Industrial policy learnings from a Soviet model versus Japanese

The governments of most countries with economic heft are now pivoting towards more interventionist policy, by promoting investments in preferred sectors through some combination of domestic subsidies as well as import tariffs. Three main reasons are usually trotted out in support of more government intervention in the economy: the desire to build some element of strategic autonomy in a more geopolitically fragile world, the need to aid a rapid transition to a green economy before climate change does more damage, and sometimes the attempt to reduce dependence on a single supplier or a single source of export demand.

This is a good time for this column to undertake one of its frequent detours into economic history. There have been several different experiments in industrial policy over the decade—some successful, some disastrous. Even the success stories are told in different ways, especially in the case of the Asian miracles east of our borders. The IMF economists have likened this to Rashomon, the classic film made by Japanese film director Akira Kurosawa on the subjective nature of truth. Picking the correct lessons is important for India as well, especially since its earlier tryst with industrial policy did not work too well.

Early Indian nationalists of all hues were broadly in agreement that the state would have to play an active role in driving economic development after independence was achieved, though there were differences in the details. In 1950, the two most important models to follow were those of Japan and the Soviet Union. Two recent publications have touched upon this issue—India Is Broken, a book by Princeton University economist Ashoka Mody, and ‘A More Indian Path to Prosperity? Hindu Nationalism and Development in the Mid-Twentieth Century and Beyond’, a paper by Aditya Balasubramanian, a young historian at the Australian National University.Mody writes in his book about how India should have followed the development path chosen by Japan after the Meiji Restoration in 1868. “Japan at the time of the Meiji Restoration had crucial features that made it the best economic model for India," he says. Japan raced ahead with its focus on higher farm productivity, rapid expansion of primary education and an early focus on export markets to accelerate industrial expansion. “By the 1920s," writes Mody, “Japan had bootstrapped itself into the ranks of the world’s industrialised countries."

Balasubramanian also identifies three ways in which the Japanese development strategy was different from the one that the Soviet Union followed, a variant of which was also embraced by India as part of the Nehru-Mahalanobis planning framework. Japan build industrial capacity with private rather than public investment. The sectoral focus was on light rather than heavy industry. Rapid productivity growth on small farms owned by families released female workers for industrial work.

“Since all industrial progress in Japan has been achieved in comparatively recent years, she offers to India the most direct and valuable lessons obtainable in material advancement and reconstruction," noted M. Visvesvaraya, the dewan of Mysore state in his 1920 book Reconstructing India. Balasubramanian writes that Visvesraya mentioned the ‘Japan’ 125 times in his book.

India’s First Five-Year Plan also mentioned the Japanese experience as a way forward. Mody writes that even Jawaharlal Nehru saw the benefits of the Japanese strategy, writing in a letter to the heads of Indian provinces in 1949 that Japan had even more to teach India than the Soviet Union did at that point of time, though what his government finally chose was a Soviet-style growth model.

Among the dissenters of the Nehru-Mahalanobis strategy were the Mumbai economists C.N. Vakil and P.R. Brahmananda. They argued that India should focus its development strategy on the production of wage goods rather than heavy industry, broadly similar to what the Japanese did. In 1996, M.J. Manohar Rao of the erstwhile Bombay School of Economics formalized the wage goods model in terms of mathematical relationships.

A new book on the Mahalanobis growth model written by Chetan Ghate, Pawan Gopalakrishnan and Shrishti Grover, which deserves to be in more libraries, has a chapter on the Vakil-Brahmananda critique. The three economists quantify the possible growth paths of the two development strategies. While the wage goods model outperforms the Mahalanobis model in the short run, the growth rates converge over a longer period of 40 years. However, the three economists add that this is under the unrealistic assumption of a very high initial savings rate. With more realistic savings at the beginning, the Mahalanobis model actually outperforms the wage goods model, a surprising result.

The point of this detour into economic history is to highlight the fact that industrial policy has had mixed results over the years, and much depends on the economic logic as well as internal consistency in the way it is pursued.