Industrial Policy for Transition: A Way to Strengthen Sustainability

  The present crisis in the transition economies has revealed – among others – a high vulnerability of the economies due to the frequently unbalanced composition of their respective supply sides: There are the resource-rich economies of Russia, Kazakhstan, Azerbadjan, Turkmenistan, and others which are heavily dependent on world demand and prices for their raw materials, mainly, but not exclusively, energy resources; at the other extreme, there are economies, like e.g. those of Moldova, the Baltics or Montenegro, whose economic base is extremely weak, since they rely on one or two products (wine) or services (tourism) for their economic survival. But there are also countries like the Czech Republic, Hungary and Poland whose sectoral composition is more balanced and comprises strong shares of agriculture, manufacturing, construction and services. The latter need to make the next step up the value-added ladder.

This weakness in the composition of the supply side can be attributed to basically four distinct, if sometimes overlapping, causes: the first is the existence of significant amounts of raw materials as a “nature-given” comparative advantage, which however, has elements of the well-known “resource-curse”, i.e. the fact that heavy domination of natural resources draws resources from other parts of the economy and may lead to “Dutch disease” phenomena, namely overly high prices for the rest of the economy via this one component which ties the economy into the global one. Such economies are also frequently highly exposed to corruption. The second cause may be attributed to the fact that the economies of the CIS states and those of former Yugoslavia were once part of a more integrated and balanced economic space which has since been torn apart, thus depriving the remaining “rest economies” of balancing other sectors. The third cause is due to the fact that the dominant transition model at the beginning of the nineties was mainly geared towards liberalizing macroeconomic adjustment, condemning the (more interventionist) sectoral policies of before into the realm of to-be-overcome state interventionism, in short neglecting and even disavowing them. This does not imply that Soviet or Yougoslavia-type of industrial policy had much to recommend for today’s globalized economies. A fourth reason might be that much of the development process and economic policy was geared towards attracting foreign direct investment – in whichever sector the foreign investors chose, thus creating a dependency model of transition which in some cases became heavily geared towards one or two dominant industries.

It may be one of the very few positive aspects of the present crisis to have given rise to stronger considerations of actively promoting a more balanced economy in the transition countries, thus making industrial policies more palatable. The crisis has also shown that over-reliance on one specific industrial sector, e.g. the automobile industry in Slovakia or Hungary, has also increased the vulnerability of these economies.

More balance might do two things: a) make the respective economy more resilient vis-a-vis sectoral fluctuations; b) move the economy onto a higher value-added level, thus supporting higher wage levels and improvements in the living standards. Designing appropriate industrial policies for the transition countries could be the medium-term answer to these problems. While country-specific policies need to be devised, depending on the knowledge base, the resources (both natural, commercial and human), the existing structures and infrastructure of each country, a few general principles apply to all transition countries:

-Successful industrial policy needs to combine bottom-up with top-down elements: it must not attempt to “pick winners”. This approach failed in most countries and circumstances. Rather, it must strive to create the conditions for self-selection by entrepreneurs, by creating the necessary physical and immaterial infrastructure and by aiding individuals and enterprises to overcome some of the existing barriers to entrepreneurship and innovation. It needs to be bottom-up by building on existing bases, be it skills, traditions, manufacturing activities. While reforms guided by the gap analysis of the “Doing Business” Reports by the World Bank Group or the BEEPs indicators by EBRD are important, they are not sufficient. Risks to entrepreneurship, especially start-ups, are very high, their mitigation cannot be left to market forces, since their social benefits outweigh their private ones. Access to capital, access to technology, access to business advice, access to marketing services, and others, are restricted in transition economies, mainly because of the general absence of SMEs in the previous Soviet style economies where large enterprises, single-company towns (where companies provided also social and educational services, training and industrial services) and local monopolies dominated the landscape. Experience in Western economies shows that step-by-step policies where each step builds on the success of previous steps, has the most chance of success.

-While there is no generally applicable rule about the optimal size of economic sectors, a certain amount of balance makes economies less vulnerable. E contrario: over-reliance on one or very few sectors should be avoided and mitigated by promoting the development of additional sectors. The old Fourastie “norm hypothesis” where economies across the world develop by shrinking the primary sector (agriculture, fisheries, mining), first to the benefit of manufacturing and construction (“secondary” sector), later both of those to the benefit of (industrial) services may be a truism rather than a guide towards a development or industrial policy. It has also been shown that countries which deviate from such “norms” may grow faster because of their exploitation of market niches (see e.g. Chenery-Taylor : Development Patterns Among Countries and Over Time, REStat, 50, 1968; Bayer: Charakteristika der österreichischen Industriestruktur: ein Vergleich mit der BRD, Monatsberichte 8, Vienna 1978). But Stiglitz has shown that this pattern underlies the successful modernisation of Chinese economy, where initially productivity potentials in agriculture are exploited to both feed the local population and release labor for manufacturing. However, the very rough division into a primary, secondary and tertiary sector is by far to general and non-specific to serve as guide for development.

-Successful industrial policy needs to build on existing strengths: where a forestry industry exists, sawmills and furniture production should be developed, as well as pulp and paper; where a large grain sector exists, steps into food production are the “natural” next steps, for heavy machinery producers to develop light machinery with electronics components; to develop industrial services around centers of manufacturing; for cotton producers to develop textiles and clothes production, etc. To attempt otherwise, to “artificially” create (even with lots of money) new industries, where no basis exists, has utterly failed all over the world, wasted much money, goodwill and scarce resources.

-Many countries have individual industries whose synergy potential is not exploited: cluster concepts which promote to fill the gaps between these industries could make the economy more resilient; e.g. it would make sense to bring sawmill, furniture and paints industries together to develop joint products; to bring pharmaceuticals and packaging industries together; to bring metals manufacturers and construction together, etc. Also in many more developed economies, the synergy potential between often diverse-appearing industries needs to be tapped: chambers of commerce which are frequently organized by sector also often do not see this joint potential.

-Small and medium-sized enterprises are the backbones of dynamic economies. They are more adaptable, more flexible, need less capital to develop and are easier to manage than large firms. (Of course, they also have their well-acknowledged restrictions). The creation of more SMEs should be a core objective of industrial policy. Advisory services, subsidized by governments and IFI, need to be established country-wide, in order to give advice to potential entrepreneurs and to bring them into the official economy. This requires also considerations about tax breaks for the start-up phase of SME.

-A very important strand of industrial policy is innovation policy. This is not only true for the more advanced transition countries, but for all of them. This requires, on the one hand, to give much more attention to education and training, both at the secondary and the tertiary levels and on-the-job in enterprises. Technical high schools, combining both general education with sector-specific technical skills, as e.g. in Austria, have produced a large pool of highly skilled workers and engineers who are able to adapt foreign, imported technologies to the circumstances of the country and develop genuinely new ones. University scientists and engineers should be the vanguard of innovation. This type of education has fallen into disarray and neglect in many transition countries, thus depriving these economies of the potential for further catching up with more advanced nations. Education itself, but also the combination of scientific with industrial needs, e.g. by creating joint university-industry research facilities, the promotion of patenting by university researchers, opening up the possibilities for high school and university teachers to spin-off their own SME from their research, all these could lead to a very desirable increase in the value content of transition countries production units.

-The establishment of innovation centers as agglomerations of technology-intensive research and development and its applications, or at a less ambitious level, of industrial centers as locally concentrated clusters of co-operative research and development could create the necessary poles of innovation which are able to increase the value content of transition economies. Many examples of how to do this, and of how not to do this, exist in the recent European economic history.

– Industrial policy, as well as its sub-component, innovation policy need also to be demand-driven. While market considerations underly the rationale of foreign direct investors and local investors, policy also needs to consider non-market factors, such as demand for social services in the country, like health care, old-age care, education, childcare, help for handicapped, etc. To set regulatory standards may also help industrial development: the compulsory introduction of motorcycle helmets or safety belts has aided local producers, safety standards incentivize producers to upgrade both their products and processes, energy and environmental standards do the same, etc.

The Role of IFIs in Industrial Policy

International Financial Institutions, especially the development banks are (unwitting?) carriers of industrial policy in transition countries by means of their project financing role. This role can be enhanced, however, by making industrial policy approaches part of their country strategies. The recent creation of a “corporate” division within EBRD is a manifest sign that more attention to (directed) manufacturing investment will be given to EBRD interventions in the future. A strategic approach would combine policy discussions with the relevant government institutions with directed investments, thereby creating spillovers, clusters, poles of manufacturing and innovation.

Basis for such a strategic approach would be a country-by-country assessment of what kind of industrial activity exists, which skill and technology levels are available, both from inside the country and outside and eventually careful selection of industrial project financing and/or investment where spillovers are greatest. Greater integration of the EBRD-led Business Advisory Services and Turnaround Management Activities (TAM/BAS) into this approach , with the eventual objective to make the public provision (by EBRD) obsolete by helping to create such infrastructure within the countries, are already implemented. Like in the recent co-financing of an innovation center close to St. Petersburg, for larger and more advanced countries, such centers may be appropriate, if the academic and industrial know-how are available on spot, or can be attracted. Such centers can become focal points for domestic and foreign investors, thus creating agglomeration economies driving innovation forward.

IFI may also explore the cross-border potential of such institutions, given the very small market size of many countries of operation. Just like the interlinking of energy and transport infrastructure beyond country borders, joint educational and industrial policy efforts may re-create some of the linkages which existed before the breaking up of constitutional structures. The case for public goods which warrant joint and governments-cum-IFI interventions can be made rather easily, thus also satisfying the non-government-interventions schools of thought.

The crisis has shown the fragility of the transition process, not only in the financial sectors of the transition countries, but even more so in their “real economy” features. It is high time to take this lesson seriously and engage in an industrial policy strengthening the sustainable path towards eventual convergence with the more advanced countries of the “West”. Many lessons can be learned from industrial policy experience of countries like Germany, Austria, France, the Nordics, but also from the early experience of Japan, Korea and Taiwan. Even more relevant might be some of the recent experiences of China, notwithstanding the extremely large size of the World’s fourth largest economy.


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  1. Pingback: Industrial Policy for Transition: A Way to Strengthen … | austriatoday

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