therefore should be carefully dealt with.

Nevertheless, the role of government has never been insignificant in the history of capitalism, although for certain reasons it has sometimes been ignored in developed nations like Britain, France, Germany and the USA. This pattern is largely consistent with the rise of newly industrialised countries (NICs), particularly in East Asia where governments’ frequent and aggressive interventions have contributed significantly to economic growth. In the following section, our concern is to review the main theories relating to government intervention, and then to examine the specific industrial policies that were implemented in these economies.

Rationales for government intervention: a theoretical interpretation

The theoretical interpretations of government intervention provided by the current literature are mainly based on the theories of market failure, government failure and political ideology.

Market failure

Market failure is a conventional motive for government intervention. Market failures can be categorised into allocative failures and dynamic or ‘creative’ failures. The former refers to failures resulting from monopoly power, public goods, externalities and merit goods, information failures, an incomplete market, macroeconomic disequilibria including inflation and cyclical unemployment, poverty and inequality (Stiglitz 1986: 90). The latter refers to failures to expand the production frontier at an optimal rate, either owing to suboptimal levels of investment and innovation, perhaps due to scale economies, or owing to inadequate entrepreneurial resources leading to failure to exploit economic opportunities and to propel the economy forward (Killick 1990: 25). To correct market failure, the government should promote capital accumulation and coordinate the allocation of resources through programming and planning.

Stiglitz points out that:

The recognition of the existence of imperfect and costly information, incomplete markets, and transaction costs and of the absence of future markets extended the range of market failures beyond the earlier attention to public goods and externalities that required only selective government intervention.

(cited in Meier 2001: 21)

This consideration applies to the developing countries, especially in their early stages of development, when markets may either not exist or be incomplete and highly imperfect. In such situations, market failures occur largely in terms of coordination failure resulting from insufficient and asymmetric information. Since the institutional arrangements for cooperation and information exchange are very weak, there is a greater need for government to play a role. In this sense, government is viewed as another form of coordination mechanism. Among the markets most affected by information problems are capital markets (World Bank 1993). In the absence of insurance and equity markets, government comes in as the ‘second best’ risk insurer and capital provider to substitute for missing and difficult-to-develop capital markets (Chang 1994). For example, in the East Asia economies the governments established credit-based financial systems in which they could exercise influence over the allocation of credit and over the balance between investment and consumption. Although such a control of

credit was imperfect, it did contribute significantly to economic growth and international competition. By setting up and managing directed credit programmes, government reduced the risks borne by investors through explicit and implicit guarantees or other forms of intervention (World Bank 1993). On the other hand, firms depending on bank credit can concentrate on long-term investment rather than short-term profitability which can lead to pressure from shareholders in a market-based system. In response to information asymmetry, governments develop communication systems through which business and government can exchange information and coordinate investment decisions. A good example is ‘deliberate council’ in Japan and South Korea, which is used to facilitate formal and informal interaction between the private sector and government, among firms, and between management and labour.

Government failure

The second possible explanation of government intervention is concerned with the correction of government failure. Causes of government failure may include deficiencies in planning, inadequate information and resources, unanticipated dislocations of domestic economic activity, institutional weakness, and failings on the part of the administrative civil service (Chakrvarty 1991).

Literature on government failure has three major strands – the information argument, rent-seeking theory and public choice theory. The information argument points out that government is not necessarily well informed about the nature of a given problem or about the complex consequences of its own policy actions, which may produce perverse or unwanted effects (Lal 1983: 74). It also argues that government may be able to collect and process all the information relevant for the correction of the market failure only at costs that are greater than the resulting benefits. Government failure seems inevitable. The rent-seeking theory argues that government intervention creates additional ‘waste’ that may more than offset the benefits it produces. Common examples include efforts by businessmen to secure import licences and to persuade governments to provide protection against competition or a budgetary subsidy, enabling them to consume resources without contributing anything to output. Government failure in the face of a market failure may worsen rather than improve the situation (Bhagwati 1982; Krueger 1974; Killick 1990; Tullock 1980).

Public choice theory, stressing the self-serving or egoistic behaviour of government bureaucrats, has added further strands to this argument (Bhalla 2001: 29). Government failure results from the intrinsic difficulties in improving the accountability and control of bureaucracies; and the problem is aggravated both by the existence of corruption, nepotism and other malpractices and by the tendency for state agencies to be ‘captured’ by special interest groups ( Killick 1990; Stiglitz 1986).

However, there are ways and means to correct government failure, just as there are to correct market failure and to reduce the costs of government intervention while not forgoing its possible benefits (Chang 1994). Chang states:

the state may resolve the co-ordination problem at a lower cost than the market (and other economic institutions) and thus reduce transaction costs, which are the costs of co-ordination, in the economy. Institution of an effective property-rights system, macroeconomic stabilisation, organising society into large groups, promoting national ideologies, and co-ordinating complementary investment decisions are examples of such a role. This type of intervention is particularly attractive because it is relatively cheap compared with other types, which may indeed incur large transaction costs (for example central planning).

(Chang 1994: 54)

This type of intervention depends to a great extent on government’s ability to establish the necessary institutions and mechanisms and to improve the quality of policies.

Political ideology

The third rationale for government intervention goes beyond market failure and government failure, both of which fail to tell the whole story as they focus merely on allocative and productive inefficiency without paying much attention to the political and ideological context. Instead, it suggests that some concepts of the old political economy, such as nationalism, power, ideology, class and the relationship between the state and society, may have some relevance. In reality, looking from a political viewpoint, the governments of East Asian countries have perceived economic development as the primary means of establishing their legitimacy and consolidating their own positions (Wade 1990). Following serious devastation during times of war, drastic measures were needed to rebuild the nations quickly. From an ideological point of view, although the governments claim they are conforming to free market principles, in fact they mistrust the free market and free competition based on comparative advantage. (Such anti-liberal ideologies can be traced to the half-century before the First World War, when the global economy was at its first peak in terms of colonisation and inequality of competition.) The creation of an ‘independent economy’ and ‘self-sufficiency’ were the dominant themes of the policymakers. In consequence, governments intervened in the economy, using subsidies deliberately to distort relative prices and encourage big business in the oligopolistic market in order to stimulate economic activity and compete with foreign rivals. This has been true of Japan and South Korea, also of Taiwan, Singapore and Malaysia.

Industrial policies: government intervention in a historical perspective

Having established the rationale for government intervention, we now examine the policies that different economies actually adopted for their development. Here we focus on industrial policy. We define industrial policies as anything involving

direct or indirect government intervention in the market place typically by a range of policy instruments, in order to achieve a different allocation of resources to specifically defined priority industries at any point in time than would occur through the normal operation of the market place.

(Patrick 1997: xiii)¹

In this book, we do not intend to set trade policy and foreign investment policy apart from industrial policy, as the boundaries between them are becoming increasingly blurred and it is extremely difficult to distinguish the one from the other. In the following subsections, we first examine the industrial policies pursued in the three economies of East Asia – Japan, South Korea and Taiwan – and then the developed Western countries during the post-war period, including Britain, France, Germany and the USA.

East Asia – Japan, Taiwan and South Korea

It is not surprising that we examine these three economies together as they show striking similarities with respect to both institutions and instruments. This is in part because Japan was, to a large extent, the textbook example for both South Korea and Taiwan. With regard to their industrial policies, empirical evidence shows that there was considerable diversity across the three economies in terms of their exact policy mix and time scale. However, some common strategies can still be easily identified in the three economies: the governments focused on industries with a high entry barrier which could help overall productivity and growth. These industrial policies were designed to reduce the uncertainty associated with really large-scale investment by implicitly and explicitly sharing risks with the private sector. They included targeting, nurturing and protecting.

TARGETING

Targeting is the practice of singling out particular industries for support and development (Porter 1989). Typically, governments select certain industries for ‘targeting’, and enact financial measures and other policies designed to create national champions. In Japan, the government targeted industries with high elasticity of demand, and constantly changed its targeting and promotion measures. For example, the targeted industries to which huge credits were made available were steel, shipbuilding, automobiles, textiles and petrochemicals in the 1950s, and computer and consumer electronics in the 1960s. After the 1970s, targeting sometimes involved more of a signalling role, highlighting the importance of an industry and influencing private investment without explicitly offering subsidies or tax incentives. The targeted industries were semiconductors, aerospace and robotics in the 1970s, and biotechnology, fifth-generation computers and superconductors in the 1980s (Johnson 1982; Nester 1991). The same approach continued until 1999, when MITI announced that it would publish an Industrial Technology Strategy in 2000 which would identify technological sectors in which the private sector should concentrate its efforts (Porter et al. 2000). As in Japan, in South Korea it is common practice to give priority to certain industries; this originated in the very early years of economic development. In the First FYP (1962–66), cement, fertilisers and oil refining were targeted as ‘basic’ industries, then chemicals, steel and machinery in the Second FYP (1967–71). During the Third and Fourth FYPs (1972–81), non-ferrous metals, shipbuilding and electronics were added to the list. The selected priority sectors during the Fifth and Sixth FYP periods were machinery, electronics, automobiles, chemicals, shipbuilding and various high-tech industries (Chang 1994).

In Taiwan in the early 1970s, the government promoted intensive growth in heavy industry, the chemical industry and technology-intensive industries, so as to reduce dependence on imported intermediates and upgrade the export portfolio. Unlike Japan, the government generally established new upstream industries – often, single factories – itself. Then it either handed the factories over to selected private enterprises (in the case of glass, plastic, steel and cement) or ran them as public enterprises. The government has helped by identifying particular items on Taiwan’s own production frontier and targeting them with fiscal investment incentives and concessional credit (Johnson 1982; Wade 1990).

NURTURING

Targeting is not a single policy, but involves a group of policies. The three governments employed a variety of policy tools to nurture their domestic industries and to shield them from foreign competition until they reached a scale and level of product quality and sophistication that made them competitive in world markets. The greater the backwardness, the larger the amounts of government support needed, including subsidies, creation of recession cartels and mergers, and selective protection against foreign direct investment.

Subsidies are one of the main sources of nurturing. An important feature of subsidies is that they are based on performance standards for private ...

Table of contents

• Cover Page
• Half Title Page
• Title Page
• Copyright Page
• Dedication
• Contents
• Figures
• Tables
• Preface
• Acknowledgements
• Abbreviations
• 1 Industrial policies and globalisation in theoretical and historical perspective
• 2 Industrial policies in China
• 3 The domestic appliance industry
• 4 The Haier Group
• 5 The Hisense Group
• 6 The Aucma Group
• 7 Conclusion
• Notes
• Bibliography
• Index