The Case for Industrial Policy

1. The Case for Industrial Policy Amber Huber

2. 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 KamilSaggi (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.

3. 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.

4. 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).

5. Externalities, the Role of Exports, and FDI • 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

6. 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)

7. South Korea Exports 1966-1990

8. Issues with South Korean Industrial Policy • 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.

9. Do Industrial Policies Work? • 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.

10. Conclusion • 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.