How to tell good industrial policy from bad

Gillian Tett in The FT

 
Five years ago Reda Cherif and Fuad Hasanov, two economists at the IMF, wrote a paper with the (slightly) sarcastic title: “The Return of the Policy That Shall Not Be Named: Principles of Industrial Policy”. 

This pointed out that while strategic policy intervention was widely viewed as a key reason for the east Asian economic miracle, it had a “bad reputation among policymakers and academics” — so much so that, from the 1970s onwards, the phrase was rarely mentioned in polite company, or by the IMF. 

No longer. Last month the fund reported that it had observed no less than 2,500 industrial policy actions around the world in the last year alone, of which “more than two-thirds were trade-distorting as they likely discriminated against foreign commercial interests”. 

More striking still, industrial policies used to be far “more prevalent in emerging economies” than developed ones; between 2009 and 2022, there were cumulatively 7,000 subsidies tracked in developing countries, and fewer than 6,000 in developed ones. But last year’s surge was “driven by large economies, with China, the EU and the US accounting for almost half of all new [industrial policy] measures”. 

That shift can be seen not just in data, but rhetoric too. Last month, Mario Draghi, former head of the European Central Bank, lamented that Europe “lack[s] a strategy for how to shield our traditional industries from an unlevel global playing field caused by asymmetries in regulations, subsidies and trade policies”. He called for the EU to fight back with industrial policy. 

In the UK, the opposition Labour party is echoing these themes, calling for a “New Deal” and touting what it calls “securonomics”. In the US, Donald Trump wants huge trade tariffs, while Joe Biden has called for tariffs in sectors such as steel. The president’s Inflation Reduction Act is yet more industrial policy. 

But anyone pondering that striking number in the IMF report should remember a crucial point that ought to be obvious but is often overlooked: “industrial policy” can mean many different things. As Cherif and Hasanov told a seminar at Cambridge’s Bennett Institute this week, there is an important difference between policies that try to create growth by shielding domestic companies from foreign competition and those which help those companies compete more effectively on the world stage.  

The former “import substitution” strategy was pursued by many developing countries in recent years, including India. It is also the variant favoured by Trump and the one being considered by some European politicians, for instance in the case of Chinese solar panels. 

But it is this latter approach that has given industrial policy a bad name. On the basis of copious data, Cherif and Hasanov argue that import substitution models undermine growth in the long term since they create excessively coddled, inefficient industries. 

By contrast, the second variant of industrial policy aims instead to make industries more competitive externally in an export-oriented model, while worrying less about imports. This approach is what drove the east Asian miracle, and is what creates sustained growth, the data suggests. 

The difference in approach is embodied by the contrasting fortunes of Malaysian automaker Proton car and South Korea’s Hyundai. The former was developed amid import substitution policies, and never soared; the latter flourished on the back of an export-oriented strategy.  

A cynic might retort that policy is rarely so clear cut as these contrasting car tales might suggest. It is hard for any company to fly on the world stage if its key competitors are excessively subsidised in closed markets — as evidenced by the woes of EU solar-panel makers trying to compete with their Chinese rivals. It is also tough to tell countries to aim for export-driven growth in a world where trade is fragmenting and protectionism rising. 

In any case, while export-oriented strategies work for small or medium-sized countries such as South Korea, they may seem less relevant for a giant such as America. 

Then there is a more fundamental question around economic change. As a thoughtful paper published last year by the economists Réka Juhász, Nathan Lane and Dani Rodrik notes, while “industrial policy has traditionally focused on manufacturing”, it is the service sector that now dominates. Thus “governments are likely to look beyond manufacturing as they consider productivity-enhancing ‘industrial’ policies in the future”. 

Cherif and Hasanov think institutions such as America’s Darpa give one clue to innovation-boosting measures in this space; Juhász, Lane and Rodrik cite worker training and export credit. But this needs holistic policy, which America, say, lacks. 

Either way, the key point is that insofar as western politicians are now increasingly happy to utter the once forbidden words “industrial policy”, they need to define what they mean. Is the goal to exclude competitors from the domestic stage, via tariffs? Or to make domestic producers more competitive and innovative in a global sense and better able to compete? Or is it something else? Investors and markets need clear answers. So, more importantly, do voters.

A Level Economics Essay 10: Development Policies

Consider how effective the interventionist policies of import substitution and export-led industrialisation are likely to be in raising the levels of economic growth and development in LEDCs. 

Import substitution and export-led industrialization are two interventionist policies that countries can adopt to promote economic growth and development. Let's consider how effective these policies are likely to be in raising the levels of economic growth and development in LEDCs (Less Economically Developed Countries).

1. Import Substitution: Import substitution is a policy strategy where a country aims to reduce its dependence on imported goods by promoting domestic production of those goods. The idea is to protect domestic industries from foreign competition and foster self-sufficiency. LEDCs adopting import substitution policies typically impose high tariffs and trade barriers on imported goods, making them more expensive and less competitive compared to domestically produced goods.

The infant industry argument comes into play in import substitution policies. According to this argument, emerging industries in LEDCs may initially face disadvantages compared to established industries in developed countries. They may lack economies of scale, experience higher production costs, and face technological and managerial challenges. To overcome these obstacles and enable the growth of these industries, protectionist measures are implemented.

However, import substitution policies have shown mixed results in raising economic growth and development. While they may initially protect domestic industries and promote industrialization, there are several drawbacks:

a) Lack of competitiveness: Import substitution policies often lead to the development of industries that are not internationally competitive. Due to limited exposure to global competition, these industries may struggle to innovate, achieve economies of scale, and produce high-quality goods at competitive prices.

b) Limited market size: LEDCs generally have smaller domestic markets compared to developed countries. Relying solely on domestic demand can limit the growth potential of industries. Without access to international markets, firms may face challenges in achieving economies of scale and attracting investment.

c) Dependency on inefficient industries: Import substitution policies may lead to the development of industries that are protected from competition but are inefficient and less productive. This can result in a misallocation of resources and hinder overall economic growth.

Example: During the mid-20th century, many LEDCs, including India and some Latin American countries, implemented import substitution policies. While they initially aimed to reduce dependency on imports and develop domestic industries, the results varied. Some industries thrived, but others became inefficient and uncompetitive. Over time, many countries shifted towards more market-oriented policies to promote economic growth.

2. Export-Led Industrialization: Export-led industrialization is a policy approach where a country focuses on developing industries that can compete in international markets and promotes exports as a driver of economic growth. This strategy involves implementing policies such as export incentives, infrastructure development, investment in human capital, and market-oriented reforms to attract foreign investment and boost exports.

Export-led industrialization has been relatively more successful in promoting economic growth and development compared to import substitution policies. Some reasons include:

a) Access to larger markets: By focusing on exports, LEDCs can tap into larger international markets, allowing their industries to achieve economies of scale and expand production. Export-oriented industries are driven by international demand, which can provide sustained growth opportunities.

b) Technological spillovers: Engaging in global trade can expose LEDCs to advanced technologies and knowledge from developed countries. This transfer of technology can contribute to productivity improvements and innovation, benefiting the overall economy.

c) Foreign direct investment (FDI): Export-led industrialization policies often attract foreign investment, which brings in capital, technology, and managerial expertise. FDI can help boost industrialization, create employment opportunities, and enhance productivity in LEDCs.

Example: China and Japan are notable examples of countries that successfully implemented export-led industrialization policies. China, through its policy reforms and export-oriented approach, has become a global manufacturing powerhouse, exporting a wide range of goods to countries around the world. Japan also pursued export-led industrialization after World War II and transformed into a major exporter of automobiles, electronics, and machinery.

In conclusion, while both import substitution and export-led industrialization have been employed by LEDCs, export-led industrialization has generally proven more effective in raising economic growth and development. By focusing on exports, LEDCs can access larger markets, benefit from technological spillovers, and attract foreign investment. However, each country's specific circumstances and policy implementation play a crucial role in determining the success of these strategies. The infant industry argument provides a theoretical justification for protectionist measures under import substitution policies, acknowledging the initial disadvantages faced by emerging industries. However, striking a balance between protection and competitiveness is essential to avoid long-term inefficiencies and promote sustainable development.

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What if Britain left the EU?

Eurosceptics want a vote on the ultimate question – and the PM does not seem entirely opposed. Ben Chu in The Independent examines the consequences of saying bye bye to Brussels

Exports

The European Union is easily Britain's biggest single export market, with 53 per cent of our goods purchased by our fellow European nations in 2011. This sector of our economy, directly and indirectly, supports three million jobs, according to Sir Iain Begg, a professorial research fellow at the European Institute of the London School of Economics. Without export growth last year, we would have fallen back into recession much earlier. If we were to leave the EU, we would almost certainly still be allowed to sell goods into the single market. Norway, Iceland and Switzerland already do so through a free-trade agreement. The difference would be that the UK would not be able to set the rules that govern the European single market. It would, of course, have to implement those rules to keep selling into those markets though. The argument sometimes deployed by those who want out of the EU is that leaving would, somehow, encourage British manufacturers to concentrate on exporting to the likes of China, Brazil and India.

Imports

Britain also imports a great deal from other nations in the EU – more than it exports, in fact. In 2011, we exported £159bn of goods to the EU and imported goods worth £202bn – an annual trade deficit of £42bn. Some argue that this deficit gives us leverage to demand more opt-outs and budget rebates from our European partners. The argument is: "They need us more than we need them." The problem is that we import a lot of European goods, not because we are doing the Europeans a favour, but because our people want to buy things that cannot be produced at home – think of all those German cars and French luxury goods. If Britain were to leave the EU, the Government might decide to impose large tariffs on European imports, but this probably wouldn't prove very popular. The likelihood is we would still run a trade deficit with the EU, but, as with imports, we would have no say over the rules governing the single market.

Growth

Would foreign capital still want to invest in the UK if it were not part of the EU bloc? Some economists say overseas investors would be put off. The National Institute of Economic and Social Research, for example, estimates that foreign direct investment would fall. And, mainly for this reason, it argues that our GDP would permanently be 2.25 per cent lower if we left the EU. However, Capital Economics argued last month that, because of the eurozone crisis, levels of foreign investment in the UK could actually go up if we left the EU, because we would seem like a safe haven.

Immigration

If Britain left the EU, the Government would not be required to permit the free movement of all citizens of the 27 nations of the union into Britain, nor their right to work here. About EU 165,000 citizens migrated to the UK in the year to September 2011, after 182,000 arrived in the 12 months to September 2010. Proponents of withdrawal argue that stopping such flows would improve quality of life because there would be less strain on public services and infrastructure. Opponents argue that immigrants are an economic benefit for Britain, filling holes in our labour market and boosting overall productivity. But the free movement of people is two-way. An estimated 748,010 Britons live or work in the European Union. Many have holiday homes in France and Spain. If we decided to restrict inflows of EU citizens to Britain, the European Union would be likely to respond in kind.

Budget

The UK makes an annual gross contribution to the EU budget of £15bn and it gets a rebate of €6bn in various subsidies – mainly agricultural. This makes an annual net contribution of €9bn. Ending those payments by leaving the EU would help to reduce the UK deficit, but these are not transformative sums. Our EU contributions are equivalent to 0.6 cent of GDP. We presently have a deficit of 8.3 per cent of GDP. Plus, one has to consider the benefits of those contributions. Structural funds – as payments into the common EU budget are known – are used to develop post-Soviet bloc countries in Europe, building up their infrastructure and making them bigger potential markets for British goods and services.

Business

A study by the British Chambers of Commerce has estimated that the annual cost to the UK of EU regulation is £7.4bn, but costs must be set against benefits. The EU has forced the mobile phone networks to stop ripping of customers when they use their handsets abroad. It has tackled Microsoft and airlines about over-charging. Britain outside the EU would have to rely on British competition authorities alone to protect customers from the malfeasance of corporations.

Banking

This is a complex relationship. The UK actually wants to impose higher capital requirements on its domestic banks than the rest of Europe does. Yet Britain is also fighting a Financial Taxation Tax, something that much of the rest of Europe

supports. British bankers, for their part, are generally in favour of staying in the EU. They fear that their access to lucrative European capital markets could be impeded if Britain left the bloc. And both banks and businesses calculate that Britain's EU membership is in their interests because the EU can help to open foreign markets such as China up to them more effectively than the UK acting alone.

Agriculture

The EU's Common Agricultural Policy is almost universally considered a wasteful mechanism that encourages over-production and undermines African farmers. Between 2007 and 2013, the UK will contribute £33.7bn to the Common Agricultural Policy (CAP) and get back £26.6bn, according to the Open Europe think-tank. That works out as a net contribution of £7.1bn. If the UK left the EU, our Government could scrap these subsidies at home and save the money. But it already has discretion at home about what to do with the payments – enabling ministers to channel the money to conservation, rather than production. And, within the EU, it can push for badly-needed reform of the CAP. Outside the EU, it would have no influence.

Politics

Europe is more social democratic than the UK. Even countries with centre-right governments tend to tax more, spend more on welfare and are less laissez-faire when it comes to markets. Those on the left in Britain tend to be in favour of the UK's continued membership because they feel it will help to move the country in this direction. Those on the right tend to be opposed for similar reasons; they feel Europe is helping to undermine Britain's social and economic freedoms. Yet there are global politics to consider, too. The right wants to rely on Britain's "special relationship" with the US, but Washington prefers Britain to work in closer partnership with the EU. Rising Asian giants such as India and China also seem to regard Britain's membership of the EU as a good reason to build economic and diplomatic ties with us.