links for 2007-06-28
The Economics of the iPod

Does China's Rise Make Things Harder for Other Developing Countries? Yes.

Michael Kremer convinced me the answer was "yes." Now Dani Rodrik weighs in:

Dani Rodrik's weblog: Does China make it harder for other developing countries to make it?: Yes, according to FT's Alan Beattie. He writes in today's FT:

Being a developing country used to be easy. You followed leaders - Japan, Hong Kong, Taiwan, South Korea - up a well-trodden ladder from agriculture through manufacturing to services. Starting with tilling the soil, you moved on to turning out T-shirts, then toys, then tractors, then television sets, and ended up trading Treasuries.

The rise of China has made that less straightforward. Not only is the first rung harder to reach, thanks to the hundreds of millions of rural migrants to Chinese cities still willing to work for low wages stitching garments, but also exports of goods from China's coastal industrial fringe are rapidly becoming more sophisticated, threatening those halfway or more up the ladder. While the shoemakers of Italy and the steelmakers of Pennsylvania may complain loudly about Chinese competition, those with more to worry about are middle-income Asian countries geographically and economically close to the Middle Kingdom. So what is a poor developing nation to do? 

There are two schools on thought on this, as Beattie notes. One thinks that government cannot possibly do much and they better get out of the way, after taking care of the usual list of fundamentals of course:

For countries such as the Philippines, without a big arsenal for public investment, policy recommendations from most business people for competing with China involve no magic elixir. Governments should improve logistics, infrastructure, the business climate and education; try, possibly, to spot specialities emerging and support them, but otherwise get out of the way. They warn against governments crashing into the market having decided what the economy is likely to be good at and then promoting it at all costs.

The other school (which includes me) thinks that by following this route you not only remain in a rut, but you also miss out on the most important lesson from China's success: the need for the government to be strategic (and yes also flexible) in supporting industries. You do need an industrial policy--but... not of the traditional type...

The industrial policy that Dani recommends is one that focuses: not on the policy outcomes-—which are inherently unknowable ex ante—-but on getting the policy process right. We need to worry about how we design a setting in which private and public actors come together to solve problems in the productive sphere, each side learning about the opportunities and constraints faced by the other.... [I]ndustrial policy is as a discovery process—-one where firms and the government learn about underlying costs and opportunities and engage in strategic coordination.... It is the information externalities generated by ignorance in the private sector that creates a useful public role.... Yes, the government needs to maintain its autonomy from private interests. But it can elicit useful information from the private sector only when it is engaged in an ongoing relationship with it-—a situation that has been termed “embedded autonomy” by the sociologist Peter Evans (1995)....

[I]nnovation in the developing world is constrained not on the supply side but on the demand side. That is, it is not the lack of trained scientists and engineers, absence of R&D labs, or inadequate protection of intellectual property that restricts the innovations.... [T]he demand for innovation is low... because entrepreneurs perceive new activities to be of low profitability.... [A] useful analogy to keep in mind is with education and human capital. For quite a while, policy makers thought that the solution to poor human capital lay in improving the infrastructure of schooling.... [I]t became evident that the increase in schooling did not produce the productivity gains that were anticipated (Pritchett 2004). The reason is simple. The real constraint was the low demand for schooling—-that is, the low propensity to acquire learning—-in environments where the absence of economic opportunities depress the return to education...

The problem is that we now more-or-less now how to do light-industrial export-led development. We don't know how to do much of anything else. So "adopt a pro-development industrial policy" isn't much help. For China's rise has made it much harder for Mexicos, South Africas, and Perus to take that road.