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Economic policy
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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]
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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.
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.[5] These early examples are followed by interventionist ISI strategies pursued in Latin American countries such as Brazil, Mexico or Argentina.[6] 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.[7] The success of these state-directed industrialization strategies are often attributed to developmental states[8] 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.[9]
During the Reagan Administration, an economic development initiative called Project Socrates was initiated to address US decline in ability to compete in world markets. Project Socrates, directed by Michael Sekora, resulted in a computer-based competitive strategy system that was made available to private industry and all other public and private institutions that impact economic growth, competitiveness and trade policy. A key objective of Socrates was to utilize advanced technology to enable US private institutions and public agencies to cooperate in the development and execution of competitive strategies without violating existing laws or compromising the spirit of "free market". President Reagan was satisfied that this objective was fulfilled in the Socrates system. Through the advances of innovation age technology, Socrates would provide "voluntary" but "systematic" coordination of resources across multiple "economic system" institutions including industry clusters, financial service organizations, university research facilities and government economic planning agencies. While the view of one president and the Socrates team was that technology made it virtually possible for both to exist simultaneously, the industrial policy vs. free market debate continued as later under the George H. W. Bush administration, Socrates was labeled as industrial policy and de-funded.[10][11]
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.[12]
The main criticism against industrial policy arises from the concept of government failure. Industrial policy is seen as harmful as governments lack the required information, capabilities and incentives to successfully determine whether the benefits of promoting certain sectors above others exceeds the costs and in turn implement the policies. The East Asian Tigers provided successful examples of heterodox interventions and protectionist industrial policies,[13] industrial policies such as import-substitution-industrialization (ISI) has failed in many other regions such as Latin America and Sub-Saharan Africa. Governments in making decisions with regard to electoral or personal incentives can be captured by vested interests, leading to industrial policy would only supporting rent-seeking the political elite, while distorting the efficient allocation of resources by market forces at the same time.[14]
Despite existing criticism, there is a growing consensus in recent development theory that state interventions are often necessary when market failures prevail.[15] 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[16] 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 overall, the best ways of promoting industrial policy are sill widely debated.[17].
One key question is which kinds of industrial policy are most effective in promoting economic development. For example, economists debate whether developing countries should focus on their comparative advantage by promoting mostly resource- and labour-intensive products and services, or invest in higher-productivity industries, which may only become competitive in the longer term.[18]
Much debate also still surrounds the issue whether government failures are more pervasive and severe than market failures.[19] Some argue that the lower government accountability and capabilities, the higher the risk of political capture of industrial policies, which may be economically more harmful than exisiting market failures.[20]
Of particular relevance for developing countries are the conditions under which industrial policies may also contribute to poverty reduction, such as a focus on specific industries or the promotion of linkages between larger companies and smaller local enterprises.[21]
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