The Case for Industrial PolicyAmber Huber

What is Industrial Policy?

Government intervention to give economic opportunities to production sectors that wouldn’t have occurred without said intervention.

Three main arguments in favor of it: The infant industry argument Coordination failures Informational externalities

Sources Pack, Howard, and Kamil Saggi (2006), “Is There a Case of Industrial Policy? A Critical

Survey,” World Bank Research Observer 21 (2), 267-297. Westpal, L. (1990), “Industrial Policy in an Export-Propelled Economy: Lessons from South

Korea’s Experience,” Journal of Economic Perspectives 4, 41-59. Nam, Sang-Woo, and Se-Jong Kim. "Evaluation of Korea's exchange rate policy." Changes in

Exchange Rates in Rapidly Developing Countries: Theory, Practice, and Policy Issues (NBER-EASE volume 7). University of Chicago Press, 1999. 235-268.

The Infant Industry Argument

Foreign competitors in established industries have the upper hand.

Industrial policies foster infant industries and protect them until they can become successful (via lowering production costs and learning by doing).

If infant industries have comparative advantage, becoming successful can raise national income.

Baldwin’s Argument

Period of learning is an initial fixed cost. Capital markets finance investment if future returns > initial loss. Investors hesitant to invest in initial learning due to spillover potentially benefitting competitors. Knowledge spillover is an externality that occurs when a firm’s innovation creates economic

benefits in other firms.

Coordination Failures

Infant industries and independent agent investment.

Rodrick’s Model

High-Tech and Low-Tech good sectors.

High-Tech needs access to intermediate goods, coordination required.

Okuno-Fujiwara’s ideal industrial policy for goods x and y (where y is intermediate good of x)

Government intervention on facilitating information exchange (planned production of x and planned demand of y).

Rodrick Goal of industrial policy is strategic collaboration between private and public sectors to

determine comparative advantage. Level of investment/entrepreneurship the market delivers isn’t enough. Initial producers provide benefits to subsequent producers.

Mayer Information asymmetry with new products to foreigners. Beneficial industrial policy of subsidizing exports.

Foreign Direct Investment Blalock

Positive impact from FDI on domestic productivity growth. MNC source simple inputs from local firms. Technology Transfer

Externalities, the Role of Exports, and FDI

Industrial Policies: Lessons from South Korea

Downward growth spiral in late 1950s.

Export-led industrialization strategy.

Export composition of GNP up from 3% (1960s) to 40%(1990s)

Virtual free trade regime for exports. Capital and intermediate inputs used in exports free from import tariffs.

Exporters borrowed working capital in proportion to their export activity.

Preferential access to credit and tax/tariff exemptions for infant industries.

Chaebols (Hyundai, Samsung)

South Korea Exports 1966-1990

Credit rationing denied financial institutions the experience needed to make independent decisions.

Over targeted intervention in the 1970s in developing heavy engineering industries, causing performance to deteriorate. Inadequate labor and capital.

Changed exchange rate system in 1980s to peg Korean won to basket of currencies for major partners to maintain more stable REER.

However, authorities failed to disclose weights applied to currencies of major trading partners. Caused REER of the won to fluctuate during the 1980s.

Trending away from selective intervention, imports have been liberalized. Government still has large control over bank lending.

Issues with South Korean Industrial Policy

Lawrence and Weinstein – relationship between policies and TFP growth from 1955-1990 in Japan. Subsidies/Loans negatively associated with TFP growth. Imports positively associated with TFP growth. Why? Imports allow domestic firms to use specialized intermediate inputs. Imports create competition, domestic firms have to cut cost and increase quality. Japan’s growth would have benefitted from cutting tariffs and expose domestic firms to competition.

Pack asserts that governments should focus away from complex industrial policy and instead focus on negotiation with MNCs.

Changing political climate and international policy constraints.

World Trade Organization constraint examples: Trade-Related Aspects of Intellectual Property Rights (TRIPS), signed in 1994. Trade-Related Investment Measures (TRIMS), signed in 1994. Lengthy dispute settlement procedure.

Do Industrial Policies Work?

No guarantee that low production costs will lead to foreign sales.

Rather than protecting infant industries, competition from the global market may force them to become more competitive.

Trade constraints may not allow the same industrial policies that benefited countries in the past to be used today.

In developing countries, policies to help coordination failures may be beneficial to prevent being stuck in a low tech rut.

Conclusion