Friday, 19 January 2007

Loser's Sentiment and Economic Policy

"What’s So Special about China’s Export?"

- Dani Rodrik, 2006, NBER Working Paper 11947

The Danger of Seeking a Grand Narrative

I have often been accused of being a believer of a particular school of thought, or an advocate of a certain strand of economic ideology. They usually take the following forms:

“Aha, you are just so Keynesian, Elanor”
“Yes, Elanor, you so believe the Market will solve all problems of human civilization”
“Gosh, you are such a nerd!”

While I still can’t find a suitable defense against the third sort of claim, I am often dumbfounded by accusations such as the first two. I normally respond by giving a blank look (or, occasionally and only when it is entirely appropriate, I say “go bless your lil’ cotton socks”). Firstly, I have no idea what I have to believe in if I am a Keynesian, or how Market should be defined, or if I have to join a political party if I am supposed to be a Liberal. All I know is that if I am all these at the same time, it means that I am most probably schizophrenic.

Secondly, and more important, I don’t believe in any form of grand narrative that is supposed to provide elegant and complete explanation to any particular issue, event or phenomenon, especially complex ones. Just as how capital liberalisation alone doesn’t explain the miracle of the Asian economies in the 1990s, neither does it, by itself, explain the end of the miracle. Almost all the time, it is the collection of small tales that explains the whole story. The same, of course, applies to our personal lives, but that is for another post.

Any attempt to view any complex issue through the lenses of any single convention based on dogmatic convictions will ultimately reduce our ability to comprehend the issue in its entirety. The danger arises when this is used as a basis to come up with remedies or policies. It is due to this danger why we should always have in mind that short-term interest rate is very blunt policy tool for diverse macro-economic issues, why a free-floating yuan is not a panacea of the global imbalances, why war does not solve terrorism, why hasty privatisation cannot be the sole solution to the efficiency problem of the transition economies in the Europe, or why affirmative action is not the only way we could address economic inequalities.

And this brings me to my titular topic.

Picking Winners, Dropping Losers

Dani Rodrik, an economist from Harvard, recently published a working paper (read the paper here) explaining China’s exports and economic performance. It is a middle-length empirically based-paper with many interesting results. One of the main messages is how China’s economic policies allowed its exports composition to achieve a level of sophistication of a country that has at least three times the level of income now (and six times back in the early 1990s), giving China a formidable competitive advantage (low-cost, high-tech).

In his own words, Rodrik says (page 3):

“…China’s policies resemble more those of a country that messed up big time than those of a country that became a formidable competitive threat in world markets to rich and poor countries alike.”

So what exactly did China get right in its policies? You can’t explain it with some grand economic theory. Nor can you find China’s policies neatly described in a 5-year national economic plan or a 15-year industrial master blueprint manual. No, its success is a collection of smaller stories. Rodrik’s concluding paragraphs (page 24-25) summarise his findings very well, as well as providing a lesson that I personally feel is very germane to the economic policies of Malaysia:

“This brings us to… the nature of future industrial policies. A clear implication of this paper is that China’s industrial policies—however incoherent they may have been—have had a hand in China’s past success. Future economic performance may also need to be supported by such policies…

The usual criticism of industrial policy is that governments cannot pick winners, and therefore should not try. But this is not the right way to think about industrial policy. In environments that are rife with uncertainty and with technological and informational spillovers, markets under-provide investment in non-traditional products. The appropriate role for industrial policy is to fill in this market incompleteness by subsidizing investments in new products. It is a given that not all of these additional investments will prove to be socially profitable. Good industrial policy consists of withdrawing support from those projects that are revealed to be failures, so that resources do not get bottled up in unproductive activities. Hence the appropriate criterion of success for industrial policy is not that “only winners should be picked” (an impossible task) but that “losers should be let go” (a much less demanding and more doable task). The latter is the relevant yardstick against which industrial policies ought to be measured.

Therefore, a key question for China going forward is whether Chinese policies will maintain their experimental and flexible nature—whether governments will remain willing to support new industries but also willing to turn against ventures that under-perform…

We can identify the higher-order principles involved at a sufficient level of generality, but need to fashion blueprints that are suited to the local context. The challenge for China therefore is to develop institutional models that are based on Chinese realities.”

The lessons on the design of economic policies are profound. Firstly, picking winners is not just justified, it is a prerequisite. Protection of infant industry and so on, can lead to successful development stories. Malaysia has always been good at doing this.

Secondly - and this is really the key message of this post - we have to let the losers go and move on. If the current strategy is not working out, change the strategy. If a policy has already outlived its usefulness, end it. And Malaysia has shown that she is capable of doing this too. Our very own capital controls is a classic case in point.

However, one can’t help but to ponder the wisdom of extending a sweeping and unorthodox national economic policy that has been in place for almost four decades without clear efficacy or results; or protecting a clearly failing and extremely distortionary ‘infant’ industry for over two decades that seems to epitomises the very worst of Malaysia industrial prowess. And more. Juxtapose these against the merciless forces of global integration and rising hegemonic powers; one is left to wonder if there remains a place for Malaysia in the future of the global economy.

1 comment:

CY said...

I find your posts informative and educational. You make economics interesting to non-economists like me. Keep up the good work! Oh, love your style of writing too :)