Does Thailand need an industrial policy?

8 March 1997

At a recent conference, the president of the Japanese Chamber identified four things Thailand needed to stay competitive: better infrastructure, upgraded labour skills, more efficient investment, and an industrial policy. The first three items are uncontroversial. The senior Thai technocrats and businessmen in the audience nodded in agreement. The fourth provoked confusion. Some Thai delegates argued Thailand had done well in the past precisely because it had no industrial policy. Malaysia and Indonesia, for example, were trying to produce their "own" cars. But it was Thailand, which ditched its automotive policy five years ago, which now attracted big investments.

Behind this little exchange lies a huge international controversy over economic development. The seemingly innocent phrase "industrial policy" is at the heart of this controversy. What does it mean? Basically, a government policy to identify industries with good prospects, then help specific firms to grow fast and become competitive internationally. Whether or not Thailand should have such a policy is a key question in finding the way ahead.

First, let us look at the controversy. In the 1980s, Asian economies grew much faster than the rest of the world. The World Bank initiated a study to find out why, and the Japanese government funded it. Published in 1993 under the catchy title "The East Asian Miracle", the study concluded that Asian economies grew so well because their governments did not interfere too much. Barriers between the national economy and the outside world were torn down. Markets were allowed to work freely and thus efficiently. Government limited its activity to infrastructure, education and macroeconomic stability. Other countries could follow suit by liberalising, deregulating, privatizing.

There was a howl of protest. Other economists pointed out that the World Bank had been advocating free-market policies for years. Now it was patting itself on the back and claiming these policies accounted for the "Miracle". But it was nonsense to claim governments in Japan, Korea and Taiwan left their economies alone. In fact they intervened heavily. Sure, replied the World Bank, but such interventions were effective only when they helped markets to work as they should. Other interventions, particularly the elaborate industrial policies of Japan’s MITI or Korea’s EPB, were a waste of time. Either they did not work. Or they achieved the same thing that the free market would have achieved anyway, only at greater cost. Other countries had tried the same policies with disastrous results.

The Miracle report made the Japanese furious. They had paid for the study in the hope of getting policy packages which could be applied to countries whose growth would synergize with Japan. Instead, the Bank report suggested such packages were pointless. And it pooh-poohed the industrial policies which many Japanese proudly believed had been the key to their own extraordinary growth.

In reaction, the Japanese now sponsored economists critical of the World Bank. A group working in the UN Conference on Trade and Development (UNCTAD) came up with a very different interpretation of Asian growth and its lessons.

The UNCTAD group argues it is foolish for a developing country to open itself up completely to the world. It will just get raped. Its own businesses will get crowded out. Liberalising trade and finance too fast will cause instability. The World Bank Miracle Study ignored the most basic thing in economic development theory: the balance-of-payments constraint. Developing countries need to import lots of things - fuel, machinery, inputs, consumer goods, often food. If they don’t manage this well, they soon run out of funds, get into debt, and stop growing. The best way to avoid this is to keep exports growing fast. But development tends to push up wages and other costs. Industries which are export-competitive today will not be tomorrow. So countries have to plan ahead, to nurture the industries which will be competitive tomorrow. That may mean temporarily shielding firms from competition; reducing their costs through tax cuts and cheap loans; helping them with training and technology; and incentivizing them to reinvest, upgrade, grow and export. According to the UNCTAD group, it was industrial policies like these, not the World Bank’s faith in free markets, which made Japan, Korea and Taiwan grow so fast.

How does this matter to us? In many ways, Thailand finds itself in the World Bank camp in this controversy. The Bank helped formulate several policy changes which preceded the mid-80s boom. Financial and trade liberalization have followed Bank guidelines. The Bank likes to cite Thailand’s past decade of growth as proof that its theories work. The Bank has helped to mould the thinking of many Thai technocrats - including those who leapt up to reject the Japanese suggestion about industrial policy at the recent seminar.

But there is an alternative view. Market liberalisation and integration with the world may not have contributed much to Thailand’s recent growth. Indeed, they may have created some of today’s big problems. Financial deregulation brought in a flood of foreign money which has destabilised the economy. Left to their own devices, financial markets tend to put money into all the wrong places, like property and a bloated finance industry. Reliance on foreign investment has helped create the current account deficit, because foreign firms are big importers of machinery and inputs. Financial deregulation has contributed to macroeconomic instability by undermining monetary policy.

More importantly, which way should we turn to sustain Thailand’s growth? More doses of World Bank style liberalization? Or an UNCTAD style industrial policy?

Firms in late-comer developing countries face high costs and high risks in getting going in the face of established international businesses. In the first phase of industrial growth after 1985, the inflow of Japanese investment and the gung-ho flair of Thai entrepreneurs overcame these barriers. But as we move up the technological ladder, the costs and risks get higher. Many Thai firms which plunged into export manufacture have already been competed out. Many moved across into finance or property because these areas looked easier and more profitable, with eventually disastrous results. Thailand has generated a lot of investment capital, but wasted too much of it.

The first part of an industrial policy is laying down a strategy for the future. This is not much different from the forward planning by an individual firm. It means looking at how world markets are expected to develop, and identifying opportunities suitable for Thailand to grasp. Both the NESDB and Industry Ministry have industrial plans, but they are sketchy. On appointment as Minister of Industry, Korn Dabaransi announced he would concentrate on salvaging declining industries such as textiles and foods. This is not surprising. Korn is heir of a business group which made its fortune in these sectors. It is not altogether bad. Thailand ought to retain its share in these industries. But it is not enough. The Asian economies which sustained growth beyond a single spurt looked carefully into the future and identified the industries which would lead the next phase of growth.

The second part is building an integrated range of policies which make these future-potential industries grow rapidly. In the East Asian Tigers, these policies had five parts. First, providing some protection from outside competition while these industries are acquiring the size and learning needed to compete. Second, providing cheap sources of capital, as that is the simplest and most elegant way to reduce a firm’s costs. Third, controlling entry into the sector so there is enough competition to provide incentive, but not too much to drain away profit. Fourth, building linkages to other sectors to create competitiveness over the long term. Fifth, providing subsidies and incentives to develop technology and human resources.

In Thailand now, we cannot simply copy these policies. The world has changed, and Thailand is different from the Tigers. But we can follow the same underlying principles - of looking ahead, helping firms to become competitive faster, and force-feeding growth. Thailand has developed a very open economy with a high dependence on foreign investment. So protection is not on the cards. Rather we need an industrial policy which can accelerate industrial growth with both foreign and local participation, and which can maximise the benefits to the national economy.

The automobile industry is a good example. Over the next few years, the industry is set to expand rapidly as international firms establish plants in Thailand. But suppose these firms import most of their inputs and parts. Exports may go up, but so will imports, and we will still have the problem with the current account deficit. All the profits from making the parts will be made elsewhere. The major reason for the corporations to base their plants in Thailand will be the local market opportunities and low labour costs. When these costs rise, the firms will go elsewhere.

But if we can force-feed the growth of firms which produce the parts, inputs and services the auto-makers need, there will be a much larger benefit: more wages and profits made locally; more trade gains; and more reason for the auto-makers to stay here longer.

To implement such a policy is not that difficult. Simply take the same packages we have been offering (quite successfully) to exporters, and offer them to firms supplying the auto-makers. As these coming industries are rather more sophisticated, add in more help with infrastructure, more assistance in sourcing technology, and more provision for training.

Today industrialisation moves very fast. Thailand quite suddenly became very competitive in textiles and garments. Then just as suddenly it lost its advantages. Our current slump is partly a result of this kind of cycle. In the Tiger economies, governments worked with business to identify sectors with high prospects, and to tailor packages to accelerate their growth. The important element here was anticipation - looking ahead to develop the industries of the future, to lessen the risk of slumps, and to ensure the economy keeps growing.

In a hole-and-corner way, we do have industrial policy already. We are setting up institutes for the food and textile industries. Government has just approved a soft loan to help textile firms to upgrade. Telecom firms are so close to government it is difficult to know who is a technocrat and who is an executive. Government provides a lot of direct help to firms, but in bits and pieces, often guided by cronyism rather than economic rationale. Too many interventions are designed to bail out the failures of the past, rather than force-feed the successes of the future. There is no overall vision, no planning. We ought to be doing this better.