The Importance of Government Incentives Relative to Economic Fundamentals: The Case of Software Industry in Thailand

Larsson, Christoffer, Venkatesh, Sundar, ASEAN Economic Bulletin

I. Introduction

Countries have been using a combination of government incentives to facilitate industrial development including development of specific sectors. Equally important for this development is a set of essentials that a country should have. We call these economic fundamentals and contrast these with government incentives. Economic fundamentals could be the result of chance such as geographical location and climate or the result of long-term government policies such as affordable and abundant higher education.

If economic fundamentals are indeed distinct from government incentives in influencing investment decisions, it would be useful for policymakers to understand the relative importance of each in decisions made by investors.

Section II is a review of the literature on industrial policy and success factors of current software industry clusters. Section III describes the theoretic model adopted in this study. Section IV provides an overview of the software services industry in Thailand and the government policies in promoting this industry. In section V we describe our methodology, data and sample. Section VI reports our findings and analysis. Section VII concludes with a discussion of the results.

II. Review of the Literature

To our knowledge there are no current studies on the development of high-skill sectors that have divided success factors between government incentives and economic fundamentals.

However, there are studies focused on the development of industrial clustering and software industry, in particular, discussing the role the government has had in this development.

H.1 Is There a Case for Industrial Policy?

There is an intense debate on whether active government intervention, including sector-specific government incentives, is an effective instrument in the industrial development of a country. It is an issue that is dividing economists, and there are arguments both for and against industrial policy. One of the reasons behind this is that while it is easy to recognize failures, successes are more difficult to prove. For instance, consider the argument that Japan's industrial policy was crucial for its success. As we do not know how Japan would have developed without these policies, it is also difficult to attribute its success to its industrial policy (Pack and Saggi 2006).

A more interesting approach to industrial policy is provided by Rodrik (2004). The approach is focusing on how governments should act to get its industrial policies right and it is less concerned about its pros and cons. Rodrik defines industrial policy as "an interactive process of strategic cooperation between the private and the public sectors which, on the one hand, serves to elicit information on business opportunities and constraints, and on the other hand, generate policy initiatives in response", i.e., instead of viewing industrial policies, as some opponents would call a "distortion" of market forces, they should act as a complement that maximizes its potential to contribute to economic growth while minimizing the risks that it will generate waste and rent-seeking.

Rodrik also disagrees with the claim that there is a shortage of evidence on the benefits of industrial policy. On the contrary, his survey of successful sectors in Latin America reveals that "it is difficult to come up with real winners in the developing world that are not a product of industrial policies of some sort".

While the academic debate on this issue will continue, the trend seems to be toward more active government interventions rather than less. Even Hong Kong, known for its off-hand government policies, has revisited the government's role in promoting economic growth, and is now making special efforts to encourage the growth of six industries (The Economist 2010).

11.2 The Role of Government in Two Recent Software Industry Successes

India and Ireland are two recent software industry successes that are worth taking a closer look at. The software industries of both countries are export-based, but each one occupies its own distinguished market niche. India exports primarily software services, and Ireland exports software products (created by MNCs located in-country as well as by a growing number of local companies) (Tessler, Barr, and Hanna 2003).

The case of India suggests that the government played a minor role in its successful software industry. Although, the economic reforms introduced in the beginning of the 1990s did play an important role, these policies were not specifically targeted towards its software industry. Coward (2003) identified three factors leading to India's success. First, India had strong scientific and technical establishments dating back several decades. "Whether through luck or extremely keen foresight, India began producing the knowledge workers of the 21st century from the early 1960s." With strong English proficiency, India possessed an exceptional pool of human capital suitable for IT services. A second factor relates to India's overseas diaspora, in particular within the Silicon Valley and other high-tech areas of the United States. This diaspora helped direct outsourcing projects back to India. Workers who returned fiome contributed to the IT industry with enhanced knowledge about overseas software markets and Western business norms and practices. A third factor relates to timing. India had the abovementioned advantages at a time when the dotcom boom caused a severe shortage of software professionals. This forced companies, particularly those in the United States, to look for talents overseas. Together, these three factors arose due to unique circumstances that are difficult or time consuming for new entrants in the software industry to duplicate.

While India is an example where the relative importance of economic fundamentals outweighed government incentives, Ireland may provide an example where industrial policy played a greater role. A study by Tessler, Barr, and Hanna (2003) discusses the case of Ireland in greater detail. In the beginning of the 1970s Ireland faced a situation of high unemployment and emigration of its most educated people. The government identified software as a sector with a high-growth potential. A strategy was created to attract high-tech multinational corporations to Ireland through promoting the advantages of Ireland (English-speaking workforce, low telecom rates) together with a raft of incentives such as tax exemptions. According to Tessler, Ban', and Hanna the results of this strategy were mixed. Although it was successful in terms of job creation, the long-term goal that it would create a local software industry, through spin-offs did not materialize. Multinational corporations typically only outsourced technical support, testing and other low skill activities, and thus did not hire the most creative and software knowledgeable workers as intended. Recognizing this failure, Ireland focused on nurturing a venture capital industry to support entrepreneurship and R&D programmes to support technology innovation. As a result Ireland's local software industry grew from almost nothing to US$2.8 billion in revenues within 10 years (Arora, Gambardella, and Torrisi 2002). Though, according to Tessler, Barr, and Hanna, multinational corporations did play an important part in Ireland's success story apart from job creation. They also helped to stop the outflow of knowledge workers, who were essential to the success in the later stage of creating a local software industry.

II.3 Identification of Economic Fundamentals for Software Industry

The economic fundamentals for the success of a particular industry may be different depending on the industry. In a study of factors important to the success of software industry, Carmel (2003) developed the "Oval Model". Carmel identifies eight factors and explains why each of the factors is important in the development of the software industry. These factors provide the base for the theoretical model adopted in the survey of software investors in Thailand.

The eight factors are:

1. Government vision and policies: "Governments can play a proactive or facilitating role in every one of the other factors in the oval model".

2. Human capital: The human capital of a software industry covers the collective characteristics and abilities of its software professionals such as quantity, language skills, and managerial skills.

3. Wages: "Managers buying offshore outsourcing services tend to shop for the lowest-cost supplier. These costs are driven by the wages of software labour: from the junior programmers to the seasoned project managers".

4. Quality of life: "Talented professionals are not scattered at random but tend to concentrate in desirable locations characterized by higher quality of life standards".

5. Linkages: Some linkages of importance are cultural similarities, linguistic (English language), time-zone proximity, and overseas diaspora linkages. In many ways linkages are about trust, and without trust little trade takes place.

6. Technological infrastructure: This infrastructure refers to the availability and reliability of telecommunication technology. Software companies require cheap and reliable telephone and Internet connections.

7. Capital: A software industry must have access to capital to grow. Some sources of capital include government funds, venture capital, investment capital, and equity offerings.

8. Industry characteristics: These characteristics consists of clustering effects, the number of firms, their size, the associations which organize the industry's firms, and the industry's degree of common vision and branding.

III. Theoretical Model

In line with the review of the literature we …

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Publication information: Article title: The Importance of Government Incentives Relative to Economic Fundamentals: The Case of Software Industry in Thailand. Contributors: Larsson, Christoffer - Author, Venkatesh, Sundar - Author. Journal title: ASEAN Economic Bulletin. Volume: 27. Issue: 3 Publication date: December 2010. Page number: 312+. © 2008 Institute of Southeast Asian Studies (ISEAS). COPYRIGHT 2010 Gale Group.

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