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Dani Rodrik November 2012 Structural Transformation Policies and Economic Growth

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Latin America has been doing better (sort of) Developing country growth trends by region, 1950-2011

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Outline Structural change: why and how it matters Structural transformation and fundamentals as drivers of economic growth Policies for structural transformation What can/does go wrong?

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Why structural change matters Developing and emerging nations are characterized by structural heterogeneity wide dispersion in labor productivity across activities Some industries are escalator industries higher productivity level and trajectory typically tradables and manufactures though increasingly tradable services exhibit similar features too Moving resources (especially labor) to these escalator industries (i.e., structural change) is a key source of economy-wide productivity growth

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Escalator industries: unconditional productivity convergence in manufacturing Source: Rodrik (2012) Notes: Vertical axis represents relative growth rate of labor productivity, controlling for period fixed effects. Each country enters with most recent decade for which data are available.

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Manufacturing as indicator of structural change South Korea Colombia Thailand

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How structural change contributes (or not) to economic growth Different patterns of structural change Thailand Hong Kong Colombia Argentina

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Growth-increasing structural change: Thailand

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Growth-increasing structural change: Hong Kong

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Colombia: Growth-neutral structural change

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Growth-reducing structural change: Argentina

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The two dynamics of growth 1. Fundamentals: building broad capabilities in the forms of human capital and strong institutions Takes time, requires broad-based complementary investments, and produces steady but moderate growth 2. Structural transformation: emergence and expansion of modern industries Requires narrower range of reforms (that are often sectoral) to remove/compensate for costs modern industries face, and produces rapid growth until dualism eliminated The set of policies required to foster these two dynamics overlap, but are not same In particular, role of unconventional policies to stimulate new industries (as in East Asia)

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A typology of growth outcomes

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Structural transformation is impeded by both market failures and government failures Government failures generic poor labor laws, inadequate property rights, lack of contract enforcement, red tape, corruption, macro instability, high taxes, sectoral/micro specific regulations and taxes; lack of specific public inputs Market failures Demonstration effects and learning spillovers from introduction of new products or new technologies (discovery) Coordination and agglomeration externalities (e.g., clusters)

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Orthodox development policy Government failures generic poor labor laws, inadequate property rights, lack of contract enforcement, red tape, corruption, macro instability, high taxes, sectoral/micro specific regulations and taxes; lack of specific public inputs Market failures Demonstration effects and learning spillovers from introduction of new products or new technologies (discovery) Coordination and agglomeration externalities (e.g., clusters) unsatisfactory outcomes in Latin America since 1990

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The new industrial policy Government failures generic poor labor laws, inadequate property rights, lack of contract enforcement, red tape, corruption, macro instability, high taxes, sectoral/micro specific regulations and taxes; lack of specific public inputs Market failures Demonstration effects and learning spillovers from introduction of new products or new technologies (discovery) Coordination and agglomeration externalities (e.g., clusters) is about removing bottlenecks to new economic activities, whether due to market or government failures

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The wrong questions Should we have IP? Case for IP no different than case for government policies in other areas such as education, health, infrastructure, macroeconomic stabilization Failures occur in all these areas too, but are not an argument for non- intervention How to do it better, rather than whether to do it Most countries are engaged in IP, whether they say so or not Sector-specific incentives pervasive in Colombia Better to do it explicitly and self-consciously than surreptitiously But can governments pick winners? Of course not Good IP requires much less from government: Ability to learn, revise policies, and to let losers go Mistakes are a natural, expected feature of good IP Too few mistakes indicate too timid IP

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The right question: how to do IP? Traditional IP: A list of sectoral priorities + sectoral incentives Top-down, relying on quality of bureaucracy (honesty, competence, implementation) Presumes solutions are known Modern IP: A process of institutionalized collaboration and dialog Focused on identification of constraints and opportunities And the generation of pragmatic private-public solutions Continuous monitoring and evaluation Presumes only that solutions can be discovered

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Institutional design for industrial policy Must be built on three ideas, each of which leads to a different design principle: 1. The requisite knowledge about the existence and location of the spillovers, market failures, and constraints that block structural change are diffused widely within society => embeddedness 2. Businesses have strong incentives to game the government => carrots and sticks, discipline 3. The intended beneficiary of IP is neither bureaucrats nor business, but society at large => accountability

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The many ways in which IP can fail No institutionalized dialog No clear targets Market failures? Protecting rents? Social policy? No clear instruments No clear commitments No monitoring No review/revisions Not enough coordination across government agencies No political leadership and ownership No transparency

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Industrial policy as work in progress No country can get everything right East Asia, for example, typically falls short on accountability and transparency But this is not an argument for not doing it Need to look at IP as a normal government function, that can be performed better or worse IP is a craft, which improves with experience

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What industrial policy cannot do Substitute for the lack of fundamentals human capital proper institutions Compensate for macro imbalances fiscal unsustainability large external deficits across-the-board uncompetitiveness due to high prices/overvalued currency