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What is “smart” industrial policy? Can it be done successfully?Can it be replicated?
RichardNewfarmerInternational Growth CentreOctober 13, 2011
What is industrial policy?
Definition“Any deviation fromsectoralpolicy neutrality…or deviation from laissez faire”“Policy attempts to alter the structure of production …”Policy interventions to tilt market prices in favor of one activity over another
Instruments (“hard IP”):TariffsTax breaksSubsidies through the budget (including special programs, procurement)State enterprise pricingSubsidized credit programsInstruments (“Soft IP”)StandardsExport promotionInfrastructure
Two conclusions ex ante:All countries have industrial policies (though they may not call it that)Industrial policy to support one activity comes at the cost of penalizing other activities – particularly “hard” IP
Many different objectives…
Promote growth (including “competitiveness”, productivity)Otherobjectives, sometimes as vehicles to growth:Moving intohigher value addedproductsTrade:Exportsand import substitutionInnovationLocalemploymentProtecting theenvironment
Not unusual: Programsoften havemultipleobjectives, and many times lack quantifiableindicators ofsuccess.
Economic rationales for government interventioncenter around “market failures”
Latent comparative advantage:Thesector protected through industrial policy should soon be able to survive withoutprotectionExternalities: firms underinvest because they don’t capture spillovers to other activitiesLack ofappropriability: firms underinvest (in technology or export searches) because new entrants using the technology will soon erode profitsInformational asymmetries: government + private sectorComplementarity between goods and inputs such as infrastructureAgglomeration economies: Silicon Valley, Bangalore, clustersImperfect competition in product markets and capital markets

Does industrial policy work?
DaniRodrik(2004): Yes“…it is not surprising to observe that industrial restructuring rarely takes place without government assistance. Scratch the surface of nontraditionalexport successesanywhere in the world and you will more often than not find industrial policies, public R&D, public support, export subsidies, preferential tariffs arrangements, and other similar interventions lurking beneath the surface”(2004).Pack andSaggi(2005): No“[In recentindustry successes], publicinterventions have played only a limited role.Moreover, the recentascendance anddominance of international production networks in the sectors in whichdeveloping countriesonce had considerable success implies a further limitation on the potential roleof industrial policies.Overall, there appears to be littleempirical supportfor an activist government policy even though market failures exist that can,in principle, justify the use of industrial policy.”
Yes and no =Yo
Harrison - Rodriguez Clare (2010) review of many studies: “Soft” industrial policy has higher success rate…
“Hard” industrial Policy:TariffsSubsidies to specific sectorsTax breaks for foreign investorsDomestic content requirements
Soft” Industrial Policy:Special Economic Zones offering lower cost infrastructureRoads and ports designed to increase tradeSpecial Credit for exporters (Trade Credit)Promoting clusters in order to export
?

Source: Ann Harrison, “Growth Week” International Growth Centre Sept, 2011
…and increasing exposure to trade competition is a common element of success…
“…trade and FDI policies have generated the greatest welfare gains when they are associated with increasing exposure to trade…interventions that increase exposure to trade (such as export promotion) are likely to lead to higher welfare gains than other types of interventions (such as tariffs or domestic content requirements).”
Source: Harrison and Rodriguez- Clare, 2010
Aid for trade …about20%of WTO case stories concernedsome form of industrialpolicy
Up-grading quality: Brazil’s projects in Cotton 4; tea in Rwanda; fish in GrenadaSpur new products: organic coffee in Guatemala; phones to ladies in Bangladesh
All increased exposure to trade competition and to learning economies from exporting
Some advocate focusing on specific sectors:Targetemerging sectors(Clemensand Williamson2001)Targetskill-intensivesectors (NunnandTrefler, 2006):Manufacturedexports(Easterlyetal, 2009)But… this literature routinely overlooks agriculture and servicesand focus of policy depends on each countryOther focus on types of activities:Rodrik(2004):only new activities (and not sectors)Harrison- Rodriquez Clare:activities with spilloversRodrik(2008) suggests under-valuing the exchange rate to promotetradeablesAghion, et al (2011): promote intocompetitively structured sectors
Whatyou promotematters…
Howyoupromote matters even more…
Begin: removing policy, institutional, and cost elements in the value chain that limit production and exportsTransparency: Quantify amounts inbudget toparliament; begin by quantifying the industrial policy you haveIncentives/subsidies:Should be provided only to “new” activitiesObjectives:clear withbenchmark/criteria for success and failureSunset clause: phase out subsidies automatically over say 3 yearsProjects should entailprivate riskcommensurate withpublic risksCompetition: Avoid raising barriers toentryandimport competitionAgency administering IP: must have demonstrated competence – with clear political oversight and accountabilityMinistry: Maintain channels of communication with the privatesectorEvaluations: Subject portfolio to regular ex post external evaluation
10 principles of “smart” industrial policy
Solyndra’scautionary tale
Chu announces $535 loan guarantee toSolyndrafor its cylindrical solar photovoltaic cells (March 2009)“…to put Americans back to work…reduce dependence on foreign oil…rewableenergy…create millions of new jobs…a new green energy economy”“DOE take steps to ensure risks are properly mitigated…performs due diligence”“shows speed at which the DOE can operate when barriers to success are removed…”
Costs turned out to be higher than anticipatedPrices of silicon panels fell dramatically from 2008 highsBoth China and US rival First Solar sell at 25% of the per watt cost ofSolyndra’stechnologyDOE program, created in 2005, had excess uncommitted funds..Solyndragoes for scale, and cash out investors through IPO.But company ceased operation on Aug 31,2011DOEs program head resignsSome US Congressmen call for protection againstChina
Lessons:Even with DOE/OMB checks, (a) business plans subject to considerable uncertainty, and (b) politics can trump good financial analysisBut: Program did not curtail competition, and so prices to downstream buyers were not adversely affected…and losses were limitedTransparency helped hold political authorities accountable
What issmartindustrial policy?Focus on removing obstacles & creating incentivesThose measures that abide by the 10 principlesEspecially, competition, transparency, and sunset clausesCan it be done successfully?Yes, but soft industrial policies tend to have higher success rates than hard policiesOjo: Littleconclusive evidencethat industrial policy by itself explains high rates of growth of the fastest growing countriesCan it be replicated?Yes…and since bad experiences can be replicated along with the good, caveat emptor
So…
References and FurtherReading
Aghion,P., M.Dewatripont, L. Du, A. Harrison & P.Legros «IndustrialPolicy andCompetition” June28, 2011Nolan, Marcus and Pack, Howard, 2005. “The East Asian Industrial Policy Experience: Implications for the Middle East”.Working Paper Series, 05-14. Washington DC: Institute for International EconomicsHarrison, Ann and Andres Rodriguez-Clare (2010) “Trade, Foreign Investment, and Industrial Policy for Developing Countries” NBERWorking Paper15261.Pack, Howard andSaggi, Kamal, 2005. Is There a Case for Industrial Policy? A Critical Survey.Oxford Journals,21:267–297. Oxford University PressRodrik,Dani, 2004. “Industrial Policy for the Twenty-First Century”.Discussion Paper SeriesNo. 4767.Rodrik,Dani, 2008. “Normalizing Industrial Policy”.Commission on Growth and Development Working PaperNo.3.

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