Should the government be picking strategic industrial winners?
Last week, the government made a decision to abolish the previous governmentrsquo;s policy goal of manufacturing 2 million cars. It also called off the support for the auto industry as strategic sector or lsquo;global nichersquo; due to the absence of comparative advantage, high dependency on foreign investment, technology, and high protectionism. The auto industry, therefore, is the second industry after textile and clothing which the government discontinued support to be Thailandrsquo;s strategic industry. (It should be noted that the government has just ended the Bangkok Fashion City project).
Such measures reflect the previous governmentrsquo;s failure in making industrial development policy. This is conformed with the outcomes of my research on Thailandrsquo;s industrial competitiveness submitted to the National Defense College in 2005 clearly indicated that both industries should not have been supported as lsquo;global nichersquo; strategic industrial sectors in the first place.
Such a failure made me ponder that, in order to make the domestic manufacturing sector competitive and self-reliant in technology, the government should intervene market mechanism to determine which industry needs support and which one does not.
This question has been a major topic of controversial debate, with the Chicago School economists believing in market mechanisms and disagreeing with the use of government intervention while the Harvard School sees some merit in government intervention.
As I had the chance to conduct some research work at Harvard University and exchange intellectual opinions with Harvard academics, I know that Harvard School economists believe that pure market mechanisms are likely to result in market failure, which in turn makes government intervention necessary.
Market failure is caused by the fact that firms usually face high risk if they want to turn out new products because they will only understand production function after they have invested their capitals in producing those products. The problem is, however, that once the investment has been made other firms will learn the production function without having to face the same risk as the original firms. The result is that those pioneer firms have to bear the high costs of risk while other firms can make huge profits from making imitation goods. As such, new investment to manufacture new products seldom emerges.
Due to the above phenomenon, governments need to intervene by making policy that increases the pay-off for the first investors in order to encourage investment in new businesses.
In this context, industrial support policies can be divided into two types; namely, compensation to innovators in case of business collapse, and increase of pay-off in case of business success.
The advantage of compensation policy for innovators, like government guarantee or government loans, is that it allows for the distinction between innovators and copycats. However, its disadvantage is that it may cause moral hazard since firms will not have to worry too much about their success or failure.
On the other hand, the strength of policy that increases pay-off in case of business success, like export subsidies, is that it does not generate moral hazard. However, it does not allow for a clear distinction between innovators and copycats (because tariffs or subsidies apply across-the-board to all domestic manufacturers.)
Nevertheless, government intervention will not be beneficial in the long run, as it does not encourage the subsidized industries to improve their productivity. Therefore, the government should gradually pull out these supportive measures in the long term to enable industries to remain competitive in normal circumstances where market mechanisms operate freely.
Given the above scenario, the Harvard School thinking should be useful for Thailandrsquo;s industrial policy-making. This is because it suggests the conclusion that the previous governmentrsquo;s market intervention policy may be a right direction, but the mistake lies in the wrong choice of industrial winners based primarily on the opinions of certain leaders rather than on academic research outcomes.
Therefore, my view is that we should not shy away from picking the lsquo;Global Nichersquo; industries altogether. However, the government should be able to invest in research and development to identify these winners without conflicts of interest. In so doing, the government can pinpoint a clear direction to give the private sector more confidence in making their investment decisions. Such a clarity of policy direction would also benefit the overall national economy in the long run.
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2007-01-26