Monday, February 28, 2005

Competitive pressure makes great exporters

What's the best way to get your exports going? Recently I've heard a lot of support for government intervention to protect industries, infant or otherwise. The Asian tigers, in particular South Korea, practiced a lot of interventionism, and still do, and have a lot to show for it. On the other hand, there are plenty of examples of situations where state intervention led only to lazy industries and fat industrialists. India is perhaps the poster boy for interventionism gone wrong. The answer is probably that protection is only effective in the presence of some necessary conditions that both India and Latin America are lacking.

Many of my Latin American friends argue that free trade is not a good idea because Latin American industries are not competitive enough. I couldn't disagree more. In order to make Latin American industries competitive, competition is what the doctor ordered. After all, Latin America enjoyed protection for almost half a century following the great depression and WWII, and protection didn't quite result in world-class manufacturers. I don't see how a return to those policies would work now.

This IMF paper shows some compelling evidence that as the state got out of the way, Indian exporters actually got more competitive. This in turn helped to bring about the exporting miracle that India is now witnessing.
India's exports nearly tripled in the 1990s. Decomposing export growth shows that it has been driven by incumbent firms rather than the entry of new firms. By using a new panel on Indian firms and estimating a dynamic discrete-choice model of the firm's decision to export, we find evidence that economic liberalization has led to greater domestic competition, spurring firm efficiency and increasing Indian firms' competitiveness and ability to export. We show that export growth has been an outcome of local firm innovation which has come about due to increased competitive pressure from FDI entry.

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