Webinar Summary: The Future of Industrialization in a Post-Pandemic World

On Tuesday, September 13, Dr. Justin Yifu Lin, Director of the Institute of New Structural Economics at Peking University, joined the Fall 2022 Global China Research Colloquium to discuss the future of industrialization in a post-pandemic world.

Industrialization has been a dominant goal for developing nations for much of the last century. Lin is a pioneering expert on this topic; his theory of New Structural Economics incorporates past experiences of countries that have attempted industrialization with mixed results. The theory recommends that developing nations pursue an industrial policy that combines the strengths of competitive markets and the coordinating and facilitating role of states. Lin is the co-author of Going Beyond Aid: Development Cooperation for Structural Transformation, with GDP Center Senior Researcher Yan Wang.

Dr. Lin began his presentation by explaining the necessity for developing countries to undergo structural change (a shift in the sectors that underpin an economy) through industrialization to achieve the UN 2030 Sustainable Development Goals (SDGs) and escape the low- and middle-income traps. The problems of poverty, hunger and public health (SDGs 1, 2 and 3) that developing countries face are not based on a lack of employment, but on the fact that employment is characterized by subsistence agriculture and low-income informal economic activity. Lin argues what is needed is decent work that brings sufficient income to raise living standards. Expanding formal-sector employment in higher-productivity industries is a key requisite to fill this gap.

The SDGs make clear that innovation and industrialization (SDG 9) are necessary parts of development, and that these goals should be pursued in sustainable and inclusive ways (as specified in SDGs 10-15). But the question remains of how best to pursue the goals of industrialization and structural change.

If well designed, industrial policy can help address these challenges. Unfortunately, governments have often been unsuccessful in their use of industrial policy in the past. Lin attributes these difficulties to a failure to harness the strengths of competitive markets and the state. To be effective, Lin argues, industrial policy must foster a competitive market system in order to allow firms to choose technologies and industries based on the relative prices of inputs (such as raw materials, labor and capital) as well as the prices of finished products. The approach can help ensure investors take advantage of the country’s factor endowments, as inputs that are more abundant will have lower input prices relative to more scarce resources.

In Lin’s view, the state has an important coordinating and facilitating role to play. For example, “pioneer investors” in new industries often face “first-mover disadvantages,” as they must invest time and capital in learning how to pursue a new activity in a particular country context. This extra effort benefits later investors, who can learn from the successes and failures of their predecessors. Governments can encourage pioneer investors through a variety of approaches. Another important role for governments is solving coordination problems among investors in order to lower costs, through developing “hard infrastructure” (such as roads and railways) as well as “soft infrastructure” (such as well-functioning government bureaucracies to facilitate licensing and oversight of firms).

These avenues for action are detailed in six steps for states seeking to industrialize: Lin’s first step is for a state to identify a promising industry, one that is compatible with a countries’ existing endowments but brings the potential for productivity growth and decent work. In this step, Lin recommends learning from the experience of higher-income countries with similar endowments, particularly countries who have industrialized very recently and seen rapid growth in productivity and income in the last few decades. Once this predecessor economy is identified, a state interested in industrialization can identify a dynamic industry that has performed well in that economy over that time frame. By looking outward to predecessor economies, states can avoid capture by prominent domestic industries seeking to be chosen as “winners” and thus gain greater influence and resources.

Once a promising industry has been identified, states can then look inward to identify any private domestic firms already involved in those industries, whether they are in nascent or operational stages. By studying the experiences of these firms, states can discover and alleviate the constraints that the industries face in upgrading quality or attracting more firms. This second step may involve targeted finance to expand access to capital, improving education to upgrade the workforce and similar interventions.

In some cases, a state may find that no domestic firms have been able to enter the identified industry, due to firm-specific barriers such as lack of technology or experience. For this reason, Lin’s third step is to seek foreign direct investment (FDI) in the chosen industry or organize new incubation programs to encourage new firms to invest in the skills and technology necessary to begin operation.

In addition to the identified industry, states should be aware of the possibility of “spontaneous self-discovery,” in which firms see and act on new opportunities in other industries. Where firms are finding some success in identifying their own new industries, states can step in to support these processes by facilitating access to new technologies that give rise to this spontaneous activity. This work is Lin’s fourth step.

Frequently, firms developing countries face higher costs from poor roads and rail and unreliable power and communications networks. Lin’s fifth step is for governments to alleviate infrastructure constraints by establishing special economic zones (SEZs) or industrial parks with upgraded transportation, power and telecommunication infrastructure. SEZs and industrial parks attract firms interested in lowering their costs, and thus create clustering benefits for firms who can more easily find upstream and downstream partnerships and learn from each other’s experiences.

Finally, the sixth element of the process is for states to compensate “pioneer” firms with financial supports. Rather than across-the-board subsidies or permanently lower tax rates, Lin recommends fixed-time tax incentives that target new market entrants and direct credits for specific investment types, as well as facilitated access to foreign exchange. By pinpointing this financial support to the specific constraints that states are hoping to alleviate (such as new firm entry and technology upgrades), governments can avoid capture from domestic industry groups that might seek short-term financial benefit without the promise of long-term growth and competitiveness.

Lin concluded his remarks by addressing the recent complications that the COVID-19 pandemic has presented developing countries seeking to industrialize. Due to global public health concerns, travel restrictions, supply chain disruptions, inflation and interest rates increases, attracting foreign capital has become particularly difficult for developing countries. During these challenging years, states may face additional obstacles in following Lin’s recommendations. He suggests focusing on assisting existing firms rather than attracting new ones, and targeting fiscal support to identifying and resolving the bottlenecks faced by firms. This may involve upgrading existing SEZs and industrial parks in order to retain current FDI and help firms weather this period of higher prices by reducing transportation costs. Once the global economy returns to more normal conditions, states can return to more active strategies.