The case for industrial policy (a paper and a rant)

A new paper, where some very good economists look at data from Chinese medium and large firms:

…sectoral policy aimed at targeting production activities to one particular sector, can enhance growth and efficiency if it made competition-friendly.

…if subsidies are allocated to competitive sectors… and allocated in such a way as to preserve or increase competition, then the net impacts of subsidies, tax holidays, and tariffs on total factor productivity levels or growth become positive and significant.

“You can’t pick winners” is the knee-jerk retort to the mention of anything that even rhymes with industrial policy. I would call it the triumph of ideology over evidence, except that even “ideology” feels like a generous term. Lazy thinking might be a more accurate description. Some have given the question a great deal of thought, but most have not.

I’m not suggesting that the paper above has the right answer (odds are, like most papers, it does not). I’m also not suggesting that governments can pick winners (probably they can’t). Nor am I forgetting that industrial policy is easily politicized and distorted (as surely it is). So what am I talking about?

I’ll make two claims. The first: industrialization is the most important and essential process of development. Everything from lower poverty, reduced inequality, and tax bases to support education and health and welfare systems will (and must) spring from high value-added production. Anything policymakers can do to hasten the process will have unparalleled benefits. The problem? We have little to no idea how to do that. And many of the tools in the current policy tool box are deeply flawed.

Some take this as evidence economists and researchers should focus on other things. This brings us to the second part of my argument, where I make the opposite claim: there is no more important or promising frontier of knowledge. The fact that we know so little, and the tools are so poor, suggests (to me) that the marginal gains from more research are huge. there is no more important place for scholars to spend their time.

As for the worry that industrial policy is too easily politicized or captured, I say: what policy is not? Again, this is simply a yet more promising opportunity for experimentation and learning.

When my students run rushing in the direction of micro-poverty programs, or randomized trials, I steer them away. Yesterday’s research and policy frontier is tomorrow’s old news. What is the next frontier? I would put money on industrial development and, with it, a new breed of industrial policy.

Some of the most interesting development research is coming from people swimming ahead of this wave: Eric Verhoogen, Nick Bloom, David Atkin, David McKenzie, Dani Rodrik, Ricardo Hausman, the authors of this post’s paper, and a slew of others. I haven’t seen the same swell in political science, but surely it will come.

9 thoughts on “The case for industrial policy (a paper and a rant)

  1. This seems like potentially good news.

    I’d be very interested in a list of questions that represent potential “low hanging fruit” in this space. Those of us without a good sense of the current frontier work have no way to make such a list, but I hope a quick sketch would be easy for you.

  2. I stopped reading the Aghion, et.al. paper at sentence two: “First, we develop a model…” But my rant, in response to your rant:

    I completely agree that industrial policy is essential for resource-rich countries facing the problem of international wage and price competition, if they hope to maintain or improve their standard of living. And that China is the best possible example of such a rising economy. And that in order to maintain its standard of living the U.S. badly needs a policy of government directed support for the not-necessarily-industrial sectors of its economy, for example, education and healthcare. (Though why you need A Model to prove this isn’t clear. I’d say a heartbeat and 20/20 eyesight.)

    But I don’t agree that every country, regardless of natural endowment, can/should pursue industrial development. This is particularly true if it needs to borrow under onerous conditions from international organizations for financing. Industrialization has become geographically fungible, flowing to ever-lower wage regions in increasingly brief stages, until like Japan, an industrial country’s standard of living bumps up against the limits of its resources and population.

    I don’t understand why you think that industrial development is a revolutionary new approach to development economics. Modernization theorists have been trying to push agricultural populations off the land and into industrial cities (producing real, “high-value” things) for decades. And poor socialist and neo-capitalist countries have been trying with greater or lesser success, in Asia and Africa, to industrialize via government-directed investment. But there are natural resource constraints in most countries. In some cases, they would be better off with government supported agricultural policy (like the ECU). In other cases, they would be better off forming resource-complementary trans-national protective currency zones — with political controls and situationally mandated transfer payments. Governments need a standard-of-living-improvement policy.

    The fallacy of modernizing/industrializing paradigms of development is that they assume that historical evolution can be indefinitely replicated thorough identical “stages” of development. Universality-to-some-degree is the presumption of this modeling. (A correlate is that future growth is always a better way to raise the standard of living than present redistribution.) But there are compatibility and reciprocity constraints of industrial production: you need people to be able to consume what you have more of. There’s no guarantee that they need or want to pay the price you require. The debt accrued and sacrifices of living standards required are real — and a lot less easy to justify when they are imposed by government policy.

    Why discourage your students from pursuing micro-level empirical research in order to write papers that begin, “First, we develop a model…”?

  3. Thanxs Chris for this post.
    For sometime now, those studying Asian development liked to mention the important role of industrial policy but the ideological mainstream has avoided the issue….But now we even have the Justin Lin, the chief economist of the World Bank talking about it…it is good to see that the debate on industrial policy is back in countries like the US or Britain. I would also suggest the work of Ha-joon Chang, Robert Wade or Alice Amsden.

  4. Chris,
    I have been interested in Industrial Policy for quite some time, and was excited to read this paper and see you post about it. On a similar topic to Jed Harris above, what do you think are the important (but also answerable) questions in relation to this topic? More specifically, where is the most promising space for further investigation for those without extensive economics training and the ability to collect primary data (for example, for a Masters dissertation, apologies for the shameless request for guidance)?

  5. Some of the interesting work I’ve seen on industrial policy is in urban/regional planning journals, which suggests an interesting area of research in industrial policy at the sub-national level (bringing into consideration city and state government policies – see papers on urban infrastructure and industrial policy by the WB, for instance). In general, I think using GIS techniques to analyse spatial considerations for industrial policy is a fascinating (not necessarily new) area of research.

    While I certainly agree that industrialization is essential on the path to development, it’s difficult to align the growth-oriented model of industrial development with its impacts on global climate change. The question of whether countries can industrialize and raise people out of poverty in an environmentally sustainable way also presents an interesting area of research for industrial policy, related to mitigation and adaptation (as the authors note).
    http://goo.gl/2B10c

  6. Well, it’s not yet proven that the industrial policy of China will show to have been that meaningful in the long term.

    They are those talks about whole phantom cities built in the middle of nowhere :
    http://finance.fortune.cnn.com/2010/12/21/ghost-town-mongolia-inside-chinas-empty-cities/
    http://www.dailymail.co.uk/news/article-1391868/This-city-built-million-people–lives-here.html
    http://www.liveleak.com/view?i=ff1_1308354536

    And they are reports this is seriously beginning to burst :
    http://www.bbc.co.uk/news/magazine-17390729
    “Mr Li’s private financier naturally invested the money in property, and paid him interest every three months at the rate of about 40% a year. […] At least half of Mr Li’s money now seems to have disappeared.”

    Then there’s the story of massive wind power development whit nobody who cares about whether or not it’s possible to connect it to the national grid :
    http://blogs.worldwatch.org/revolt/beyond-the-numbers-a-closer-look-at-china%E2%80%99s-wind-power-success/
    “local GDP statistics will capture the economic effect of new wind installations regardless of whether the projects end up generating electricity for the grid–making the issue of grid access little more than an afterthought”

  7. Of course you can pick winners. You just have to expect and be tolerant of picking a lot of losers as well. And that’s hard for governments in a democracy, where there are lots of people (commonly known as Republicans) who have a strong incentive to criticize every real or perceived bad picks and the accompanying waste of taxpayers money.

  8. Samot, or those known as Democrats. I seem to remember this being as much a leftist criticism of the right during the right’s turn in power as it is a Tea Party criticism today under Obama.

    Corporatism is an alluring idea. Social partners cooperating to increase productivity and jobs and control inflation; a perfect free lunch! The problem is it has never worked outside of relatively small, ethnically homogenous states.

  9. Political science and industrial policy, a brief reading list…basically anything on East and Southeast Asia..anything by Atul Kohli. On corruption and industrial policy try Kahn & Jomo ‘rents, rent-seeking and economic development’. Andrew MacIntyre on politics and business in East and Southeast Asia. Almost anything by Richard Donor, Stephan Haggard, pathways from the periphery, Woo Cummings (ed) Developmental state, I think you can still learn a lot from Cardoso & Faletto (oh no, though, they’re Marxists so cannot be read in America)….. Roselyn Hsueh’s most recent book on China is good….
    Basically stop reading things with regressions in them written by Americans and you’ll be able to find a good couple of hundred books and papers.