3a Industrialization and industrial policy Overview Rationales for industrialization SEA industrialization patterns Industrial promotion policies, esp tariffs Effects of a tariff on industry growth, welfare and distribution Motives for industrialization Modernization, technology transfer Diversification  Less reliance on season/climate  Less price risk – manufacturing prices are stable  Less dependence on foreign sources (Belief in) increasing returns in some industries - lower unit costs permit more output using same resources Marshallian interfirm/interindustry externalities (shared infrastructure, agglomeration externalities) Overall aim: capture 'long-run comparative advantage' as an industrial economy Why so much variation in industriztn and employment rates and patterns among apparently similar economies? GDP Share 1990 Country Output per worker 1990 Agric Ind Serv Agric Ind Serv Indonesia 22 40 38 0.4 2.9 1.2 Philippines 22 35 43 0.5 2.3 1.1 Thailand 12 39 48 0.2 2.8 2.2 Source: World Development Report, various years Y/L in $’000 Industrial promotion strategies Why? Promote industrial growth, get growth dividend How? Mainly, but not exclusively, trade policies Economics of protectionism  Tariffs are most popular, if not best, way to protect favored industries  Easier to monitor trade flows at the port  Raise revenue for G  Easy to levy (many losers, but per capita losses are small)  Some of the biggest losers may be foreigners anyway S p*(1+t) a p* b c d D Q1 Q2 Q3 Q4 A tariff boosts production by raising domestic price from p* to p*(1+t) Diverts demand from imports to domestic products (a) Reduces total demand (consumers must pay more) Raises gov’t revenue (c) Causes deadweight losses through misallocation (b + d) Exch rate (Rp/$) S = export earnings E0 E1 D = import bill D' F1 F0 For exchange • Supply of forex comes from exports; demand is to cover imports • Tariff on imports reduces the demand for forex Floating exchange rate: tariff causes ER appreciation • Lerner symmetry: a tariff discourages both imports and exports Philippine protectionism and development  In SE Asia, the Philippines had highest and most persistent tariffs  High rates of nominal protection on imports produced negative effective protection for traditional exports (agriculture) Import 1960 1970  Effective protective rates by import category: category Consumer items Nonessential 349 354 Semiessential 149 57 Essential -15 Nonessential 173 203 Semiessential 52 14 Essential 50 19 Producer items 10 • What effect would these have had to produce and invest Trad’l exports -27 on incentives -33 Intersectoral impacts: agriculture Industry protection hurts agriculture indirectly: higher input costs, less competitive exchange rate, etc Nominal rate of assistance – direct policies Real rate of assistance – includes indirect effects Joining WTO was indirectly good for Philippine agriculture Philippines 1965-69 1970-79 1990-94 2000-04 Nominal rate of assistance to agriculture 14.3 -6.0 16.7 27.9 Nominal rate of assistance to nonagriculture 20.3 16.3 9.9 7.3 Real rate of assistance to agriculture -5.0 -19.8 6.1 19.1 11 Static gains and losses from protection Protected industries grow, at expense of foreigners, consumers and other industries Gov’t revenue will probably be higher due to tariffs Inward orientation: domestic markets for all goods become relatively important Industry structure: protection tends to create monopolies  “rent-seeking society” • Distortions to investment and FDI incentives 12 Dynamics: growth implications of protection Does inward orientation have long-run effects on growth? Answer depends on how protection is used Do infant industries really grow up? Do the costs of protection inhibit/enhance growth in other sectors? Protection and growth in the long run  Incentives & opportunities for rent-seeking (infant industries fail to grow)  Investment follows rents rather than seeking efficient opportunities … 13 The Bhagwati effect in Thailand Bhagwati hypothesis: rent-seeking FDI creates fewer productivity gains than efficiency-seeking FDI  High tariffs and monopoly power attract rent-seeking FDI  Protected industries are more capital-intensive than average, so there’s a ‘technology gap’ as well  Growth dividends from this FDI are small – or even negative Kohpaiboon (World Dev 2006) finds this for Thailand:  At the mean rate of industry protection, labor productivity is lower by 0.15% for every 1% higher foreign ownership share Implication: protection “damages” the growth effect of FDI Any comparisons with Vietnam? 14 Protection and income distribution (1) Supply side (factor markets) What are the characteristics of industries most likely to be awarded protection?  Which industries display least comp adv? What are the likely factor market effects of expansion in these industries (& contraction/slower growth in others)?  Factors used intensively in expanding industries enjoy price rises (demand for their services has risen)  Factors used intensively in contracting sectors lose In SE Asia, which factors are likely to gain most from industry promotion? Lose most? 15 Demand side (product markets)  Consumers of goods produced in protected industries lose thru higher prices  Industries using inputs produced by protected sectors lose  Consumers of goods whose prices are indirectly affected (N goods) lose  Protection and non-traded goods: if T and N goods are substitutes, raising some T prices will increase N demand and price Combined distributional outcomes  Losers from protection are owners of factors not intensively used in protected industries, and/or consumers of protected goods and/or non-traded goods 16 Winners and losers from protection Given the chance, which groups would vote for industry protection, and which against? Why? (at least reasons… individual interest and national interest) Each group contains:  President Marcos (1 person)  Manufacturing sector capitalists (2 people)  Farmers in export crop sectors (coffee, coconut, tropical fruit) (2 p)  Skilled workers/middle class (1 p)  Unskilled workers (2+ p)  “Make the case” to President; President decides what to and why, and explains decision to class 17 Industrialization and protection: summary Development benefits of industry growth are clear But ISI in SE Asia was not the most efficient path to industrialization  Uncompetitive industries rely on (small) domestic market  Protected industries are capital-intensive, their growth does not generate many jobs  Spillover costs to other industries, including exporters  Protected industries attract ‘bad’ (rent-seeking) investment  Protection favors owners of capital against owners of labor Any alternatives? Under what conditions might industry grow successfully without protection? 18 ... symmetry: a tariff discourages both imports and exports Philippine protectionism and development  In SE Asia, the Philippines had highest and most persistent tariffs  High rates of nominal... decision to class 17 Industrialization and protection: summary ? ?Development benefits of industry growth are clear But ISI in SE Asia was not the most efficient path to industrialization  Uncompetitive... characteristics of industries most likely to be awarded protection?  Which industries display least comp adv? What are the likely factor market effects of expansion in these industries (& contraction/slower