After the Crisis: Industrial Policy and the Developmental State in Low‐Income Countries

Abstract The current global economic crisis has been disastrous for many millions of people. But it has also had the desirable effect of prompting a little more skepticism towards the economic beliefs that have constituted the mainstream view about public economic strategy for the past three decades, both in the major western states and in international lending organizations like the World Bank and the IMF. They have at their core the proposition that ‘government failure is generally worse than market failure’, which supports the default policy setting of ‘more free market’ in most countries most of the time. The new crisis‐induced skepticism is good news because the previous confidence rested more on what J. S. Mill called ‘the deep slumber of a settled opinion’ than on a solid empirical base. The present article begins by summarizing some powerful pieces of evidence that challenge core mainstream propositions in the context of developing countries, which have received less attention than they deserve. Having shown why the mainstream prescription for the role of government in development is questionable, the article describes some key points about the nature of industrial policy in East Asia and about the general rationale for a certain kind of industrial policy even where state capacity is relatively weak. The rationale is all the stronger in the world economy after the crisis, when a major surge of innovation around energy, water, nanotechnology and genetics is likely, rendering many existing specializations unviable. The article then presents an argument about the institutional arrangements of a ‘developmental state’ through which national strategies can be formed and implemented. It ends by describing small signs of new flexibility in World Bank and IMF thinking. Policy Implications Liberalizing markets, attracting FDI and promoting good governance are not necessary conditions of long‐term economic growth and development in low‐income countries. In the wake of the global financial crisis and the impending surge of new technologies, the role of industrial policy – promoting some sectors or products ahead of others – should be expanded. Import replacement as well as export orientation are crucial components of a successful industrial policy. Four organizational features are important in a developmental state: (1) an even balance between the state and business groups; (2) a public service mindset among state officials; (3) delivery of patronage resources separately from the economic bureaucracy; and (4) an industrial extension service, with tight limits on its officials’ discretionary control of resources. Developing country governments and firms should be prepared to push back against the shrinking latitude for industrial policy instruments allowed in international trade and investment agreements.