Linking: Rodrik on industrialisation

One of the leading scholars on the topic of industrialization is Prof Dani Rodrik. Two of his recent blogposts are relevant for the readers of my blog.

The most recent post by Prof Rodrik is titled “Premature deindustrialization in the developing world“. In this article he explains that industrialization is affecting the developing world more than the industrial world. This is a brilliant read. The full NBER paper that his blog post is based on can be found here.

Another recent post by Prof Rodrik is about services, manufacturing and new growth strategies. In a presentation that he mentions in this post he argues that many developing countries are focusing too much on unproductive small enterprises that face high costs, but that these same small enterprises often absorb low skilled labour. If I say anything more I will most likely mess up his argument, so take a look for yourself!

The oblique search for new industrial opportunities

Industrial policy is typically set at national level. It is often aspirational and attempting to “stretch” an economy into new kinds of production and value addition. Programmes are designed, targets are set such as doubling manufacturing contribution of x% within 7 years. Therefore it is sometimes disconnected from the present as it seeks a new Status Quo, a different structure of production.

Yet the natural process under which new production activities are created is complex. It is not as simple as finding a market opportunity, finding the right production process, securing funding and launching a business. The economic context, the political climate, the entrepreneurs with the right levels of experience, backing and confidence are all needed. And don’t forget individuals with a desire to expand, take risks and try new things.

Danni Rodrik argues that Industrial Policy should be a search and learning process. Many centrally planned industrial policies even cite Rodrik as they then commence with outlining with great certainty what must be done, by whom, with which resources and to which effect. This logic completely ignores the importance of what exists, and what is possible from here. It ignores that fact that the past matters, and that the current structures are the result of a series of evolutionary steps. Complexity science teach us that these plans ignore the fitness landscape, a landscape that is dynamic and constantly changing. Any attempt to extend the horison further than what is within reach should be treated with great caution. One of the greatest obstacles is the attide towards risk and the optimism of enterprises. I don’t think Rodrik meant the ministers officials must do the search, rather, industry must do the search or at least be actively involved in the search in partnership with government and institutions.

But the search is not about answering a simple question. A more oblique approach is called for (see John Kay, Obliquity). Which means we should set aside targets and indicators, and focus on creating small experiments to introduce more variety and options into the system. It means that finding out that something is not possible is as valueble as figuring out that something else is indeed possible. Taking Rodrik literally, it would mean also giving much more attention to what entrepreneurs are searching for and experimenting with in the background. It requires that we recognise that the current economy is creating what is viable under the current dynamic circumstances, and that only strategies that recognise where we are and what is certainly within reach from here is in fact viable. The challenge for developing economies is that what is possible is typically limited and further constrained by strong ideological bias as to what is possible or desirable. For instance, many South African business owners are trying to shift out of price sensitive markets competing on a basis of low cost skills. Entrepreneurs are moving into knowledge and capital intensive production, with more focus on service and integration. Government is searching for a way to employ people with low skills because its own social programmes and service delivery is not a viable fall back for people with insufficient skills.

The search is not about analysis
Complexity describes a situation where the patterns of what exactly is going on is unclear or shifting. We cannot entirely figure out what is leading to what and what is reinforcing what. Due to the dynamism, we cannot really understand the situation better through analysis. Another way of explaining this, is that a situation is complex when more than one competing hypothesis can with some probability explain what is going on. The only way to make sense of complexity is to try something, actually, try many things. And then see what seems to work better. It means that we start with what we have and who we know (and can trust), and then try a range of things with the simple purpose of seeing what is possible within the current constraints of the economic system. Steps must be taken to reduce risks (for instance by ensuring that the costs of failure are small, or that the experiments try different ways of solving the same problem), but then this whole approach in itself must be recognised to be politically risky.

This is where donors and development partners come in. By assisting developing countries to conduct low key experiments in order to create variety is essential, as development partners can reduce the political risks of their counterparts. This approach will furthermore require the abondenment of targets and indicators as an attempt to measure accountability and progress. A more subjective approach that sets indicators that monitors the overall health or dynamism is needed so that the experimentors can sense when they are indeed making progress. Thus the indicators does not measure success, nor input.

Perhaps then a skunkwork approach to a more complexity sensitive industrial policy approach is needed. Let the normal industrial policy targets and rigmarole be there. Politicions and bureacrats like this sense of certainty and purpose. But allow for some experimentation on the side under the heading “industrial policy research”. Allow this team to work with private sector partners to conduct small experiments to try new business models in an incremental way. For instance, do incubation to try new ways of mineral beneficiation, but without investing in large buildings or expensive equipment. Use what is existing as far as possible, even if it means having the manufacturing done on a contract basis elsewhere in order to test if local demand for the outputs exist.

Industrial policy is different at local and national levels

Industrial policy at the national, provincial or sub-national and local levels is different. While at the national level, industrial policy is often focused on coordinating public resources around certain priority areas, local industrial policy is almost completely focused on the pressing issues of the private sector and organizing the public sector around these needs. While at the national level, selecting opportunities for investment is often difficult and focused on the future, at the local level industrial policy might get trapped into grappling with “what is” and the legacy of the past.
At all the levels policy makers will be grappling with balancing “what we have now” with “what is desirable”. All too often “what is possible or within reach with what we have” is not asked enough of public and private actors. These questions are much harder to ask and to answer at the higher levels, because the industries are further away or maybe not even entirely visible, and emerging competencies in public and private actors may still be hidden.
At the local level, business is more visible. Unfortunately, at the local level past relations and power struggles between various actors still shape the current dialogue and possibilities for future collaboration. Therefore, industrial policy implementation at a local level must have a strong process element that attempts to reconfigure stakeholder relations around areas of common potential or concern. In our practical experience we know that at the local level it is easier to mobilize the private sector around problems (such as skills shortages and inadequate infrastructure) than around opportunities. However, it requires a certain confidence and maturity of local government and local public agencies to engage with the private sector when they know that they will be dealing with complaining business people. The one thing both the local private sector and the local agencies of the public sector have in common is limited resources. Perhaps local industrial policy then should focus on making the best of the existing limited resources. The focus should be to find opportunities for collaboration that can be exploited in a process approach, not focused on large projects or a grand vision dominated by the public sector, but on a process of finding small opportunities to make better use of local competencies, local knowledge and local capacity in both the public and the private sector. I am not arguing that local industrial policy must be completely inward looking, as the relation between local firms and external markets are an important resource. However, I am arguing that local industrial policy must start with the current reality while mindful of the past and focused on what is called the adjacent possible. The adjacent possible means opportunities or solutions that are within reach by combining, recombining and maybe adding a little to what we have now.
I conclude by stating that at the local level, industrial policy is not so much about the public sector supporting structural change or achieving a vision of new industries. At a local level, industrial policy needs to be entrepreneurial in that it should focus on exploiting existing resources, knowledge and competencies to the fullest. Local industrial policy must have a process approach that does not get trapped into existing stakeholder and sectoral interests, but that strive to unlock the potential of the different knowledge bases and competencies in the locality to solve existing problems in innovative ways, while searching in an ongoing basis for opportunities for collaboration.

Building institutions that supports knowledge flows to industry

It sounds like a cliche to state that manufacturing has changed a lot in the last 30 years. Yet people often say this without thinking of how it has changed. It is not just about the size of our manufacturers, or the increased competition from Asia or elsewhere. It is also not about the sophisticated equipment and the tremendous range of products that are now available to consumers. An important aspect of manufacturing change is the dependence on knowledge from internal and external experts, or Knowledge Intensive Business Services (KIBS). These knowledge experts include engineers, product developers, process experts, industry experts or logistical experts. While in a country like Germany, there are many public, academic and private specialists to go around and assist manufacturers to tweak their processes or solve specific problems, in developing countries we have a bigger challenge. Knowledge intensive services are prone to several market failures, and therefore it is important that we consider the role, importance and challenges that these knowledge services have.

Let me just state upfront that despite my PhD research focusing on the importance of knowledge services in the manufacturing sector, I am hesitant to treat the “knowledge economy” as something separate as it is often done in the South. The increasing importance of many different kinds of knowledge throughout the economy is pervasive. Just ask a commercial farmer in Africa how they have had to change their farming practices in the last 3 decades. It is almost unthinkable that 30 years ago a person could start commercial farming without a tertiary education or at least one highly experienced supervisor. The same goes for manufacturing.

There is a big difference between generic Business Development Services (BDS) and Knowledge Intensive Services. While with BDS our problem is to get good all-rounders to provide services to enterprises where it is very hard to determine the real value of the service offering, in Knowledge Intensive Services the service is very specific to a certain (technical) problem, it is deep knowledge and the value (and cost) is usually very clear. Firms that know what they are doing need knowledge intensive service providers to fill in the gaps where deep knowledge is needed, a BDS provider is typically out of their depth with a manufacturing enterprise that are trying to be competitive.

  • The first challenge we have with intensive or specific knowledge is scale. When just a few manufacturers use more advanced equipment in a country there is a good chance that few service providers, experts or technicians will be available. In market failure terms, this is called an indivisibility (you cant divide the cost of the expert easily between different enterprises, or just take a small piece of the expert). It could also be about scale (not enough business to justify the emergence of a specialized service provider). It is often difficult for manufacturers to coordinate their use of expert service providers, or to coordinate the procurement of similar equipment that makes the development of a pool of service providers possible. This is called a coordination failure and it is pervasive in our developing economies.
  • A second challenge is that many manufacturers are hesitant to search outside their firm. This is often due to costs (which includes the time spent to find the right expert), but also because for so long manufacturers had everything they needed in-house. In South Africa, many of our older firms are hesitant to use “consultants” because they don’t trust them. This could be described as a market failure around asymmetrical information or adverse selection.

One way to increase the availability of knowledge intensive service provision in a developing country is through the connection between academic institutions, public funded industry support programmes and industries themselves. This requires that technical or knowledge experts are able to be released from certain teaching or research duties to work with firms. This is often very difficult due to the high student load in many of our African universities. I am often astounded by the world class research capacity and expertise that are hidden inside universities that are desperately needed in industry. This failure has many names, but in market failure terms it is called a public goods failure, in other words, public funds are not used to overcome persistent market failures in industry.

A second and parallel strategy should be to make sure that the Meso level organizations (which include universities and higher education institutions) are concentrating on overcoming the market failures in industries and in firms. In developing countries these Meso organizations, meant to address specific performance issues at firm or industry level, are more focused on securing and spending national (or international) funding than to become valuable and responsive to the needs of industry. To get the Meso organizations focused on the plight of firms requires an industrial and modernization policy that is focused on building the right economic and industry supporting institutions – this cannot be done just by merely implementing projects or programmes – it must be systemic. With right I mean relevant and equipped with high level experts that understand and can relate to the issues in industry.

This phenomena of the disconnect between public knowledge services and the need of industry is more widespread than you would think in our developing countries. It is a public good failure that undermines the well being of our economies. I believe this is also an ideological failure, because governments tries to use their funds to provide incentives or prioritize certain kinds of behavior both in the public sector and in the private sector. Instead of responding to what is emerging or what is needed in the private sector, the public sector tries to prioritize what it believes to be ideal. The result is that the firms that are most able to create jobs and wealth are left without public support.

In Mesopartner we will be working on consolidating our experience in bottom up industrial policy. We will work closely with research organizations and development partners around the world to strengthen and develop a body of knowledge on how some of these issues can be addressed in the developing world. We do this by developing a theme where instruments, concepts, theories and practice can be integrated. If you are interested in participating in this process, or have experience to share, please give us a shout.

I have previously written about this some years ago in the post about the service sector  and about the increased importance of knowledge intensity here.

Moving from generic to specific and then onto systemic

When working with development organizations in the mesolevel we often find that their programmes are very generic. The same can be said of the findings of many diagnosis. The result is that firms do not really use the services of these organizations, because the value add and the impact of the services are not really clear.

For me there should always be a movement from the generic (e.g. the foundry sector is not competitive) towards the specific (e.g. the foundry industry is not competitive because it lacks capacity to do good front end engineering and design). After we have developed a sense of some specific issues that are affecting the performance of firms, there are two things we have to do.

Firstly, we want to try and figure out if there is something that we can do at a more systemic level to try and influence the specific issues. With systemic I mean that instead of addressing a particular issue repeatedly at various firms, see if there are other ways to achieve the same outcome. An example would be instead of only offering a design service to firms, make sure that the university curricula includes sufficient content dealing with design. Of course, we should always strive to have multiple interventions to address a particular issue.

Secondly, we should verify whether our specific findings are unique to the firms we have diagnosed or engaged with. For instance, and food initiative run by a university might find that the private sector is affected by a lack of a particular kind of testing lab. Then instead of designing a solution just for a limited number of producers, the university should check whether similar firms in other industries (related and not even related) are facing the same constraints. It may just be possible to design a solution that is useful to a much broader target group, making the solution more sustainable and more relevant to the private sector.

From my experience of working within many different value chains is that there are many issues that are treated as being unique (or specific) to a particular value chain that are in fact affecting many different kinds of enterprises. The South African Industrial Policy framework for instance is designed around many different sub-sectors, with many different interventions implemented by different organizations and programmes that are actually not unique to a particular sub-sector. This is expensive and also not really systemic, these interventions are not permanently changing the meso level in South Africa or the service offerings of meso organizations such as universities and other development programmes. The South African manufacturing sector is struggling with low volume, outdated designs and rapidly increasing costs across the board. I imagine that it should be possible to based on the insights from the different sub sectors to design much better programmes that are cross cutting over many different sub sectors, and that from the start are designed to improve the service offerings from meso organizations to firms.

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