East Asia must strike a balance between industrial and trade policies so that they do not lose out on the benefits of participating in global trade, writes Arianto A Patunru (ANU).

Author: Arianto A Patunru, ANU

Since the World Bank published The East Asian Miracle report in 1993, a myriad of studies debating the merits of industrial policy have appeared.

Proponents argue that the success of Hong Kong, South Korea, Singapore and Taiwan was due to selective industrial policies, including trade and protection policy, capital controls and labour market restrictions. Critics argue that the impressive growth of the East Asian ‘tigers’ was, on the contrary, the result of economically orthodox strategies such as stable macroeconomic management, non-discriminatory and incentive-based export promotion measures, exchange rate stability and commitment to human capital formation.

Now, three decades later, industrial policy seems to have made a comeback. In Indonesia, where slow industrial growth is a concern, President Joko Widodo is promoting an activist industrial policy by pursuing ‘downstreaming’. He has banned exports of nickel ore to encourage domestic processing and, motivated by a significant increase in the exports of processed nickel, has extended the strategy to bauxite and other minerals as well as resource commodities such as crude palm oil and seaweed.

This strategy is a touchstone of Indonesia’s new 2025–45 National Long-Term Development Plan. In Malaysia, the New Industrial Master Plan 2030 aims to build more competitive industries and ‘advance economic complexity’, and South Korea and Japan have also tailored their industrial policy to foster their semiconductor industries to compete with China and the United States.

In the past, industrial policies were largely domestically oriented, subsidising the expansion of certain sectors over others. As countries engaged more in international trade, policies were used to affect cross-border flows of goods and services. Industrial and trade policies do not operate in isolation.

Recent industrial policies for commercial purposes take many forms, as opposed to the blunt import tariffs commonly used in the past. The most prominently used strategies at the global level are trade financing, state loans, financial grants, financial assistance to expand foreign markets, local sourcing, loan guarantees and import tariffs. In countries such as Indonesia, Vietnam, Thailand, Malaysia and China, frequently used industrial policies include capital injection and equity stakes, anti-dumping measures, tax or social insurance relief, state loans and financial grants.

There are several reasons for the resurgence of industrial policy. Economic shocks such as the Global Financial Crisis and the COVID-19 pandemic have increased the appetite for government intervention. Recent US legislation addressing inflation, semiconductor supply chains and employment is a significant driver of industrial policy. This is also the case with the EU’s Green Deal Industrial Plan and the Made in China 2025 initiative. Such an embrace of industrial policy by major economic powers has motivated other countries to follow suit.

At the same time, the global trading system has become more fragmented, and the WTO has weakened. Member countries have introduced trade measures that do not legally comply with WTO regulations.

Policymakers’ misreading of history has also repopularised industrial policy. The false belief that richer countries were successful because they protected manufacturing gave respectability to arguments favouring industrial policy. Industrial policy is also tied up in political agendas. In Indonesia, for example, industrial policy is often linked with nationalism and self-sufficiency, objectives which have roots in the country’s colonial history. In this regard, Indonesian industrial policy in the form of trade protection is easier, more expedient and politically popular.

Most industrial policies implemented in East Asia are designed to increase domestic value added. At the same time, governments want to establish vertical integration in the global value chain. These two objectives are contradictory — global value chains involve the slicing up of production processes across borders, which thins out the domestic value added in each process.

The emphasis on the share of domestic value added in exports as a policy criterion is misguided. First, production for export markets requires high-quality inputs procured in the world market to maintain competitiveness. Second, total export earnings are driven by volume rather than per unit of value added. Third, intermediate production is typically capital intensive, while final assembly is labour intensive, so shifting domestic production towards the latter would generate better jobs in countries like Indonesia. Finally, in the case of resource-rich countries, most major producers export large amounts offshore for processing as the domestic demand and processing capacity is far smaller.

There are areas in which industrial policy is justifiable. One is in response to climate change. As environmental problems involve externalities, it is likely that state interventions in this area will increase. The challenge is how to disentangle the objective of mitigating climate externalities from the protection of domestic industries from foreign competition. The semiconductor and electric vehicle battery industries are examples of this.

As in other parts of the world, it seems that the use of industrial policy in East Asia will remain a factor, if not an increasing issue. This is not necessarily a bad thing. To ensure that the policy is not simply about picking winners, but enhancing the productivity of the overall economy, it should prioritise measures with the least distortion — incentives instead of targets and export taxes instead of export bans.

Complementary policies are also needed. These include labour market, bureaucratic and regulatory reforms. Governments should focus on domestic issues and seek the most appropriate solution, not just copy others. They should also note that many countries have become advanced or are fast developing largely due to globalisation, while many past industrial policies have failed.

East Asia and countries like Indonesia and Malaysia need to find the right balance of industrial and trade policies so they do not lose out on the benefits of participating in global trade. Policymakers should not forget past failures of industrial policy, exemplified by Malaysia’s and Indonesia’s unsuccessful transition from Japanese and Korean automobile components to domestically produced parts or the government-funded Nihon Aircraft Manufacturing Corporation’s failed attempt to commercialise an economically viable domestic civilian airliner in Japan.

Arianto A Patunru is a member of the ANU Indonesia Project and a Fellow at the Arndt-Corden Department of Economics, Crawford School of Public Policy, The Australian National University.

This article appears in the most recent edition of East Asia Forum Quarterly, ‘Industrial policy 2.0’, Vol 15, No 4.

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