Industrial Policy Revisited: Fostering of new industries is becoming a global trend

Among the economic policies of the Shinzo Abe administration, his macroeconomic policy, including the setting of an inflation target, is drawing great public attention. According to a questionnaire survey conducted in December 2012 by the Nihon Keizai Shimbun , however, the top executives of major Japanese companies prioritized the "growth strategy," such as the creation of new industries and innovation, over the correction of the strong yen and the promotion of large-scale public investment as policy issues that must be addressed by the new administration. This article will focus on microeconomic policy, one of the "three arrows" of the Abe administration's economic policies, and consider its meaning from a long-term perspective.

The Abe administration at its outset established the Headquarters for Japan's Economic Revitalization as the command tower of microeconomic policy, along with the Council on Economic and Fiscal Policy, which deals with macroeconomic policy. Under the Headquarters, the Industrial Competitive Council was established with such members as company executives and private-sector economists. The Headquarters and the Industrial Competitive Council are working to formulate a growth strategy to help improve Japanese companies' international competitiveness and support technological innovation. Prime Minister Abe announced the three pillars of a growth strategy: the Japanese industry revival plan, which aims to revive the manufacturing industry; an international deployment strategy to support Japanese companies' overseas operations; and a new targeting policy to foster new industries.

This term "targeting" was frequently used when Western governments and researchers made critical comments on the industrial development policy promoted by the then Ministry of International Trade and Industry (MITI) during the high-growth period of the Japanese economy. Prime Minister Abe's choice of the term suggests his intention to promote industrial policy aggressively. The emergency economic package announced in January includes the encouragement of private investment as part of measures for the "creation of wealth by growth." Specific measures related to the fostering of industries include building charging infrastructure for next-generation vehicles, developing materials alternative to rare earth and other materials, and accelerating regenerative medical research using induced pluripotent stem (iPS) cells.

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Let us take a look at past developments from the angle of changes in Japanese industrial policy since the 1980s. Until the first half of the 1980s, Japanese industrial policy had the following characteristics. It aimed at specific industries, with each designated industry targeted as a unit, as typified by the Act on Temporary Measures for the Structural Improvement of Specific Industries ("the Industrial Structure Reform Act") (Act No. 44 of 1978 as amended by Act No. 53 of 1983), and it provided the Antimonopoly Act exemption, an anti-competitive measure. With Japan's economic presence growing and current account imbalances increasing, this traditional industrial policy received severe criticism from overseas.

During the U.S.-Japan industrial policy dialogue in 1983-1984, the U.S. government argued that Japan's export competitiveness to the United States had been fostered through subsidies to designated industries (targeting policy) under the Japanese industrial policy and that the Industrial Structure Act constituted an import barrier as it was aimed at protecting declining industries. In addition to these criticisms, the Japanese government adopted a policy of promoting international cooperation, as represented by the Maekawa Report, which advocated deregulation and expansion of domestic demand. Accordingly, Japanese industrial policy began to change in the second half of the 1980s.

The start of the change was symbolized by the establishment in 1987 of the Act on Temporary Measures for Facilitating Industrial Structure Adjustment ("the Facilitation Act") (Act No. 24 of 1987), which took over for the Industrial Structure Reform Act. Industrial adjustment continued to be an important policy issue due to the rapid appreciation of the yen after the 1985 Plaza Accord. However, the Facilitation Act was not aimed at each specific industry as a whole but at specific companies and regions, and there was no exemption from the Antimonopoly Act. These conditions constituted differences from traditional industrial policy. These features have been taken over by the Act on Temporary Measures for Facilitating Business Innovation by Specified Business Operators ("the Business Innovation Act") (Act No. 61 of 1995) and the Act on Special Measures Concerning Industrial Revitalization ("Industrial Revitalization Act," 1999).

Furthermore, during the period from the 1990s to the 2000s, the MITI and its successor, the Ministry of Economy, Trade and Industry (METI), shifted the emphasis from industrial policy to the institutional design for economic structural reform. The MITI and the METI were key players in the reform, which was initiated by the Ryutaro Hashimoto administration and reached a peak at the time of the Junichiro Koizumi administration. Consequently, "horizontal" or indirect measures to revitalize the economy through improving the institutional environment, including regulatory reform and enhancement of the economic legal system, have held an important position in industrial policy since the second half of the 1990s.

Thus, viewing from changes in the Japanese industrial policy since the 1980s, the policy set out by the Abe administration suggests that the government has started changing course, and it aims to foster specific industries again as symbolized by the term "targeting."

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Interestingly, similar moves are seen outside of Japan. The Organisation for Economic Co-operation and Development (OECD) published a paper titled Beyond Industrial Policy last year. The paper is based on the recognition that interest in industrial policy has been growing in recent years among OECD member countries, of which most are developed countries.

For example, a document issued by the European Commission in 2010 proposed a new approach--supplementing horizontal policy by measures targeting specific industries. The U.S. government, which had been the most critical about traditional Japanese industrial policy, announced its policy for promoting innovation in designated areas, including clean energy, biotechnology, and medical and health care, in a report released in 2011 by the National Economic Council and others titled A Strategy for American Innovation (see Table).

There are reasons behind these trends in developed countries. First, just like Japan, these countries increasingly need to find new economic growth engines amid a prolonged economic stagnation and the financial crisis and severe competition with emerging countries facing their existing industries.

Second, the buds of major innovation and new industries are appearing in a number of areas. They are included in the Japanese emergency economic package and the U.S. National Economic Council's report, such as energy and medical and health care.

What is important is that technologies in these new areas, which are basic and have a broad range of application, are expected to involve large external economies. That is, companies and individuals other than the developer of the technology would enjoy benefits not through the market. If this holds, it would be meaningful from an economics viewpoint that the government provides these areas with subsidies to increase investment incentives to prevent research and development investment amounts from being at a sub-optimal level.

Of course, a theoretically meaningful policy measure does not necessarily mean that it is effective in practice. In fact, there were many examples where measures to correct market failures caused more serious government failures. Harvard University Professor Dani Rodrik considered desirable institutional designs for industrial policy, finding three factors: close cooperation between the government and the private sector; the carrot and the stick; and accountability.

The carrot in this context is policy measures, such as subsidies and tax breaks and exemptions, while the stick means that results expected of the industries/companies targeted by policy measures are to be clarified, and, if they fail to achieve the desired results, subsidies and other support measures will be terminated. Industrial policies adopted by East Asian economies, such as South Korea and Taiwan, in the 1960s-1980s were conditional on the export performance of target companies. They are often cited in industrial policy-related literature as successful examples.

Meanwhile, accountability is the responsibility of the public institution in charge of industrial policy to explain to the public about its results. It is in accordance with the definitiveness of the institution's competence (autonomy). The Reconversion Finance Bank, a policy finance institution established in Japan right after the end of World War II, frequently faced external interference in connection with lending. This obscured the accountability of the institution, leading to reckless lending. Learning the lessons from its predecessor, the Japan Development Bank, which took over the function of the Reconversion Finance Bank, established autonomy for lending decisions. This helped clarify the accountability of the bank.

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With developed countries competing to promote innovation in new areas using industrial policy as a tool, it is appropriate for Japan to participate actively in the competition. In so doing, it is necessary to adopt an appropriate institutional design based on the experience of industrial policy accumulated in the country.

>> Original text in Japanese

* Translated by RIETI.