Industrial policy

Two questions to economists: Could excessive outsourcing be considered a market failure in light of excessive dependence on strategic metals and commodities and excessive social unrest due to excessive unemployment? Is predatory capitalism (or mercantilism by a foreign country) a market failure? ---lee

The Industrial Policy plan of a nation, sometimes shortened IP, "denotes a nation's declared, official, total strategic effort to influence sectoral development and, thus, national industry portfolio."[1] These interventionist measures comprise "policies that stimulate specific activities and promote structural change"[2].

Industrial policies are sector specific, unlike broader macroeconomic policies. Examples of horizontal, economywide policies are tightening credit or taxing capital gain, while examples of vertical, sector-specific policies comprise protecting textiles from foreign imports or subsidizing export industries. Free market advocates consider industrial policies as interventionist measures typical of mixed economy countries.

Many types of industrial policies contain common elements with other types of interventionist practices such as trade policy and fiscal policy. An example of a typical industrial policy is import-substitution-industrialization (ISI), where trade barriers are temporarily imposed on some key sectors, such as manufacturing[3]. By selectively protecting certain industries, these industries are given time to learn (learning by doing) and upgrade. Once competitive enough, these restrictions are lifted to expose the selected industries to the international market[4].

History

The traditional arguments for industrial policies go back as far as the 18th century. Early arguments in favor of selective protection of industries have been prominently associated with US economist and politician Alexander Hamilton (1790) and the German economist Friedrich List (1844). These arguments were picked up subsequently by scholars of early development economics such as Albert Hirschman and Alexander Gerschenkron, who called for the selective promotion of key sectors in overcoming economic backwardness.

While early development theory affirmed the crucial role of industrial policy, the rise of neoclassical economics in 1970s - also known as the counter-revolution in development thinking[5] - was more critical towards the interventionist measures and instead stressed the importance of free market laissez-faire in promoting structural change. In recent years, however, the advent of endogenous growth theories has led to a convergence towards acknowledging the role of the state in correcting externalities and market failures.

Historically, there is a growing consensus that most developed countries, including United Kingdom, United States, Germany and France, have intervened actively in their domestic economy through industrial policies[6]. These early examples are followed by interventionist ISI strategies pursued in Latin American countries such as Brazil, Mexico or Argentina[7]. More recently, the rapid growth of East Asian economies, or the Newly Industrialized Countries (NICs), has also been associated with active industrial policies that selectively promoted manufacturing and facilitated technology transfer and industrial upgrading[8]. The success of these state-directed industrialization strategies are often attributed to developmental states[9] and strong bureaucracies such as the Japanese MITI. Many of these domestic policy choices, however, are now seen as detrimental to free trade and are hence limited by various international agreements such as WTO, TRIM or TRIPS. Instead, the recent focus for industrial policy has shifted towards the promotion of local business clusters and the integration into global value chains[10].

In August 2010, The Economist highlighted a renewed trend of industrial policy in rich countries, with examples of active government intervention in the United States, Britain, France, Germany, Japan and South Korea. The revival has been driven by four main forces: pressure to reduce unemployment and stimulate growth; a desire to 'rebalance' certain economies away from financial services; popular demands for increased government action; and the perceived need to respond to apparently successful policies being pursued in China.[11]

[edit] Criticism

The main criticism against industrial policy arises from the concept of government failure: While industrial policy is seen not as harmful per se, governments - especially in developing countries - often lack the required information and capabilities to successfully select and promote sectors. Even though the East Asian Tigers provided successful examples of heterodox interventions and protectionist industrial policies[12], industrial policies such as import-substitution-industrialization (ISI) has failed in many other regions such as Latin America and Sub-Saharan Africa: If governments are captured by vested interests, industrial policy would only support the rent-seeking of an elite, while distorting the efficient allocation of resources by market forces at the same time[13].

However, there is a growing consensus in recent development theory that state interventions are often necessary when market failures prevail[14]. Market failures often exist in presence of externalities and natural monopolies. These market failures hinder the emergence of a well-functioning market and corrective industrial policies[15] are required to ensure the allocative efficiency of a free market. In practice, these interventions are often aimed at regulating networks, public infrastructure, R&D or correcting information asymmetries. While the current debate has shifted away from dismissing industrial policies in overall towards assessing the efficacy of specific types of industrial policies, much debate still surrounds the issue whether government failures are more pervasive and severe than market failures.[16]

The Economist identified three lessons for 'successful' industrial policies. First, initiatives that fit with a country's comparative advantage are more likely to succeed. Second, policy is more effective when it follows the market rather than trying to lead it. Third, government intervention is more appropriate in spheres where there is obvious public policy interest, such as military technology or energy supply.[11]

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