Industrial policy: World Bank turning the corner?

6 April 2011

World Bank chief economist Justin Lin continues to stir the waters by pushing for increased global investment to boost growth and by suggesting that developing country governments need more interventionist industrial policies.

Lin, a Chinese national, speaking to the G24 group of developing countries in mid-March, called for "a global push for investment along the line of Keynesian stimulus [which] is the key for a sustained global recovery." He argued that current policies of richer countries risked locking in a period of low growth, but "a push for investment will increase the demand for capital goods and reduce manufacturing sectors’ underutilisation of capacity in high-income countries, which in turn will increase … employment, consumption, demand for housing, opportunity for private investment, and growth."  This runs contrary to the austerity measures being pursued by many countries at the behest of the IMF (see Update 74, 74, 73).

Over the past year, Lin has tried to reopen debate at the Bank over whether developing country governments should adopt active industrial policies, previously taboo at the institution.  In a May 2010 article for Global Policy journal he continued to promote his ‘six steps for strategic government intervention,’ first set out in his May 2010 paper Growth identification and facilitation. His thesis is that though the market remains the motor for economic development, "the government should play an active role in facilitating industrial upgrading and infrastructure improvements." While maintaining the Bank’s belief that countries should stick to their existing comparative advantage, his proposals appear to push the boundaries towards governments identifying future comparative advantages. He suggests that a government should  analyse which kinds of products and services are being successfully produced in the economies of countries at roughly twice its own average  GDP.  The resulting list should be used to guide which new or existing industries might be given some additional government-backed encouragement at home.

In a January reply to Lin, London School of Economics academic, Robert Wade, argues that this "door opening" argument could signal a move away from the “Washington consensus”  that "economic growth is a function of the size and competitiveness of markets" and "government ‘intervention’ tends to be more costly than ‘market failure’."  Wade highlights Lin’s role as the first non-G7 Bank chief economist and "his awareness of the inconsistencies between these [Washington Consensus] propositions and the actual roles of several East Asian governments in helping to stimulate high-speed growth".

However, a previous push from the Bank-funded 2006 Growth Commission to re-examine industrial policy (see Update 61) fell on stony ground. The fact that the operational part of the Bank which is running with Lin’s ideas has the market-friendly sounding name, ‘competitive partnerships initiative’, indicates the level of resistance that remains within the Bank for anything that sounds like governments intervening to manage markets.  

Foreign investment questioned

Lin also introduces some nuance into the Bank’s previously unreserved championing of foreign direct investment (FDI), arguing that while much overseas investment can be good for developing economies, certain types can cause severe problems (see Update 75). He highlights that portfolio investment in stocks and shares "tends to target speculative activities (mostly in equity markets or the housing sector), which create bubbles and fluctuations. They are volatile by nature and often contribute to Dutch disease and currency crises."  This more nuanced approach appears to be at odds with the received wisdom at the Bank as reflected in the strong push for FDI liberalisation in its Investing Across Borders report (see Update 72) and the rankings of the Doing Business report produced by the International Financial Corporation (IFC), the Bank’s private sector arm (see Update 67, 66).

Finally, Lin agrees with Wade that the Bank’s emphasis on ‘good governance’ as a prerequisite for growth may also be off the mark, saying that "an exclusive focus on governance may be misguided." In fact, he argues, "sustained economic growth in developing countries may be needed before their governance converges with that of high-income countries."   In other words, better governance is more a result of higher income levels than a cause, though Lin recognises some iteration between the two. 

Duncan Green of international NGO Oxfam argues that this "low-risk industrial policy-lite" is a step forward, but ignores the difficulties created by climate change.  "What worked in a world oblivious to environmental limits may not apply to one where growing economies will have to move quickly to a low carbon growth model".  He implies that a stronger directive role for government may be needed to make the shift in growth models than Lin endorses. 

Collins Magalasi of NGO the African network on debt and development (Afrodad), commented that "the truth is that the Bank has for several decades consistently and recklessly undermined countries’ ability to set their own economic policies, and promoted the kind of ‘one size fits all’ liberalisation and deregulation policies that make it impossible for them to use sensible industrial policy."