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How Can Developing Countries Catch up? The Case for Open-Economy Industrial Policy

Robert Hunter Wade

Even after two and a half decades of Washington Consensus-type market liberalization, economic performance in most developing countries -including in Latin America- remains (by several key indicators) worse than in the preceding three decades and worse than the average of the North. Putting aside the upswing of the past few years, this is the opposite of catch up. East Asia plus India are important exceptions to the trend, not typical; and most of these “exception” countries are still at income levels far below Latin America’s.

The general failure of catch up has fuelled renewed interest in “industrial policy” in pockets of academia and heterodox international organizations like CEPAL, despite the toxicity of the phrase in orthodox economics. This paper outlines a new approach to industrial policy and the role of the State in industrialization. It is based on the proposition that (a) diversification is the core process of development, not specialization; (b) a State which limits itself to providing generic public inputs and institutions will constrain diversification -because diversification beyond “nearby” products depends on the State providing new, sector-specific inputs.

However, the provision of these specific public inputs is subject to “government failure” stemming from problems of (a) information, (b) incentives on public officials, and (c) exit mechanisms. The art of designing institutional arrangements of industrial policy is the art of solving these problems.

The paper illustrates some of the general points with reference to Taiwan; and draws out several implications for national and international policy (including that the Doha Round is best left to fail).

 

Key words: Industrial Policy; Function of the State; Developing Countries; Development Strategy

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