Industrial Policy
NABIL ALIMI
ACADEMIC YEAR
2023 - 2024
Introduction
1. Does industrial policy work?
2. What kinds of industrial policies are
effective?
3. Industrial policy for the green and digital
transitions
4. How does political economy affect
industrial policy?
5. Is industrial policy compatible with
business environment reform?
6. Does industrial policy serve the poor?
7. What can donors do?
Industrial policy is defined as the strategic effort by
the state to encourage the development and growth
of a sector of the economy. UNCTAD (2009) defines
industrial policy as a “concerted, focused, conscious
effort on the part of government to encourage and
promote a specific industry or sector with an array
of policy tools”. Pack and Saggi (2006) provide a
more detailed definition: “any type of selective
government intervention or policy that attempts to
alter the structure of production in favour of sectors
that are expected to offer better prospects for
economic growth in a way that would not occur in
the absence of such intervention in the market
equilibrium.” This note explores six key issues and
debates within industrial policy.
Supporters of industrial policy argue that
it is the only paradigm that delivers real
economic growth and transformation.
From this perspective, development is a
matter of identifying and promoting the
technologies and activities that are most
relevant for economic growth. For example,
some economists advocate for an
“entrepreneurial state,” which restlessly
searches out new opportunities for growth
(Mazzucato, 2018 (book), her original
'pamphlet' on the entrepreneurial state
Mazzucato, 2009 (open access) and short
TED Talk (2013)).
Such advocates argue that developing
countries can never emerge from aid
dependency "if they are unable to use
the industrial policies (which) they will
need to transform their domestic
industries, diversify their economies
and build up their own tax bases over
time" (Rowden, 2011).
Others argue that markets already allocate
resources efficiently, and that
governments are unlikely to improve
matters. Economists have highlighted the
difficulty of achieving well-targeted and
effective interventions in practice. The
evidence used to support both arguments
may be based on the same examples, yet
interpreted or framed in different ways;
India's car industry and Bangladesh's
garment industry are used to show both
that liberalisation 'works', and that
industrial policy 'works' (Khan, 2014).
1. Does industrial policy
work?
A number of factors have led to the
growing interest in industrial policy.
Firstly, industrial policy has been
increasingly used as a response to crises.
Western governments have sought to
intervene more strongly in domestic
industries after the 2008 global financial
crisis, and more strongly again in response
to the COVID-19 pandemic, to restart
economies and „build back better‟ (INET,
2021; IISD, 2020).
Secondly, the success of many East
Asian economies, most recently China,
is often associated with industrial
policy. Some advocates of industrial
policy also argue that despite their
promotion of free markets abroad, rich
countries have often used industrial
policy as part of their own development
strategies (Chang, 2008; Chang, 2019
Mazzucato, 2013).
Dani Rodrik (2020) identifies a variety of trends
that have contributed to this renewed interest,
suggesting (thirdly) that there has been a
pushback from developing countries against
the market fundamentalist approach, and
demand for proactive government policies, in
light of shortfalls in actual quality
manufacturing jobs generated. Lastly,
industrial policy is also increasingly considered
an important tool for green and digital
economic transitions, especially in the context
of shifting geopolitical dynamics (EC, 2020).
On the other hand, critics stress that poorly
designed industrial policies risk having worse
outcomes than the market failures they seek to
address. Some argue that lack of transparency
and technical capacity among policymakers in
low-income countries often lead to poorly-
designed industrial policies. A separate concern
relates to the practicality of industrial policy;
international trade agreements outlaw many
active industrial policy tools, although Least
Developed Countries are sometimes allowed
greater flexibility.
While debates continue over the merits
of industrial policy, attention is
increasingly focused on how to design
and implement it. Five “how to” issues
currently discussed among experts and
practitioners are outlined in the
following sections.
2. What kinds of industrial
policies are effective?
One aspect of this debate is whether
governments should use industrial policies
to make the most of their country‟s
current comparative advantage, or instead
invest in higher-productivity industries
that are not competitive in the short-term.
According to Justin Yifu Lin, former Senior
Vice President of the World Bank, where
industrial policies fail, this is “due mostly
to governments‟ inability to align their
efforts with their country‟s resource base
and level of development” (Lin, 2010).
For Lin, developing countries should first seek
to profit from the (mostly labour- and resource-
intensive) products and services that they are
currently most competitive in (see also Khan
(2012) for a similar argument). They will
accumulate human and physical capital in the
process. This capital, Lin argues, can be
reinvested over time in more productive
industries. Several methodologies are available
to donors and governments seeking to identify
competitive advantages (see for example
German Development Institute, 2016).
Ha-Joon Chang (2019) in contrast, argues
that developing countries should define
their comparative advantage. For Chang,
the cost of moving capital between
industries (e.g. from sewing machines to
car plants) means that countries should
actively promote high-productivity
industries at an early stage in their
development. A debate between Justin Yifu
Lin and Ha-Joon Chang (2009) provides
more information on this topic.
Dani Rodrik (2008) states that
industrial policy “is not about industry
per se”, but that “policies targeted at
non-traditional agriculture or services
qualify as much as incentives on
manufacturers”. Some argue that while
manufacturing should be given special
policy treatment, governments should
not favour particular manufacturing
industries (UNIDO, 2011).
One way to do this is by improving the
infrastructure that manufacturers require,
e.g. by creating Special Economic Zones
(e.g. World Bank, 2016). Critics argue that
such an approach may only attract short-
term investment, achieving little, if any,
positive spill-over into the wider economy
(Farol and Akinci, 2011). The World Bank
(2016) summarises success factors of
Special Economic Zones, based on
experiences in different countries.
3. Industrial policy for the
green and digital transitions
Within the renewed interest in
industrial policy, across the political
spectrum, is an increasing focus on
green and digital sectors. Green
industrial policy involves governments
ensuring that „green‟ industries are
prioritised, to transition overall to a low-
carbon economy.
It comes with the challenge of combining both
economic and environmental considerations.
Green industrial policy could involve, for
example, ensuring that green technologies like
solar power receive adequate investment,
directing research and development towards
climate change adaptation and mitigation,
creating tax incentives for eco-friendly actions
by firms, or implementing green public
procurement rules (e.g., EC, 2016). Dani Rodrik
(2014) suggests that the theoretical case for
using industrial policy to facilitate green growth
is quite strong
UNEP and DIE (2017) propose several
industrial policy measures to balance
wealth creation and environmental
sustainability, illustrated with examples
from four countries. They show that
market-based allocation of resources is
unlikely to foster positive structural
change, but that green industrial policy
has the potential to provide social and
economic co-benefits, as well as
environmental improvements (for
examples, see GGKP, 2020 (webinar
recording)).
More recently, there has been debate on the
best way to „build back better‟ after the COVID-
19 global pandemic, with many (e.g., INET,
2021; OECD, 2020) positing that the crisis can
be used as a positive stimulus to redirect policy
attention to foster a resilient, environmentally-
friendly recovery. State intervention has
become the norm in many countries
throughout the pandemic, setting the precedent
for further intervention. Governments are
under pressure to integrate green industrial
strategies into all levels of COVID-19 response,
from emergency „rescue‟ policies, to medium
term economic stimulus packages, to longer-
term transition planning (PIGE, 2020).
The role of industrial policy to promote the digital
economy is also receiving growing attention. Early
digital innovations were often the direct result of
government investments in R&D related to defence
and security. But governments have many other
levers to encourage digital progress, e.g. as a
regulator to encourage competition between firms,
as a promoter of demand through subsidies and
taxation, as a customer through public
procurement, and potentially as an investor in new
technologies to accelerate their commercialisation
(UNCTAD, 2018). At a regional level, co-ordinated
industrial policy could help expand and integrate
digital infrastructure and fast-track dissemination
and uptake of new technologies through cross-
border investments (EC, 2021)
4. How does political economy affect
industrial policy?
One dilemma for policymakers in developing
countries is that while the “the need to correct
market failure is much greater than it is in rich
and institutionally advanced societies, the
ability of the public sector to tackle such failure
is also much more limited” (Altenburg, 2011). A
strong administrative capacity on the part of
policy makers is required. This includes “clear
goals, detailed policy measures, adequate
budgets, and effective monitoring” (Asian
Development Bank, 2015). The government
must have a full grasp of market information
gathered in the field.
Governments in East Asia had good relations
and continuous dialogue with the private
sector. In some developing countries, the
reverse is now true: the majority of business
owners are allied to the political opposition.
Fairness was another critical success factor in
East Asia‟s industrial policies; the granting of
privilege was made conditional on export
performance (Lall, 2004). Dani Rodrik (2008)
points to a related factor: governments‟ ability
to recognise mistakes and withdraw their
support before it becomes too costly.
In South Korea, for example, failure to achieve
export targets could result not only in a loss of the
subsidy, but also in a transfer of the plant to
another chaebol (industrial conglomerate) (Khan,
2014; Chang, 2019). Where the threat of such
enforcement practices is credible, firms have the
incentive to increase their competitiveness; this is
however unlikely to be the case where clientelistic
and patrimonial governance systems increase the
risk of policies being captured by special interest
groups (Khan, 2013). Furthermore, the skills and
resources needed to design, implement and
monitor industrial policies are often lacking in
developing countries.
Some therefore argue that the lower the
government’s capabilities, accountability
and commitment, the lower the
sophistication of industrial policies that the
government can be trusted with (e.g. Lall,
2004). Where certain preconditions are not
present, and the risk of political capture is too
high, it may be necessary to focus on
accountability-enhancing measures and the
promotion of a business-enabling environment
(e.g., Kaufmann and Krause, 2011).
Altenburg (2011) however observes that some
governments have succeeded in promoting
industrialisation and have developed more
efficient and transparent bureaucracies, despite
their poor performance in other aspects of
governance. This resonates with Khan (2012)
who suggests that gradual successes in
industrialisation can also be achieved in
countries with less favourable political
settlements, through narrowly defined and
pragmatic industrial policy strategies that start
with critical constraints in potential growth
sectors where it seems feasible to develop
relevant governance capabilities, and to deliver
results.
The economist Joseph Stiglitz argues
that “limitations on the capacity of
government should affect the choice of
instruments for carrying out industrial
policies, but not whether they should
undertake industrial policies.” (Stiglitz,
2016).
5. Is industrial policy compatible
with business environment reform?
The donor community for many years has
been supporting reforms in developing
countries that improve the business
environment by reducing legal,
institutional and regulatory constraints for
all businesses, and promoting competition
(DCED, 2008). This is often seen as very
different to industrial policy, as the latter
involves direct interventions targeting
specific businesses or sectors and aims to
change the structure of the economy.
A DCED paper (DCED, 2013) assesses
how compatible these two approaches are
and finds that business environment
reform is compatible with what some
authors refer to as ‘strategic industrial
policy’: this approach focuses on
developing entire sectors, technologies
or activities and encourages
time bound, results-based management
(see also DCED, 2016).
6. Does industrial policy serve
the poor?
Industrial policy is often guided by
multiple objectives. These may include
stimulating innovation, promoting
human capital development, boosting
employment and reducing income
inequalities (Stiglitz, Lin and Monga,
2013; Mazzucato, 2018). Of major
interest to the development community
is the question whether or not
industrial policy is pro-poor.
Disagreements over the poverty impact of
industrial policy reflect the range of views
on how likely the poor are to benefit from
economic growth in general. Some argue
that industrial policies should be used to
target social enterprises, while others
point to the poverty reduction achieved by
emerging economies focused on promoting
productivity-based growth (see also the
DCED (2016) working paper on business
environment reform for inclusive
business).
Altenburg (2011) cites evidence that growth is
not inevitably good for the poor and argues in
favour of „inclusive industrial policies‟. He
defines these as policies that aim to promote
“structural change in a way as to enhance
competitiveness and productivity growth while
increasing the incomes of the poor more than
proportionally”. Such policies may involve
safeguards for vulnerable groups, a focus on
labour intensive industries, or the
strengthening of linkages between SMEs and
larger firms.
Others argue that industrialisation and
labour intensive manufacturing may offer great
economic opportunities for the poor in the
medium to long term, but that it is critical to
complement industrial policies with measures to
improve incomes for poor workers in the short-
term – in particular through support to
agricultural productivity and rural household
enterprises (e.g. Louise Fox, 2014; Page and
Shimeles, 2014).
7. What can donors do?
Donor-funded technical experts can
help to design and implement reforms
that improve the performance of public
agencies which support the overall
functioning of the target industry. For
example, many donor agencies have
provided technical assistance to
investment promotion agencies (see
OECD, 2011).
Donor-funded experts can also help to
improve the policy formulation process.
As Ansu et al. (2016) noted, effective
public–private collaboration for
transformation requires collaborative
experimental learning. Effective,
transparent public private dialogue, for
example, can allow private sector actors
to provide timely feedback on policies
and governments.
As a complement to industrial policy,
donors can support partner governments‟
efforts to grow priority industries by
ensuring that the service markets which
support these industries function well.
Strengthening markets for business
development services, for example, can
assist firms to upgrade their management
practices, make well-informed decisions
about which new technologies to adopt,
and lower their costs through greater
resource and energy efficiency.
It may however not be enough for
donors to simply rely on technocratic
approaches to industrial policy support;
an important success factor is how
industrial policies are communicated to
partner governments. Because of public
perception that industrial policy has
failed in many cases, some governments
are demoralised and lacking in
confidence (Wade, 2015).
Other governments may themselves be sceptics
of the development potential of industrial
strategies. This means that donors not only
need evidence and success stories of industrial
policy when communicating with governments;
„framing‟ industrial policy support in a way that
resonates with the values and beliefs of public
officials may be equally important (Dietsche,
2017). Adapting rationales and language in
responsive, flexible ways when discussing
whether and how governments should promote
structural change can therefore be a key
ingredient of successful donor strategies.