The Return of Industrial Policy
Liberalization isn’t for everyone. The “liberalize everything” approach came under pressure after being blamed for both the 1998 Asian financial crisis and the 2008 global financial crisis. The perfect-market assumption that underpinned financial liberalization policy collapsed immediately in the wake of both crises.
The return of industrial policy further dealt a blow to libertarians. Anti-government-intervention policies were once all the rage. Industrial policy should be kept to a minimum; let the market work and the economy will run efficiently. That argument was built on the assumption of perfect markets. Unfortunately, market failures – a hallmark of low to medium income countries – are the root cause of liberalization’s ineffectiveness.
Criticism of trade liberalization came from Rodrik and others. According to Rodrik, free markets also fail at growing industry because the market doesn’t have sufficient economies of scale to develop and conduct research. This doesn’t have to be high-tech research – even “research” as basic as job searching or identifying promising sectors requires costs with non-trivial failure rates. This is where government must step in.
Rodrik’s argument is supported by many researchers, including Cherif and Hasanov. They argue that had Japan, South Korea, and Taiwan followed free-market dictates back then – in other words, focused on their Revealed Comparative Advantage (RCA) – they might never have become major players in automotive, shipbuilding, and electronics as they are today. They illustrate how East Asian countries’ RCA shifted from low-value exports to high-tech goods with very high value added.
Research on East Asia’s success has grown richer, seemingly supporting the case for industrial policy. Perhaps the most eloquent non-economics work on this topic is Joe Studwell’s book. In How Asia Works, Studwell describes how government played a role in overcoming market failures in Japan, South Korea, Taiwan, and China. Governments drove agrarian reform so their citizens had sufficient incentives and personal assets to springboard into manufacturing. When the leap to manufacturing was needed, government again intervened to support domestic industry. The book also describes how countries like Indonesia, Malaysia, and the Philippines failed to do what those four Asian Tigers accomplished.
Indonesia failed even during the agrarian reform stage under Soekarno’s leadership – perhaps even up to the present day. Industries controlled by cronies and liberalization rife with information asymmetries further lengthened Indonesia’s list of failures according to Studwell. So what should be done?
All proponents of industrial policy seem to agree on the recipe for effective industrial policy. Intervention should target industries deemed strategic. According to Cherif and Hasanov, strategic industries are those with advanced technology, high value, and export capability. Exports are a critical key – first, to expose domestic firms to international competition. Another advantage is for designing incentives. The government should design incentives for strategic industries but only grant them to exporting firms. Set export targets for companies, provide export incentives, and withhold incentive access from non-exporters.
Indonesia has long had national industrial planning, from the old National Industrial Policy established through Presidential Regulation No. 28/2008, to the latest Making Indonesia 4.0, which doesn’t yet have formal regulations. All emphasize strategic national industries, which have evolved over time. The latest iteration identifies automotive, chemicals, textiles, food & beverage, and electronics as priority industries. An initial step worth appreciating.
Currently, Indonesia appears to be designing incentives to advance the Making Indonesia 4.0 roadmap. These include Super Tax Deduction tax incentives for companies that allocate profits to apprenticeship and research activities. A bold move, given that corporations remain one of the most important sources of government revenue. But incentivizing companies to conduct R&D is a crucial step toward addressing market failure.
Research incentives are a good step. However, incentives based on export performance remain absent so far. Policies like subsidized loan interest rates proportional to export value – as practiced by Park Chung-hee, South Korea’s leader in the 1970s – have not yet been implemented by the government.
Nevertheless, we remain hopeful that the government’s current efforts will bear fruit. At least economists have begun to recognize the importance of government intervention in economic growth. Let’s keep our fingers crossed.
Even without formal regulations yet, Making Indonesia 4.0 seems to be taken very seriously. Check out this Ministry of Industry ad on Tirto:
