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.