Part 3 of the Report will draw on lessons from case studies of countries that have designed and implemented
specific policies to accelerate growth. The team has commissioned work on European Integration (Bulgaria,
Estonia, Poland), the experience of Korea, and lessons from Spain. Other cases focusing on specific aspects
of creative destruction will also be integrated. This part of the Report will also discuss how middle-income
countries can use insights from Schumpeterian growth theory to initiate and sustain economic growth,
which include the following:
- Policies that promote growth in technologically advanced countries/sectors do not necessarily
promote growth in less advanced countries/sectors (Aghion and Howitt 2006). There is a powerful
reason for this: innovation and implementation are affected differently by the same policies. For
example, tighter competition policy in a relatively less advanced country might slow down
technology development by local firms discouraged by the threat of foreign entry, whereas in more
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advanced countries, firms will be spurred to increase R&D investments when threatened by
competition. - A country’s growth strategy and economic institutions have to be as dynamic as its firms and
entrepreneurs. Scholars such as Gerschenkron (1962) and Phelps (1966) highlight that not every
country needs to innovate at all times. Developing countries can turn what Gerschenkron (1962)
terms their “economic backwardness” into an advantage if they can unleash the incentives to imitate
the rest of the world. For instance, Acemoglu, Aghion, and Zilibotti (2006) highlight that
innovation requires high-skilled entrepreneurs, whereas imitation can be achieved by less-skilled
entrepreneurs. The form of technological progress may depend on a country’s distance to the global
technological frontier and its human capital composition. While the former can directly affect the
return to imitation (and thus the opportunity cost of innovation), the latter can directly affect the
cost of innovation because it will require more effort for a poorly educated workforce to innovate.
The key is to develop requisite institutions that affect timely transitions from imitation to
innovation, so that countries are not trapped with structures that no longer have any use. - Contestability and policy coordination are the bedrock of a dynamic economy. Technological
progress (be it in the form of diffusion or discovery) involves better technologies replacing obsolete
ones and younger entrepreneurs and new skills replacing unproductive incumbents. In other words,
churn (turnover among technologies, firms, and workers) is a reality in every aspect of
technological progress. The process of economic growth cannot be understood without considering
the dynamic implications and political economy of contestability (the possibility of incumbents
getting challenged by newcomers). Growth strategies also need to recognize the importance of
combining and amplifying policies that enhance growth (policy coordination). Economic policies
that reward firms for their innovative efforts should be combined with the right education policies
and policies that encourage high-skilled immigration, which in turn can provide those firms with
the much-needed technical staff to undertake the relevant adoption and R&D. A country that
undergoes these different stages of growth will need to recognize the importance of policy
coordination along its path to the global technological frontier.
Specifically, the Report will examine the driving forces of creative destruction—Competition,
Contestability, and policy Coordination—and calibrate policy prioritiesto suggest ways that middle-income
countries can match the dynamics of their firms, entrepreneurs, and capabilities. This section will address
three current policy imperatives: (1) keeping markets competitive; (2) making elite echelons contestable;
and (3) engineering a steady energy transition.
Keeping markets competitive
Big firms, both private and state-owned, have a central role in investment and innovation. But by exercising
varying types of state capture, they put stresses on competition regimes. Global trade, which has been
growing since the 1950s, has helped regulators keep domestic markets competitive, but rules-based trade
has been under threat since the 2000s. This raises the question: Can middle-income countries regulate
private enterprise and grow as quickly as in the past without the spur of productivity-promoting competition
regimes in global markets? The answer is No, because competition from domestic policies and global
trade/foreign direct investment (FDI) are complements, not substitutes.
Competition and innovation-led growth drive productivity gains that support broad-based economic
growth. The expectation of profit motivates the decisions of investors and the behavior of entrepreneurs.
Policies, regulations, and the institutions that enforce them in an economy shape these decisions and
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behaviors in favor for, or against, development. The Schumpeterian growth framework highlights three
salient points: - Competition policies are crucial for strengthening churn (entry, exit, and turnover) among firms.
A massive volume of small firms may suggest insufficient competition rather than a lack of
financing. In India, for instance, a glut of small firms is not merely a reflection of frictions that
those small firms face, but rather an indication of a lack of competition stemming from larger firms
(Akcigit, Alp, and Peters 2021). Pro-competitive policies can make the more innovative firms
expand and push out unproductive firms. Outward orientation in global value chains can expand
the size of the market for producers, creating space for innovators. The elimination of nontariff
barriers to trade and openness to foreign investors creates contestability from outside producers and
investors. - Response to competition varies by type of firms. Firms close to the technological frontier are likely
to escape competition by innovating (the creative side of the Schumpeterian process); firms far
from the technological frontier will lose markups and are likely to be cleansed from the market (the
destruction side of the Schumpeterian process). In Chile, for instance, firms in the 85th to 95th
percentile bracket of the TFP (revenue) distribution experienced a boost in productivity of 31
percent compared to other firms in the relevant market, following intervention by the competition
agency. By contrast, firms below the 55th percentile suffered declines in productivity, markups,
product quality, and innovation (Sampi, Urrutia, and Vostroknutova 2022). In Mexico, there is
evidence of “destruction” in the lower part of the productivity distribution following competition
with imports from China, after its entry into the World Trade Organization (WTO) (Iacovone et al.
2013).