The Industrial Policy Revolution I

The Role of Government Beyond Ideology

Justin Lin Yifu, J. Esteban, J. Stiglitz

• Publisher: Palgrave Macmillan
• Year: 2013
• Print ISBN: 9781137335166
• eBook ISBN: 9781137335173
• Topic: Business
• Subtopic: Business General
• Index: Business

This volume is the result of the 2012 International Economic Association's series of roundtables on the theme of Industrial Policy. The first, 'New Thinking on Industrial Policy,' was hosted by the World Bank in Washington, D.C, and the second, 'New Thinking on Industrial Policy: Implications for Africa,' was held in Pretoria, South Africa.

Part I

Conceptual Issues and Principles of Industrial Policy

1.1

Comparative Advantage: The Silver Bullet of Industrial Policy

Justin Yifu Lin

Peking University

Célestin Monga

World Bank

1.1.1 Introduction

Throughout human history, people have held their political leaders responsible for the general social and economic conditions of their nations. Fairly or unfairly, some leaders have been hailed as national heroes while others have been thrown out of power or even punished more harshly depending on the level of collective happiness or anger. But never in modern history has the leader of an industrialized country been convicted by courts for his stewardship of the national economy. Yet, that is what happened recently when former Iceland Prime Minister Geir Haarde was prosecuted and found guilty of failing to manage his country’s economy appropriately prior to and during the 2008 global crisis. While he was cleared for the most serious charges and barely escaped jail sentence, his reputation and political legacy were forever tarnished. The irony of the story is that he had long been viewed as instrumental in transforming Iceland from a fishing and whaling backwater into an international financial powerhouse before the global crisis.¹

Former American President John F. Kennedy famously observed that “life is unfair.” Many political leaders across the world have come to embrace those words, especially in this new era of slow growth in high-income countries, high unemployment, uncertainty, and social vulnerability. The Geir Haarde trial, has been seen as a sign of growing economic malaise in the era of globalization, even in rich countries. It is also an illustration of the tense debate over the appropriate role of government in economic policy, and the ultimate responsibility of policymakers who are expected to create the optimal conditions for social welfare maximization.

Questions about the nature of political leadership in difficult times raise the fundamental issue of the scope of government intervention in economic policy. While the debates are often framed over the narrow issues of financial and macroeconomic management policies (as was the case in Iceland) and unemployment and social safety nets (as seen in both industrialized and developing countries), the reality is that they cover much broader problems about the pace, quality, and inclusiveness of growth. Sustained economic growth is a process of constant industrial and technological upgrading, associated with parallel and consistent social and institutional changes that guarantee shared prosperity.

In an interlinked world economy, the main challenge for policymakers and economists is to constantly find the appropriate formula for governments and private agents to continually anticipate their country’s evolving needs, or adjust to and manage change. The specifics of such a formula are likely to differ in each country context depending on its level of development, initial conditions, and endowment structure. But regardless of their economic philosophies, almost all political leaders in the world have always tried to use the power of the state to avert the risk for their national economies of Iceland-types of crises. Following a long tradition of government support to firms in specific sectors, industries, or location,² the US federal and local governments constantly implement ambitious programs that can be assimilated to industrial policy.³ The same is true for countries as diverse as the United Kingdom, Germany, Switzerland, Singapore, Japan, China, or Sweden.

But industrial policy remains highly controversial, not least because of the many failed attempts recorded across the world over the past century. The controversies stem partly from the fuzziness of its definition, scope, and instruments, which often differ from a country to another depending on levels of development. This paper contributes to the debate and tries to sort out the conditions under which industrial policy – and more broadly, government interventions in the economy – are likely to fail or succeed. While the paper focuses on industrial policy from the perspective of developing countries whose economies are still within the global technological frontier, its main conclusions are relevant for all countries regardless of their level of development.

Section 1.1.2 discusses some of the conceptual issues associated with industrial policy and its theoretical foundations, which are now part of various strands of the mainstream economic literature. Section 1.1.3 analyzes the reasons why industrial policy has often failed and stresses the fact that the mistakes were not in the design or implementation of the strategies followed by many governments but in the very development goals set by policymakers – goals inconsistent with the level of development of their countries and the structure of their endowments at that time. Deriving lessons from the experience of unrealistic development goals, it sketches an economic analysis of why economic strategies in Iceland or elsewhere should always aim at consistency with comparative advantage determined by the existing endowment structure, which is the condition for continuous growth, shared prosperity, and social cohesion. Section 1.1.4 concludes that industrial policy is a central and indispensible feature of any successful development and sustained growth strategy.

1.1.2 Theoretical rationale for industrial policy

Historically, except for a few oil-exporting economies, no country has ever become rich without industrializing. Yet the distribution of roles between governments and the private sector in the process of industrialization and economic development remains controversial. It is therefore useful to start with a brief discussion of the definition and scope of industrial policy, and a presentation of the strong theoretical grounds for government intervention in the economy.

1.1.2.1 Beyond the semantic controversies

The first and perhaps biggest source of confusion about industrial policy is the fuzziness of its definition in the economic literature, which reflects the debate over its scope, objectives, and instruments. Harrison and Rodríguez-Clare (2009) have suggested that government decisions aiming at tilting incentives in favor of some particular groups of investors, which means abandoning policy neutrality, can be considered “industrial policies.”⁴ The presence of externalities is then viewed as the main theoretical justification for deviating from policy neutrality. That definition is broadly consistent with Cohen’s, which asserts that “industrial policy in the strict sense is a sectoral policy; it seeks to promote sectors where intervention should take place for reasons of national independence, technological autonomy, failure of private initiative, decline in traditional activities, and geographical or political balance” (2006: 85). That sector- or industry-specific approach (often labeled as “vertical”) is defined in contrast to an economy-wide (“horizontal”) approach to policymaking, which consists of general business environment policies that have an indirect impact on industry – including macroeconomic and social policies, as well as capital equipment and national defense policies.

In practice, however, the delineation between policy areas that are affected exclusively by a particular set of government measures is difficult to establish, as rules always have indirect, unintended, and sometimes even unobservable effects. That may explain why some authors define “industrial policy” as any form of selective intervention not just that favors manufacturing. The term then refers to all “policies for economic restructuring […] in favor of more dynamic activities generally, regardless of whether those are located within industry or manufacturing per se” (Rodrik, 2004: 2). Because there is no evidence that the types of market failures that call for industrial policy are located predominantly in industry, he suggests specific illustrations of industrial policies that concern non-traditional activities in sectors such as agriculture or services. That broad definition of industrial policy is then used to cover functional and selective and market-based as well as direct policy measures.

Still, many researchers continue to advocate a minimalist approach to industrial policy. Weiss, for instance, argues that broadening the term too far makes it not very useful conceptually. He also suggests that it focuses exclusively on manufacturing industry, which has a special role in growth due to its greater scope for generating high levels of and growth in productivity (at least at relatively early stages of development) and externalities. In that sense, industrial policy refers to

policy interventions designed to affect the allocation of resources in favor of industry (principally manufacturing) as distinct other sectors. Such interventions may also affect resource allocation within industry in favor of either particular branches or sub-sectors or particular firms (so they may be “selective” rather than “functional”). Interventions can involve either the price mechanism or direct controls and be focused on export as well as the domestic market. Industrial policy in this definition is thus much wider than import substitution trade policies with which it is often associated. (2011: 1)

Such semantic controversies do not really help address the challenges faced by policymakers around the world. While the rationale for narrowing the definition and scope of industrial policy may be useful from a purely conceptual standpoint, it is difficult to implement in practice, as most state interventions cannot be restricted neatly to specific policy areas. Moreover, the role of all governments is to design and implement a range of policies to foster business creation in some locations, support specific sectors of the economy, encourage exports, attract foreign direct investment, promote innovation, all of which amount to favoring some industries over others. In fact, one can even argue that the whole budget preparation and execution exercise carried out often through political debates every year by governments and parliaments around the world is mainly about industrial policy. As Nester observes, “every nation has industrial policy whether they are comprehensive or fragmented, or whether officials admit the practice or not.” His research shows that “every major industry in America is deeply involved with and dependent on government. The competitive position of every American firm is affected by government policy. No sharp distinction can validly be drawn between private and public sectors within this or any other industrialized country; the economic effects of public policies and corporate decisions are completely intertwined” (1997). These observations about a country often presented as the most successful free market economy in history invalidate the semantic controversies and the proposition that industrial policy is necessarily a misguided development strategy.

Most countries, intentionally or not, pursue an industrial policy in one form or other, which broadly refers to any government decision, regulation, or law that encourages ongoing activity or investment in an industry. After all, economic development and sustained growth are the result of continual industrial and technological change, a process that requires collaboration between the public and private sectors. Historical evidence shows that in countries that successfully transformed from an agrarian to a modern economy – including those in Western Europe, North America, and, more recently, in East Asia – governments coordinated key investments by private firms that helped to launch new industries, and often provided incentives to pioneering firms (Gerschenkron, 1962; Amsden, 1989; Wade, 1990; Chang, 2003).

Even before the recent global financial crisis and subsequent recession, governments around the world provided support to the private sector through direct subsidies, tax credits, or loans from development banks in order to bolster growth and support job creation. Discussions at many high-level summits sought to strengthen other features of economic policy that eventually favor specific industries or locations, including the public financing of airports, highways, ports, electricity grids, telecommunications, and other infrastructure, improvements in institutional effectiveness, an emphasis on education and skills, and a clearer legal framework. The recent global crisis has led to a rethin...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of Tables
• List of Figures
• Foreword
• Notes on the Contributors
• Introduction: The Rejuvenation of Industrial Policy
• Part 1: Conceptual Issues and Principles of Industrial Policy
• Part 2: Special Issues for Developing Countries
• Part 3: Instruments of Industrial Policy
• Part 4: Regional Case Studies of Successful and Unsuccessful Industrial Policies
• Part 5: Country Case Studies of Successful and Unsuccessful Industrial Policies
• Index