This month's featured article
Industrial Policy Fit for the 21st Century
Alessio TERZIEconomist / Author / Lecturer
Industrial policy is a term that is often interpreted differently depending on the audience. The fact that it cuts through a variety of economic policy tools, ranging from innovation programmes and tax policy to trade and Foreign Direct Investment (FDI), makes the matter even more complex. As such, it lends itself to easy misinterpretation. At its core, it refers to “any type of selective intervention or government policy that attempts to alter the structure of production toward sectors that are expected to offer better prospects for economic growth than would occur in the absence of such intervention” (Pack and Saggi, 2006, p. 268). This might or might not include sectors/technologies where leadership might have geopolitical, security, and military implications. The concept is built on two fundamental principles: (i) production in some sectors is more desirable than in others (Hausmann et al., 2007), and because of this, (ii) governments should make an active effort in nudging the production structure in that direction.
It is important to note that, irrespective of simplistic characterisations (e.g. capitalism vs socialism) or standard economic modelling of markets under perfect conditions, practically all countries engage in various forms of industrial policy, and always have, including the US, UK, France, Singapore, China, Taiwan, and South Korea, just to name a few (Rodrik, 2009; Terzi et al., 2023, 2022). Notoriously, Japan has a long history of using industrial policy to foster rapid industrialisation and growth, at least since the end of WWII (Okazaki, 2017).
Historical cycles in industrial policy
Over the past few decades there has been a general reduction in the use of industrial policy, which moved to the margins of mainstream economics. As this principle got engrained in policymakers’ minds, it was framed under the narrative that governments cannot pick winners in a market economy, and in fact they are at a relatively high risk of being captured by interest groups (Rodrik, 2014). And of course, narratives eventually shape policies (Shiller, 2019).
Industrial policy was also seen as harmful to the pursuit of a more globalised world economy, which to some extent became a leading objective in and of itself (Rodrik, 2011). In the service of a rule-based global trade order, richer nations of the West sided against a preponderant government role in altering production in a certain direction, preferring comparative advantages to manifest themselves freely.
The idea that industrial policy was unhelpful was to some extent codified in the so-called ‘Washington Consensus’, or else the idea that a small government (together with open current and capital accounts) was instrumental in achieving rapid development. As such, the resistance to industrial policy was exported to the Global South, in particular during macroeconomic adjustment programmes (Irwin, 2022). In Japan’s case, it was the Industrial Policy Dialogue with the US in 1983/84, that led to a scaling down of standard industrial policy practices, which were substituted with a more broad-based push for structural reforms (Okazaki, 2017).
To read the full text:
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