The Structural Transformation: The Industrialization Process

1. The Structural Transformation:The Industrialization Process Cypher and Dietz, Ch. 9 & 10

2. What type of economic policy for industrialization? protective import-substitutionist industrialization (infant industry protectionist) versus liberal export-lead growth

3. What type of economic policy for industrialization? A third way: protective import-substitutionist industrialization within a limited time frame Strategy switches between protective import-substitutionist industrialization and export lead growth (export substitution)

4. the rationale for infant industry protection • If domestic producers’ unit cost > foreign competitor’s unit cost,and • domestic country opens borders to international trade, then ↓ likely to lead to domestic producers closing down due to price competition from foreign countries. • “transitional inefficiencies”: competitive disadvantage of less-developed countries’ young firms vis-a-vis existing, more mature foreign firms.

5. Why transitional inefficiencies in the firms of developing countries? • Lack of finance for investments due to imperfect markets in banking and finance • Lack of technology • Few trained entrepreneurs • Lack of learning by doing

6. How can firms of developing countries become internationally competitive? • In order for domestic producers to reach internationally competitive levels of productivity, they need to decrease their unit cost. How? ↓ through technological change and experience-based learning • Yet such technological change and experience based learning entails high costs that necessitates financing until domestic producers become competitive.

7. The rationale behind ISIImport-Substitution Industrialization Government protection enables the overcoming of transitional inefficiencies of domestic firms by allowing them the time required to initiate the production process, invest in technology and engage in learning by doing.

8. Infant Industry Protection as a form of financeto raise productivity and reach international competitiveness • a protective tariff tax on imports →prices of imported goods increase → domestic goods are able to compete better in domestic markets • as domestic demand for domestically produced goods increases, domestic producers slide down the ATC curves • also domestic producers have a chance for learning by doing Also other policy tools for Infant Industry Protection: • tax incentives, low interest rate credit, direct subsidies to lower cost of production • undervalued exchange rates • creation of para-state firms

9. Opponents of ISI: infant industry protection as an internal barrier to development No motivation for domestic producers to invest in technology and learning ↓ • Productivity remains low;unit costs high ↓ • Consumers suffer from high prices and low quality. • Overextended protection can lead to a few domestic firms benefiting from rents at the expense of consumers. ↓ • Corrupt interest relations formed between bureaucrats and industrialists leading to factional state. ↓↓ Eventually long-term growth and development process is inhibited.

10. How can firms of developing countries become internationally competitive? • they need to decrease their unit cost. How? ↓ through technological change and experience-based learning • This entails high costs that necessitates financing until domestic producers become competitive.

11. The rationale behind ISIImport-Substitution Industrialization • Government protection enables the overcoming of transitional inefficiencies of domestic firms by allowing them the time required to • initiate the production process, • invest in technology • engage in learning by doing. • workers, managers and entrepreneurs can improve efficiency in the process of actually producing

12. Infant Industry Protection:a form of finance to raise productivity &achieve international competitiveness • a protective tariff tax on imports →prices of imported goods increase → domestic goods are able to compete in domestic markets • as domestic demand for domestically produced goods increases, domestic producers slide down the ATC curves • also domestic producers have a chance for learning by doing

13. Impact of infant industry tariff Prior to tariff consumer surplus: PFfPM Producer surplus: P0aPF With the tariff, CS: PTdPM PS: P0bPT loss in CS: PFfdPT government tariff revenues: bcde additional PS: PFabPT deadweight loss: PFfdPT– PFabPT – bced = abc + def After efficiency increase: CS: PFPMf PS: PFfg (larger) dynamic welfare gains  Higher efficiency  g 13 Source: Cypher & Dietz (2004): p. 263

14. Additional policy tools for Infant Industry Protection • tax incentives, • low interest rate credit, • direct subsidies to lower cost of production • undervalued exchange rates • creation of para-state firms

15. infant industry protectionwith a timetable for phasing out • Government announces a clear timetable at the beginning of ISI. • Domestic firms can anticipate the end of tariff protection; • hence they do not become complacent; • instead they take advantage of the protectionist period to prepare themselves for international competition when the tariff is phased out. ISI protection measures should not become a permanent feature of the economy.

16. Long-term Industrialization Policy:suggested sequence of ISI Easy (primary) ISI (consumer non-durables) ↓ Strategy switch: export substitution ↓ Need for increasing import of complex, intermediate inputs domestic vertical integration ↓ Secondary ISI (consumer durables and intermediate goods → capital goods) ↓ Strategy switch: export substitution export lead growth

17. Long-term Industrialization Policy:important guidelines • Using infant industry protection, a country can create its own comparative advantage; but such protection can also lead to negative consequences. Hence: • protection should always take place within a clearly defined timetable • it should end whenever enough time has been allocated for domestic suppliers achieving international competitiveness. ↓↓ Long-term aim is integration into international markets but with a carefully planned strategy for industrialization.

18. How long to protect? No precise answer yet experience shows it depends on the average learning curve of the industry : • Non-durable consumer goods have relatively short learning curves: protection approximately 5 years • More complicated products have longer learning curves, hence protection might be longer.

19. ISI strategies in Latin America & India,versus in South Korea & Taiwan LA & India followed easy ISI prematurely with secondary ISI. This failed because: 1. Secondary ISI industries need advanced technology and sophisticated proprietary knowledge & skills; • to meet this need, they had to invite TNCs; • this shortcut the growth process of local entrepreneurs. 2. Lack of competitive pressures on domestic industry → few domestic firms earn economic rents → • culture of vested interests and corrupt state • also little technical dynamism in technology and human capital. 3. Secondary ISI is less labor intensive than easy ISI (or easy export substitution) → labor absorption slows down → unemployment

20. ISI strategies in Latin America & India,versus in South Korea & Taiwan In South Korea & Taiwan; • easy ISI lasted only for about a decade (1950s into 1960s), and then the strategy switch to export substitution. • This lead to a more dynamic export pattern, dominated by manufactured goods. • Hence no prolonged protection for domestic industrialists; domestic firms felt competitive pressures from international firms; • and became more adept at making necessary technological and human capital investments. • Also use of “contests” → a performance based allocation system where the state imposes rules, rewards and referees for private firms wishing to gain access to protection.