Picking winners or subsidizing losers?

Picking winners or subsidizing losers?

Hal Hill examines Indonesia's experience with industrial policy.

One of the most important intellectual challenges of the late 20th century is to understand the bases of East Asia's rapid economic growth. A key element is undoubtedly the role of trade and industry policy. In the 1950s and 1960s the dependencia and liberal economic schools slugged it out, the latter winning as much through the demonstrated success of the Japanese and Newly Industrialized Economies (NIE) export machines as through intellectual arguments.

But just when the "orthodox" school might have expected to be able to rest on its laurels, another challenge emerged in the early 1980s. Few people now doubted the importance of export orientation as a key to economic success, but the means by which this is achieved has become hotly contested. An important new school of thought has emerged over the past decade and is associated with such international names as Alice Amsden, Chalmers Johnson and Robert Wade.

According to these writers, the path to international export success is through governments selectively intervening, "picking winners", and allocating resources -- credit, foreign exchange, public investments -- to achieve planners' long-term industrial vision. This group rejects the traditional economists' emphasis on "getting prices right" and confining the government's role essentially to the provision of public goods.

As an illustration, one of these writers approvingly quotes the statement of a former Governor of the Korea Central Bank: "Don't listen to 'comparative advantage' advice. Whenever we wanted to do anything the advocates of comparative advantage said, 'We don't have comparative advantage.' In fact, we did everything we wanted, but whatever we did, we did well."

This literature has focused almost entirely on Northeast Asia, apart from the important study of the World Bank (The East Asian Miracle) which, because of its parentage and therefore its need for consensus, was inconclusive on the issue. What about Southeast Asia? The test case is clearly Indonesia: the region's giant, the country in which "liberalism" is still a dirty word in some quarters and the country with the strongest interventionist proctivities.

Indonesia is also an admirable case study because of its distinct swings in policy orientation. Under the long rule of President Soeharto, the country has consistently recorded creditable rates of economic growth, and moderately low inflation. But at the microeconomic level there has been constant tension between the more orthodox approach of the "technocrats", and those advocating a more interventionist strategy. The latter group has included the "nationalist" camp, the "import substitution" camp (in which the Department of Industry has been prominent, although less so now) and, most important of all, the group headed by the Minister of State for Research and Technology (or "Minister for High Tech"), Professor B.J. Habibie.

During the oil boom, until 1984, Indonesia embarked on a strategy of state-led heavy industrialization. Huge investments in oil and gas refining, fertilizer, cement, steel, alumina, and aircraft manufacture were financed by the oil revenue windfalls. Other nominally "private" investment received extensive state support through subsidized loans from the state banks and through a proliferation of import barriers.

When international oil prices softened in 1982-1983, and fell sharply in 1985-1986, this strategy was no longer sustainable. If Indonesia was ever going to experience a debt crisis, as many other developing OPEC countries did, it would have been then. That it did not, and that by the end of the 1980s it had returned to a high-growth East Asian trajectory, has much to do with the bold and decisive reform measures introduced from the mid-1980s: customs reform, banking deregulation, trade liberalization and other measures, combined with effective exchange rates and macroeconomic management.

To return to the question posed in the heading, can one attribute Indonesia's rapid industrialization to government policy? In one sense, the answer is obviously yes. The "New Order" government has provided a predictable and stable economic and political environment, property rights have by and large been respected; capital controls, a source of endemic corruption in developing countries, were abolished in 1970; there have been big investments in infrastructure and education; and the record on poverty alleviation has been impressive.

But these measures and strategies are in the realm of "public goods", which governments are best placed to supply and manage effectively. The issue of debate concerns the micro, industry level. Here it is much more difficult to sustain the argument that the plethora of interventions has really made much difference to Indonesia's performance.

Consider briefly the main tools of industrial policy -- protection, credit subsidies and state enterprises. There is no evidence that, through import protection, the government has successfully picked winners. This can be demonstrated rigorously by correlating protection levels across industries and subsequent performance -- efficiency, export performance, etc. But Jakarta's well-informed taxi drivers could give you the same answer: the most intensely protected industries are generally the poorer performers. Witness, for example, the automobile industry, dubbed by the Jakarta press "bayi yang sudah tua" (the old baby).

In the case of state enterprises, their financial performance is known to be poor. Admittedly, the government has assigned social objectives to these firms, as "agents of development". But various pieces of firm-level research suggest that these non- economic contributions are insufficient to compensate for the low rate of return on publicly-owned assets.

Credit subsidies were mostly abolished as part of the 1983 and 1988 financial reform packages. But even before these reforms, credit subsidies were never as focused as, for example, in Korea. More generally, Indonesia's political economy has been such that the New Order has rarely been a "hard state" at the micro- economic level. Government support of firms -- through credit and financial incentives -- has been much less tightly tied to performance criteria than in the Asian NIEs.

The lessons for Indonesia from the NIE experience of rapid industrial upgrading are clear. The government plays a key role in investing in a high-quality education and training system; in maintaining macroeconomic stability; in providing a clear, transparent, and incorruptible commercial environment; in carefully structured environment programs; and in social policies which ensure that all groups benefit from rapid growth.

The evidence from East Asia that governments can accelerate industrial growth through selective, firm-level intervention and subsidies is weak. And, obviously, the more prone a regime is to "capture" by vested interests intent on personal enrichment, the more likely is such intervention going to result in scarce public funds being diverted to costly bail-outs.

Dr. Hal Hill is a Senior Fellow in Economics, and Head, Indonesia Project, Research School of Pacific and Asian Studies, Australian National University, Canberra.