The new industrial policy
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Argument pro-trade
- specialisation, economies of scale, productivity selection, varieties.
Argument against free trade:
Zero-sum-game for losers (usually better organized)
Zero-sum-game for large countries (leads to FTAs)
Dynamic efficiency: infant industry.
Important to differentiate between all those arguments.
Industrial policy definition
Definition from Juhasz, Lane & Rodrik (2023):
government policies that explicitly target the transformation of the structure of economic activity in pursuit of some public goal
Typical goal is a structural change: from agri to manufacturing, from low-tech to hi-tech, etc.
Also sometimes climate change, good jobs, lagging regions, exports promotion or import substitution.
Any policy that can achieve these is an industrial policy.
Industrial policy rationale
We must differentiate these goals with zero-sum-game goal.
Economists tend to agreed on an intervention that does not help an industry for the sake of itself:
- that is, some kind of a market failure must exists to justify an intervention.
Therefore, its important to design an industrial policy with a set of goals and timeline in mind.
Old vs new industrial policy
Debates on industrial policy evolves with economic tools that evaluates them.
that market is imperfect and has its own failures.
capital market liberalization that leads to more crises.
The best practice changes amid GVC, global financialization, and global rules of trade & economic system.
- less emphasize on trade policies
Old vs new
| Old paradigm | New paradigm |
|---|---|
| Always bad: govt failure > market failure | Both present. addressing market failure is important to be rich |
| Focuses on why (theoretical) | Focuses on how (empirics & policy evaluation) |
| Use comparative advantage | build new comparative advantage |
| Dealing with govt failure by reducing their role | Focus on institutional setting |
| Domestic oriented | Global oriented |
More market failure
Coordination problem: A new sector needs to reach a critical scale to be viable.
tool makers won’t make tools unless the industry that uses it exists, but the industry won’t exist without tool makers.
Why study data science if there are no data collectors & industries that use data science? OTOH, firms won’t come if they cannot find talent.
remember external economies of scale & agglomeration?
Coordination matters on how much to produce: too much, then not enough profit to upscale.
- notice this is practically a collusion!
More market failure
Learning externalities: sometimes firms do not know what products can succeed in the market, what kind of market they are entering (especially in the export market).
Sometimes market solve this:
- Vietnam’s destination for electronic industries was discovered by Intel, Samsung entering the foldable market.
Sometimes it requires a push from the government, particularly amid spillover effect.
More market failure
Other types of externalities may be considered as well:
A negative externalities if a country relies too much on an adversaries or high risk countries.
Good jobs that’s can be useful for society as well e.g., STEM jobs, middle-class jobs.
More market failure
Imperfect capital market: Developing countries lack good quality financial institutions, hence more credit constraints.
However, evidence emerges since the various crises that the market is not as efficient in general.
- More crises since 1980s, the age of financial liberalization.
Even in the developed world, finance does not come to the promising future industries.
Government failure critique
information shortcomings: government probably knows no better than the market.
even if they do, there’s a possibility of political capture.
Rent-seeking by sectors, corruption, inefficient SOEs, mercantilist pressure, land & real estate grabbing.
Failed to plan exit strategy: forever infant.
Design principle
Pursue a new industry, preferably with large multiplier.
Conditionality and Accountability from the receiver of supports.e.g., performance targets such as export market growth.
Exit clause: how long these performance must be met.
Maintain competition both domestic and globally.
Independent evaluation outside the government (Australia: Productivity Comission, Indonesia: UKP4)
Decision-making framework
Targeting: Which sectors & why? What are the market failures? Do we have enough resources to deal with the market failure? What is the goal to impose to this sector? (jobs created, new tech discovered, how much exports, etc)
Implementation: How to assist? What type of public supports are needed? How long should they last? Can we minimize government failures? How to monev?
Governance: who decides which sectors to target? Who is the PIC of which intervention? Who conducts the monev? Who coordinates the action plan? Who collect market feedbacks?
Which sectors?
Cherif & Hasanov (2019): Often emerge in a tradable goods & services sectors with high degree of R&D and high-skill labors.
The argument for new industrial policy requires a newly emerged industries, not an old one.
Examples: high-tech manufacturing, transportation, communications, financial intermediaries, business services (Cherif et al. 2022),
Other industries? Solve the government failure first!
Cost-benefit test
Must conducted rigorously: capital & labor’s opportunity cost
unless labor are taken from unemployment.
demand for capital can be seen in growth of consumer credit relative to production credit.
Assessing cost is often easier than benefit amid uncertainty (another market failure).
The government must be prepared to absorb loss (but this is exactly why industrial policy was scrutinized).
Tools: goods market
Many classic trade tools (tariff and NTMs) are prohibited by trade agreements.
- Engaging with global market is essential for capital, inputs, and competition.
Export promotion: lower income tax from export revenue, import subsidies for important inputs, export credit subsidies.
Attracting FDI (for spillover purposes) with tax incentives often too costly with little benefit.
Tax incentives to use domestic supplies works better than LCR.
Provide certainty of demand from government procurement.
Tools: labor market
Training for workers with specific skills required by the targeted industry.
improve vocational education & training.
work very closely with the industry.
tax incentives to encourage apprenticeship.
Avoid rigid labor regulations.
Tools: capital market
tax incentives for capital investment.
Direct lending has mixed results, require general knowledge of credit constraint.
- interest payment subsidy also mixed, with a fiscal burden on top.
Credit guarantee can create moral hazard.
Indonesia is much more conservative after 1998.
Other tools
Special Economic Zones: encourage agglomeration, reduces uncertainty in the land market, and can be subject to special price for land. Additionally, can be controlled by the central government.
R&D subsidy (or via tax incentives), or direct R&D using the state budget.
- U.S.’ DARPA is a great example of the emerging internet-based industries.
Macroeconomic stabilisation may benefit one sector than others (e.g., international borrowings vs exports).
Financing industrial policy
New industrial policies emphasize on the use of global market instead of import substitution.
Mostly use tax incentives or some type of subsidies.
Rich countries with AAA bond ratings are in better position to finance their industrial policies.
Using tax incentives may reduces other welfare improving programs, and may reduce evaluation budget.
Typical problems in evaluation
Endogeneity of treatment: industrial policy typically assigned non-randomly.
researchers usually rely on natural experiments.
Better evaluation design requires a degree of randomness, or at least quasi-experiments.
Just because policy exists does not mean it will be used.
Lack of attention given to evaluation process: data procurement and monev.
References
Aiginger, K., & Rodrik, D. (2020). Rebirth of Industrial Policy and an Agenda for the Twenty-First Century. Journal of Industry, Competition and Trade, 20(2), 189-207. https://doi.org/10.1007/s10842-019-00322-3
Chang, H.-J., & Andreoni, A. (2020). Industrial Policy in the 21st Century. Development and Change, 51(2), 324-351. https://doi.org/https://doi.org/10.1111/dech.12570
Cherif, R., & Hasanov, F. (2019). The Return of the Policy That Shall Not Be Named: Principles of Industrial Policy. IMF Working Paper, 19(74).
International Monetary Fund. (2022). Industrial Policy for Growth and Diversification: A Conceptual Framework. IMF Departmental Paper.
Stiglitz, J. E. (2015). Industrial policy, learning, and development. WIDER Working Paper 2015/149. https://www.wider.unu.edu/publication/industrial-policy-learning-and-development
Wim, N. (2010). Industrial Policy. In (Vol. 2010). Helsinki, Finland: UNU-WIDER.
