South urged to pursue active industrial policies

In TDR 2016, UNCTAD highlights the importance to developing countries of industrial policy, underlining the need for them to integrate such policy with macroeconomic, trade and financial policies in order to go down the industrialization path.

by Kanaga Raja

GENEVA: Highlighting the role of industrialization and manufacturing growth as an engine of sustainable and inclusive development, UNCTAD has called on developing countries to pursue active industrial policies, which have long been neglected in these countries.

In its Trade and Development Report 2016, UNCTAD also called on developing countries to build up domestic demand, use regulation to protect themselves from the risks of financialization in their domestic contexts and protect their policy and fiscal space in order to manage any unforeseen shocks.

TDR 2016 called for a more sophisticated approach to industrial policy, including the construction of linkages and capabilities to build a production base fit for purpose in a rapidly changing world where sufficient space is available for experimenting and learning, in both the public and private sectors.

According to UNCTAD, standalone industrial policies are unlikely to deliver and instead the key to success lies in the effective integration of macroeconomic, financial, trade and industrial policies.

In an overview, TDR 2016 said that in order to promote a structural shift towards manufacturing and industrialization, governments need to adopt policies with the objectives of ensuring high levels of aggregate demand, high levels of investment and a stable exchange rate; cultivating the capabilities needed to change the composition and sophistication of production activities and promoting a strong learning environment; and pursuing intermediate input substitution industrialization, particularly in middle-income countries that have entered global value chains (GVCs) but are struggling to upgrade their industrial capacities.

Other objectives include avoiding adopting export strategies that rely on compressing wages; promoting development-oriented competition rules that can offset the global dominance of multinational enterprises; bolstering access to finance for structural transformation, not only in terms of supporting particular lines of investment, but also as a useful vehicle for monitoring and influencing corporate behaviour in support of long-term decision-making; and closing tax loopholes through fiscal and regulatory measures at national, regional and international levels and requiring greater transparency in corporate decision-making.

On the issue of trade, TDR 2016 said under current structural conditions and policy stances, assuming that no significant changes in the direction of policies are implemented, trade growth will continue to be sluggish as the global wage share will continue to decline.

There are strong connections between the long-term deterioration of global wage shares and both the trade surge in the 1990s and 2000s and the slowdown of trade and economic activity since 2011. If these trends persist or worsen, then the threat of more determined protectionist responses could become real, the report said.

“However, like the boy who cried wolf in Aesop’s fable, blaming protectionism for current trends runs the danger of not only distracting policymakers from making inclusive growth the axis of a globally coordinated programme but, as in the 1930s, of being ignored when a real protectionist threat emerges,” warned UNCTAD.

“Lopsided reliance on monetary policy”

Speaking at a media briefing on 16 September, ahead of the 21 September release of TDR 2016, UNCTAD Secretary-General Mukhisa Kituyi highlighted the state of the world’s economy “as we continue through a flat spell” now getting into its sixth year.

Kituyi pointed to political anxiety, which is a reflection of the absence of adequate gainful employment and job insecurity, translating into a political challenge which is partly reflected in an angry electorate in the US and Britain. The absence of a clear explanation and a clear answer to the deficit in gainful employment is resulting in tirades against globalization – “in some cases, even tirades against global trade”, he said.

As an institution, UNCTAD has found it necessary for its analytical work to look at the challenges and issues underlying this phenomenon that is giving globalization a bad name, said Kituyi. What UNCTAD’s work, published in the TDR this year, has done is, first of all, to look at the core issues relating to the continued joblessness. “Why are enterprises not creating enough jobs? Where is the engine of global recovery that in a way will start creating inclusive sustainable prosperity?”

Kituyi said one of the main explanations is the reluctance of major corporations to invest in gainful productive investments. Substantial attention has to be given to the discourse about the impact of the form of use of profits on the potential of enterprises to create gainful employment.

He noted that as financial markets get more and more integrated, the vulnerabilities that come with monetary decisions and policies in one place trigger effects in other areas of the world. Many emerging economies and developing countries have been very substantially subdued by flat commodity prices. The ease of borrowing money over the past decade, as UNCTAD has warned in a number of recent publications, made a lot of these countries more vulnerable to policies undertaken elsewhere.

Also at the media briefing, Richard Kozul-Wright, Director of the UNCTAD Division on Globalization and Development Strategies, and lead author of the TDR, said while the audience for the TDR is the developing countries, “it is quite clear that much of what we have to say in this report also speaks to the concerns of developed countries.”

He said that UNCTAD is worried about the current health of the world economy. “We call it a year of living dangerously. It remains a year of living dangerously.”

He highlighted several potential faultlines that could cause serious problems in both developed and developing economies.

As UNCTAD has been insisting, the real problem for the global economy is the failure of the advanced economies to find a sustained recovery from the financial crisis of 2007-08; “we attribute that largely to a lopsided reliance on monetary policy.”

In this context he pointed to the continued fixation with, or at least flirting with, austerity fiscal policy and a very limited – although increasingly more sophisticated – willingness to deal with issues of a structural nature in the developed countries themselves. While structural reforms continue largely to be about the liberalization and deregulation of markets, the structural problems that the developed countries face are of a rather more profound nature than that.

In particular, Kozul-Wright said, there is a major distributional imbalance in the advanced economies between wages and profits. Wages as a share of national income have been on a downward trend for many years now and this has not been reversed since the crisis. This imbalance continues to feed into a weak growth performance in many developed economies.

“[I]f there is any structural problem that needs to be addressed urgently in the advanced economies, it is that distributional issue,” said Kozul-Wright.

“Trade slowdown due more to weak global demand”

A lot of the tensions that these imbalances have given rise to have recently focused on the issue of trade, and there has been a significant slowdown in global trade over the last four or five years, Kozul-Wright said.

“We expect that to continue this year. Our take on that is that it is very much linked to the problem of insufficient global demand. Although there has been a lot of talk recently about protectionism, we don’t actually see very much evidence in the numbers for that right now.”

“If you don’t deal with your structural imbalances properly, [there] is always the danger that protectionism will come back and make things worse for most people,” he said. “It’s the knee-jerk reaction that many countries will use as other policies seem to fail in dealing with these kinds of imbalances. But [protectionism] has not been the problem so far … The numbers don’t suggest that the slowdown of trade is to do with protectionism. But it is everything to do with a very weak global demand and slow growth in the advanced economies.”

Asked about how the WTO keeps repeating that trade protectionism is the source of the current problem, Kituyi said his sense is “not that we are devaluing the significance of protectionism but the statistics are not bearing out” that the current problem is because of a growth in protectionism.

Asked about a statement by WTO Director-General Roberto Azevedo that anti-dumping and countervailing measures (which are legitimate) constitute protectionism, Kituyi remarked in jest that “journalistically of course it would be interesting if you quote Kituyi and Azevedo as disagreeing.”

He said his sense was that protectionism “is not a solution but the scale of the issue that we are dealing with is not directly the product of any rise in protectionism.” As much as protectionism can be an issue, the challenge is more related to declining aggregate demand.

“Not that it devalues protectionism as a problem, but under the current circumstances it’s not as bad a problem as it could be. Looking for solutions by declarations against protectionism is only partially the solution. But it’s not addressing the core challenge of flat economic growth and joblessness,” Kituyi underlined.

Revisiting industrial policy

According to Kozul-Wright, the danger in the discussions on globalization right now is that a lot of it is focused on the advanced economies and their electoral politics, and there is a tendency to assume that the South is doing extremely well, and that somehow the South doing well is why the North is doing badly.

That, he said, is “a very crude interpretation” of the last 30 years of global economic development. “We want in this report in particular to highlight what we see as some serious weaknesses in the patterns of structural transformation in the developing world which, if not dealt with, could hold back sustainable and inclusive growth moving forward.”

In particular, it is around the longstanding question of the role of industrialization and manufacturing growth as an engine of sustainable and inclusive development.

“We believe that manufacturing still has that role,” Kozul-Wright said. The problem is that outside of East Asia, manufacturing performance in the South has been very weak even as growth has been strong.

Kozul-Wright highlighted that part of the success of East Asia was that it was a very successful exporting region. Export-led growth was part of the reason why East Asian economies fared so well in the 1970s and 1980s, unlike most of the rest of the developing world.

He said that in the TDR, UNCTAD has raised a series of concerns about whether the same kind of performance can be achieved through exports under the current global economic situation. This has to do with the problems of weakness of global growth and global demand and increasing competition amongst developing countries at the lower ends of value chains, and their ability to export more but earning less from those exports.

While exporting was key to success in East Asia, it was not exports alone that drove growth in the region, it was the relationship between exports and investment – very fast rates of capital formation leading to strong productivity growth and to technological upgrading.

The profit-investment nexus is a key complement to any sort of investment-export nexus that drives sustainable growth, Kozul-Wright said, noting that TDR 2016 raises “serious concerns about the weakening of the profit-investment nexus in emerging economies.”

“We have seen that weakening already in the advanced economies because of the impact of financialization and unregulated financial markets,” he said.

A weakening of the profit-investment nexus in the South combined with a weakening of the potential for export-led growth is a very worrying combination for many developing countries.

He said that there has been a neglect of domestic markets in many developing countries in the belief that they can replicate the East Asian experience.

What UNCTAD has emphasized in its report is the need to revisit, rethink and reengage with the industrial policy discussion.

“[I]ndustrial policy has long been neglected in developing countries. It was kind of identified as the … problem policy in the Washington Consensus, as somehow typifying the problems of developing countries in the 1970s and 80s, and it was unfairly neglected as a consequence,” said Kozul-Wright.

Finding ways of combining industrial policy with traditional macroeconomic policy and traditional trade tools is the big challenge for many developing countries moving forward over the next few years. It is a challenge that many developed countries also need to take seriously, he said.

Asked whether there should be a paradigm shift away from export-led economic growth, which has been the thesis of neoliberal economic policies over the past decades that have downgraded import substitution and industrialization, Kozul-Wright said that it is already happening in the case of China.

One of the explanations for why trade has slowed is that China is now starting to essentially substitute for the intermediate goods that it previously imported by producing them itself.

Part of the reason why China has been successful as an industrializing power is precisely because it has engaged – just like the Koreans, Taiwanese and Singaporeans did – in a combination of import substitution and export orientation, Kozul-Wright explained.

“It’s the combination that works. Not one or the other,” he said. “We believe that is a model that has wider resonance but in a sense we are simply reflecting on the Chinese experience and suggesting that is something that needs to be looked at more generally by other emerging and developing economies.”

Industrialization, profit-investment nexus, industrial policy

In some overall conclusions, TDR 2016 suggests that public sector involvement in the process of industrialization is essential for both productivity growth and linkage creation.

Another argument in favour of state involvement is based on the recognition that domestic infant industries need to be supported and protected from more advanced competitors until they develop their own capacities to compete.

“Since the key to productivity growth and upgrading of manufacturing activities lies in sustained capital accumulation, a favourable macroeconomic policy stance and a well-functioning financial system that provides adequate long-term investment are of the utmost importance for the industrialization process and the realization of productivity gains.”

The experiences of successful industrializers demonstrate that the promotion of structural transformation requires attention to different sources of growth, including boosting private and public investment, fostering technological progress, strengthening domestic demand and increasing the capacity of domestic producers to meet the exigencies of international markets.

This implies the need for interaction between several areas of public policy: macroeconomic management, financial policies, trade policies, technology policies and public education.

“The successful implementation of the 2030 Agenda for Sustainable Development in part rests on the full use of the available policy space for developing countries to expand their manufacturing sectors, accelerate productivity growth and actively support the creation of linkages between the most dynamic sub-sectors of manufacturing and the rest of their economies,” said TDR 2016.

Structural change and higher rates of capital accumulation are impossible without adequate access to sources of finance. This is all the more relevant if, as has increasingly been the case, there is a steady rise in the minimum level of investment required to successfully launch an industrialization drive.

“A functioning profit-investment nexus is as vital for successful catch-up strategies and their continued financing as it was in early industrialization experiences,” said UNCTAD.

However, a number of current global trends militate against a strong profit-investment nexus and, in particular, against establishing a strong nexus in developing economies.

Easier access to finance in the wake of capital account liberalization and financial market deregulation has not translated into increased financing for long-term investment for upgrading production capacities, especially in manufacturing.

What is more, an excess supply of credit finance is not generally conducive to improved capital allocation among sectors, and may favour sectors with lower labour productivity, such as services, as well as lending to households.

Moreover, the financialization of corporate strategies and the rise of shareholder primacy in developed economies may have contributed to the worsening of income distribution and a deflationary bias through slower growth of global demand.

A major feature of this trend has been that a growing share of corporate profits, rather than being used for corporate reinvestment, is being used for purposes such as dividend payments and equity repurchases. This ultimately strengthens the role of financial intermediaries in capital allocation, which in turn contributes to economic instability and financial imbalances.

In order to establish and strengthen the profit-investment nexus, it is necessary to find ways of ensuring that private finance is once again used for productive purposes, in developed as well as developing countries.

“Establishing a strong profit-investment nexus requires substantial institutional and policy initiatives and change, including the creation or deepening of the banking system, ensuring it has appropriate capacities for long-term credit provision, along with proactive industrial policies. Developing-country governments should design policies aimed at directly supporting their own process of catching up and structural transformation.”

Furthermore, governments can improve the macroeconomic environment through public investment on an appropriate scale to support infrastructural development and rapid economic transformation, thereby helping to increase private sector profitability.

It is therefore vital to counteract current tendencies that diminish the state’s investment capacities, including through taxation reforms both at the national and at the international levels. National initiatives in this regard are indispensable for the promotion of industrialization in developing economies.

However, these alone are insufficient. For developing countries to achieve successful structural transformation, much deeper reforms of the international financial and monetary system will also be necessary, aimed at delivering financial stability and reliable sources of development finance, said TDR 2016.

The experience over recent decades echoes that of centuries past. No country has been able to achieve successful structural transformation without the visionary nudging and pushing of targeted and selective government policies.

Often called “industrial policies”, it would be more accurate to term them “production transformation policies”, because their role is equally important in agricultural, industrial and post-industrial transformations.

Despite being out of fashion in some quarters since the 1980s, they have made a strong comeback on the radar screens of governments in all parts of the world, including in the United Kingdom, where the term Industrial Revolution was first coined.

TDR 2016 has sought to glean some of the major lessons that have been learnt over many years with respect to the successful design, implementation and monitoring of industrial policies.

These include the creation of a particular geometry of state-business relations that ensure government support efforts aim at overcoming the right challenges and problems, and that business is only supported when it produces the right actions.

They also include the establishment of an integrated and coherent framework of interlinking policies that complement each other and serve the overall vision. Such policies include, for example, macroeconomic policies that aim to create a pro-growth and stable environment alongside targeted industrial policies, fiscal policies that provide incentives to encourage long-term productive investment, and income and wage policies that promote skills, learning, and production and consumption goals.

“Getting these basics right is more important now than ever before, owing to the greater challenge of industrialization. It is not just the adverse impact of continued secular stagnation and the diminished prospects for international trade that are forcing further reflection; it is also because many of the policies that propelled earlier generations of catch-up growth are now proscribed under various international, regional and bilateral agreements.”

Nonetheless, significant policy space remains, and new products and product markets can offer various opportunities for countries that have yet to embark on the path to industrialization, as well as for others that have already made some progress but have reached an impasse and need to change direction, said UNCTAD. (SUNS8317)                           

Third World Economics, Issue No. 625, 16-30 September 2016, pp6-8, 16