The Economic Success of East Asia: Industrial Policy or Sound Fundamentals?

When it comes down to discussions of whether the United States needs an activist industrial policy to power future economic growth, maybe the most common argument I hear is that other countries like China are doing it, so the US needs to do it as well.

“US companies can’t compete against foreign governments” is a common line. Just to be clear, I’m talking here about the kind of industrial policy that goes beyond general policies like supporting competition, education/job training, and research and development, and instead focuses on government support for certain industries or companies (perhaps with financial subsidies or trade protection).

The modern version of this argument typically focuses on how the US needs to subsidize key industries as a counterbalance to China. But for economists, there’s some history here. I remember in the 1970s when the argument for US industrial policy was the need for competing against the USSR (because “US companies can’t compete against foreign governments”) and then in the 1980s and 1990s when the argument for US industrial policy was the need for competing against Japan (because “US companies can’t compete against foreign government”). Now, it seems pretty obvious that Soviet industrial policy didn’t work too well. In Japan, by far the biggest government subsidies always went to the agriculture industry, suggesting that once government industrial policy is run through the political system often more about propping up existing money-losing firms, than turbo-charging potential new firms that will take market share from incumbents.

But more broadly, the idea that the great economic success stories of the 20th century were driven by focused and specific industrial policies, rather than by policies that were broadly supportive of economic growth, doesn’t seem to be borne out by the evidence. Gary Clyde Hufbauer and Euijin Jung discuss “Scoring 50 Years of US Industrial Policy, 1970–2020″ (Peterson Institute of International Affairs, November 2021). I discussed the findings of the report last week. Here, I want to focus on their brief summary of the evidence about how fundamentals like sound macroeconomic policy and expanded education were far more important for economic development in Japan and East Asia than targeted industrial policy. They write:

The World Bank’s acclaimed volume, East Asian Miracle: Economic Growth and Public Policy (Birdsall et al. 1993), while acknowledging industrial policies, emphasized sound macroeconomic policies (later labeled the “Washington Consensus”), together with superior education and land reform, as drivers of remarkable growth in Hong Kong, Japan, South Korea, Singapore, and Taiwan. A decade earlier, Chalmers Johnson (1982) had published MITI and the Japanese Miracle: The Growth of Industrial Policy, 1925-1975, giving outsized credit for Japan’s spectacular postwar economic growth to government support for specific firms and industries. These two volumes set the stage for prolonged
debate, still underway, on the role of industrial policy in East Asian economic prosperity. Numerous academic articles and books have dissected contributing factors. This brief section merely skims the surface of a substantial literature.

Three key facts … set the stage. Between 1950 and 1990 in the East Asian stars, real exports generally grew, real GDP soared, and per capita income dramatically closed the gap with US levels. Industrial policy protagonists saw cause and effect between government intervention—trade protection, easy credit, assorted subsidies, cartels—and these indisputable outcomes. … Japan, South Korea, and Taiwan were the clear exemplars of industrial policy.

In 2003 Marcus Noland and Howard Pack authored Industrial Policy in an Era of Globalization: Lessons from Asia, first summarizing the literature, and then contrasting macro forces with industrial policy in the postwar recovery and subsequent growth of the three examples. Their analysis relied heavily on quantitative measures rather than accounts of targeted government policies or the rise of specific firms such as Mitsubishi, Toyota, POSCO, Samsung, China Steel, or Taiwan Semiconductor Manufacturing Corporation (TSMC). Analyzing sector growth, value added, capital accumulation, and total factor productivity in Japan and Korea, Noland and Pack (2003) found little or no correlation between the quantitative outcomes and various industrial policy indicators such as tariffs, tax rates, and government loans … On the other hand, they found that the growth of physical capital per worker, education per worker, and total factor productivity fully explained the remarkable growth of output per worker in South Korea and Taiwan …

These contributing factors were much weaker in Latin America and South Asia, two regions that heavily favored industrial policy and fared poorly during the era of the East Asian miracle. The differing fates of East Asia and the other two regions owe to the political and economic stability and superior macroeconomic and education policies of East Asia: few coups, relatively low inflation, high savings rates, modest budget deficits, and high secondary and tertiary education rates. The authors conclude (p. 93) that, “on balance, the weight of the evidence derived from both econometric and input-output studies of these economies … indicates that industrial policy made a minor contribution to growth in Asia.” … The relevant lesson for our report is straightforward. If extensive industrial policies made only a minor contribution to East Asia, far less extensive industrial policies—minuscule by comparison—cannot be expected to shape the economic destiny of the United States.

The ingredients for economic growth are fairly straightforward: people with more education and training, investment in physical capital and research, and an economy with flexible incentives to reward efficiency, quality, and innovation. If economic success were as simple as politically-directed and -focused industrial policy, then every country would just enact the requisite laws and succeed. Clearly, it’s not that easy.

I’ll close by saying that the extraordinary economic growth of China since the early 1980s is obviously not from China’s government carefully directing the development of its economy. China’s government has of course contributed with general policies like macroeconomic stability, dramatically rising educational achievement, opening up its internal markets, involvement in international trade, and support for science and technology. The growth and energy has all come from private firms, often in unexpected ways, while China’s state-owned firms have lagged behind. Moreover, the current push in China to strengthen its industrial policy of additional state control over its private firm seems much more likely to end up like the old-style Soviet industrial policy, rather than to set off a new wave of economic growth.