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Learning from Earlier Rounds of “Industrial Policy”

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What kind of a comeback is "industrial policy" making? Certainly the way the term is used has changed, and along with it, how it is being received. In the 1960s and 1970s, it often justified state financial and regulatory backing of specific, targeted sectors, usually manufacturing in capital-intensive sectors. And there were some notable success stories of sectors that expanded rapidly, including among the East Asian Tigers. Hence, the potential for success, along with the attractiveness of steering funds to particular recipients, continues to fuel politicians' interest in the approach. However, the broader track record of these earlier rounds of industrial policy was sobering — too often associated with white elephants, cozy deals with connected individuals, and blunted incentives on the part of the recipients to compete or innovate.

Photo credit: 06-05-11 © porcorex

Today's proponents argue that they won't be repeating the mistakes of the past, because the new form of industrial policy will rely on monitoring, accountability, experimentation, and learning. But will that be enough? A recent World Bank conference — Making Growth Happen: Implementing Policies for Competitive Industries — debated this issue. The participants seemed hopeful that redefined (or reconfigured) industrial policies could nurture growth and development, although the path would be strewn with a lot of obstacles.

Clarifying "industrial policy"

Let's begin with some clarifications. Does "industrial policy" need to be "industrial"? Certainly, the traditional focus was on industry (including heavy industries such as ship building or chemicals), with the need for public investment justified by the fact that the private sector on its own might not allocate sufficient capital to develop these capital-intensive sectors, particularly if there were large economies of scale. But the new generation of advocates takes a much wider view. They contend that services and agriculture can also be viable candidates for consideration, with the emphasis on a country's comparative advantage and the likelihood of generating positive externalities — notably learning. A key advocate of this viewpoint is Nobel prize-winner and former World Bank Chief Economist Joseph Stiglitz.

Which "policies" fall under industrial policies? This is somewhat harder to discern. The potential set is quite expansive, capturing any types of policies that will have differential effects across locations, sectors, firm sizes, or factors of production. Education systems that favor academic achievements will shape a different workforce than one that focuses on vocational skills or one that prizes STEM (science, technology, engineering, and math) subjects over the humanities. Tax policies that apply different rates to labor income and capital gains will affect the relative use of labor and capital. Bankruptcy laws that prioritize different creditors, including workers, again tilt the allocation of resources. And most infrastructure projects — like building roads, bridges, and ports, or establishing access to the electric grid and internet connectivity — have location-specific effects. Understood as such, all countries pursue industrial policies, whether they say they do or not.

One question then is how much are these various policies designed with an eye to how they will shape the allocation of resources across locations, sectors, and firms. Stiglitz, among others, calls for much greater transparency in how policies affect resource allocation as well their distributional impacts. He also argues for more weight to be put on dynamic benefits of policies that promote learning sectors. Solow's famous growth model emphasized the importance of technological change, rather than increases in capital, as the source of continued growth. (Interestingly, the terms "industrial policy" and "technology policy" are sometimes used interchangeably.) Mastering new technology, the spread of knowledge, and facilitating learning (and learning how to learn), says Stiglitz in a JKP interview, are the key to dynamic economies.

Transparency, monitoring, experimentation, and governance

While it is one thing to recognize many policies affect resource allocation and to call for greater transparency and awareness of the trade-offs, it is another step to then argue that additional sector-specific policies are needed to accelerate this process. Directing credit and subsidizing or giving favorable regulatory treatment to certain selected sectors is still what many see as "industrial policy" more narrowly defined. And it is this narrower view that most of the other speakers addressed.

How can today's industrial policies avoid the mistakes of the past? The speakers called for a greater emphasis on transparency, monitoring, and evaluation. Indeed, progress in methodologies to evaluate policies and a willingness to experiment with new approaches underpins much of the enthusiasm — and is what learning is all about. Moreover, this experimentation is already occurring given that many industrial countries have responded to the global financial crisis with policies that fall into the narrowly defined industrial policy category. Naturally, developing countries are watching closely.

However, the renewed enthusiasm for industrial policies also raises the question of whether many developing countries will be able to replicate the successful cases of today and even those from the earlier round. Here a major concern regards governance, given that the selection of recipients of state assistance is not always transparent, sunset clauses can fail to be in place, and there can be little accountability or need to show results. As Mushtaq Khan (University of London) cautioned, as the set of countries following an industrial policy approach expands, the challenges of governance can be more acute. He tells the JKP that the big hurdle will be translating this knowledge into countries where the political environments, the governance capabilities, and the existing capabilities of the private sector are much weaker. That is why he advocates a cautious, rather than an ambitious approach, which will entail pursuing many small-scale experiments and designing instruments that have a better chance of success in the different political and institutional settings.

(For more on this topic see the JKP's interview with Stiglitz and new books edited by Stiglitz and the World Bank’s former chief economist Justin Yifu Lin — "The Industrial Policy Revolution 1" and "The Industrial Policy Revolution II" (the latter is also edited by Ebrahim Patel). Next week, the JKP will feature a 2-part interview with Mushtaq Khan.)

This post was first published on the Jobs Knowledge Platform.


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