Free Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram G. Rajan Page A

is to push them to prove their mettle by exporting. Managed capitalism has proved enormously successful in its immediate objective of getting countries out of poverty. It is not, however, an easy strategy to implement.

Missing the Turn
     
    Managed capitalism initially requires a producer bias that is not easy to sustain in populist democracies. Then the government, despite coddling firms in their early years, has to turn and push them toward exports. For small nations like Taiwan, limited domestic markets made the second step virtually a necessity. But for countries with large domestic markets like Brazil, that second transformation was long delayed.
    One country that flubbed this move was India. Under its first prime minister, Jawaharlal Nehru, India did strive to build organizational capacity. Although Nehru reserved industries like steel and heavy machinery for the state sector, he never actively suppressed the private sector. Instead, a system of licensing—the infamous “license-permit raj”—was put in place, ostensibly to use the country’s savings carefully. This meant guiding investment away from industries that bureaucrats thought were making unnecessary consumer goods (even durable ones such as cars), and instead into areas that could lay the basis for future growth, such as heavy machinery. The result, however, was that incumbents, typically firms owned by established families that were well enough connected to procure license early, were protected from competition. Barriers were also erected against foreign competition in order to provide a nurturing environment to India’s infant industries until they matured and became competitive.
    The protection India offered these industries, however, became an excuse for the companies to become “Peter Pans”—companies that never grew up. Car manufacturing is a case in point. Over nearly four decades, only five different models of the Ambassador car were produced, and the sole differences between them seemed to be the headlights and the shape of the grill. After growing rapidly just after independence, the Indian economy got stuck at a per capita real growth rate of about 1 percent—dubbed the “Hindu” rate of growth.
    Like Korea or Taiwan, India should have made the switch toward exports and a more open economy in the early 1960s. But because the protected Indian domestic market was large, at least relative to that of the typical late developer, firms were perfectly happy exploiting their home base despite government attempts to encourage exports. This is not to say that government efforts to change were particularly strenuous, especially given that protected firms were an important source of revenue to the ruling party for fighting elections. Democracy at this stage may well have seemed a source of weakness: leaders like Park Chung Hee in Korea and Lee Kuan Yew in Singapore did not have to worry about such niceties. As a result, India stayed closed, poor, and uncompetitive long after the economies of countries like Korea, which were at similar levels of per capita income in the early 1960s, had taken off.

What Happens When the Exporters Get Rich: Germany and Japan
     
    Not every country has been able to succeed with an export-led growth strategy. Moreover, this strategy also has weaknesses that may become clear only gradually, as countries grow rich. To understand these weaknesses, we should take a closer look at Germany and Japan. Neither was really poor after World War II—their people were educated, these countries had the blueprints to create the necessary organizations, and some of their institutional infrastructure survived—but both had devastated, bombed-out economies, with their capital stock substantially destroyed, large firms and combines broken up or suppressed by the occupation authorities, and households too downtrodden to be an important source of consumption. Exports were the obvious answer to their problems.
    With a large number of