Import substituting industrial policy threatens India and Indonesia’s development success
5 November 2023Authors: Peter Drysdale and Rojan Joshi, ANU
The rise of security-driven economic policy in industrial countries gives licence to atavistic inward-looking policy thinking, infecting the framing of development strategies at a critical time in countries on the cusp of major developmental breakthroughs like India and Indonesia.
Geopolitics is changing the global economic policy landscape. Today’s backdrop of strategic competition and conflict has seen the return of industrial policy in advanced countries, driven by a security-based logic mixed with a second-best approach to the energy transition without a price on carbon. There has been an explosion of trade interventions, industrial policies and subsidies, exacerbating the threat to the world economy posed by the widespread derogation from the global trade rules.
How should developing economies like India and Indonesia navigate this policy environment, where self-sufficiency and import-substituting strategies are finding potent new favour?
East Asian economies have effected the only significant transformation from economic backwardness to advanced economy status in modern times. It’s thus wise to understand the lessons from the East Asian growth miracle, which still hold true today. And developing economies, constrained by their fiscal capacity, should recall the waste and futility of past industrial policies that picked industry champions rather than creating public goods to lay the base for broad-based industrial growth.
Successful East Asian development, based on the historical experience of Japan, South Korea, Taiwan, Singapore, Southeast Asia and China, was founded on trade-oriented growth (anchored in the disciplines of participation in international markets) and deeper integration into the international economy, not retreat from it or reliance on import-substitution. The rapid trade growth enjoyed by these economies was supply-driven, built on the expansion of market share in old, established industries, not expansion of trade in new, high-growth sectors of the global economy. Government investments were directed towards social and economic infrastructure in public goods such as roads and schools, with withdrawal from state involvement in enterprise.
Today, policymakers seem to live in a different age. Domestic events and geopolitical circumstances are visiting the prospect of stagnating growth upon established industrial economies, globalisation appears to have peaked, the international economy is becoming fragmented, and a policy pathology that favours self-sufficiency and import-substituting industrial policy is sweeping around the world.
The trope that a less optimistic outlook for global market growth now recommends that emerging economies turn to inward-looking import-substitution does not square with the experience of successful industrial growth in Asia.
In an international economic context, development is about drawing abundant labour into more and more productive employment, lifting productivity and national incomes.
Pro-development strategies are thus those that favour export-specialisation in labour-intensive products, drawing large amounts of labour into internationally competitive production and higher productivity employment. With the accumulation of capital, dynamic comparative advantage drives a more technology intensive export trade structure over time. The beneficent corollary of export-oriented development strategies has been a distribution of income that commonly favours labour.
The recent trend towards self-reliance and security has seen countries emphasise the production of high-tech capital-intensive goods from the start. Focusing on these sectors requires skilled labour, in short supply relative to abundant unskilled labour, and expensive government outlays, which come at the cost of providing essential government infrastructure. Failing to create jobs risks an entrenchment of inequality and an unsustainable stretching of public resources if a country grows old before it gets rich.
Successful trade-oriented growth comes from absorbing labour into industries that can capitalise on its abundance and establish international competitiveness. Doing this allows countries to take over others’ market shares as comparative advantages evolve, a process underwritten by a policy regime based on the principles of non-discrimination and open markets.
Even in a period of slow growth, the logic of comparative advantage still holds. Import-substituting policies undermine this transition by restricting access to low-cost and high-quality capital and technological inputs, preventing firms from achieving international competitiveness.
The East Asian economic miracle was certainly a messier and more complex story than has sometimes been portrayed in the narrative that describes its main features. In Japan, Northeast Asia, Singapore, China and Southeast Asia, the policy strategies that drove success were fashioned in different institutional and political settings and each had their own distinctive national character. Policy idiosyncrasies, technological context, geographic size and location have all shaped particular national paths and patterns of development across the region.
But some factors were ubiquitous throughout the East Asian experience. Opening up to competition from foreign markets and embracing international investment were central to rapid growth by enabling access to inputs that facilitated the absorption of abundant domestic labour into productive manufacturing employment. In addition to domestic reforms to support openness, increased mobilisation of state investment in education, health, transportation, communications networks and supportive industrial infrastructure, and reduced state shares in economic enterprise and the allocation of capital, typified successful industrial policy across the region.
China was no exception to these principles or to this experience. It has been a central element of it, at scale.
India and Indonesia, two of Asia’s most promising candidates for transformative industrialisation over the coming few decades, stand at a critical juncture in their development trajectories. Their youthful populations and recent strong economic performance put them in a demographic sweet spot.
Yet both countries are in danger of being caught in the undertow of industrial policy 2.0. The attunement of their development strategies to the principles derived from the East Asian experience would position them better both to fulfil their economic potential and avoid the danger that both now face of jobless growth.
Peter Drysdale is Head and Rojan Joshi is Research Assistant at the East Asian Bureau of Economic Research in the Crawford School of Public Policy at ANU.