The state : What is it? Why does it exist ? These have been questions frequently revisited by philosophers, political scientists, and more recently economists. The questions of whether and how much the state should intervene in the economy (which is debated by economists varying from Adam Smith to Karl Marx), and in particular whether it can be useful in economic development (discussed by economists such as Friedrich List, Arthur Lewis), have been even more controversial.
The state designs and implements industrial policy with a view to push industrialization and consequently economic development. Thus, the level and quality of the state’s capacity (or capability) to pioneer, drive, or at least support industrialization are crucial in achieving successful industrialization and thus economic development in general.
On the other hand, a strong industrial layer will enable the success of the industrial policy and a healthy and comprehensive industrialization. The corollary is that if the industrial layer is weak industrial policy may be doomed. Thus, it turns out that considering industrial policy as a set of measures independent of the formation and development of a strong industrial layer may seriously jeopardize the effectiveness of policy.
The state with adequate ‘capacity’ which realizes the importance of the industrial layer can be a significant force behind the formation of the industrial layer, which consequently can ensure successful industrialization.
On these lines, this chapter discusses the dimensions of the state’s capacity to design and implement policies.
11.1 State Capacity and the Developmental State
The concept of state capacity has received attention among political scientists, who considered it a crucial characteristic of a political system.1 At a general level, state capacity can be defined as “the ability of a government to administer its territory effectively.”2 In practical terms, one aspect of state capacity refers to the power of the state in mobilizing financial resources from people in a legitimate and, if necessary, coercive way. This is referred to as the ‘extractive capacity’ of the state. The second aspect of the state capacity, however is to direct the mobilized funds towards the achievement of what “the central policymakers perceive as the national interest.”3 That is more important, as it represents effectiveness in reaching policy objectives which have a societal meaning.
Historical experience shows that more often than not, state decision makers in different countries have used the extractive capacity of the state to finance war and expansion or to achieve other political objectives that dominated objectives related to economic development. However, long-term economic development has nevertheless also been a major occupation of the state in many countries. That is referred to as the state’s ‘steering capacity,’ which is the capacity “to guide national socioeconomic development.”4
Consequently, state capacity is more appropriately defined as “the ability of policymaking authorities to pursue domestic adjustment strategies that, in cooperation with organized economic groups, update or transform the industrial economy.”5 That is very close to the concept of ‘developmental state’ as minted by economist Chalmers Johnson when explaining the rapid industrialization and economic development in Japan after the Second World War. To Johnson (1982), Japan’s ‘plan-rational’ developmental state is one for which the achievement of rapid economic development was a high priority. That was possible through an elite bureaucracy that would intentionally ‘guide the market’ by getting the ‘prices wrong’ intentionally.6 In other words, the Japanese developmental state aimed to build up dynamic comparative advantage in selected priority industrial sectors or products rather than leaving its resource allocation decisions to current market prices.
A developmental state does not necessarily mean an autocratic or a statist one. Successful developmental states (mostly in East Asia), while exerting considerable influence on the domestic financial institutions,7 were careful to establish consultation mechanisms with the private sector.8 In the process, in consultation with the private sector, the (elite) bureaucrats were responsible for policy design, while ruling politicians maintained political stability by providing the bureaucrats with a conducive political and economic environment and conveying them the needs of the social and political groupings.
Maria Mazzucato has extended the developmental state concept, stressing the pioneering role of the state in leading the firms to high-technology areas. Investment in high-technology areas is considered too risky and costly by firms, which are concerned about how to internalize the returns (i.e. how to reap more profits) if successful. Significant initial R&D investments are necessary in those areas to achieve returns but success rates are very low. Thus, an entrepreneurial state levels the ground by funding R&D, enabling the entry of the firms to the high-technology areas by lowering initial private R&D risks and costs. Mazzucato’s (2015) work revealed that every key technology (such as the internet, GPS, touch-screen display and the voice-activated Siri) underlying iPhone’s success was funded by the American government, which is generally described as an economically non-intervening state.
Mazzucato’s argument is not much different from Adam Smith’s , who underlined that where public goods are concerned, lack of state intervention would lead to undersupply. Thus, policies involving state subsidy can efficiently increase the supply of public goods (including of R&D) to the society.9
11.2 Steering Capacity
The state—whether developmental, entrepreneurial , traditional, or having whatever characteristics—designs policies and implements them by continuously taking decisions and monitoring results. When compared to the original policy objectives, the achieved results determine the level of effectiveness of the institutional capacity of the state. On the other hand, the results that are obtained relative to resources employed signify the efficiency of the process, which is also related to the same institutional capacity of the state.
It is arguable that the magnitude of the steering capacity of the state can determine or at least significantly influence the pace of economic development. In particular, the success of industrial policy in different countries in the recent or distant past has a lot to do with state success. In East Asia, Sweden, and Germany, among others, state capacity has arguably been one of the main defining factors of successful economic development.
The steering capacity of the state: policy design and implementation process
Things often do not go as planned due to many reasons: design mistakes, inadequacy of inputs deployed, insufficiency of the implementation capacity, and so on. Therefore, the quality of monitoring, which is also an important component of steering, is crucial. Monitoring may lead to corrections in the implementation or, more substantially, reforms in policies.
11.3 Market Failure Versus Government Failure
Markets fail, and so do governments. Following the collapse of the markets during the Great Depression, Keynesianism and government intervention strengthened. Higher involvement of government in the economy helped positive social outcomes emerge. However, in time, extensive intervention and government’s institutional limits started to generate negative costs for the society and slowed down overall productivity growth in the economy. Budget deficits and mounting public debt were the other significant outcomes.
So failed the government, and in the late 1970s and early 1980s, starting especially in Margaret Thatcher’s Great Britain and Ronald Reagan’s USA, a new round of liberalization wave started. For a while things went very well; in particular growth resumed. But market forces unchained by liberalization soon led to different problems in different countries; hyperinflation and high inflation continued for quite a while, income distribution and poverty outcomes worsened in many countries, and financial crises emerged. By the global financial crises in 2007, it was clear to many (again) that markets could also fail.
The failure of governments shows itself through their policies either in terms of design or in terms of implementation quality. And failures speak louder than successes. In Europe many successful government policies went without proper acknowledgement. Some historical ones were explained in the first part of this book. Some other, more contemporary ones that directly targeted sectors and products are explained as case studies in this part of the book. The successful development of East Asian countries happened by significant government intervention.
In fact, one could imagine no economy—except perhaps in Alice’s wonderland—where there is no government intervention with both short- and long-term economic objectives. Government intervention has, no doubt, societal costs. But that is also the case for fully market-based solutions. So, the question becomes how to make the most out of policies and generate positive net impact for the society. That is determined by the state’s developmental capacity.
11.4 The Educational System
The educational system is a product of the state whether or not the participation of the civil society occurs during its formation and management. And it is a key determinant of successful industrialization and economic development.
Education is a public good. Public goods are defined as goods whose consumption by one person does not deter the consumption of others. Public goods create market failures; people want to consume the public good, but they do not like to pay for it. Thus, there is a role for government to provide the market with public goods such as education; a completely free market would lead to an undersupply of education.
Educational public good is defined by not only the quantity (number of classrooms and school buildings or school attendance) but also the quality. Education and economic development are positively related. While measurement of the quality of education proved to be a critical aspect of determining the impact of education on economic development,10 there seems to be a strong relationship between not only quantity but also quality of education and economic development (measured by per capita GDP). The empirical study by DiCorrado et al. (2015) reports a positive relationship between the quality of STEM (science, technology, engineering, and mathematics) education and per capita GDP.
Industrialization is a capacity-building process. Capacity building occurs in people, and the key process of capacity building is learning. The educational system provides the key input to the industrial sector: skilled labour in the form of industrial workers, engineers, and managers. It is thus no surprise that successful industrialization (and economic development in general) experiences have always been accompanied by a good educational system. Moreover, reforms in education tend to precede economic development. Germany, Sweden, Korea, Finland, and the USA are some of the major examples of that.
German Educational System: A Good Case of How Education Supports Business and Industry
Germany is possibly the best historical example elucidating the positive role of education in industrialization. Prussian educational reform started before the country’s industrialization. It was so much so that today there is still a debate, in the USA, on the country’s current educational model (‘the factory model’), which was imported from Prussia in the nineteenth century by Horace Mann, an American Congressman and educator who studied the Prussian system and visited the country. Prussian education reforms had been a sensation in Europe. Victor Cousin (1836), for example, analysed it and authored a report in France that was later translated into English, inspiring Horace Mann and other interested American leaders.
Prussian educational reforms go back to the beginnings of the eighteenth century during the reigns of Frederick William I and his son Frederick the Great. In 1716, state-financed public education (Volksschulen) was made compulsory in Prussia. Part of the reason for the reforms was, no doubt, to strengthen the unity and power of the fledgling Prussian state and render the Prussian populace obedient to authority.11 But it was also the case that the reforms led to a populace ready to grasp industrial and technological development. In time the vocational aspects of the Prussian (and subsequently German) educational system were further developed. The system not only made possible but also strongly encouraged—and sometimes made mandatory—the practical experience of the students in the industry.
From the beginning, the Prussian elite were aware of the importance of education. Emphasizing the crucial role of education in industrialization, Friedrich List (1841: 113) set out the importance of the intellectual capital in industrialization:
Adam Smith has merely taken the word capital in that sense in which it is necessarily taken by rentiers or merchants in their book-keeping and their balance sheets … He has forgotten that he himself includes (in his definition of capital) the intellectual and bodily abilities of the producers under this term. He wrongly maintains that the revenues of the nation are dependent only on the sum of its material capital. (p. 183)
The present state of the nations is the result of the accumulation of all discoveries, inventions, improvements, perfections and exertions of all generations which have lived before us: they form the intellectual capital of the present human race, and every separate nation is productive only in the proportion in which it has known how to appropriate those attainments of former generations and to increase them by its own acquirements …
It was thanks to the advocacy of List and like-minded economists, as well as to the long-established Prussian system, that Germany developed one of the best technical education and training systems in the world. This system was not only, according to many historians, (e.g. Landes 1970; Barnett 1988; Hobsbawm 1968) one of the main factors in Germany overtaking Britain in the latter half of the nineteenth century, but to this day is the foundation for the superior skills and higher productivity of the German labour force (Prais 1981) in many industries.
The current German education system