Industrial Development
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Industrial Development

How States Build Capabilities and Deliver Economic Prosperity

Greg Clydesdale

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eBook - ePub

Industrial Development

How States Build Capabilities and Deliver Economic Prosperity

Greg Clydesdale

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About This Book

Governments are regularly judged by their ability to deliver economic prosperity, however many policies fail to deliver their desired outcomes. Industrial Development examines historical examples of how governments have attempted to build productive capabilities and promote industrial learning. Each chapter shows a different way in which this is done whether it is imitating existing production technologies, building new advanced technologies, tapping into existing global chains or building their own value chains.

The book looks at a wide spectrum of countries and industries from Silicon Valley to the early Asian model of building domestic industries. The book also reveals that academics and policy makers can be a major source of policy failure.

This book makes an important contribution to our understanding of capability building, industrial development and economic growth and will be an essential reading for economists, policy makers and government officials making policy in a global economy.

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Information

Publisher
Routledge
Year
2021
ISBN
9781000472981

1 Introduction

DOI: 10.4324/9781003207719-1
I’m cutting taxes. We’re going to grow the economy. It’s going to grow at a record rate.
Donald Trump
Politicians customarily come to power on promises of economic growth. They recognise that economic growth is one of the most important issues for the voter so invariably make promises about the economy. But how much power do governments have over the economy? Can politicians truly influence economic growth as much as they say they can or do politicians take credit for events that are beyond their control?
Many of the forces driving economic growth have nothing to do with the government in power. Consider the influence of business cycles. A number of economists have noted that economies can go through cycles of growth and stagnation. One of the most influential theories is the idea of technologically driven cycles. Under that theory, the discovery of a new technology leads to more efficient production methods and new products. This leads to a growth spurt.
A politician in power during a technological upswing could take the credit for positive growth even though their policies had little influence. Of course, it works both ways. Some politicians suffer because they were in power during a period of decline. Whatever the case, the economy is being driven by factors beyond their control.

What is economic growth?

Economic growth is the increase in an economy’s capacity to produce goods and services. The size of an economy is referred to as Gross Domestic Product (GDP). Growth in GDP over time illustrates that an economy is increasing the value of its production. From this simple definition, we would expect economic growth to occur when an economy adopts more effective production techniques that expand output and make more goods available to its people. But where do these new production techniques come from?
New techniques can come from a number of sources. One of the earliest to write on this topic was the Greek philosopher Plato who argued that the key was for people to specialise. If people specialised in what they do best, they can produce more and everyone benefits. Plato stated:
all things are produced more plentifully and easily and of a better quality when one man does one thing which is natural to him and does it at the right time, and leaves other things.
…the husbandman will not make his own plough or mattock, or other implements of agriculture, if they are to be good for anything. Neither will the builder make his tools – and he too needs many; and in like manner the weaver and shoemaker.1
In other words, the builder should restrict himself to building houses, and buy the tools from someone who specialises in tool-making. The labour force would be divided into many specialist professions, each focusing on what they do best. This ‘division of labour’ and the resulting trade that occurred between them was the basis of a prosperous state.
Plato’s observation recognises that we cannot be good at everything, so we should focus on what we do best and trade with others who also concentrate on what they do best. With everyone operating at a higher level, output is increased. This also reflects the superiority of a market economy, in which goods are traded, over a subsistence economy where everyone produces for their own needs.
What Plato observed in his own lifetime was borne out in subsequent centuries as other market economies enjoyed higher productivity and wealth than those societies that still operated under subsistence. Writers from other cultures witnessed the same phenomenon. For example, the fourteenth century Islamic scholar Ibn Khaldun noted:
Each particular kind of craft needs persons to be in charge of it and skilled in it. The more numerous the various subdivisions of a craft are, the larger the number of the people who [have to] practice that craft… the craftsmen become experienced in their various crafts and skilled in the knowledge of them. Long periods of time and the repetition of similar [experiences] add to establishing the crafts and to causing them to be firmly rooted.2
Adam Smith, the father of modern economics, reinforced the importance of trade and specialisation in his 1776 book The Wealth of Nations. However, he also noted the importance of motivation and incentives. Smith recognised that the market enabled people to work hard and improve the conditions in which they live. He argued that workers would increase their productivity because it is in their own interests to do so:
… it is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest 3
In other words, people will work hard and increase their output because they benefit from doing so. Their productive efforts are rewarded by money or whatever else they trade for. Hence, they end up improving their own life conditions, but they are not the only ones who benefit. All of society, producers and consumers, benefits from their production:
… By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.4
However, Smith recognised that a large number of ‘obstructions’ exist that stop the market functioning effectively. Groups with political influence could influence government decisions, resulting in outcomes that did not enhance productivity, but instead benefited the small few with political influence. This was not just a problem for Britain but for other countries around the world where governments used their power to redistribute wealth to those at the top. Today, this behaviour is known as ‘rent seeking’ and remains one of the biggest criticisms of government involvement in the economy; that is, government intervention is often not in the best interests of the nation but in the interests of a small few in the chosen industry.
Adam Smith also recognised that governments can influence the structure of industry and trade. He severely criticised the East India Company which had been given a monopoly on trade with India. Monopolies lack competition and this reduces their need to operate efficiently. At the same time, their market power enables them to charge high prices to the detriment of the consumer:
Such exclusive companies, therefore, are nuisances in every respect; always more or less inconvenient to the countries in which they are established, and destructive to those which have the misfortune to fall under their government.5
Adam Smith’s book sent a very clear warning of the problems that occur when governments distort the functioning of markets. In the nineteenth century, an Englishman David Ricardo built on the principles of free trade and specialisation into his theory of comparative advantage. Unlike Adam Smith, who was a professor in moral philosophy, Ricardo had more experience in business. At the age of fourteen, he began working as an assistant to his father in the London Stock Exchange. By 1815, he had built a sizeable fortune and began to focus on public life, working in parliament and writing on political economy.6
In his theory, Riccardo extended the idea of specialisation to countries. In the same way that individuals should focus on what they do best in order to maximise productivity and welfare, so too should nations. Countries should not try to emulate each other, but specialise. They should concentrate on producing what they have a ‘comparative advantage’ in.
Perhaps the biggest problem with Riccardo’s theory is that it has a static view of productive capabilities. His theory assumes that an industrial nation, like Britain, should focus on manufacturing, while an agricultural nation like Argentina should stay focused on agriculture. There is an undeniable logic in this position but it ignores the fact that Argentina might also have the potential to be a manufacturing nation, and be even richer. It might have potential that it has not yet developed.
Under Riccardo’s theory, countries should exploit the strengths they have at any given time, but this does not acknowledge that competitive strengths can change. Nor does it consider the process by which those competitive strengths are built. This can be seen in merchant shipping. At the time of Riccardo’s writing, the British had the most powerful merchant navy in the world. It had the best ships and the best seamen. It had advanced technologies and the geographic knowledge necessary for ocean navigation. To anyone writing at the time, it would be logical to use British shipping simply because they were the most efficient producers.
However, Britain was not always the best sea-faring nation. In the seventeenth century, the Dutch had the leading merchant navy. If the British had followed Ricardo’s theory of comparative advantage, they would have hired Dutch transporters and never developed their own capabilities. Instead of doing this, the British government introduced an infant industry policy designed to build capabilities in shipping. This included a series of laws titled “The Navigation Acts” which restricted trade to English ships. Bounties were given to cargoes like wheat and other grains if they were carried in British ships, while an export duty was placed on coal if it was carried in foreign ships. Industrial protection did not just extend to shippers, but also to those who built the ships. English shippers were forbidden from using Dutch-built ships. As a consequence of this government intervention, Britain built the capabilities that enabled it to become the world’s leading sea-faring nation.7
If the government had followed the theory of comparative advantage, Britain would never have become the leading nation. In other words, Riccardo had a ‘static’ view of the economy which considered one period of time. A ‘dynamic’ view takes a longer perspective and considers the possibility of change.
The problem with a static view of capabilities can also be seen in Adam Smith’s attack on the East India Company (EIC). Smith was correct to criticise the company’s monopoly as being wasteful. Replacing the monopoly with a competitive structure would be far more efficient and fairer on the consumer. However, Adam Smith was writing in 1776 when the EIC was well established. If he had been alive when the company was created in the early seventeenth century, he would have found a very different situation. The East India trade was largely unknown and risky, consequently having a monopoly reduced risk and helped to attract investors. Hence, the monopoly was necessary to encourage investment and build capabilities where it might otherwise not occur.
The idea of granting a monopoly in the early days of a business is the same logic that lies behind patent laws. Today, if an inventor comes up with a new product, they will apply for a patent which gives them a monopoly in the use of that product for a number of years. The patent monopoly encourages people to take risks and develop new production technologies.
This raises the possibility that what is good at one stage of an industry may not be good for the same industry as an industry matures. A monopoly might help a new or emerging industry which contains high levels of risk and uncertainty. However, monopolies become increasingly wasteful as the industry matures and productive capabilities are developed.
Unsurprisingly, the theory of comparative advantage was not universally accepted. The German economist George Friedrich List thought that Britain’s preaching of free trade was the same as a man who had climbed to the top of a ladder, then kicked the ladder away so no one could follow him.8 Instead of sticking to this theory, List believed that governments could introduce policies that improved productivity and increase wealth. He advocated a range of policies that enabled a nation to acquire new technologies. The industries he believed were most likely to succeed were those with strong home demand. That is to say, a local market existed for the businesses. These industries should be targeted with government assistance, including tariff protection and other policies promoting capital accumulation and capability building.
Nevertheless, Ricardo’s theory of comparative advantage contained powerful logic in that it maximis...

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