Good industrial policies require co-ordination, feedback
May 9, 2008
By Ricardo Hausmann, Dani Rodrik and Charles Sabel
In South Africa, the government has explicitly acknowledged the potential contribution of sound industrial policy to economic growth and employment. It is a main plank of the accelerated and shared growth initiative for SA.
Industrial policy is based on the idea that the private sector needs the government to help internalise the externalities associated with cost discovery and to provide the public inputs that only a government can.
The government in turn requires the co-operation of business because it needs to know what obstacles and opportunities firms and entrepreneurs face and it has to be able to influence their behaviour in the desired direction.
The acid test for an industrial policy framework is whether there are institutions that engage policy officials in an ongoing conversation with the private sector; whether the government has the capacity to respond to the opportunities that these conversations help identify; and whether there are monitoring and evaluation procedures to ensure the policy process is self-correcting.
South Africa has a plethora of instruments and agencies involved in formulating and implementing industrial policies. The department of trade and industry (dti) is in charge of developing customised sector programmes (CSPs), and provides cash and other incentives. The department of public enterprises has a large capital expenditure programme to develop local supplier capacity.
The department of minerals and energy is encouraging beneficiation of minerals. The Industrial Development Corporation (IDC) finances small businesses and empowerment deals, and provincial governments have their own investment promotion agencies.
The good news is that many elements of a better policy apparatus are already in place. In some important cases we think it is possible to build on existing institutions, while rebalancing their portfolios.
At the opposite extreme are programmes that have outlived their usefulness and have to be refounded. In between, as it were, are cases where current arrangements are so disorganised that we think it advisable to create institutions with overlapping responsibilities and let competition bring out the best.
Here are some specific ideas to improve prevailing practices:
A new budgetary procedure to elicit information on missing public inputs and pay for them. We propose that every year a share (4 percent) of economic cluster department budgets be allocated to a central fund that aims to finance specific public inputs, ranging from infrastructure to training to research. Allocation of funds would be made on the basis of proposals from the private sector.
The chief criterion would be that the input enhances productivity (and not just profitability). The fund would solicit proposals, which would then be vetted by a technical secretariat. An inter-departmental committee would make the final decisions.
Reorienting the IDC towards self-discovery activities, such as scanning the economy for opportunities in new industries, lending or investing in the early stages of the industry's development, and communicating information about obstacles and constraints to the relevant government agency.
We would like to see this becoming the core of IDC's portfolio, not a peripheral activity. Essentially, we would like to see IDC act much more like a venture fund and much less like a commercial bank, by being more proactive in identifying opportunities, more willing to get involved early, and having a greater appetite for risk.
A revamped motor industry development programme focused on strengthening the supplier base. The central issue faced by the motor sector is one of large-scale co-ordination.
Many of the original equipment manufacturers (OEMs) can see a path of scaling up to a competitive level, but they need a well-developed domestic supplier base. Potential first-tier suppliers, on the other hand, have to operate at large scale to meet the needs of the OEMs, but they are hesitant to invest in South Africa if they will be tied to a single OEM.
The solution is to focus incentives away from exports and towards incentivising capacity expansion and generation in supplier industries directly.
Improving the customised sector programme (CSP) processes. At present, the CSP is not a systematic programme, but a collection of disparate policy initiatives.
In the capital equipment industry, the process resulted in a rich dialogue between the dti and the sector, but the broader policy system appears to have failed to respond appropriately.
In the business process outsourcing sector, the process produced a useful market analysis, which led to a strategic bet on the industry and temporary wage bill subsidies to encourage new investments, but with no criteria for success, no monitoring of progress, and no continuing discussion about next steps. We believe the CSP needs enhanced focus from dti.
Avoiding forced beneficiation. There has been much talk about the need to beneficiate South Africa's mining resources. We think beneficiation, or incentivising the domestic processing of natural resources, is not a sensible policy.
The capabilities developed through mining can be exploited in a number of ways that are only accidentally connected to the further processing of ores and minerals. For example, the skills for cutting and polishing diamonds are quite different from those for mining diamond ore. But the needs of mining generate a host of skills in the design of capital equipment for other industries. A policy focused on beneficiation has such a narrow focus that it tends to encourage the wrong activities and generates inefficiency.
Industrial policy assists firms in their search and discovery processes for new lines of comparative advantage. The implementation of industrial policy itself is a process of discovery about the appropriate institutional practices that will bring the desired results about.
Internalising what industrial policy is about - and continuously striving to bring practice in line with its objectives - is perhaps more important than starting with the "right" set of policies.
The most important lesson from east Asia is that industrial policy is a mindset - one that rejects big-bang reforms in favour of experimentation, and gradual, but transformative change through identification of bottlenecks and self-correction, with continuous attention to making projects work.
This is an edited version of the article. More documents on the work of the panel are available at www.treasury.gov.za/publications/other/growth/default.aspx
Key points:
1. A fund is required to research what public inputs are needed and to pay for them.
2. The IDC should become more like a venture fund and less like a bank in order to nurture promising new industries.
3. The MIDP should focus on large-scale co-ordination and the development of a supplier base.
4. Processes for the customised sector programmes should be more systematic, with more attention from dti's leadership.
5. The narrow focus on the forced beneficiation of minerals should be dropped as it tends to generate inefficiency.
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