Six Steps for Strategic Government Intervention

Professor Robert Wade’s article, ‘After the Crisis: Indus-trial Policy and the Developmental State in Low-IncomeCountries’, is a bold and thought-provoking exposition ofhis long-held ideas on the political economy of develop-ment and the dynamics of structural change. I agree withmuch of what he suggests but would like to offer a coupleof nuances on the relative roles of the market and the statein the process of economic development, and then suggesta framework for conceptualizing and operationalizing suc-cessful government intervention.The need to differentiate between ‘good’ and ‘bad’ capitalinﬂows is an important lesson from the recent global crisis.I have argued elsewhere that liberalizing inward directinvestment should generally be an attractive major compo-nent of industrial policy (Lin, 2010). Foreign direct invest-ment (FDI) usually ﬂows to industries that are consistentwith the recipient country’s comparative advantage. It isalso less prone to sudden reversals in a panic situation thanbank loans, debt ﬁnancing or portfolio investment. In addi-tion, FDI tends to bring technology, new managerial prac-tices, access to markets, and social networking, which areoften lacking in a developing country and yet crucial forthe industrial upgrading process. By contrast, portfolioinvestment tends to target speculative activities (mostly inequity markets or the housing sector), which create bubblesand ﬂuctuations. They are volatile by nature and often con-tribute to Dutch disease and currency crises. Wade takesthe analysis further; he points out that FDI ﬂows must bemanaged strategically for developing countries to avoiddeﬁcit-prone industrialization. He rightly suggests thatpriority be given to inﬂows that foster the growth of inter-mediate inputs and producer services within the nationaleconomy – this helps reduce the income elasticity of importdemand.I also agree with his reﬂections on the direction of thecausality between growth and governance. Governmentfailures have indeed been as pervasive and damaging in thedeveloping world as market failures. But an exclusive focuson governance may be misguided. Governance is likely tobe endogenous to the stage of economic development, andsustained economic growth in developing countries may beneeded before their governance converges with that ofhigh-income countries (Meisel and Aoudia, 2008).I do not share Wade’s severe assessment of neoclassicaleconomics on two points. First, despite the absence of con-vergence among world economies, the progress made bydeveloping countries in recent decades cannot be underesti-mated. The fact that the majority of states have remainedin the same income category over two decades may bethe reﬂection of general progress (a tide-lifting-all-boatsphenomenon) rather than a sign of general stagnation.Although relative incomes among various groups of coun-tries may not have changed much, the absolute levels ofincomes have increased steadily in recent decades. This hascontributed substantially to the reduction of world poverty(Ravallion and Chen, 2008). Clearly, an open world econ-omy has offered opportunities for many developing coun-tries throughout the world to achieve sustained growth andimprove their living standards (Growth Commission,2008). This is true even in many countries that have notmoved up the convergence ladder.Second, the market is an important resource allocationmechanism at any given level of development. Economicgrowth occurs when ﬁrms are given the incentive system totake advantage of existing opportunities determined by thecountry’s endowment structure. They can also create poten-tial new business niches by identifying and exploiting theeconomy’s latent comparative advantage. They spontane-ously enter industries and choose technologies consistentwith the economy’s comparative advantage only when theprice system reﬂects the relative scarcity of factors in thecountry’s endowment. Therefore, a competitive marketsystem should be the economy’s fundamental mechanismfor resource allocation at each stage of its development.However, economic development is a dynamic processthat requires industrial upgrading and corresponding