Finding the Recipe for Successful Productive Development Policies

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Latin America boasts a wealth of creativity and resources. Since the turn of the century, its creative industries—from Argentina to Colombia to Mexico—have been flourishing. However, the region has been getting bad grades in productivity, a key ingredient for development. Its levels of research and development are low. Compared to rich countries, its productivity has been falling for decades and is now stagnant. Moreover, other developing regions, such as East Asia, have caught up with developed economies and surpassed Latin America in per capita income.

A big part of the reason why the region’s productivity has fallen behind is its productive development policies (PDPs, or industrial policies), explored in-depth in the IDB’s 2014 flagship publication, “Rethinking Productive Development.” Although Latin America has accumulated plenty of productive factors—both in physical and human capital—its economies have been unable to transform themselves and leap forward by adopting and adapting new developments from advanced economies.

It hasn’t been for want of trying. But Latin America’s history of PDPs has yielded mixed results. In a previous blog, a comparative example illustrated how different policies within a particular sector —rice—can lead to very different outcomes. Therefore, analyzing the quality of policies from the point of view of productivity is key to finding the recipe for designing the kind of PDPs that the region needs to catch up with advanced economies.

The following are some crucial principles that governments should follow to design, implement, and evaluate PDPs, in order to avoid mistakes from the past and achieve success. An IDB paper also discusses the organizational structure and the technical, operational, and political capabilities required for making it possible.

  • PDPs must pass three key tests regarding their justification, design, and implementation:
  1. What’s the market failure that justifies the PDP? While some public policies supplement and improve the market’s performance, others just serve as shortcuts to reach certain aspirational goals that ignore or supplant what the market does well. Policymakers in market economies do not need to plan from scratch, proceeding by trial and error, but may zero in on the instances in which the market fails to perform correctly. They must ask themselves a simple question: Why isn’t the market taking advantage of opportunities that seem desirable to policymakers?

A classic market failure is related to the externalities of private actors’ decisions: costs or benefits that are passed on to other actors. Externalities imply that private and social gains are different, e.g. innovative activities that generate knowledge but can’t obtain a patent to prevent others from copying.

Another classic market failure is the collective action problem: The inability of private actors to agree on solutions that are beneficial for everyone. Such is the case of underinvestment in collective inputs of production whose use cannot be restricted to individual agents, e.g. environmental degradation because each individual producer has the incentive to exploit common resources before others do. It’s also the case of projects that require coordinated investment in different sectors, e.g. investment in hotels and transport to develop a new tourist destination.

  1. Is the policy designed in line with the market failure, be it to fix it or reduce its impact? An adequate policy must be the right solution for the problem that has been identified, so that the market performs better after its implementation. Blunt instruments or focused instruments that are not precisely calibrated may have serious adverse side effects and become medicines worse than the disease.

Depending on the market failure that’s being addressed, policymakers can choose different types of instruments, namely policies to alter market incentives or policies to provide public productive inputs to the marketplace. Incentives can be subsidies or tax exemptions, among others. They are well suited for externalities but, since they directly benefit the business bottom line, they provide incentives for capture by private interests and need to be applied with care. Public inputs can include providing public services (e.g. certifications, specialized infrastructure) or helping private actors to coordinate. Useful public inputs are often relatively easy to spot, but they also need to be cost-effective. In an ideal case, successful coordination among private actors to fund a public input reveals that the emerging collective benefit exceeds the cost of providing the public input and validates the policy. An example is the policy implemented in the rice sector in Argentina in the late 1990s, as described in the aforementioned blog.

  1. Are institutional capabilities strong enough to implement the policy as it was conceived? Even if the first two tests are passed, implementation can derail a policy. There are usually two main challenges: problems of cooperation between public agencies, and difficulties in collaboration with the private sector. These can limit the policies that are feasible in a country: Policies that work in countries with strong implementation capabilities can be ineffective or even damaging in countries that lack those capabilities. Prudent countries recognize their weaknesses in public-private interaction and refrain from engaging in risky policies that may be captured by the private sector. Frequently, the main problem of existing PDPs lies in public-public cooperation, and this is therefore a crucial aspect of the exam a policy must pass.
  • Institutions for productive development are key for generating successful PDPs.

One key reason why institutions are decisive in this policy realm is that productive development policies must be discovered through a learning process led by institutions. Therefore, testing the institutions that generate the PDPs goes hand in hand with the tests policies must undergo.

  1. Search engines for policy discovery. In most cases, problems must be discovered as part of the process of generating policies. Even if the market failure is well known, finding the right PDP to address it can be difficult. The process should be configured as a search engine, exploring to identify the most important problems, the right solutions, and the best ways of implementing them. A key ingredient of discovering policies is public-private collaboration, since the government only has access to part of the information necessary to identify needs. A previous blog explores the mostly positive impact that creating public-private partnerships had on productivity in Colombia, explained in detail in an IDB paper.
  1. Learning, evaluation, and adaptation. The process of formulating and implementing policies should foster an institutional culture that encourages experimentation, calculated risk, and pilot programs, as well as evaluating policies to perfect them. A credible evaluation system that consistently discards failed policies also improves incentives for fruitful public-private collaboration because any gain from rent seeking would be short lived.

Taking these key steps to vet PDPs in a collaborative learning process can help governments in Latin America leave behind their erratic paths on industrial policy. A mix of technical rigor and institutional flexibility is the much needed recipe for successful PDPs that help increase productivity and reduce the gap with advanced economies.

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The Author

Eduardo Fernández-Arias

Eduardo Fernández-Arias

Eduardo Fernández-Arias is Senior Advisor of the Research Department and Coordinator of the Network of South America Central Banks Financial Stability and Development. Formerly, he was Regional Economic Advisor for the Southern Cone Department and, before joining IDB, researcher in the International Economics Department of the World Bank. Dr. Fernández-Arias, an Uruguayan national, received a Ph.D. in Economics, as well as an M.A. in Statistics, from the University of California at Berkeley. His main interests include financial integration and capital flows, financial crises, and productivity and economic development. He has written and published extensively in journals including the Journal of International Economics and Journal of Development Economics. Dr. Fernández-Arias has directed numerous multi-country policy research projects, edited several books, the most recent one the IDB flagship report Development in the Americas (DIA) 2014: Rethinking Productive Development, and is currently Associate Editor of Economía (LACEA).
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