Role of the Government

In general, underdevelopment is associated with insufficient knowledge about both technology and attributes [30]. Examples of technical knowledge (know-how) are software engineering, accountancy, and nutrition. Unequal distribution of know-how between countries and within countries creates knowledge gaps. Knowledge about attributes, such as the quality of a product, the diligence of a worker, or the creditworthiness of a firm, is crucial to effective markets. Incomplete knowledge of attributes, referred to as information problems, prevents markets from functioning properly. Information is the lifeblood of markets. Information problems lead to market failures and impede efficiency and growth.

Governments can close the knowledge gaps between LDCs and MDCs by: (1) acquiring knowledge through an open trading system, foreign investment, and foreign licensing; (2) absorbing knowledge through universal basic education and tertiary technical education; and (3) communicating knowledge by using communications technology as well as through increased competition, private sector provision, and appropriate regulation.

Less developed countries can reduce information problems by establishing standards and certification through government, private organizations, laws, or social norms. Without standards and certifications for quality of products, consumers will not buy and markets will fail. For instance, without good accounting and auditing standards, banks may fail and the banking system may collapse. Without certification for food, the consumers may buy spoiled food and get sick, forcing the stores that sold the goods to be closed. Without the approval of the government, some commodities, which proved to be harmful to the users or to the public, may be traded. Thus, in many cases, governments must step in to enforce standards, verify quality, stop harmful products, prevent fraudulent practices to protect consumers, monitor performance, and regulate transactions. Certification informs employers of the skills of the prospective workers and thus facilitates the hiring of workers in the labor markets. Enforcement requires laws and a good judicial system. Without commercial law, there is little incentive for foreign firms to invest in an LDC, which requires joint ownership with local investors. There must be clear law on collecting debt or assigning liability for damages. Foreign investors will not sign contracts that cannot be enforced legally. Setting up a non-profit third-party consumer protection agency may be necessary if governments do not have resources for that purpose. Governments can establish institutions and (public or private) agencies to improve transactions like: finding a job, obtaining a loan, buying food, making investment decisions, etc. Development requires an institutional transformation that improves information flow and creates incentives for effort, innovation, saving, and investment.

The problem of insufficient technical knowledge can be solved by "learning to learn" new technologies. A developing country needs to build learning capability by investing in new skills, technical information, organization methods, and external linkages. This costly learning process, which may be short or long depending on whether the technology is simple or complex, is part of the TC to be developed at the firm level and the national level.

Technological capability is defined in terms of physical investment (plants and equipments), human capital (education and training), and technological effort (e.g. facilities to promote research and development). At the firm level, relevant are capabilities on investment (identify, prepare, design, obtain technology for, construct, equip, and staff plants), production (process optimization, quality control, operation, maintenance, inventory control), and linkages (procurement of inputs and raw materials, absorbing/providing technology from/to input suppliers, subcontractors, consultants, service firms, etc.). At the national level, governments should provide appropriate macroeconomic incentives (interest rates, exchange rates, etc.), incentives to promote healthy domestic competition, and incentives to foster flexible and efficient factor markets. It is the interplay between incentive structures, capabilities, and institutions that determines industrialization success [31].

Government plays a critical role in reducing the uncertainty created by lack of rules mentioned above. Government should provide a framework of clear-cut general rules for doing business, as well as resolving conflict in a free-market setting. It should not favor any industry by special subsidies, tariffs, quotas, or other non-tariffs barriers. Nevertheless, in its early phase of economic development, an LDC may protect infant and strategic industries to be developed based on resource endowments. Coordination failure created by externalities calls for government intervention to organize private entrepreneurs into investments that they might not otherwise have made. For instance, the Korean government masterminded early import-substitution projects in cement, fertilizers, oil refining, synthetic fibers, heavy machinery, chemicals, steel, and shipbuilding. The Taiwanese government initiated and financed the establishment of such industries as plastics, textiles, fibers, steel and electronics [32]. A similar story can be found in the successful leadership and assistance by the Brazilian government in the building of the civil aircraft industry [33] and the automobile industry [34].

More importantly, government may take the lead in providing technological development. The best example is given by Korea which is the most technologically capable among the East Asian NICs. Korea followed the footstep of Japan by forming a close relationship between three sectors: industry, banking, and government. The giant local private firms, the chaebol, were given the mission of spearheading the industrialization drive, just as the Japanese counterparts, the keiretsu, once were. Korea selectively encouraged activities and firms via credit allocation and subsidization. It provided technology financing in the form of both grants and subsidized loans which were directed by the government to specific activities or firms. Just as once was the case in Japan, FDI in Korea was severely restricted and only permitted when it was the sole way of obtaining technology or gaining access to world markets. Thus it relies primarily on capital-goods imports, technology licensing, and other technology to acquire technology.

Finally, government should provide hard infrastructure such as roads, railways, seaports, airports, communications network, and schools, and soft infrastructure such as legal, political, and educational institutions that support freedom and democracy with considerable citizen participation, ensure property rights, and enhance human capital. The policy conduct should be carried out with transparency and integrity. Correct strategies and policies are essential to development success [35].

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