Kazakhstan's industrial policy: between pipedream and pipelines?

By: Ralph De Haas Senior Economist

Can something good come out of the crisis? Perhaps. Kazakhstan – battered by a sudden stop in bank funding and a lower oil price – recently announced updated industrialisation plans that seem more realistic than earlier versions. The stated goal is still to advance economic diversification and reduce the country’s dependence on oil. But with less oil money floating around, the government seems to have put its feet back on the ground.

Before the crisis, government officials liked to muse about developing break-through projects in high-tech sectors such as biochemistry and space technology. About 30 to 50 ‘corporate leaders’ were the be hand-picked by the government, receive preferential treatment, and develop into competitive players in the regional and even global economy. So far this program has been disappointing, perhaps because the coveted industries are too far removed from Kazakhstan’s current technological frontier.

The ‘corporate leaders’ concept was no longer mentioned in a recent speech by President Nazarbayev. Instead, he focused on developing sectors that are closer to Kazakhstan’s current or potential comparative advantage given the country’s existing capabilities and resource endowments:

(1) Agriculture and agri-processing. Kazakhstan’s vast land mass gives it a comparative advantage in agriculture, but substantial investments are needed to improve the productivity of primary agriculture and agri-processing. Better infrastructure (such as sufficient railway capacity to export grain) is needed as well.

(2) Construction industry and building materials. Although the construction sector and the manufacturing of building materials is currently hit hard by the bust in the real estate market, there is still a need to increase the quantity and quality of commercial and residential real estate.

(3) Oil refining and the infrastructure of oil and gas industry. The three oil refining and processing facilities in the country are in desperate need of upgrading. Kazakhstan also needs to increase and diversify its oil export capacity to allow for increasing oil production during the next years.

(4) Metallurgy and manufacturing of finished metal products. Sensible given the large-scale mining industry (copper, iron ore).

(5) Development of the chemical, pharmaceutical and defence industries. The development of a (petro-)chemical cluster makes sense given the abundant hydrocarbon and mineral wealth. The development of a viable pharmaceutical industry is less likely. Eventual WTO accession will be problematic for this sector.

(6) Energy sector, including the development of clean power. Reducing the economy’s energy intensity by 10 per cent by 2015. Important given the capacity constraints in the power sector and low energy-efficiency of the industrial and manufacturing sectors.

In addition, the government announced reforms in infrastructure and the financial system, two sectors that are key for the emergence of new industries and a better utilisation of domestic and foreign saving than in the past. The further development of transport infrastructure (including the Western Europe – Western China highway corridor) is crucial to unlock export potential (and related economies of scale in production) in light of Kazakhstan’s limited domestic market. The need to create a ‘new national financial architecture’ is obvious as well, now that Kazakh banks no longer have access to virtually unlimited amounts of foreign funding. Banks will need to develop a deeper and stable deposit base and reduce their dependence on foreign wholesale funding. This will also allow them to bring down their FX lending.

So how actively should the Kazakh government promote the growth of these industries? There can be good reasons to use industrial policy to further economic diversification. Kazakhstan will substantially expand its oil production between now and 2015 and this means that the underlying tendency for the economy is to become more, not less, dependent on the hydrocarbon sector. A sensible form of industrial policy may assuage this underlying trend and partially prevent its harmful impact on other economic sectors.

The economics profession also increasingly recognises that industrial policy may help to overcome market failures in emerging markets, such as when various projects require simultaneous large-scale investments in order to become profitable (see also Chapter 5 of EBRD’s Transition Report 2008 for an overview of industrial policy in a range of transition countries). However, recipes on how to practically implement industrial policy remain scarce. For instance, while a recent book by Dani Rodrik – professor of international political economy at Harvard University – argues why carefully crafted and country-specific industrial policies may be necessary to kick-start economic growth, it is less convincing in the practical recipes that it prescribes. Rodrik argues that governments in emerging markets should not simply hand-pick companies that will get government support. Instead, there should be a continuous process of national economic ’self-discovery’ in which the government in consultation with the private sector discovers the productive potential of the country.

While Rodrik acknowledges that ‘embedding industrial policy within a network of linkages with private groups’ may facilitate corruption and rent-seeking, it remains difficult to see how this interactive process of economic self-discovery will not be captured by vested interests and political elites that dominate many transition and emerging countries. However, even when taking these caveats into account, there are still a number of general ‘do’s and don’ts’ of successful industrial policy that can be distilled from the current state of the economic literature:

Governments have a bad track record in ‘picking winners’. Attempts to hand-pick successful companies have only been successful when countries ensured that companies were at some point exposed to competition. One way of doing this is through supporting exporters, since these will have to compete internationally.

Even better is to do a ‘market test’ before the government supports a project or sector, for instance by consulting the private sector (see above). The government should only support companies in which foreign or domestic private companies are willing to invest subject to the removal of certain obstacles (or the provision of certain incentives). Likewise, the government could mainly support companies that are ‘vetted’ by IFIs such as EBRD.

The success of industrial policy depends not so much on ‘winner picking’ but on ‘loser sticking’: state support should stop as soon as the government discovers that a firm performs poorly. This will be very difficult in case of vested interests. A solution may be to introduce ’sunset clauses’ that ensure that state-support is limited in time and that support is phased out automatically when projects fail.

Industrial policy should mainly be ‘horizontal’ in nature: making sure competition is encouraged across the board, for instance by improving infrastructure that is available to all firms. Improving education, in particular to alleviate shortages of managerial skills and entrepreneurship, is another effective ‘horizontal’ policy to stimulate sustainable development

 

Industrial policy cannot substitute for long-term deficiencies in state governance, such as red tape, corruption, and a weak rule of law. Industrial policy may even increase the scope for corruption. Sustainable long-term growth is only possible when it is embedded in a ‘deeper institutional transformation’ and democratisation. Here lies the real longer-term challenge for many transition countries and emerging markets.

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