Chapter 11. Lessons for Today and the Way Forward

Reda Cherif, Fuad Hasanov, and Min Zhu
Published Date:
April 2016
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Reda Cherif, Fuad Hasanov and Alfred Kammer 

Reda Cherif, Fuad Hasanov, and Alfred Kammer

Will Singapore be around in 100 years? I am not so sure. Whatever the choices are, I am absolutely sure that if Singapore gets a dumb government, we are done for. This country will sink into nothingness.

Lee Kuan Yew, the late founder of Singapore

This volume makes a case for the importance of the “leading hand” of the state in the development process. Whether we call it the “developmental state” or the “entrepreneurial state,” the growth miracles of the Asian Tigers, in particular Singapore and Korea, illustrate the “leading hand” principle in practice. The Asian experiences show how the state successfully led the development process, whereas in Latin America and more recently in most of Africa and the Middle East, by and large, the “leading hand” of the state has given way to the “grabbing hand” or retreated to market-centered development and private interests.

Following this chapter we have included the transcript of a conversation between His Excellency Minister Muhammad Al Jasser of Saudi Arabia and IMF Deputy Managing Director Min Zhu, which makes it clear that the way the state intervenes is important, and both incentives and market forces have their role. His Excellency Minister Anas Al Saleh of Kuwait, at the beginning of this volume argued that a large public sector providing comfortable jobs acts as a strong deterrent to the investment in skills and industry development, and a change in incentives, practices, and societies is needed. These discussions shed light on the state’s role in promoting sustainable growth and they raise an important question: How should the state intervene; that is, which key goals and policies should the state focus on?

Building a dynamic and sophisticated tradable sector to support sustainable growth is the prevailing theme of this volume. It discusses at length the state’s role in creating industries, promoting innovation, and investing in human capital, from East Asia to Latin America. Whether the missing ingredients are human capital, infrastructure, or innovative firms, the state needs to devise policies to remedy them. Engaging public agencies, the private sector, and citizens to achieve this goal would increase the odds of success.

Oil exporters, especially in the Cooperation Council for the Arab States of the Gulf (GCC), provide stark examples of the market failures preventing the development of sophisticated tradables, given their highly risky nature. These countries are plagued by Dutch disease—the crowding-out of the non-oil tradable sector by oil-export income—which exacerbates the failures and produces a growth model that relies on oil as the major export and the recycling of petrodollars through government spending, imports of most tradable goods, and a high level of production and consumption of nontradables. For the past decades this model has yielded sizable achievements for human and infrastructure development. However, the model has led to income and productivity stagnation, as the GCC countries and oil exporters in general have been outperformed by many other countries. Similarly, many Latin American countries, including “high performers” and natural resource exporters, have experienced dismal productivity growth compared with East Asian countries (Chapter 6). In essence, productivity growth is at the heart of the development process and its engine lies in the development of sophisticated tradables (Chapter 7).

To correct market failures and spur the development of the sophisticated tradable sector to sustain productivity growth, the state needs to change the incentive structure for workers and firms (Chapter 1). The main hurdles facing diversification efforts in the GCC stem from market failures rather than government failures. Although there is room for improving the business environment, infrastructure, skill sets, and institutions, these are unlikely to be enough to develop non-oil exports on their own. The government needs to encourage individuals to develop skills and work in the private sector, and help firms to look beyond the confines of domestic markets and seek new export opportunities. Improving the quality of education, especially in early childhood, and implementing a social development program are important elements of changing incentives.

Experiences in other countries discussed in this volume show that diversification policy often followed a mix of vertical diversification in existing export industries and horizontal diversification in suppliers’ clusters for those industries and in industrial beachheads into high-value-added and innovation sectors. Policy instruments included subsidies to support exporters and taxes on firms in the nontradables, access to financing and business support services through venture capital funds, development banks, and export promotion agencies, and the creation of special economic zones, industry clusters, research-and-development centers, and start-up incubators. This support was combined with skill development, the emphasis on technological upgrading and competition in international markets, and accountability frameworks for the firms receiving support.

Developing skills and human capital is among common elements that underlie the development experiences of the countries discussed in this volume. The experiences of Algeria and Saudi Arabia (Chapter 2) indicate that achieving a high level of human capital, although important, is not a prerequisite for industrialization. Algeria has created many skilled workers, who have remained underemployed in the economy without much tradable production. In contrast, Saudi Arabia has developed heavy industries but human capital has not caught up.

Developing tradables needs to go hand in hand with improvements in primary and secondary education (for example, in math and basic skills proficiency), technical degrees, and teacher quality. Faced with a shortage of skilled professionals, Singapore not only made it easier to bring in foreign skilled workers, but also created training institutes and technical and business schools to upgrade the skills of the local labor force (Chapter 3). Korea’s Saemaul Undong movement has paved the way for rural households to get educated and provide the needed labor for the industrialization of the country (Chapter 10). Malaysia has also put an emphasis on science, technology, and innovation skills in its five-year development plans, but has yet to succeed in achieving a high ratio of science graduates in the local workforce (Chapter 4).

Building a strong work ethic, trust, and social capital—that is, transforming society—is key to development, if not the ultimate societal goal. A social development program should be another important component of the development strategy. Korea’s Saemaul Undong program shows how the state can combine the social fund program on various projects (for example, in local infrastructure) with a community movement to mobilize human resources and change social attitudes (Chapter 10). Community leaders and local officials engaged the population in a grassroots movement to participate in local infrastructure projects by providing labor services with the goal to improve quality of life and instill self-reliance and cooperation among community members. The state provided start-up resources and later supported efforts for businesses to diversify their sources of income (such as establishing food processing plants instead of relying only on raw agricultural products). Designed to alleviate citizens’ concerns, the movement attracted participation and encouraged social integration as the society was transforming from rural poverty-stricken communities to an urban industrialized nation. Singapore also engaged in social development with the provision of low-cost housing development programs, environmental cleanups, and urban planning and development (Chapter 3).

The promotion of industries provides the final piece of the development puzzle. Singapore promoted manufacturing to build factories in place of swamps and provide employment for its population, moving to higher-value-added industries, value chains, clusters, and research and development. Integrating public and private sectors, relevant infrastructure such as urban planning and high-tech zones, and human capital development, Singapore expects to move forward as an innovation- and knowledge-driven economy (Chapter 3). Malaysia has used its natural resources such as oil, palm oil, and rubber to create value added and build around the value chains (Chapter 4). Specific tasks, such as promoting rural development or improving urban public transport, assigned to relevant public agencies promote accountability and efficiency. Malaysia has also embarked on the path of science, technology, and innovation, which are integral to high-value-added production and export sophistication.

Korea’s relatively recent path to industrialization in the 1960s to 1970s was strongly driven by the state, with officially targeted industries such as steel, chemicals, metals, machine building, shipbuilding, and electronics (Chapter 5). Large economies of scale were targeted and the products had to be of high quality not only for import substitution but mostly to gain market shares for exports from the beginning. With resources spent and various forms of support given to chaebols, the Korean state nevertheless used strict disciplinary actions if targets were not met.

The choice of industries is not particularly straightforward, but a focus on exports and high-value-added production with spillover potential and productivity gains is clear. Dubai used its locational advantage and business-friendly environment to set up free trade zones and attract foreign investment, but its exports are yet to expand much beyond gold and jewelry. Further, in the GCC, some degree of coordination of industry promotions may be needed to ensure that countries do not all develop in the same area (tourism, logistics, or finance hubs, for example) and thereby risk crowding each other out. Moreover, cross-country competition in the tradable sectors and intrasector trade, as is the case among advanced economies, could be helpful. In contrast, Singapore established various manufacturing, science, and high-tech parks to promote industry clusters and research and development, and it was much more successful in export diversification. After the return of industrial policy in the 2000s, Brazil decided to develop pharmaceuticals, sugarcane, and software industries and, with the support of the Brazilian Development Bank, has made substantial progress (Chapter 9).

Innovation with the help of an adapted innovation policy can make it possible to compete in high-value-added goods on international markets. Research and development activities ignite higher productivity growth as the innovation and learning-by-doing processes take hold (Chapter 6). International markets provide the discipline for firms from developing economies to compete and improve productivity. Investment in research and development, knowledge, and innovation would level the playing field of fierce global competition. The introduction of new goods and efficient processes would require public inputs and market interventions across both horizontal and vertical (sectoral) spheres. For instance, for the past decade, Brazil has focused on innovation policy to support industry growth (Chapter 9). Properly designed targeted sectoral policies could improve innovation, the growth of firms, and productivity. The state intervention should focus on developing specific sectors rather than picking firms, and should preserve competition and “creative destruction” (Chapter 7). In other words, “picking winners” should be about picking sectors rather than picking firms. Government failures such as short-term focus, agency problems, and public capture would require proper institutions, clear assignment of responsibilities across public agencies, and transparent rules for selecting sectors and providing and terminating support to these sectors.

To finance innovation, the state and the private sector, including the financial system, would need to collaborate as a venture capitalist for the country as a whole. Venture capital, private equity, stock markets, and other risk-sharing financial arrangements such as Islamic finance can support risky innovation activities. The state can further provide financial support through fiscal policy instruments such as tax credits and research spending and other programs such as loan guarantees and equity investments (Chapter 8). The Small Business Innovation Research program to promote technology and innovation in small firms in the United States has worked well.

In conclusion, as Meredith Woo stressed in Chapter 5, learning “piecemeal” from each other, from people’s interactions and books, country experiences, theories and empirics, is an important way forward on the path of understanding development. “Creative destruction,” as argued by Philippe Aghion, one of the pioneers of the Schumpeterian paradigm in growth theory, fuels the development lift-off that a developing country seeks. Each country’s path is unique, but the collective history of nations offers patterns to uncover for the seeker of the grail of economic development.

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