Six Steps for Strategic Government Intervention
| Date | 01 October 2010 |
| Author | Justin Yifu Lin |
| Published date | 01 October 2010 |
| DOI | http://doi.org/10.1111/j.1758-5899.2010.00046.x |
Six Steps for Strategic Government
Intervention
Justin Yifu Lin
World Bank
A response to ‘After the Crisis: Industrial Policy and the
Developmental State in Low-Income Countries’
Robert Wade*
Professor Robert Wade’s article, ‘After the Crisis: Indus-
trial Policy and the Developmental State in Low-Income
Countries’, is a bold and thought-provoking exposition of
his long-held ideas on the political economy of develop-
ment and the dynamics of structural change. I agree with
much of what he suggests but would like to offer a couple
of nuances on the relative roles of the market and the state
in the process of economic development, and then suggest
a framework for conceptualizing and operationalizing suc-
cessful government intervention.
The need to differentiate between ‘good’ and ‘bad’ capital
inflows is an important lesson from the recent global crisis.
I have argued elsewhere that liberalizing inward direct
investment should generally be an attractive major compo-
nent of industrial policy (Lin, 2010). Foreign direct invest-
ment (FDI) usually flows to industries that are consistent
with the recipient country’s comparative advantage. It is
also less prone to sudden reversals in a panic situation than
bank loans, debt financing or portfolio investment. In addi-
tion, FDI tends to bring technology, new managerial prac-
tices, access to markets, and social networking, which are
often lacking in a developing country and yet crucial for
the industrial upgrading process. By contrast, portfolio
investment 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 con-
tribute to Dutch disease and currency crises. Wade takes
the analysis further; he points out that FDI flows must be
managed strategically for developing countries to avoid
deficit-prone industrialization. He rightly suggests that
priority be given to inflows that foster the growth of inter-
mediate inputs and producer services within the national
economy – this helps reduce the income elasticity of import
demand.
I also agree with his reflections on the direction of the
causality between growth and governance. Government
failures have indeed been as pervasive and damaging in the
developing world as market failures. But an exclusive focus
on governance may be misguided. Governance is likely to
be endogenous to the stage of economic development, and
sustained economic growth in developing countries may be
needed before their governance converges with that of
high-income countries (Meisel and Aoudia, 2008).
I do not share Wade’s severe assessment of neoclassical
economics on two points. First, despite the absence of con-
vergence among world economies, the progress made by
developing countries in recent decades cannot be underesti-
mated. The fact that the majority of states have remained
in the same income category over two decades may be
the reflection of general progress (a tide-lifting-all-boats
phenomenon) rather than a sign of general stagnation.
Although relative incomes among various groups of coun-
tries may not have changed much, the absolute levels of
incomes have increased steadily in recent decades. This has
contributed substantially to the reduction of world poverty
(Ravallion and Chen, 2008). Clearly, an open world econ-
omy has offered opportunities for many developing coun-
tries throughout the world to achieve sustained growth and
improve their living standards (Growth Commission,
2008). This is true even in many countries that have not
moved up the convergence ladder.
Second, the market is an important resource allocation
mechanism at any given level of development. Economic
growth occurs when firms are given the incentive system to
take advantage of existing opportunities determined by the
country’s endowment structure. They can also create poten-
tial new business niches by identifying and exploiting the
economy’s latent comparative advantage. They spontane-
ously enter industries and choose technologies consistent
with the economy’s comparative advantage only when the
price system reflects the relative scarcity of factors in the
country’s endowment. Therefore, a competitive market
system should be the economy’s fundamental mechanism
for resource allocation at each stage of its development.
However, economic development is a dynamic process
that requires industrial upgrading and corresponding
*Wade, R. (2010) ‘After the Crisis: Industrial Policy and the Devel-
opmental State in Low-Income Countries’, Global Policy, Vol. 1,
No. 2, pp. 150–161. DOI: 10.1111/j.1758-5899.2010.00036.x
Global Policy Volume 1 . Issue 3 . October 2010
Copyright 2010 London School of Economics and Political Science and John Wiley & Sons Ltd. Global Policy (2010) 1:3 doi: 10.1111/j.1758-5899.2010.00046.x
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