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.

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A level Economics: Can India Inc extricate itself from China?

The Economist

China and India are not on the friendliest of terms. In 2020 their soldiers clashed along their disputed border in the deadliest confrontation between the two since 1967—then clashed again in 2021 and 2022. That has made trade between the Asian giants a tense affair. Tense but, especially for India, still indispensable. Indian consumers rely on cheap Chinese goods, and Indian companies rely on cheap Chinese inputs, particularly in industries of the future. Whereas India sells China the products of the old economy—crustaceans, cotton, granite, diamonds, petrol—China sends India memory chips, integrated circuits and pharmaceutical ingredients. As a result, trade is becoming ever more lopsided. Of the $117bn in goods that flowed between the two countries in 2022, 87% came from China (see chart).

India’s prime minister, Narendra Modi, wants to reduce this Sino-dependence. One reason is strategic—relying on a mercurial adversary for critical imports carries risks. Another is commercial—Mr Modi is trying to replicate China’s nationalistic, export-oriented growth model, which means seizing some business from China. In recent months his government’s efforts to decouple parts of the Indian economy from its larger neighbour’s have intensified. On August 3rd India announced new licensing restrictions for imported laptops and personal computers—devices that come primarily from China. A week later it was reported that similar measures were being considered for cameras and printers.

Officially, India is open to Chinese business, as long as this conforms with Indian laws. In practice, India’s government uses a number of tools to make Chinese firms’ life in India difficult or impossible. The bluntest of these is outright prohibitions on Chinese products, often on grounds related to national security. In the aftermath of the border hostilities in 2020, for example, the government banned 118 Chinese apps, including TikTok (a short-video sensation), WeChat (a super-app), Shein (a fast-fashion retailer) and just about any other service that captured data about Indian users. Hundreds more apps were banned for similar reasons throughout 2022 and this year. Makers of telecoms gear, such as Huawei and zte, have received the same treatment, out of fear that their hardware could let Chinese spooks eavesdrop on Indian citizens.

Tariffs are another popular tactic. In 2018, in an effort to reverse the demise of Indian mobile-phone assembly at the hands of Chinese rivals, the government imposed a 20% levy on imported devices. In 2020 it tripled tariffs on toy imports, most of which come from China, to 60% then, at the start of this year, raised them to 70%. India’s toy imports have since declined by three-quarters.

Sometimes the Indian government eschews official actions such as bans and tariffs in favour of more subtle ones. A common tactic is to introduce bureaucratic friction. India’s red tape makes it easy for officials to find fault with disfavoured businesses. Non-compliance with tax rules, so impenetrable that it is almost impossible to abide by them all, are a favourite accusation. Two smartphone makers, Xiaomi and bbk Electronics (which owns three popular brands, Oppo/OnePlus, Realme and Vivo), are under investigation for allegedly shortchanging the Indian taxman a combined $1.1bn. On August 2nd news outlets cited anonymous government officials saying that the Indian arm of byd, a Chinese carmaker, was under investigation over allegations that it paid $9m less than it owed in tariffs for parts imported from abroad. mg Motor, a subsidiary of saic, another Chinese car firm, faces investment restrictions and a tax probe.

A convoluted licensing regime gives Indian authorities more ways to stymie Chinese business. In April 2020 India declared that investments from countries sharing a border with it must receive special approvals. No specific neighbour was named but the target was clearly China. Since then India has approved less than a quarter of the 435 applications for foreign direct investment from the country. According to Business Today, a local outlet, only three received the thumbs-up in India’s last fiscal year, which ended in March. Last month reports surfaced that a proposed joint venture between byd and Megha Engineering, an Indian industrial firm, to build electric vehicles and batteries failed to win approval over security reasons.

Luxshare, a big Chinese manufacturer of devices for, among others, Apple, has yet to open a factory in Tamil Nadu, despite signing an agreement with the state in 2021. The reason for the delay is believed to be an unspoken blanket ban from the central government in Delhi on new facilities owned by Chinese companies. In early August the often slow-moving Indian parliament whisked through a new law easing the approval process for new lithium mines after a potentially large deposit of the metal, used in batteries, was unearthed earlier this year. Miners are welcome to submit applications, but Chinese bidders are expected to be viewed unfavourably.

In parallel to its blocking efforts, India is using policy to dislodge China as a leader in various markets. India’s $33bn programme of “production-linked incentives” (cash payments tied to sales, investment and output) has identified 14 areas of interest, many of which are currently dominated by Chinese companies.

One example is pharmaceutical ingredients, which Indian drugmakers have for years mostly procured from China. In February the Indian government started doling out handouts worth $2bn over six years to companies that agree to manufacture 41 of these substances domestically. Big pharmaceutical firms such as Aurobindo, Biocon, Dr Reddy’s and Strides are participating. Another is electronics. Contract manufacturers of Apple’s iPhones, such as Foxconn and Pegatron of Taiwan and Tata, an Indian conglomerate, are allowed to purchase Chinese-made components for assembly in India provided they make efforts to nurture local suppliers, too. A similar arrangement has apparently been offered to Tesla, which is looking for new locations to make its electric cars.

Some Chinese firms, tired of jumping through all these hoops, are calling it quits. In July 2022, after two years of efforts that included a promise to invest $1bn in India, Great Wall Motors closed its Indian carmaking operation, unable to secure local approvals. Others are trying to adapt. Xiaomi has said it will localise all its production and expand exports from India which, so far, go only to neighbouring countries, to Western markets. Shein will re-enter the Indian market through a joint venture with Reliance, India’s most valuable listed company, renowned for its ability to navigate Indian bureaucracy and politics. zte is reportedly attempting to arrange a licensing deal with a domestic manufacturer to make its networking equipment. So far it has found no takers. Given India’s growing suspicions of China, it may be a while before it does.

A Level Economics 89: Fiscal Policy

 1. The Fiscal Policy Framework (UK):

In the United Kingdom, the fiscal policy framework is designed to manage public finances and achieve macroeconomic stability. The key components of the UK's fiscal policy framework include:

• Government Spending: The UK government allocates significant funds to various sectors, such as education, healthcare, defense, and social welfare. For example, in recent years, the government has allocated substantial resources to the National Health Service (NHS) to improve healthcare services and address public health challenges.

• Taxation: The UK's tax system includes income tax, national insurance contributions, value-added tax (VAT), and corporate tax, among others. The government relies on these tax revenues to finance its expenditures and invest in public services. For instance, the government may increase income tax rates for higher-income individuals to enhance revenue collection.

• Budget Balance: The UK aims to achieve a balanced budget over the economic cycle. However, due to economic fluctuations and unforeseen circumstances, deficits or surpluses may occur. For example, during periods of economic downturns, the government may run budget deficits to provide fiscal stimulus to the economy.

• Fiscal Policy Stance: The UK government can adopt an expansionary fiscal policy during economic downturns to boost demand and stimulate growth. For instance, in response to the COVID-19 pandemic, the government implemented various fiscal measures, such as furlough schemes and business support grants, to provide economic relief.

• Debt Management: The UK's public debt is managed to ensure its sustainability. The Debt Management Office (DMO) is responsible for issuing government bonds and managing the debt portfolio. The government aims to keep debt at manageable levels relative to GDP.

2. The Overall Purpose and Structure of the UK Budget:

The UK budget is an annual financial plan that outlines the government's projected revenues and expenditures for the fiscal year, typically from April to March. The main purposes of the UK budget include:

• Resource Allocation: The budget allocates resources to various departments and sectors based on the government's policy priorities. For example, it may allocate additional funds to education to improve schools and enhance educational outcomes.

• Income Redistribution: The budget aims to address income inequality through targeted social welfare programs, tax credits, and benefits. For instance, the government may provide welfare support to low-income families to reduce poverty.

• Economic Stabilization: The UK budget can be used to implement counter-cyclical measures during economic downturns. It may include fiscal stimulus packages to support economic recovery.

• Public Goods and Services: The budget finances the provision of essential public services, including education, healthcare, transportation, and public safety. For instance, investment in transportation infrastructure can enhance economic productivity and connectivity.

3. Major Areas of Government Expenditure and Sources of Revenue (UK):

Government Expenditure:

• Healthcare: Significant funds are allocated to the NHS to provide healthcare services to UK residents.
• Education: Expenditure on primary, secondary, and higher education to support learning and skill development.
• Social Welfare: Expenditure on social security programs, pensions, and housing benefits to support vulnerable groups.
• Infrastructure: Investment in transport, energy, and digital infrastructure for economic development.
• Defense: Expenditure on national security and military capabilities.

Sources of Revenue:

• Income Tax: Progressive income tax rates based on individual earnings.
• National Insurance Contributions: Payments made by employees and employers to fund social security programs.
• Value-Added Tax (VAT): A consumption tax levied on goods and services.
• Corporation Tax: Tax on profits earned by businesses operating in the UK.
• Borrowing: The UK government raises funds through issuing government bonds and gilts.

Overall, the UK's fiscal policy framework, budget structure, and resource allocation reflect the government's commitment to economic stability, social welfare, and sustainable public finances. Decisions on government spending and taxation are based on a combination of economic conditions, societal needs, and policy objectives.

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Impact of Changes in Tax and Spending on the Economy using AD and AS:

Changes in tax and government spending can significantly impact the economy, as they directly influence aggregate demand (AD) and aggregate supply (AS).

1. Impact on Aggregate Demand (AD):

• Tax Changes: Reduction in taxes, especially income taxes or corporate taxes, can lead to an increase in disposable income for households and higher profits for businesses. This, in turn, boosts consumer spending and business investment, increasing AD.
• Spending Changes: Government spending on public projects, infrastructure, and social programs directly adds to AD. Increased government spending can lead to a multiplier effect, where additional income generated from spending further stimulates economic activity.

2. Impact on Aggregate Supply (AS):

• Tax Changes: Lowering certain taxes, such as taxes on production inputs, can reduce the cost of production for businesses, leading to increased AS. Lower corporate taxes can incentivize investments in technology and innovation, enhancing productivity and potential AS.
• Spending Changes: Government spending on infrastructure projects and education can improve the efficiency and productivity of the economy, positively affecting AS.

3. Impact on Price Level and Inflation:

• Expansionary fiscal policy (tax cuts and increased government spending) can lead to higher demand, potentially causing inflationary pressures if it exceeds the economy's capacity to produce.
• Contractionary fiscal policy (tax hikes and reduced government spending) can slow down demand, potentially leading to lower inflation or deflation if it reduces consumer spending and business investment.

Differences between Current Expenditure and Capital Expenditure:

• Current Expenditure: This refers to government spending on day-to-day operational expenses, such as salaries, pensions, social welfare benefits, and routine maintenance. Current expenditure does not result in the creation of new assets or long-term economic benefits.
• Capital Expenditure: Capital expenditure involves government spending on infrastructure projects, research, and other investments that contribute to long-term economic growth and create durable assets, such as roads, bridges, schools, and hospitals.

Differences between Direct and Indirect Taxes and Their Relative Desirability:

• Direct Taxes: These are taxes directly levied on individuals' income or wealth, such as income tax and property tax. Direct taxes have a clear and visible impact on the taxpayer, as the individual knows the exact amount they owe to the government.
• Indirect Taxes: Indirect taxes are imposed on goods and services, such as value-added tax (VAT) and sales tax. These taxes are ultimately paid by consumers but collected by businesses on behalf of the government.

Relative Desirability:

• Direct taxes are often considered more progressive because they can be designed to place a higher burden on higher-income individuals. They may also encourage tax compliance, as taxpayers directly see the impact of their tax payments.
• Indirect taxes can be regressive, as they tend to have a proportionately higher impact on lower-income individuals, who spend a larger portion of their income on goods and services. However, indirect taxes can be more efficient to collect and administer, and they may have a lesser impact on work incentives and investment decisions.

In summary, changes in tax and government spending can have significant effects on the economy through their impact on AD and AS. Governments must carefully consider the type and magnitude of fiscal policy measures to achieve their desired economic outcomes. Differentiating between current and capital expenditure, as well as understanding the implications of direct and indirect taxes, allows policymakers to design more effective and balanced fiscal policies.

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Keynesian View on Fiscal Policy:

Keynesian economists believe that fiscal policy can play a crucial role in controlling the level of aggregate demand in the economy, particularly during times of economic downturns or recessions. According to Keynesian theory, in the short run, an economy may suffer from inadequate demand, leading to high unemployment and low economic growth. In such situations, fiscal policy can be used to stimulate aggregate demand and boost economic activity.

Use of Demand-Side Fiscal Policy:

1. Expansionary Fiscal Policy: During economic downturns, Keynesian economists advocate for expansionary fiscal policy, which involves increasing government spending and/or reducing taxes to increase aggregate demand. The goal is to encourage consumer spending, business investment, and overall economic activity.

2. Countercyclical Nature: Fiscal policy can be used as a countercyclical tool, meaning that it moves in the opposite direction to the business cycle. In times of recession or low growth, the government can increase spending and lower taxes to offset the decrease in private sector demand.

3. Public Investment: Keynesians emphasize the importance of public investment in infrastructure, education, and healthcare, which not only boosts aggregate demand in the short term but also enhances long-term economic productivity.

Evaluation of Demand-Side Fiscal Policy:

1. Effectiveness: Demand-side fiscal policy can be effective in stimulating economic growth and reducing unemployment during economic downturns. By increasing government spending and lowering taxes, it injects additional funds into the economy, leading to increased consumption and investment.

2. Public Sector Debt: One potential side effect of demand-side fiscal policy is an increase in the public sector debt. During expansionary fiscal policy, the government may need to borrow to finance its higher spending, leading to higher deficits and debt levels.

3. Crowding-Out Effect: Expansionary fiscal policy can lead to a crowding-out effect, where increased government borrowing may drive up interest rates and reduce private sector investment. This could potentially offset some of the positive effects of the policy.

4. Time Lags: There can be time lags between the implementation of fiscal policy and its impact on the economy. It may take time for government projects to be initiated and for increased spending to filter through the economy.

5. Inflation Risk: If demand-side fiscal policy is used when the economy is already at or near full employment, it can lead to demand-pull inflation as increased demand outpaces the economy's capacity to produce goods and services.

6. Political Constraints: Fiscal policy decisions are often subject to political considerations, and policymakers may face challenges in reaching a consensus on the appropriate level of spending and taxation.

Conclusion:

Keynesian economists believe that demand-side fiscal policy can be a powerful tool to manage aggregate demand and stabilize the economy during economic downturns. However, its effectiveness and appropriateness depend on the economic conditions, the scale of fiscal measures, and the ability to manage the resulting public sector debt. Policymakers must carefully assess the situation and consider the potential side effects before implementing demand-side fiscal policy measures. Additionally, demand-side fiscal policy should be complemented by other policies, such as monetary policy and supply-side reforms, to achieve comprehensive and sustainable economic growth.

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Using Fiscal Policy on the Supply Side:

Fiscal policy can be used not only on the demand side but also on the supply side of the economy to achieve various policy objectives. Supply-side fiscal policy focuses on improving the productive capacity and efficiency of the economy in the longer term. It involves using taxation, government spending, and other fiscal tools to influence incentives for work, investment, and productivity-enhancing measures. Some examples of supply-side fiscal policies include:

1. Lowering Corporate Taxes: Reducing corporate taxes can incentivize businesses to invest more in new technologies, research, and expansion, thus fostering economic growth and job creation.

2. Investment in Infrastructure: Increased government spending on infrastructure projects, such as transportation, communication, and energy, can enhance the economy's productivity and competitiveness.

3. Skills and Education: Investing in education and training programs can improve the skills and productivity of the workforce, leading to a more skilled labor force and higher economic output.

4. R&D Incentives: Providing tax credits or grants for research and development activities encourages innovation, leading to new products and processes that enhance productivity and economic growth.

5. Reducing Regulation: Simplifying and streamlining regulatory processes can reduce compliance costs for businesses and stimulate entrepreneurship and investment.

6. Welfare-to-Work Incentives: Designing welfare programs to provide incentives for work can encourage labor force participation and reduce long-term unemployment.

Evaluation of Supply-Side Fiscal Policy:

1. Effectiveness: Supply-side fiscal policies can lead to positive long-term effects on economic growth, productivity, and efficiency. By improving incentives for work and investment, they can foster sustainable economic development.

2. Time Lag: The impact of supply-side fiscal policies may take longer to materialize compared to demand-side measures. Building infrastructure, improving education, and enhancing skills can require time and ongoing investment before the full benefits are realized.

3. Equity Concerns: Some supply-side fiscal policies, such as tax cuts that primarily benefit high-income individuals or corporations, may raise equity concerns and exacerbate income inequality.

4. Uncertainty: The effectiveness of supply-side policies may be influenced by other factors such as global economic conditions, technological advancements, and changes in consumer behavior, making outcomes uncertain.

5. Fiscal Constraints: Implementing supply-side fiscal policies may require substantial government spending, and their effectiveness may be constrained by fiscal deficits and public debt concerns.

6. Incentive Response: The effectiveness of supply-side policies depends on the degree of response from individuals and businesses to the incentives provided. Factors like the elasticity of investment and labor supply can influence the overall impact.

Conclusion:

Supply-side fiscal policies can be valuable tools to foster long-term economic growth and improve the efficiency of the economy. By creating incentives for work, investment, and innovation, these policies can have positive effects on productivity and output. However, careful consideration is required to ensure equitable outcomes and manage fiscal sustainability. Supply-side fiscal policies should be complemented by appropriate demand-side policies and structural reforms to create a comprehensive and balanced approach to economic management.

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