A good industrial policy is about creating winners and not picking

The fundamental problem with this argument is that the objective of a successful industrial policy is not to choose but to create winners. A good policy does not seek to replace the ‘invisible hand’ of markets, but introduces a guiding hand of the state where the former have failed. Industrial policy seeks to address market failure. Admittedly, the bureaucrats do not have the right information, but the businessmen and entrepreneurs do not have it either. The industrial policy aims at information gathering, risk sharing and coordination of actions between the state and private entrepreneurs to meet development goals.

The argument in favor of letting markets decide export ‘winners’ through the principle of comparative advantage is flawed because it assumes that entrepreneurs are perfectly informed about all opportunities, which is far from the truth . Under this assumption, barring emergent discovery, like India’s discovery of labor arbitrage in IT-enabled services, a country would be stuck forever waiting for a comparative-advantage sector to emerge. True industrial policy aims at correcting this information failure and expanding the area of ​​relative advantage of the economy.

Research has shown that the theory of natural comparative advantage driving exports exists only in the imagination of free-trade fanatics. Imbs and Wacziarg (‘Stages of Diversification’) show that as a country becomes prosperous, its regional concentration of production and employment tends to decrease. If the principle of comparative advantage worked, it would not be followed, as countries would specialize and see an increase in regional concentration. Klinger and Lederman (‘Discovery and Development’) show that as countries become prosperous, new export products increase. Again, this serves as evidence against comparative advantage. The key to success for rich countries has been their ability to expand into new export areas rather than focusing on areas of comparative advantage. This is a loud rebuttal to those who want India to focus on “service-led growth” rather than manufacturing.

A valuable lesson for India is that the ability to expand into new export areas is what separates moderate success and big win. Dani Roderick and many others have highlighted this in their comparisons between Latin America, East Asia (Thailand and Malaysia) and the famously successful ‘Gang of Four’ (Japan, South Korea, Taiwan and Singapore).

Latin American countries such as Chile, Brazil and Mexico have largely focused their industrial policy on areas of some comparative advantage (agriculture, fisheries and natural resources). As a result, they have grown and had successes like Embraer (aircraft manufacturing), but have stagnated from a productivity perspective for many years. This is in stark contrast to countries such as Malaysia and Thailand, which have leapfrogged to middle-income status but are stuck there, unable to achieve a trajectory that helps them match advanced countries. They focused on areas beyond their comparative advantage and saw increased productivity and improved export sophistication, but still lagged behind the Gang of Four. Herein lies the most important industrial policy lesson for India.

Japan, South Korea, Taiwan and Singapore became advanced countries within two generations because their industrial policy not only focused on areas of comparative advantage (eg Chile) but expanded these (eg Malaysia) but, importantly Typically, he moonlighted in these fields. Used new technology and innovation to dominate export markets. This is the magic ingredient missing from the industrial policy of Malaysia or Thailand, which have little innovation and focus on becoming efficient assemblers of products developed by multinationals, depriving them of a large share of value addition.

The Gang of Four, on the other hand, took many moonshots and focused on mastering the technology. Japan focused on becoming a major exporter of automobiles and ships with its technology in the 1950s, when its per capita gross domestic product (GDP) was only 19% of that of the US. South Korea entered heavy industries and chemicals in the 1960s with a per capita GDP of 6% that of the US; In 1972, it built the world’s largest shipyard. In 1983, with a per capita GDP of only 14% of that of the US, South Korea entered chip manufacturing.

So far, the Government of India has taken small steps towards a coherent industrial policy. Its recent effort began with production-linked incentives (PLIs) for industries where India has some comparative advantage, and has graduated to mild support for expanding India’s comparative advantage (semiconductor subsidies). However, we need an industrial policy for our exports to flourish, which not only builds on and expands on our comparative advantage, but also takes moonshots on technology (such as green hydrogen) that we can adopt. are and can be exported. Certainly, some initiatives will fail, as they do in all areas of economic activity, but that should not deter us. We must heed the revolutionary call of Georges Jacques Danton”Audace Encore, Audace Encore, and Audace Tour“(Audacity, more audacity and ever more audacity). Only with audacity will India be able to expand the Gang of Four into a pack of five.

Diva Jain is a director at real estate firm Arjav.

This is the final part of a two-part series,