Despite many changes in today’s modern global economy developmental states are needed more than ever
In the fall of 2017, SPERI’s Matthew Bishop and Anthony Payne gathered essays from a group of nine development economists who produced essays on ‘Revisiting the developmental state’ (SPERI Paper No. 43). They drew upon a body of work published on the SPERI Comment blog and in other publications about the state’s appropriate role in development and the nature of a modern industrial strategy. The essays examined the current status of the notion of a ‘developmental state’ in today’s contemporary context of globalization. This article reviews the series, highlights some key takeaways, and considers some other elements that were not addressed by the essays.
The key takeaways from the SPERI series
Bishop and Payne described the traditional key goal of a developmental state as building markets, but then deliberately distorting them in order to pro-actively support the build-up of domestic manufacturing firms over time. Typically, developmental states used trade policy, public financing, subsidies, tax incentives and other industrial policies to build-up their manufacturing sectors. They noted that the free market approach would have countries only exploit their current ‘comparative advantage’ as if it was a naturally determined and static condition, whereas a developmental state would view comparative advantage as dynamic and changeable over time, and to be manipulated in a long-term process of constant industrial upgrading.
Today, Mariana Mazzucato reminds us of the critical role states have played in not only making markets but also supporting technological development and innovation. She builds on a tradition of work by Alice Amsden, Chalmers Johnson, Robert Wade, Peter Evans, Meredith Woo-Cummings and many others, not to mention Alexander Hamilton and Friedrich List.
The free market critics of state intervention have long claimed that the private sector can do it all by itself – if the state would just get out of the way. In contrast, as SPERI’s Final Report of the Industrial Strategy Commission (2017) noted, the state has unique coordination and convening powers, and the ability to pool risk, create markets and provide public goods that the private sector cannot undertake.
Therefore, as David Booth’s essay noted, the debate over a role for the state in development ‘is largely settled’. The question today is how states can best carry out these functions.
Some essays alluded to the importance of state support for long-term research and development (R&D) coordination between the government, public research institutes and universities and domestic manufacturing firms. States have the financing, coordinating and convening powers to support R&D that develops firms’ capabilities in new technologies, product and process innovations, and market development. From the earliest experiences with industrialization strategies, countries learned that waiting for private companies to finance their own R&D by themselves did not produce very many new innovations. Instead, public support for R&D by ‘developmental states’ was essential.
Henry Wai-chung Yeung noted the benefits of state support for industrial clustering, and how clusters promote cooperative industrial ecosystems and inter-firm and inter-industry linkages. Clusters can also help firms to leverage new sources of technologies and markets needed for accessing global production networks. While integration with global production networks can be useful, it can also stifle development when firms face low-price pressures by monopsonies and are unable to move up the value-added production chain. State-led support for R&D can be critical for overcoming such challenges and enabling skills and technological upgrading.
Developmental states must have governments which have made long-term commitments to pursuing a pro-active industrialization strategy that are sustained over time. This requires a broad political consensus or settlement agreed among key domestic political constituencies and key sectors of the economy. Only with such a political settlement in place can a country proceed with adopting the right trade, foreign direct investment (FDI), monetary, finance, taxation, R&D and technology policies needed to pursue an industrialization strategy over time.
In many countries, however, there is an absence of such political settlements. Instead, the consensus is to maintain the status quo as a producer of primary agriculture or extractive commodities. In these cases, the small or nascent manufacturing sectors tend to be relatively newer and politically weaker than the entrenched commodity producers, and lack the political support for getting the type of trade and macroeconomic policies needed for their development. As David Booth noted, often the most important policy weaknesses in many countries have domestic causes. So, having the right political settlements in place is the critical first step for a developmental state to succeed.
Regarding discipline, experiments with industrialization in Latin America and Africa in the 1950s, 60s and 70s often went badly because the states lacked independent domestic bureaucracies and institutions which had the political will to cut-off trade protection and subsidy support from firms which were not working to improve their efficiency and competitiveness over time. In contrast, the institutions in many East Asian economies had the political support and independence to discipline non-performing firms by cutting-off industrial policy support. Thus, Kunal Sen noted the importance of political settlements that allow for the state to discipline even politically-connected firms.
On financial deregulation, Valbona Muzaka noted that the industrialization efforts in India and Brazil have become stifled not so much because of technological change but because of their premature degree of financial integration into the global economy, and that both countries will need to find a way ‘to reign finance in’. If states deregulate their financial sector too prematurely, investors will prioritize short-term speculative initiatives over long-term national economic development priorities. As Ziya Öniş noted, developmental states must pro-actively direct finance in strategic ways in order to drive industrial development – which cannot happen with a laissez faire approach to financial regulation. Courtney Lindsay pointed to the importance of strategically targeting subsidies, financing and tax incentives to support the development of infant and exporting firms as critical tools.
Önis also noted that FDI cannot be left unregulated. Rather, incentives and disincentives must be used by developmental states to prioritize the most appropriate types of FDI needed to support strategic development priorities. For example, China’s openness to FDI was always based on ‘an active bargaining process focused on aligning the terms of entry with its broader strategic priorities’. Other entry requirements such as local content rules are critical for incentivizing FDI to establish forward and backward linkages with domestic firms. Traditionally, developmental states used rules of entry for FDI that included technology-transfer requirements to assist domestic firms (but these have been largely outlawed). Notably, such an approach to regulating FDI is fundamentally different from the laissez faire open-door approach to FDI.
David Booth noted that developmental states have typically tried to ensure that an industrialization strategy is first based on improvements in the productivity of the agricultural sector. If food production becomes more efficient and fewer resources are used to produce food, it is presumed more resources could be redirected to developing manufacturing and services. There are also useful synergies that can occur between improving agricultural productivity, local farmers and manufacturers of agricultural machinery.
While the East Asian success stories tend to get a lot of attention from development economists, Valbona Muzaka reminded us that it is useful to consider the whole range of historical experiences with industrialization going back over 500 years to the earliest examples in the UK, Europe and the US. Throughout history, ‘the developmental state has always been one that designs and orchestrates socio-economic-political strategies aimed at catching up with whatever it deems an advanced economy at a given point in time’.
Things missed by the SPERI series
Although it was occasionally touched on in passing, such as by Valbona Muzaka, one critical item neglected by the authors in the series was the imperative to move towards green industrialization. Muzaka noted the need ‘to establish “smart” production-based sectors that are research-intensive and aimed at overhauling production and consumption patterns in ways that favour quality, durability, low energy, recyclability, waste management and so on.’
This is where 21st century development economics must make a big leap forward from its 20th century predecessors. The crises of climate change, environmental pollution, natural resource depletion and species extinction demand that industrial production and consumption are radically overhauled going forward. Developmental states must aggressively scale-up new green production systems based on renewable energy, materials sciences, recycled inputs and recyclable outputs, and closed systems with zero pollution, etc.
None of the essays explicitly mentioned the utility of trade protection (tariffs and quotas, etc). Economic historians such as Alice Amsden, Erik Reinert and Ha-Joon Chang have explained how developmental states used trade protection while first building–up their domestic manufacturing industries until the point at which they were competitive in world markets, and only then began to liberalize trade in those areas. Although this approach is diametrically opposed to free trade theory, this was a basic rule of thumb for all successfully industrialized economies. Today’s developmental states may want to think twice about signing trade treaties and investment agreements that prematurely lower their tariffs.
Today’s trade negotiators from industrialized countries and many mainstream university economics curricula promote the notion of a need for ‘a level playing field’ in international trade relations, which strongly appeals to most people’s sense of ‘fairness’. Despite the ubiquity of the concept, fairness has no basis in the history of how the rich countries industrialized, and the concept never guided their trade and FDI policies during their industrialization trajectories. If anything, the key takeaway from the historical record is that developmental states must temporarily pursue decidedly ‘unfair’ trade relations precisely so they can support the development of their domestic manufacturing industries. Successfully pursuing structural transformation has never been about being ‘fair’ to your trading partners.
The series did not explicitly spell out the important role of public development banks as critical institutional tools for developmental states. Development banks provide the essential long-term, low-interest ‘patient capital’ that private banks and international financial markets cannot. This is because short-term profit is not the overall goal of public development banks. Instead, their goal is to support public policy objectives that are necessary for implementing long-term national economic development strategies.
Public development banks can also steer needed finance to important sectors or regions that would not otherwise get it from private finance, supplement the financial sector by filling gaps in credit supply or demand, and promote economic stability through counter-cyclical lending. Public development banks can also support social goals such as improving standards and by linking financial access to improvements in social or human rights safeguards.
From the earliest experiences with industrialization strategies, countries learned through trial and error that waiting for private entrepreneurs to establish critical industries when the private sector was either unwilling or unable to do so was not a winning strategy. It became clear that in some sectors, the state would need to step in as the ‘entrepreneur of last resort’ with state-owned enterprises. Mazzucato goes even further, suggesting that states can step-in pro-actively as entrepreneurs of ‘first resort’, particularly when they are willing and able to take on extreme risks, independent of the business cycle.
While innovation is important, the essays did not underscore the importance of the art of reverse-engineering, emulation and the process of ‘learning-by-doing’ that are so critical to upgrading manufacturing skills over time. Today’s industrialized countries did not strictly enforce patents and copyrights, and regularly poached innovators and innovations alike from other countries during their industrialization trajectories. Only much later, when they had something to lose, did they start becoming concerned about intellectual property rights (IPR) enforcement. Yet, stealing advanced technologies, reverse-engineering and emulation have long been critical learning-by-doing pathways for manufacturing sector development.
Today’s developmental states may want to think twice about signing trade treaties and investment agreements that promise to more strictly enforce IPRs of more advanced competitors. Notably, it can take more than a few years from the time when a complaint for IPR infringement is first filed, a final ruling is issued and corrective measures are fully implemented by the offending party. Therefore, it may behoove developmental states to pro-actively violate their IPR commitments when necessary for as long as possible in order to foster strategic industrial upgrading because the long-term gains from learning-by-doing and emulation could outweigh the short-term losses from fines and penalties.
The essays neglected to mention the critical problem with what the IMF and most macroeconomists today call ‘prudent’ and ‘sound’ fiscal and monetary policy. In 1980, Milton Friedman’s monetarism – the belief that very low inflation and very low budget deficits are more important than anything else – was but only one of several acceptable positions along a range of viable fiscal and monetary policy options. It was a conservative one, but only one of several options. Yet, over the last 40 years, this one position has come to be the only thing taught at nearly all university economics departments and in nearly all textbooks.
As a result, today most central banks in developing economies regularly prioritize raising interest rates very high in an effort to keep inflation very low. But, consequently, the high interest rates make crucial deficit spending on long-term public investment unaffordable. Applied year after year for the last few decades, this approach has left public investment as a percent of GDP in many countries chronically underfunded, with often dilapidated or nonexistent infrastructure.
In contrast, developmental states understood that greatly scaling-up long-term public investment in the health and education of the workforce, national infrastructure and public transport were critical components for increasing future overall productivity rates, upon which the development of the manufacturing sector depends. Developmental states must adopt a more accommodating macroeconomic framework that involves permitting higher budget deficit paths and/or higher levels of inflation without jeopardizing macroeconomic stability.
In sum, the 9-part SPERI series, Revisiting the developmental state, provided a fascinating overview of how the ‘developmental state’ is perceived by development experts in today’s globalizing economy. It reminded us about the critical the role of the state in long-term national economic development strategies, and why ‘developmental states’ are still relevant today. The essays recapped some key lessons learned throughout history of the industrialized countries, namely the importance of: establishing domestic political settlements; disciplining non-performing companies when administering industrial policies; regulating the financial sector and incoming FDI; and increasing agricultural productivity. Notably, the series showed that some of these historical practices are at odds with today’s dominant free market orthodoxy, while others can be more aligned with it.
However, the essays neglected some other important lessons. Chief among these are the need to pursue green industrialization; the fact that trade liberalization is not an either/or proposition, but rather a matter of strategic timing, pacing and sequencing; trade policy has nothing to do with ‘fairness’; there is a need for public development banks and state-owned enterprises; and that future developmental states are presented with serious constraints posed by the growing scope of IPR enforcement and overly-restrictive IMF fiscal and monetary policies.
Overall, the SPERI series makes the case for why, despite many changes in today’s modern global economy, developmental states are still needed today more than ever. Developmental states face a growing array of hurdles and obstacles at both the domestic and international levels. Yet, despite these challenges, the series also showed that there are still creative pathways that developmental states can still pursue – if they can first establish the domestic political settlements necessary to pull it off.