The Banking Executive Magazine - May 2021

Incentives VS Capabilities quality. Would policies to lower trade protections and reduce trans- port costs enhance that capacity? Or would increased competition in the domestic market impede industrial- ization and weaken the ability to ne- gotiate with foreign companies? Without a view on how such policies affect the accumulation of capabili- ties, they cannot even be properly as- sessed. Similarly, when asked why so much of employment in emerging and de- veloping countries is in micro-firms – that is, the informal sector – the ob- vious answer, as Santiago Levy of the Brookings Institution argues, is that the government, through taxes and subsidies, has made it advantageous to remain small. But can’t the prob- lem also be explained by micro- firms’ lack of access to the capabilities needed to grow, or to large firms’ lack of access to distant workers? To expand their capabilities – and thus their options – countries and firms need to learn to do the things they don’t yet know how to do. And yet, one can’t learn to do the things one does not do simply by doing them. One cannot acquire experi- ence doing things that one does not do. How can a country escape this co- nundrum? An obvious first step is to bring in people or firms that do know how to do these things. Many studies have shown that immigration, dias- poras, foreign direct investment, and even business travel are important factors in the growth of domestic ca- pabilities. Policymakers need to ask whether countries are doing things (or not doing things) that may be lim- iting (or enhancing) these potentially transformative channels. Moreover, what matters is not only the diversity of individual skills but also the local availability of suppliers or customers, especially for inputs or products that cannot be easily shipped. Again, these factors depend on the structure of the existing busi- ness ecosystem that firms take as given. And that ecosystem, in turn, is a reflection of the previous accumu- lation of capabilities, including those acquired by the government and used to provide specific public goods and regulations. Markets alone will not lead a country to adopt electric- ity, high-speed rail, safe vaccines, and mobile banking; willing and able governments must step in to guide the process. In sum, capabilities exist at different levels – from individuals and firms to value chains and whole ecosystems comprising educational, training, re- search, regulatory, and other entities. But capabilities cannot be coordi- nated only by markets, not least be- cause many capabilities exist within non-market organizations. The accumulation of capabilities must be at the center of any growth and development agenda, and gov- ernments must be willing to engage in national and regional discussions of appropriate goals and effective strategies. There are many instru- ments that might be used to develop capabilities. These include trade pro- tection for infant industries; demand guarantees (such as the contracts to purchase COVID-19 vaccines before they are proven to work); state- owned enterprises (as in the postal system and public utilities); policies that push national conglomerates to diversify; national development cor- porations (such as Singapore’s Temasek and Malaysia’s Khazanah), moonshots (as proposed by Mariana Mazzucato); and national and re- gional innovation systems. Economics’ signal contribution to the world has been to deepen our under- standing of incentives. But lacking an equivalent understanding of capabil- ities can lead us not only to see every problem as a nail, but also to nail de- veloping countries onto a cross of a false orthodoxy. the BANKING EXECUTIVE 20 ISSUE 149 MAY 2021