Role of technological development
When we talk about industrial development, we often face the question of whether to give supremacy to the market or the government. That is, we pose the question as “market vs. the state.” The general consensus among economists is that the market is more efficient than the government in most economic activities. As an economist, I have many good things to say about the market.
Markets can efficiently allocate many different goods according to opportunity costs and preferences;
Markets are more flexible, and quickly respond to changes;
Markets enhance competition, which motivates producers to reduce costs and increase productivity;
Markets provide greater scope for dispersion of power: the actual producers who are best informed, make decisions;
The resulting economic pluralism fosters democracy and individual liberties.
But all these good things are only possible when markets are actually there and operating. The problem is that in many developing countries, this is often not the case. Many times, the market is too thin, the economy in general is not sufficiently monetized, and there are insufficient institutional mechanisms such as financial intermediaries and legal institutions that are necessary to support market operations..
Of course, apart from this “missing market” situation, there are many other kinds of market failures, even when markets are well established, where government intervention may be necessary. Markets fail, for example, when there are externalities involved, so that social costs or benefits are different from private costs and benefits, and where there is moral hazard involved as in the provision of public goods or in managing common resources. Therefore, it is always a matter of how much government is needed when, rather than trying to get rid of all government intervention completely. That is, we want to frame the question as “market + the state,” rather than “market vs. the state.”
In terms of industrial development, the following kinds of market failures may be the most important.
- Economies of scale necessary may be so large, compared to the domestic market size, so that you may have to end up with a monopoly or oligopoly, resulting in high prices.
- Market incentives may not facilitate the changes in economic structure required for development as in the case of an infant industry. Although costly at first, once established, the industry can become efficient, gain international competitiveness and become profitable over time through “learning by doing”. But private investors may be unwilling to finance the new firms because they alone cannot finance the high initial cost, and take up all high risk.
- There may also be coordination failure some industries can only thrive if intermediate materials or parts industries or services (eg retail) industries are there, but these complementary or supporting industries may not develop without sufficient demand in the first place.
In these cases, to lay down the foundation of any industrial base, government role may be required in the form of e.g. temporary protective tariff against imports or initial subsidies to at first actually create the market, generating sufficient demand, removing supply constraints, even regulating entry and exit. In this case, we can view the government as a market creator. The government fills in for the missing market, and at the same time facilitates the development of markets by building institutions, enforcing property rights, generating demand and resolving supply constraints, as well as nurturing technology capability and industrial base. Therefore, when markets are not well developed or if there are pervasive market failures, governments have important roles in development.
In the case of rebuilding or building an economy in developing countries, governments are usually burdened with this task. The Korean government’s role in its economic development is a good example.
Clearly there are limits to what governments can do, and there are many instances of government failures. We have many horror stories of poorly performing countries that relied on a strong, central role for governments in the market. That is why some aspects of the Korean experience is still very controversial. Let me review the Korean experience briefly in the next section, and point out what I think is the most important aspect of that experience and may have implications for other developing countries.
Different Views on the Korean industrial development process
The controversy can be distilled into three different views on the role of industrial and trade policies on the economic development of Korea. According to the neoclassical view, Korea is the epitome of successful export-led industrial development. But this is about the policies in the 1960s, when the government turned away from a heavily import substituting industrial policy stance. The exchange rate was adjusted to market levels. Since the exchange rate did not penalize exporters, direct export subsidies were taken away. The heavily protected domestic market began to be slowly liberalized, especially with respect to capital goods. Importantly, exports and other incentive mechanisms then in place was product neutral. The entrepreneurs determined which products they wanted to produce and export.
The supporters of the neoclassical view are skeptical about the more selective and interventionist policies of the 1970s. The investment into targeted heavy and chemicals industries at subsidized interest rate had very low rates of return. When economic conditions changed unfavorably, many of the projects had to be retrenched or restructured. In effect, the excesses of the HCI program led to its abandonment at the end of the 1970s. According to this view, Korea has grown in spite of the interventionist, targeted strategic industrial policy of the 1970s.
Against this view, the revisionists argue that the policies of the 1970s provided the basis for Korea’s long term growth through industrial deepening. Korea practiced strategic industrial policy, using infant industry protection for priority industries, export subsidies, coordination of complementary investments, regulation of firm entry, exit, investments, and pricing intended to “manage competition.” They conclude that these policies, which so often turned into failures in many other developing countries was successfully implemented in Korea, because the “developmental state” was autonomous, free from various interest groups, and that the importance put on “export performance” was used as a disciplinary mechanism. Government support could be taken away when the firms did not meet the performance standards. Nor did Korea have a very liberal “import regime,” which is a corollary to free trade. Imports were carefully managed while luxury consumer goods were banned, capital goods imports were encouraged. Of course the revisionists admit, that the developmental state can make mistakes and the Korean government did so. What is more important is that the Korean government was able to acknowledge mistakes and make amends. It was flexible enough revise its policies and plans along the way.
I would like to mention, that there is a third view. This view might seem to be an off-shoot of the revisionist school, but with a more neoclassical theoretical background and with a sufficiently distinct emphasis to treat it separately from others. I call this view the “technology capability school.” According to this view, Korea’s success primarily rests upon its efforts to invest in technological capability and moving up the technological ladder. The government did emphasize and intervene, selectively, as well as functionally, in the very area where large market failures and externalities are present: technological development, innovation process and education.
The government successfully promoted technical education, and appropriately mobilized private R&D. Korea had a well balanced expansion at all levels of education at an early stage. According to one study, with per capita income of $90, Korea’s educational achievements were close to that of the normal pattern of human resource development for a country with a per capital GDP of $380. Even though most of the educational spending came from the private sector and parents, the government undertook effective campaigns emphasizing the importance of science and technology in the 1970s, while establishing educational institutions to promote technical skills and sciences.
The large conglomerate firms that were born out of the heavy and chemicals industrialization drive became centers of technological learning. Technology diffused through subsidiaries and subcontractors, which were developed at first with the prodding of the government and were not so vibrant. However, later as industries developed, subcontracting relations were forged out of the firm’s own necessity of having to procure quality components, especially in industries such as automobiles. Korea at first relied heavily on foreign technology. The crisis created by the large technological gap pressured firms to expedite their learning, and the government acted to secure favorable bargaining positions for the Korean firms.
Moving up the technological ladder
From the Korean experience, we can see that the process of technological learning is not automatic, but requires conscious efforts and investment. The technological development process in developing countries is different from that in developed countries. It does not begin from innovate to product development and commercialization. In developing countries, it begins with imitation. In the beginning, the capability to learn is more important than the capability to innovate. And technological learning is only possible when there is a modicum of education and skills to be able to absorb something new. Such was the process of technological development in Korea.
**Korea’s technological learning can be divided into three stages. The assimilation of imported technology during the 1960s-1970s period, the production based innovation stage of the 1980s, and the innovative stage of the 1990s and on-wards. The first stage was a period when Korea began with what it had, and then slowly assimilated foreign technology and know-how, as well as quality management, through purposeful effort, through informal channels such as subcontracting for foreign buyers, and through formal technology transfer channels such as FDI and technology licensing. It is important to note that Korea did not stick with industries that were sun-set. It managed to enter into lower technology segments starting from simple assembly activities of growing and technologically dynamic industries such as electronics. It is also important that Korea was “outward oriented” in the process of acquiring new technology, but had always followed it with a process of “indigenization,” thus creating “technological capability.”
Once it had sufficient productive base, simply producing more provided learning opportunities in the second stage. Building on the technological capability accumulated throughout the 1970s, refining the imported technology, and through process innovation, including quality improvements, Korea was able to produce the later, more sophisticated models of automobiles, steel, and shipbuilding products. Then came semiconductors and IT industries such as DRAM, CDMA, TFT-LCD, DVD etc. The large sums of up-front investment into these sectors created the sectors, but running the industries would not have been possible without the supporting base of technological capability and skills resources built up throughout the 1970s and the 1980s. The innovative stage of making purposeful investment in R&D into leading technological sectors such as mobile telecom, next generation batteries, and biotechnology and so on only came very late in this long and arduous development process.
I conclude that the most distinguishing aspect of the Korean industrial policy and development has been technological learning, its ability to engage in the international division of production and R&D, starting from the low technology and low wage segment of growing, dynamic industries, moving up the technology ladder, and then growing with the world market.
Application to “Hopeland”
Let me be imaginative and apply these thoughts to another developing country. I will call this country “Hopeland.” It has a population of about 900 million people, and a GDP per capita less than $1000 (as of 2008, PPP basis). It is primarily agricultural, with rapidly falling agricultural productivity. It is landlocked and has experienced a very damaging ethnic conflict. Currently it has formidable barriers and challenges against economic development.
How might it choose strategic industries to diversify its industrial structure and promote economic development? If there is a bottleneck and coordination problem so that no industries of recognizable magnitude is taking off, it may want to choose a leading industry with high growth potential and with many backward and forward linkages with other sectors, provide a lot of initial support so that its success can stimulate other sectors and in the process the development of the private sector.
Let me demonstrate the step-by-step technological development process with respect to bio-plastics. I am not saying that this is the industry this country must pursue, but just using it as an example so that this mental exercise has some tangibility. Suppose bio-plastics is a fast growing, technologically dynamic industry, with a lot of product diversification possibilities all along the value chain, in terms of skill levels and value added of the final product.
Hopeland produces a fair amount of cassava, which is an excellent source of starch, which in turn is a primary raw material used in the bio-plastics industry. The commercialization of cassava farming to supply starch in the first instance, will stimulate agricultural productivity and development of other using industries such as food processing, animal feed, plywood, paperboard, textiles, pharmaceuticals, laundry starch, soap, detergent powders, and industrial alcohol. Bio-plastics is a relatively new industry, using patented, state of the art technology. However, Hopeland need not start with the very core of the value chain. It can start from producing simple bio-friendly products with starch such as toothpicks, candy sticks, chopsticks which do not use any state of the technology, which would only require simple molding technology with low cost of entry. However, manufacturing of these products will provide the basis of basic skills widely used in manufacturing in general.
In the next stage, Hopeland can start to supply starch to the foreign bio-plastics resin producers, and develop technological partnerships with them, receiving advices about getting the quality of the industrial starch up to specifications, resulting in informal and formal technology transfers. If Hopeland can attract FDI into resin production in the country, it can then move further upstream into molding products products that are more value added than toothpicks and candy sticks such as disposable utensils, packaging materials and all kinds of other plastic substitutes. Far down the line, when overall industrial development have reached a certain stage, Hopeland can move up into even higher value added products such as medical applications (eg biodegradable suture threads).
This whole process will have large spillovers into and create synergies with other sectors. For example, although it is landlocked, it hopes to engage in transit trade between the port harboring and more inland neighbors. It is building free trade zones, still without many specific plans as to what industries will be set up there. The re-packaging of transit goods, creating demand for bio-plastic packing materials, may be an interesting synergy development in this scenario. The creation and expansion of the plastics industry by itself will bring large import substituting effect, as Hopeland currently imports all of its plastic resin. If it can establish its plastics industry to be bio-plastic from the on-set, then it would have the first mover advantage as bio-plastics begin to replace conventional plastics, with the rise of oil prices and concerns over the environment.
The development of bio-plastics in Hopeland was a mental exercise in showing how a developing country might choose and use a strategic industry with large backward and forward linkages, and therefore potentially large spillover effects. The most important thing however, is that the targeted industry must be growing, using varied levels of technology and be technologically dynamic, so that new skills are continuously needed, providing ample opportunities to enter at the low skills end, and then to move up the technological ladder in a continuous fashion. In the process, when sufficient technological capability is accumulated and with parallel institutional development such as protection of intellectual property rights, it can begin to undertake indigenous innovation, jumping up the technological ladder, creating new rungs of its own.
Of course, technological development itself is not sufficient. It is also important for the developing country to be “outward oriented,” to be a part of the international production and R&D network. Otherwise, it will lose important sources of know-how, new technology, and economies of scale.